Can half a program succeed?<\/p>\n
With the IMF aid package for Indonesia in place, why is the
\ncurrent financial crisis deepening? ABN-AMRO Bank country manager
\nC.J. de Koning examines the question in the following article.<\/p>\n
JAKARTA (JP): While reading the full text of the IMF agreement
\nwith Indonesia, I got the clear feeling that I was only reading
\nhalf a program.<\/p>\n
In order to understand my feeling, let me try to explain how I
\nthink the Indonesian financial crisis developed.<\/p>\n
The Indonesian private sector has a foreign currency debt
\nlevel of about US$65 billion. Nearly all of this was borrowed
\nfrom foreign banks with another $15 billion arranged via the
\ncapital market. The average rate of maturity of all these debts
\nis approximately 1.5 years, which means that in 1998, companies
\nare expected to pay $59.8 billion in interest and principal to
\nforeign lenders.<\/p>\n
During the first six months of 1997, the private sector was
\ndoing business under the assumption that the rupiah would
\ndepreciate by about 5 percent per year, and that maturing loans
\ncould be rolled over or replaced by new loan facilities.<\/p>\n
Under these assumptions, many companies took out dollar loans,
\nconverted them into rupiah and kept the currency risks open.<\/p>\n
When the Thai crisis emerged, some companies started to cover
\ntheir currency risks by the end of July 1997. The assumption of a
\n5 percent depreciation of the rupiah started to look a bit shaky.<\/p>\n
During August and September, more and more companies started
\nto cover their currency risks as the rupiah started to be
\naffected more seriously. By Oct. 3, the rupiah reached Rp 3,800
\nto the U.S. dollar. After the government closure of 16 private
\nbanks in the beginning of November, the rupiah started to fall
\nmore rapidly as many companies started to look for dollars to
\ncover their debts. They became convinced at that time that the
\nrupiah would never return to the old exchange rate of Rp 2,450 to
\nthe dollar.<\/p>\n
The outlook became even more uncertain. Private individuals
\nstarted following the business trend and exchanged their rupiah
\nfor dollars. This created heavy demand for the dollar. Jan. 8 saw
\nthe rupiah crumble below the Rp 10,000 level. As of Friday last
\nweek, the exchange rate had strengthened to Rp 8,200, but this
\nweek has seen it dive to new lows of below Rp 12,000 to the
\ndollar. On top of all this, many foreigners who had been
\nsubstantial investors in the Jakarta Stock Exchange also moved
\nout and moved back to dealing in dollars.<\/p>\n
With the increased demand for dollars from local companies,
\nprivate individuals and foreign portfolio investors who exchanged
\nrupiah equities back into dollars, total demand for dollars grew
\nvery rapidly. Finally, foreign banks also saw their credit risks
\nincreasing rapidly due to the fall of the rupiah. They started to
\nrein in new lending, first to companies and later to Indonesian
\nbanks.<\/p>\n
Export earnings, however, continued to climb relatively
\nsteadily over the last six months at a pace of about 12 percent
\nper year. But the rapidly increasing demand for dollars coupled
\nwith a diminishing supply of dollars by foreign banks both to
\ncompanies and local banks, created a significant imbalance in the
\nsupply and demand for U.S. dollars, with dramatic consequences
\nfor the dollar-rupiah exchange rate.<\/p>\n
The key to this was and still is that private sector companies
\nhave foreign currency loans of $80 billion and have debt
\nservicing obligations of some $59.8 billion in 1998. In general,
\nit can be said that very few companies in the world are able to
\ngenerate sufficient cash flow to repay three-quarters of their
\ndebts in debt service in a single year. Indonesia is no
\nexception. The maturity profile of private sector debt is just
\nunrealistically short. The uncertainties in the foreign exchange
\nmarket have aggravated the problem further.<\/p>\n
All parties, including local corporations, foreign portfolio
\ninvestors, individuals and foreign banks reacted rationally from
\ntheir individual point of view due to the uncertainty levels.<\/p>\n
The question is, did all private sector parties collectively
\nreact appropriately?<\/p>\n
It is quite clear who were the leaders and who were the
\nfollowers in this process. The corporate sector was clearly the
\nleader in the demand for U.S. dollars. Portfolio investors,
\nprivate individuals and foreign banks only reduced their rupiah
\nexposure if the positive yield differential between the rupiah
\ninterest rate and the dollar interest rate was no longer expected
\nto cover the depreciation risk of holding on to rupiah assets.
\nForeign banks reacted to deteriorating abilities to pay when the
\nrupiah depreciated rapidly.<\/p>\n
The error -- if we can call it an error -- was that the
\nassumptions of the corporate sector and foreign banks proved to
\nbe wrong by using the wrong maturity profile of foreign currency
\ndebts of the Indonesian private sector. These debts were agreed
\nto between lenders and borrowers. However, the maturity profile
\nwas out of tune with the ability of many corporations to pay, and
\nwith the country's ability to pay.<\/p>\n
A financial crisis has developed out of unfounded assumptions
\nmade by foreign banks, international capital markets and local
\nborrowers.<\/p>\n
The financial imbalance of the corporate sector's demands for
\ndollars and the country's supply has clearly led to an economic
\ncrisis with the expectation of a zero percent economic growth
\nrate, 20 percent inflation and increasing unemployment for 1998.
