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Indonesian Banks Woo Remote Islanders with Floating ATMs

A farmer harvests nutmeg on the remote Indonesian island of Ambon in the Spice Islands, where financial services are in demand.

Photographer: Cedric Arnold/Bloomberg Markets

Viewed with 347 years of hindsight, it was possibly history’s most one-sided trade. In 1667, when spices were worth more than gold, England and Holland agreed to divvy up two islands over which both claimed sovereignty.

The Dutch took Run, a remote outpost of Indonesia’s Spice Islands, where the aroma of nutmeg, cloves and cinnamon scents the breeze. The English got what would become Manhattan.

Today, while New York reigns as the world’s financial capital, Run doesn’t have a single bank branch, Bloomberg Markets magazine will report in its June issue.

“Even just an ATM would be nice,” Burhan, 42, a batik-shirted local schoolteacher, nutmeg farmer and guesthouse owner, says as he sits on his porch overlooking the volcano-studded Banda Sea, 2,500 kilometers (1,550 miles) and two time zones east of Jakarta.

Burhan, who like many Indonesians goes by only one name, may not have long to wait. The country’s biggest banks, already among the most profitable on the planet, according to data compiled by Bloomberg, are emerging from their big-city strongholds to compete for customers in the farthest flung of the 17,500 islands that make up the world’s fourth-most-populous nation. Some even plan to use boats that double as floating ATMs.

The banks’ challenge: to maintain an average 24.3 percent return on equity that already dwarfs that of other banks in the world’s 20 biggest economies -- including the 9.4 percent delivered by U.S. lenders.

Economic Surge

As Indonesians prepare to go to the polls on July 9 to elect the country’s first new president in 10 years, investors are betting that, whatever the outcome, millions of newly prosperous Indonesians will continue to embrace financial services as enthusiastically as they have democracy -- from big cities such as Jakarta and Surabaya to isolated communities such as Run.

Enriched by a 13-year consumption- and resource-driven economic surge, Indonesians have accumulated assets faster than the residents of any other major Asia-Pacific country, according to Credit Suisse Group AG, which reported in October that average wealth per adult had jumped almost fivefold to $11,839 since 2000.

By 2020, the number of middle-class and affluent Indonesians may almost double to 141 million from 74 million in 2012, Boston Consulting Group says. By 2030, Indonesia, currently the world’s 17th-largest economy, with a gross domestic product of $878 billion, will have overtaken Germany and the U.K. to rank seventh, McKinsey & Co. predicted in a 2012 report.

Swank Jakarta

Already, parts of Indonesia’s capital resemble upmarket British or German neighborhoods. Pacific Place, a swank Jakarta development, features condominium and office towers built around a luxury shopping complex. At the McLaren dealership in the mall, salesmen say they’ve sold 19 of the $750,000 British sports cars since November 2012.

Across the road, at the Jakarta Stock Exchange, a resurgent equity market, together with an upswing in local bond and currency trading, testifies to renewed confidence in Indonesia’s economic credentials.

As of May 20, the Jakarta Composite Index had far outperformed this year’s 3.3 percent rise in the MSCI Emerging Markets Index to leap 21.4 percent in dollar terms, making it the world’s sixth-best performer out of 93 indexes tracked by Bloomberg.

Skittish Investors

Resource-rich Indonesia is the world’s biggest exporter of power-station coal, nickel, tin and palm oil and home to the world’s biggest gold mine and recoverable copper reserve. As such, it hasn’t been immune to tumbling commodities prices and a slowdown in its biggest export market, China.

In 2013, Indonesia’s economic growth declined to 5.8 percent from 6.3 percent in 2012. Last year, a slowing economy, a rising current-account deficit and capital flight from developing nations by skittish foreign investors wiped 20 percent from the capitalization of the Jakarta Stock Exchange and 21 percent from the value of the rupiah. A 13.3 percent decline in local-currency bonds was the steepest among emerging markets.

