POST CRISIS:

WHY WE NEED TO REFORM

STATE OWNED ENTERPRISE
IN INDONESIA

Mochammad Hadi Pratomo

National Graduate Institute for Policy Studies
Tokyo
2007

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A. Theoretical Framework

Theories about why reformation of state owned enterprise (SOE) might be beneficial to
an economy are basically laid on public choice assumption that government consists of normal,
imperfect and self-interested individuals. These theories fit with the condition in developing
countries. Empirical studies indicate that state-owned enterprises have been used to finance
politically infeasible projects or provide subsidies to particular elite groups (Kikeri, Nellis, and
Shirley 1992)1.
Less competition, greater political intervention and weaker good corporate governance
are strong theoretical arguments against state ownership and empirical studies showed that
reformation thru privatization of SOE improved performances even in poor regulatory
environments (for example Megginson (2001) and Clarke (2003)).
Generally there are three objectives of privatization 2:
1. Enhancing efficiency of asset use through the creation of private ownership
2. Reducing budgetary burdens
3. Privatization as a socio-political goal (especially in transition economy countries)

B. Overview of Indonesia’s SOE post monetary crisis

State owned enterprises (SOE) historically have long played significance role in
Indonesia's economy, accounts for around 70% of GNP by the early 1980s and partly due to
impact of monetary crisis, is for around 40% in 2001 (World Bank 2001). In general, according
to Law No. 9/1969, there are four main types of SOEs:
(i) perusahaan jawatan (perjan), government departmental agencies established to
fulfill public service obligations (PSO), do not have separate legal existence, their
employees are civil servants3.
(ii) perusahaan umum (perum), were established as separate legal entities under a
special purpose government regulation, their capital is owned by the government
and not divided into shares,
(iii) perusahaan persero (persero) is a limited liability company, and at least 51 percent
of its sharesare owned directly by the government;
(iv) other types of SOEs can be established under special laws; (i.e. Pertamina).

In 1999, total assets of the 113 SOEs 4 (book value) were $39 billion (Rp391 trillion),
equivalent to 42 percent of the total assets of Indonesia’s producing sector and SOEs employed
655,000 persons on a full-time basis. However, including their subsidiaries and the contract and
subcontract workers, the total workforce of SOEs was close to 1.4 million, or 18 percent of the
workforce in large and medium enterprises. The contribution of SOEs to the country's GDP was
estimated at 12 percent, indicating a relatively low efficiency in the use of labor and assets
(ADB 1999). In 2000, total asset of whole SOE’s were $ 86 billion (Rp 861 trillion) but only
generating $ 1.3 billion (Rp 13.34 trillion) as net profit with Return on Asset (ROA) rate 1.55%.
This table below illustrate the range of ROA rate of Indonesia’s SOE during of 1997-2001
which only about 1.55%-3.25%.5

Table 1.SOE performance from profitablity measurement view (millions rupiah)

1
See Table 2 in attachment for detailed empirical studies for relationship between privatization and
performance/efficiencies.
2
Lecture Note No. 8 Dec 7, 2006.
3
This perjan type is no longer existed in Indonesia nowadays.
4
See Table 3 in attachment for Indonesia SOE classifications.
5
See Table 4.1-4. in attachment for detailed financial condition of SOE during 1997-2003

2
 Year Total Asset Net Profit ROA
1997 425,971,407 7,310,092 1.72%
1998 437,756,394 14,226,201 3.25%
1999 607,022,845 14,271,101 2.35%
2000 861,520,494 13,336,582 1.55%
2001 845,186,151 20,186,469 2.39%
Source: SOE Performance Development report – Dirjen Pembinaan BUMN, 2001

Within this context, the implementation of a rigorous system of corporate governance

for SOEs is critical and is viewed to lead the reforms for the overall corporate sector 6.
Successful corporate restructuring, especially debt restructuring of SOEs will provide models to
accelerate related efforts in the private sector. For example, privatizations through stock
exchange listing will promote capital market development. Furthermore, SOE reforms will also
establish the best practices in managing labor redundancies.
Second critical reason why SOE need to be immediately privatized is based on the
budget deficit occurred post monetary crisis. The economic slowdown in country during the first
half of 2001 has imposed severe contraction on the budget. It is critical to deal with the issue of
the massive public debt up to $127 billion. About half of the debt is owed to foreign creditors,
including $20 billion to multilateral institutions, $43 billion to bilateral creditors, and $2.4
billion to foreign banks and bondholders. Interest payments alone currently absorb 31 percent of
budgetary revenues, reducing the availability of resources to address social development
priorities (ADB 2001). To overcome this condition, it is becomes critical that government
should launching an aggressive privatization of SOEs to mobilize the required resources for
debt repayments7. In view of the important role of privatizations for future budgets, the
Government should place a high priority on SOE reform.

