Liquidity matters in the end<\/p>\n
By Eddy Soeparno<\/p>\n
JAKARTA (JP): It is now clear that relying on foreign money
\nhas its costs. The Asian miracle, characterized by the economic
\nboom in the region over the past two decades was undoubtedly
\nnurtured by unprecedented flows of capital.<\/p>\n
Even U.S. Federal Reserve chairman Alan Greenspan confessed in
\nretrospect that \"it is clear that more investment monies flowed
\ninto these economies than could be profitably employed at
\nreasonable risk\".<\/p>\n
In addition, Massachusetts Institute of Technology's Paul
\nKrugman agreed that \"enormous inflows of capital allowed
\nIndonesia and Asian countries to spend far more than their
\nincomes\".<\/p>\n
Unfortunately, much of that money was in the form of short
\nterm investments, and could flee as quickly as it arrived. Right
\nup until the eve of the crisis, Asian economies could do no
\nwrong, in the eyes of investors and creditors.<\/p>\n
It was an absolute win-win situation for investment houses and
\nbanks, especially since opportunities seemed endless and
\ncontinued arising almost every day.<\/p>\n
Look at Asia at that time: Inflation was under control, it had
\nnone of the excessive budgets that Latin American countries had,
\nlabor costs were considerably low and savings rates were at high
\nlevels. As such, money kept pouring in.<\/p>\n
In 1996 alone, foreign banks lent the countries currently in
\ncrisis more than US$100 billion, while nonbank investors poured
\nin tens of billions more. And as soon as speculative attacks
\nagainst their currencies commenced in the second half of 1997,
\nthose same banks called in more than $50 billion worth of loans.<\/p>\n
Soon afterwards, the whole house of cards fell apart and the
\nAsian miracle became a major debacle. Investors, foreign and
\ndomestic, rushed to the exit doors, leaving governments powerless
\nto defend the currency as well as the economy.<\/p>\n
In trying to hold back the stampede of runaway investors,
\nIndonesia continually restated that its economic fundamentals
\nwere strong and different from those of Thailand and Korea.<\/p>\n
These supposedly encouraging remarks apparently did not stop
\nthe capital outflow, until the government realized that it was
\nnot fundamentals that investors were so concerned about, but
\nmarket confidence.<\/p>\n
Therefore in its quest to bring market confidence back to the
\ncountry (and at the behest of the International Monetary Fund of
\ncourse), the government responded by raising interest rates to
\n30, 50 and 70 percent to stabilize the currency, not realizing
\nthat its private sector was up to its neck in foreign debt.<\/p>\n
This in turn pushed even the soundest corporations into
\nbankruptcy, increasing the bank's nonperforming loan portfolios,
\nprovoking devastating bank runs and finally plunging the economy
\ninto deep recession.<\/p>\n
It is only modest to say that many of the now debt ridden
\ncompanies in Indonesia, were previously lectured by aggressive
\ncreditors that \"borrowing money is a good thing to do and that
\nthe more loans a creditor is willing to make is an indication of
\nhis confidence in ones business\".<\/p>\n
In the beginning, some twenty years ago, most business
\nfamilies were opposed to the idea of leveraging themselves with
\nbank loans, as it was viewed as costly, thus cutting a portion of
\ntheir bottom line earnings.<\/p>\n
In most cases, businessmen could also not accept the idea of
\n\"working for the bank\", by continuously having to service debt.<\/p>\n
It was simply against their entrepreneurial principles.<\/p>\n
Moreover, most business people were liquid during those days,
\nas the attitude of not borrowing money discouraged them from
\ngoing into any form of business they were not capable of self-
\nfunding.<\/p>\n
But soon after the concepts and benefits of \"using other
\npeoples money\" were familiarized in the seventies, Indonesian
\nbusinesses started to look for bank financing whenever possible.<\/p>\n
At the same time, government directed and sometimes guaranteed
\nborrowing also encouraged Indonesian businesses to fund
\ninvestments and expansions through either the debt or capital
\nmarkets.<\/p>\n
Thus its reliance on self financing slowly became of lesser
\nimportance, as the ability to source third party financing became
\nmore of a priority.<\/p>\n
Approaching the nineties, most of Indonesia's new breed of
\nconglomerates became familiar faces to a large and growing number