That’s now changed. Beginning in May 2013, Agus Martowardojo, Indonesia’s newly appointed central bank governor, reacted swiftly to foreign capital flight by raising interest rates five times to 7.5 percent. As a result, the rupiah surged six percent this year as of May 20 -- the biggest rise among 11 Asian currencies; and bonds jumped 6.9 percent.

‘Best-Run Economy’

The tactic also brought annualized inflation down to 7.25 percent in April from 8.22 percent in January and helped cut the current-account deficit to $4.1 billion in the first quarter of 2014 from $8.5 billion in the third quarter of 2013, according to Bloomberg.

“Compared to Brazil and Russia, Indonesia is the best-run large commodity economy,” says Ruchir Sharma, who oversees $25 billion, including shares in Indonesian companies, as New York–based head of emerging markets at Morgan Stanley Investment Management.

The question for investors now is how well the next government will run the economy. In October, President Susilo Bambang Yudhoyono must step down after completing his second and final five-year term. The favorite to replace Yudhoyono, 64, in July’s election is Jakarta Governor Joko Widodo, who turns 52 on June 21.

Decade in Power

Widodo is the candidate of a four-party coalition led by the Indonesian Democratic Party of Struggle, or PDI-P, which was the most successful party in parliamentary elections on April 9, winning 18.95 percent of the vote. He will be opposed by ex-general Prabowo Subianto, 62, a former son-in-law of the dictator Suharto, whose Gerindra Party received 11.81 percent in the parliamentary poll.

This week, Widodo chose as his running mate politician and businessman Jusuf Kalla, 72, who served as vice president during Yudhoyono’s first term in office between 2004 and 2009. Prabowo’s vice presidential pick is Hatta Rajasa, 60, who resigned last week as coordinating minister for the economy.

In a survey conducted by pollster Indikator Politik Indonesia between April 22 and 26, the Widodo-Kalla pairing was favored by 44 percent of voters and the Prabowo-Rajasa ticket by 29 percent. However, Prabowo’s position was strengthened this week when he received the backing of the second biggest party, Golkar, which received 14.75 of the parliamentary vote.

Investment Grade

During Yudhoyono’s decade in power, annual growth has averaged 6 percent, stocks have increased by more than 450 percent -- four times the return of the MSCI Emerging Markets Index -- and Moody’s Investors Service and Fitch Ratings upgraded Indonesia’s debt five and four levels, respectively, to investment grade.

However, Yudhoyono has struggled to deliver on early pledges to clean up corruption and end costly fuel subsidies that account for a tenth of government expenditures.

He’s also fallen short on promises to build power stations and unclog congested roads, ports and railways. During the past two years, Yudhoyono presided over a resurgence of nationalist sentiment against foreign investors -- culminating in a law that since January bans the export of unprocessed minerals in order to encourage the construction of smelters and refineries at home.

Traffic Jams

Widodo’s record, as governor of Jakarta since October 2012, contrasts with Yudhoyono’s. A former businessman who ran a small furniture-manufacturing company before going into politics, Widodo has made progress toward easing the capital’s chronic traffic jams by breaking ground on a long-overdue mass-transit rail system.

He also introduced a free health plan for 3 million eligible citizens and announced plans to boost Jakarta’s budget by bringing tax collection online to tackle widespread evasion.

Widodo’s performance as governor is a good sign, says Alan Richardson, a Hong Kong–based fund manager who helps oversee $122 billion, including Indonesian shares, at Samsung Asset Management Ltd. He says a Widodo victory would encourage foreign investment, currency stability, declining bond yields and growth.

“I am bullish on Indonesia as long as he is elected president,” Richardson says.

Floating Branches

Whoever wins, Indonesians’ need for financial services will probably grow unabated. Only 50 million of the country’s 250 million inhabitants have bank accounts, says Budi Gunadi Sadikin, chief executive officer of PT Bank Mandiri, the country’s largest lender by assets.

