Bill Guerin, Jakarta – A new initiative to boost prospects for small and medium enterprises (SMEs) in eastern Indonesia has been launched by the International Finance Corporation (IFC), the World Bank's private sector development arm.

Although aimed at poorer provinces far removed from Jakarta, the news will be encouraging for a vital sector that has fought against bureaucratic red tape, conflicts over funds by different ministries in their local areas, and downright fraud.

Eastern Indonesia sweeps all the way from Bali in the west, up north to Kalimantan and Sulawesi, and through to the eastern-most provinces of Maluku and Irian Jaya. With a total population of over 40 million people, the region is richly endowed with resources such as oil, gas, minerals, agricultural land, forests and fish. The downside is that not only is it one of the lowest income regions of the country, it is also affected by the same fundamental problems of security, environmental degradation, and inadequate laws as the rest of the country.

The region was left far behind during most of the New Order rule of Suharto, but he finally focused on the area in his 1990 budget speech and from then till the regional financial crisis in 1997, increased central government transfers and capital spending went east.

The new Indonesia Enterprise Development Facility will use Dutch and other donor nations' money to improve access to capital for the eastern region's small businesses, help them improve their business performance, and improve the business environment.

IFC will provide US$5 million over the next five years, with the remainder coming from the Netherlands and other donors, but the facility will be commercially oriented, seeking to recover up to 30 percent of its operating costs from fees charged for its services.

Enterprises that fall into the SME category are defined by Bank Indonesia as those with a maximum income of Rp 50 million a year, maximum assets of Rp 200 million excluding land and property, and debts amounting to less than Rp 10 billion. Though each has 100 employees or less, they make up an enormous 99.9 percent of all registered companies and employ more than 80 percent of the workforce. Sixty percent of all SMEs operate in the agricultural sector, and 23 percent in retailing, restaurant and hotel businesses.

Not only do the estimated 37 million SMEs collectively absorb a huge part of the work force, last year they contributed 54.59 percent of the country's GDP. The actual and potential contributions the companies make to the overall economy account for the unabated interest of politicians, post 1997, in what was a brand new and fertile arena for corrupt practices.

During President B J Habibie's watch, the highly popular Adi Sasono, when he was Minister for Cooperatives and Small Businesses, was able to launch no less than 17 separate credit schemes for the benefit of cooperatives, small businesses and farmers, funded largely by central bank credits. The initiative, however, was stalled by imprecise targeting and lack of publicity, as well as downright chicanery. Many businesses happily borrowed the money and deposited it in the bank.

Many SMEs now owe a lot of money. A grand total of 414,700 SMEs owes some Rp 39 trillion (US$3.75 billion) in bad debts to the banking sector and to the Indonesian Bank Restructuring Agency, though this is small by comparison with the US$10.5 billion owed by the "Top 21" largest debtors alone.

Earlier this year, SMEs were thought to be in line for a massive trim of more than 50 percent on their debts – championed by no less a figure than Vice President Hamzah Haz. Haz had been instrumental in pushing for the relief, amid charges of political patronage and a hidden agenda aimed at improving the image of his United Development Party (PPP) among the SMEs. Discussions about ways to support SME development were sidelined by the furor over Haz's proposed economic revival program, with both the International Monetary Fund (IMF) and the World Bank expressing strong reservations about its implications for the state budget.

Quite simply, the controversial Haz had wanted the government's sacred and vital asset sales and privatization program to be bled dry by using hard-earned receipts from the program to raise capital for what he dubbed "value creation". The sudden initiative followed an equally sudden move by President Megawati Sukarnoputri to insist that her vice president control the direction of the country's economic planning, much to the chagrin of the economic team of ministers, the IMF and the World Bank.

The banking industry, still struggling to survive the 1997 banking crisis, was also against such generosity and fought back doggedly. Bankers were concerned that over-lenient debt-restructuring terms to SMEs would threaten the liquidity of the many weak banks and also be seen as unfair to those SMEs that had been conscientious in repaying their debts.

The World Bank criticized Haz's proposal as misplaced, saying it was wrong to focus on providing relief to the 2 percent of SMEs with non-performing loans, while ignoring the 98 percent that have survived and even thrived through the crisis. Such a policy would have a negative impact on future bank lending to all SMEs, the bank said.