\nFurthermore, a local banking crisis has been added to the list of
\nthe country's problems recently. Acute social hardships -- if no
\ncorrective action is taken -- may also occur.<\/p>\n
Since the cause of the current crisis lies in the cash flow
\ndemands of the lending-borrowing relationships between foreign
\nbanks and international capital markets on the one hand and the
\nIndonesian private sector on the other, it is also logical, that
\nthe solution must be found through the same relationship.<\/p>\n
The financial policy aim can be easily identified: Keep most
\nIndonesian companies and Indonesia as a nation in a positive
\nforeign currency cash flow rather than in a negative cash flow
\nsituation. Foreign portfolio investors, individuals and foreign
\nbanks would all likely follow suit.<\/p>\n
Now return to the original question: Can half a program
\nsucceed?<\/p>\n
The IMF program can be seen as half a program since it does
\nnot directly address the fundamental question of how to keep
\nIndonesian companies in positive foreign currency cash flow
\npositions.<\/p>\n
The IMF program for Indonesia addresses many structural
\nreforms, including for the banking sector. But since it is
\ndesigned to enhance the country's economic efficiency over time,
\nhow many companies will be left to take advantage of it? The IMF
\nmakes foreign currency loans available to the government, but
\nthese funds are not meant to go to the private sector. The funds
\nare meant to support the government to raise confidence in the
\nrupiah.<\/p>\n
Maybe it is not within the IMF's duties to maintain the
\nfinancial health of the Indonesian private sector, but in order
\nto get the country back on its feet, the private sector's crisis
\nshould get at least equal priority if not higher than the
\nstructural reforms. A program for both is needed. Over time,
\ngetting companies back on their feet leads to a much faster
\nreturn to healthy economic growth rates, low inflation and a much
\nstronger rupiah.<\/p>\n
Indonesia's crisis is, as stated, first and foremost a
\nfinancial crisis of the private sector. The first half of a
\nprogram should therefore be directed to solve this private sector
\ncrisis. The second half (the IMF-Indonesia agreement) would only
\nwork well if it was executed in tandem with the first half of the
\nprogram.<\/p>\n
Again, the key cause of the private sector crisis came from
\nits assumptions of a 5 percent rupiah depreciation per annum and
\nthe expectations that it could roll over foreign debts.<\/p>\n
The solutions lie in the foreign currency debt profile of the
\nprivate sector and of the country as a whole. No country can
\ngenerate $59.8 billion in one year out of an $80 billion debt.
\nIndonesian companies have in the past shown an ability to earn
\nback their debts, varying on the type of industry, in about three
\nto five years. This would still require $28 billion in debt
\nservice ($20 billion in principle and $8 billion in interest) in
\n1998. On top of this comes the government debt service of $7.8
\nbillion.<\/p>\n
Under the current fragile conditions, these amounts may or may
\nnot be possible to finance for the country as a whole. Confidence
\nis the key to success and therefore I propose an arrangement in
\nwhich Indonesian companies would settle their debts in rupiah
\n(equivalent to the amount of the dollar debt service on the due
\ndate) and pay into Bank Indonesia in favor of foreign banks. The
\nforeign banks could agree with Bank Indonesia not to take out the
\ndollar-equivalent amount immediately but to stretch the amount
\nover an eight-year period. This would reduce total debt service
\nfor the country (equal dollar demands) to some $25.8 billion in
\n1998. When corporations are financially healthy again with the
\nhelp of some owners repatriating some foreign assets, then
\neconomic growth could return, exports could flow again at higher
\nlevels, the rupiah could strengthen to more reasonable levels,
\nlocal prices could drop, foreign currency loans could again
\nbecome available to good companies, foreigners would be willing
\nto invest in the Jakarta Stock Exchange, and the $25.8 billion
\nwould be easily serviceable.<\/p>\n
How can we organize this private sector half of the program?
\nPresident Soeharto has already appointed an excellent team under
\nthe guidance of Dr. Radius Prawiro. Furthermore, a senior private
\nsector businessman, Tanri Abeng, was included in the new economic
\nteam appointed last Thursday. What still seems to be missing is a
\ncoordinating entity which could be set up jointly between foreign
\nbanks and local Indonesian companies to help organize the
\nprocess. This company could be called PT Indonesian Credit
\nClearing Corporation.<\/p>\n
If a private sector program can be put in place, the IMF
\nprogram would have an excellent chance to succeed. Without the
\nformer, the country's economic turnaround will take years of
\nhardship. The IMF expects their program to take two years to get
\nthe Indonesian economy back on track. I believe that a private
\nsector program could turn the economy around in six months. Both
\nelements are needed, but implementing only half a program will
\nonly slow down the process unnecessarily.<\/p>\n
The writer is the Indonesian country manager for ABN-AMRO
\nBank.<\/p>",
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