“The penetration is very, very low,” he says.

Sadikin says he’s so determined to tap that new market that he’s opening 300 branches every year. Mandiri’s major rival, PT Bank Rakyat Indonesia, the country’s most profitable bank, has plans to open 570 branches focusing on microfinance loans to entrepreneurs and small businesses, according to President Director Sofyan Basir.

In the vast Indonesian archipelago, taking banking to the people means taking banks to the water. Rakyat is acquiring four customized boats with ATM machines to act as floating branches.

Rakyat and Mandiri also send cash via public water transport, watched over by armed guards. To service customers in Run, Rakyat has to send money from Ambon City -- the provincial capital of Maluku, as the Spice Islands are now known -- to a bank branch on the island of Banda Neira. That’s an eight-hour trip by rusty ferry.

Treacherous Reefs

From Banda Neira, it takes another two hours to reach the 2,000 inhabitants of Run by traveling in a smaller boat through treacherous currents and reefs.

The banks’ already high returns are possible because they’re charging borrowers as much as 13 percent interest while paying depositors 7 percent or less for the funds -- giving the four biggest banks an average net interest margin of 7.1 percent, according to Bloomberg.

By expanding into riskier microlending, Mandiri and Rakyat are able to charge even higher interest rates of 25 to 30 percent a year, according to Boston Consulting.

“For the next three to five years, the profitability numbers of Indonesian banks will continue to look very good compared with their global peers,” Morgan Stanley’s Sharma says.

Bosowa Corp.

Other investors clearly agree. Rakyat shares jumped 46 percent this year as of May 20. During the same period, Mandiri’s stock rose 29 percent, and the 80-member Jakarta Finance Index was up 22 percent.

Not only banks are exploiting the explosion of growth outside of Indonesia’s most populous island, Java, where Jakarta is located. Billionaire Aksa Mahmud, 68, and his son Erwin, 38, built Bosowa Corp., a $1.5 billion closely held conglomerate based in Makassar, an eastern Indonesia shipping and aviation hub.

There, the economy has grown 10 percent annually for the past decade -- more than 50 percent faster than the national average.

The elder Aksa, who is a brother-in-law of vice presidential candidate Jusuf Kalla, started in business as a car dealer. Then he opened a cement factory. When Makassar’s narrow streets became choked, he built a toll road. When his business started to be affected by blackouts, he constructed a power station.

Nickel Mine

This year, when the government banned raw mineral exports, the family decided to build a $300 million smelter to process nickel from a mine he owned. The Aksas have also acquired stakes in two small banks, and Bosowa is now Indonesia’s fourth-biggest cement company.

Though the Aksas’ business spans the country, current CEO Erwin says eastern Indonesia remains his main market. He’s selling cars and making cement in Ambon City, where a multilane bridge and bypass road are under construction.

“The only problem with east Indonesia is the infrastructure,” he says. “Once you have built that, you are OK.”

In Maluku, the much-faded spice trade is undergoing a revival. In the 17th century, these tiny islands were the world’s most valuable pieces of real estate -- especially after doctors judged that nutmeg, which grew nowhere else, could cure bubonic plague.

In the 19th century, the islands lost their monopoly after the British transplanted nutmeg trees to their own colonies in Asia, Africa and the Americas. Today, the world’s biggest producer of nutmeg is the 344-square-kilometer (133-square-mile) Caribbean island of Grenada.

Nutmeg-Spiced Coffee

Now, entrepreneurs from abroad are joining international aid workers in trying to rebuild the Spice Islands nutmeg trade. Portland, Oregon–based Mercy Corps, for example, is helping farmers get higher prices.

Dean Cycon, founder of Dean’s Beans Organic Coffee Co., visited Run last year and bought nutmeg to flavor one of his coffee lines. Next year, he says, he’ll return to collect a shipload -- and perhaps put his money where his mouth is.

“As soon as they get round to opening a bank on Run, I’ll be the first customer,” he says.

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