Assets: Getting better value for money

By C.J. de Koning

The following is the second of two articles on Indonesia's economic crisis.

LONDON (JP): How does the IMF program for Indonesia fit into this analysis? Selling state-owned companies to the private sector shifts ownership in the expectation that the same assets produce more output and income for the new owners. This an efficiency enhancing measure. It does nothing to extend the financial lifespan of the assets. Abolition of monopolies is done on the understanding that more competition leads to lower prices and more efficiency.

Abolition of subsidies is a redistribution of income activity, unless the government intends to lower the taxation levels. Reduction of tariffs is again an efficiency measure. Just like a bankruptcy court and an arbitration law are system efficiency measures. IMF's main influence on the imbalance between the economic and financial lifespan is exercised through its recommendations on monetary and fiscal policies and through the loans granted, not through its structural program.

On the monetary front, the IMF prefers to leave the determination of the exchange rate to market forces, i.e. supply and demand. This is a policy decision which is very harmful to economic growth for the reason that the exchange rate is a "mixed price".

A mixed price is a price determined by assets and output -- exports and imports --, but also by the movements in the liabilities level, a liabilities price. A rate of Rp 5,000 to Rp 6,000 to the U.S. dollar is a price reduction of respectively 51 percent and 60 percent to the original price of Rp 2,450 to the U.S. dollar as of June last year. At these rates the cost competitiveness of Indonesian exports should be beyond any doubt. One may even consider such rates very aggressive.

The real rates moved to Rp 17,000 in January and rose to the current rate of Rp 7,700 due to the demand created out of the changes in the liabilities position. This excessive depreciation both affect the sales proceeds negatively as well as the local cost levels. It is all the more undesirable as 65 percent of all Indonesian debt is in U.S. dollars. The excessive depreciation shortens the financial life span of assets even further.

Another monetary instrument which was applied was the rupiah interest rate instrument. When rates are increased from 20 percent to over 70 percent per annum, the interest costs over the outstanding loans of US$68 billion equivalent increase from $13.6 billion to $47.6 billion, an enormous sum out of the estimated total output level of $130 billion for 1998. What happens, of course, is that many individuals and companies can no longer pay and therefore default on their loans. Local banks get into deep trouble.

The affect is a further shortening of the financial lifespan of assets as risks on individuals and companies obviously increase. It also reduces the supply of funds, not for price reasons but for risk reasons. In other words, the recession is deepened by the use of this instrument.

Finally the IMF provides loans.

Such loans could have helped Indonesia at the time that the financial asset lifespan was actually being shortened. However, in real life such loan disbursements are spread out over a long period. Second, the amount -- though large in itself -- falls short of the needs of Indonesia when its asset values dropped by $194 billion and equity values dropped by over $100 billion in the year to June 1998.

In conclusion, one can say that the IMF's structural adjustment program is not geared to assist in extending the financial lifespan of Indonesia's assets. Some of its policies -- especially on the exchange rate and interest rates -- actually help to shorten the financial lifespan rather than to extend it.

There are options on how to extend the financial lifespan of Indonesia's assets and avoid economic and social waste as well as avoid further recessions. Such options are for instance:

1. To adjust the exchange rate to its asset-based level only, Bank Indonesia could issue short-term promissory notes in U.S. dollars at increased interest rates. This would increase the funding level available and compensates for the liabilities excess demand. It would extend the financial lifespan. Such U.S. dollar funding would also allow for point 2.

2. Another vital element to extend the financial lifespan is to bring down interest costs rapidly, especially rupiah interest rates, to a level of about 20 percent per annum. This would improve the risk perceptions on companies and individuals, as costs decline. It would also improve the profitability level of the local banking sector as doubtful debtor levels would decline and positive interest margins would be restored.

3. Another option to extend the financial lifespan of Indonesia's assets would be for the government to use all or a substantial portion of the IMF, World Bank and other donor funds to buy equity shares in Indonesian companies. Such equity increases have the highest multiplier in reducing the gap between economic and financial lifespan of assets. This would be a short-term holding until the equity markets could take over once the economy picks up again.

4. In connection with point 3, banks could also be asked to extend their risk period on all companies in which the government invests as a temporary equity provider. This again would lengthen the financial lifespan and bring it closer to the economic lifespan.

Economic recessions can be overcome rapidly if understanding of the engine of growth is well developed. The economic and financial lifespan gap analysis may well contribute to this.

The writer is former country manager ABN AMRO Bank in Indonesia and is currently with ABN AMRO London. This article was written in a private capacity.