Assets: Getting better value for money

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.