\nof domestic and foreign banks eager to finance any new
\nactivities, knowing that the returns would be profitable.<\/p>\n
And with more banks and investment houses struggling to obtain
\na thin slice of the cake, borrowers became not only more hungry
\nfor external financing but also more aggressive in entering new
\nand frequently unknown business territories.<\/p>\n
With the continuous flow of credit and investment, corporates
\ngrew to become business groups and business groups demanded more
\nmoney, while conditions attached to financing became less
\nstringent.<\/p>\n
Slowly and almost unnoticeably, a shift in the entrepreneurial
\nparadigm had occurred, as bank loans walked hand in hand with
\nentrepreneurship in the development of corporate Indonesia.<\/p>\n
And as almost endless amounts of money kept pouring into the
\nprivate sector, businesses had practically very little incentive
\nto maintain self liquidity to wholly finance its operations.<\/p>\n
At times, internally generated cashflows were not even
\nsufficient to cover basic operational needs, such as the purchase
\nof raw materials. But as financiers stood eagerly at the
\nsidelines waiting to extend more money, who needed self liquidity
\nanyway? Even if one creditor was limited to increasing his
\nexposure to one debtor, other creditors were already in the queue
\nwith ready-to-spend money in their pockets.<\/p>\n
During the months preceding the crisis, Indonesia's corporate
\nsector was floating in an ocean of debt. Businesses were highly
\ndependent on bank loans and other external forms of financing,
\ntherefore the financing and refinancing markets became central to
\nthe continuation of ones business.<\/p>\n
But who could ever predict a crisis of this magnitude,
\ncatching the banking and business sector totally by surprise?<\/p>\n
As soon as the rupiah depreciated and borrowers debt levels
\nincreased by fourfold overnight, the much needed financing and
\nrefinancing markets disappeared, in line the reluctance of
\nfinancial institutions to make new loans or even roll existing
\nones over.<\/p>\n
As the self-inflicting panic waves reached the boardrooms of
\nthe financiers head offices, orders to \"pull the plug\" on these
\ncompanies followed soon afterwards. But with loans primarily tied
\nup in fixed assets, none of the borrowers could make good the
\npayments when demanded.<\/p>\n
Today, while loan restructuring becomes a daily routine
\nbetween borrower and lender, almost no new lines of credit are
\nbeing extended to the business sector. The result is predictable:
\nwith hardly any internally generated liquidity in place, the
\nbusiness sector lacks the essential \"fuel\" to run its operations.<\/p>\n
And until liquidity flows back into the real industry, the
\neconomy will remain dormant, leaving the banking sector totally
\ndefunct.<\/p>\n
But certainly, even during these difficult times a handful of
\nbusiness entities are bound to pull through, especially those
\nwith low leverage and high liquidity.<\/p>\n
These companies are viewed to be more vulnerable to market
\ndemand rather than credit supply, as they are more or less self
\nsufficient in providing their internal needs for cash.<\/p>\n
However with lower than ever consumer demand (except for maybe
\noffshore demand), how much longer can say retailers, dairy
\nproducers and pharmaceutical producers sustain the pains of
\ndepressed demand? As Paul Krugman explains, even the soundest
\ncompanies are at risk of being wiped out by the crisis.<\/p>\n
However one thing remains certain, businesses with high
\ninternal liquidity and little reliance on bank financing are the
\nones who stand tall and are likely to survive as well as be the
\nfirst to recover from the crisis.<\/p>\n
These are also the ones that banks and other financiers will
\nbe targeting and insist on handing money to in the future,
\nknowing that its management successfully made its way through the
\ncirrhosis.<\/p>\n
One thing they may choose to overlook is the fact that future
\nunnecessary credit flows into these companies could make them
\nvulnerable in facing the next crisis.<\/p>\n
It is therefore important to remember that liquidity got these
\ncompanies out of the crisis and will further serve the same
\npurpose in similar conditions in the future. After all, having
\nliquidity is what counts in most situations.<\/p>\n
The writer is a corporate finance director of American Express
\nBank.<\/p>",
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