C. Problems to be encountered

Though established to serve both economic and social goals, SOEs have been an
inefficient supplier of both public and private services and goods. Inefficiencies arose because
of indiscriminate subsidization and protection of SOEs without due regard for economic
viability and competitiveness. Moreover, SOEs have been exploited for the benefit of
individuals and associated interests, accompanied by growing corruption and collusion or utter
fraud.
SOE performance in Indonesia has been affected by weak corporate governance such as
government interference in daily operations, poor internal controls, loopholes in accounting
practices, and weak auditing standards and practices. Lax supervision and insufficient
accountability have distorted performance incentives for supervisors and staff. Inadequate
enforcement of commercial laws and regulations, market protection, and administered prices
has contributed to ineffective SOE management.
Generally there are five issues of SOEs condition considered to be urgently restored.
There are corporate governance, burden as PSO facilitator, poor financial performance,
excessive labor and endemic corruption8.

1. Corporate Governance

6
Ministry of SOE has been evaluating and mapping condition for SOE privatization. See chart 1. in
attachment for illustration of privatization.
7
See Table 5 in attachment for steps might be occurred during privatization.
8
For comprehensive proposal action, see Table 6. which containing matrix of action.

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Problems
Overall, Indonesia's corporate and commercial system is not working under a strong
system of corporate governance. Existing rules and regulations have not been rigorously
enforced, in private companies or SOEs. External mechanisms and enforcement through banks
and capital markets, which are a feature of corporate discipline in other countries, have not
functioned well. As a result, the following mechanisms common in other countries are either
unavailable or only nominally available:
(i) comprehensive disclosure in corporate reporting, independent directors or
commissioners safeguarding the rights of minority shareholders, and transparency
in financial dealings with related parties;
(ii) sound legal system, with a good record of enforcement by an impartial judiciary 9,
and;
(iii) external discipline exercised by the financial sector 10.

Scenario of improvement
(i) Apart from enforcement of general standards, corporate governance should
establish proper ownership and control structures for SOEs that align risk borne by
owners with management control to improve their financial and operational
performance. For the internal governance to be effective, the Government should
enforce thorough accountability and transparency, and provide autonomy and
adequate incentives to supervisors, managers, and employees to meet business
objectives.
(ii) Contractual arrangements between the shareholder, BOC and BOD, where they
exist, are not uniform or transparent, and do not establish clear accountability.
Consequently, it is difficult to assess the performance of BOCs and BODs. Since
Ministry of Finance (MOF) represents the Government as the sole shareholder in
SOEs, it should have regular and unlimited access to the relevant financial,
operational, and strategic information of SOEs. In particular with the following
provisions on corporate governance:
 appointment of independent commissioners in proportion to the number of
shares held by non-controlling shareholders;
 establishment of an audit committee comprising at least three members, one of
whom is an independent commissioner and the others independent
professionals in accounting and/or finance recruited from outside the company;
and
 appointment of a corporate secretary, who must be a member of the BOD or a
corporate officer specifically appointed to this function.

2. Public Service Obligations (PSO)

Problems
Government has proved in many cases using SOEs to provide public goods and services
to public (transportation services, education and health care services). Currently a large segment
of SOEs are entrusted with PSOs, such as obligations to provide for reforestation services in
Sumatra and Kalimantan, supply vaccines at below cost prices to the public health system,
maintain unprofitable air and shipping services, and operate remote air and sea ports.
Furthermore political interference in set-up pricing of such services has resulted in inefficient
delivery mechanisms for SOEs. This practice diverts SOEs from profitable activities, lowers
overall returns, and weakens the growth potential of SOEs.