State Minister of Cooperatives and Small and Medium Enterprises H Alimarwan Hanan, from Hamzah Haz's PPP party, slammed the IMF for opposing the debt reduction scheme. "Outsiders need not intervene into our domestic affairs because the [SME restructuring] does not cause others to bear burdens," he told journalists in March.

In any event, Minister of Finance Budiono and Minister of State Enterprises Laksamana Sukardi won the day. SMEs with bad debts now enjoy a 25 percent debt reduction if they make a one-time cash settlement.

Local economists had earlier warned that the SME restructuring scheme might be used by politicians to gain popularity ahead of the 2004 general election. This was all taking place at a time when the government was acutely aware of the urgent need to set aside 40 percent of budget expenditure to service a whopping US$129.7 billion in sovereign debt.

Constraints or barriers to successful investment in the East and every other region have increased as local governments scramble for more political power and control over the country's natural resources, since regional autonomy was implemented last year and the country's 180-plus districts need to survive on their own revenues.

These constraints hit local investors just as much as foreign investors, and SMEs in the Eastern regions were thwarted and spooked for the some of the same reasons as mega-sized enterprises, such as Kalta Prima Coal, Freeport McMoRan and BP.

The Wahid administration had allocated funds to empower SMEs and programs dedicated to SMEs were distributed among several government bodies, namely the newly established Ministry of SMEs and Cooperatives, the Ministry of Trade and Industry, the Ministry of Agriculture and Laksamana Sukardi's State Owned Enterprises Ministry.

The idea was that these bodies would give cross-subsides to SMEs, but implementation across the regions varied from poor to none at all and businesses slammed them as being little more than a formality, with the funds allocated for the programs being fought over by the ministries concerned.

In July this year, after a year of political wrangling, Megawati finally gave the green light for the restructuring of SME debts when she signed off Presidential Decree No 56/2002.

This restructuring will be a vital element of any plan to get the banks to woo SMEs seeking working capital to expand their businesses. There are indications that domestic banks may once again be turning their attention to SMEs. Central bank figures were released recently showing a 10.9 growth in bank lending to the sector in the first five months of this year against the same period last year, which saw only a 3.3 percent hike.

The banks handed over Rp 11.4 trillion, or 35 percent of their total amount of lending commitment, to SMEs from January to May this year.

"SME friendly" programs such as these should spur the small companies to greater heights and enable them to absorb more and more of the country's vast numbers of unemployed. After all, while the larger industries collapsed in the midst of turmoil in the banking sector and massive currency falls, the SMEs carried on, seemingly able to adjust well to the rapidly deteriorating business climate of the time. One great advantage has been their low level of dependency on imported materials.

One proposal said to be being mooted in the corridors of power is a new draft banking bill, which would make it mandatory for commercial banks to allocate 40 percent – twice as much as currently – of their total loan portfolio to SMEs. That's one extreme. At the opposite end of the spectrum is the crying need for SMEs to have access to capital for growth and expansion.

The problem for the targeted SMEs in the Eastern regions is even more acute, located as they are in rural areas where incomes and access to business services lag way behind other wealthier regions. Access to any information at all is difficult, and the owners are unlikely to have had any business education or training and they generally have poor management skills.

The new program should impact positively on the willingness of banks to lend to these SMEs and, in the words of the IFC, is designed to create a healthy and fair business environment, to build local capacity for SME development, to promote market-based business development services, and to develop the capacity of banks to lend to SMEs.

The needs of SMEs across the nation, however, are the same as those who will benefit from the IFC initiative. Banks must be given more incentives to invest in SMEs and SMEs in turn need the long promised empowerment and training in the ways to qualify for commercial bank credits.

Insufficient capital, low collateral and thus limited access to bank loans, means they cannot expand and increase their efficiency or the quality of their products.

An earlier Asia Foundation survey found that only 17 percent of SMEs had ever received a bank loan in Indonesia, mainly because they had very little, if any, information about credit programs or they were unable to qualify for a loan with banks that typically ask for collateral of up to 90 percent of the value of the loan.

A new government initiative now would square with the recent drive by the country to woo locals into investing in their country on the assumption that they have a better tolerance for the recent security fears than the ever-elusive foreign investor.