Scenario of improvement

9
breaches in corporate governance, even if detected, were not pursued for judicial resolution.
10
i.e. for well-connected individuals and conglomerates, capital was always available before the crisis.

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 PSOs should be contracted out separately and transparently to ensure full cost recovery
by their effort to provide such services. To increase transparency and achieve full management
accountability for commercial success, the Government needs to separate PSOs from
commercial activities in SOEs in preparation for their eventual privatization. Without such
separation, SOEs cannot achieve a return on capital sufficient to attract private investors.

3. Corporate Restructuring

Problems
During the 1990s, SOEs were unable to generate sufficient profit to finance expansion.
Consequently, they ended up borrowing excessively or establishing joint ventures. Many SOEs
became high-cost producers of products and services as they, under political pressure,
participated in nonviable ventures or served the Government's social and employment goals. For
example, many SOEs were forced to take shareholding in toll road projects designed by the
national toll road operator. SOE performance was affected by lack of clarity about objectives,
weak incentive structures, and soft budget constraints that enabled financing of their losses and
capital outlay.

Scenario of improvement

Financial restructuring is needed in SOEs with unsustainably high levels of debt. The
methods of financial restructuring of SOEs can involve:
(i) selling subsidiaries and/or surplus assets,
(ii) equity injection from third parties,
(iii) mergers of SOEs, and
(iv) debt restructuring

Operational restructuring is needed in SOEs which has poor operational performance,

even before the crisis. Operational restructuring can involve changes in
(i) management information systems;
(ii) production and logistics planning;
(iii) distribution network;
(iv) marketing strategy;
(v) workforce number and composition; and
(vi) organizational structure.

Comments
Financial restructuring will take place within a well-defined legal framework, enforced
through newly established institutional arrangements. In cases of liquidated SOEs, commercial
courts, which constitute a part of the general court system, have the mandate of hearing
bankruptcy and also commercial cases relating to arbitration, competition, and security issues
The alternative for financial restructuring is by restructuring viable SOEs with the
objective of eventual privatization involving overseas portfolio and strategic investors.
However, where restructuring involves the injection of fresh capital, it has to be left to future
private owners.

4. Labor Redundancies

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Problems
SOEs have about 10-20 percent of excess labor and the costs for labor redundancies
across SOEs is about 10 percent of their current staff (about $170 million) (ADB 2001).

Scenario of improvement
SOEs need to reduce employment by 10 to 20 percent. Support for SOEs to finance
labor retrenchment and training will improve their prospects for successful restructuring and
privatization. Therefore to minimize threat of dissatisfaction from SOE employees because of
liquidation, privatization, and restructuring of SOEs, government should formulate explicit
labor rationalization policy which covering:
(i) severance payments and gratuity based on length of service;
(ii) early retirement;
(iii) assistance with re-employment, training or retraining of employees and financing of
entrepreneurial initiatives; and
(iv) employee rights in assessing claims against pension funds.

5. Corruption, Collusion, and Nepotism (KKN)

Problems
KKN is attributable to lack of transparency, availability of privileges linked to
connections, and inadequate action against malpractices. KKN in SOEs is mainly concentrated
in procurement.

Scenario of improvement
Government via Ministry of SOE should guarantee that SOEs follow procurement
procedures as prescribed by these public sector regulations. These actions will
(i) require compliance of SOEs with transparent and fair procurement practices with
full accountability;
(ii) commence random audits of procurement in SOEs, publish a summary of findings
to public, and initiate measures to recover losses and prosecute wrongdoer; and
(iii) founded on the results of the random audits, hence improve the detailed
procedures for the procurement by SOEs.

D. Concluding comments

In general by implementing these agenda hopefully SOEs will:

(i) achieved the establishment of sound policy, legal, regulatory, and operational
frameworks for improving corporate governance;
(ii) improved awareness of international norms and practices in corporate and financial
governance;
(iii) promoted transparency and disclosure by stipulating the regular submission of
financial, operational, and procurement audits that include financial outcomes,
board compensation, and compliance with legislation (labor, environmental, and
procurement);

In particular, subsequent tasks still remaining following these scenarios is government

should be focused on initiatives to improve macroeconomic growth environment condition in
commercial sector by addressing key issues relating to competitiveness.

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References

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