Bonds to revive banks

Indonesia's first treasury bonds in over four decades were finally born on Friday through a huge, yet unusual issue totaling Rp 157.61 trillion (US$19.43 billion), of which Rp 103.83 trillion is to recapitalize 23 private and regional development banks and Rp 53.78 trillion is to reimburse Bank Indonesia for its payments to depositors and creditors of banks closed in 1998 and in March. Another Rp 247.8 trillion in new government bonds will be floated soon to recapitalize 16 other banks, including Rp 233.25 trillion for the seven state banks, in a massive restructuring program which will make the government the controlling shareholders in all major domestic banks.

But none of the bonds is likely to see the light of day at least until 2000. The bonds will simply be put on the balance sheet of banks as capital to raise their capital adequacy ratio to the minimum 4 percent.

It is highly questionable, though, as to whether the bond- financed recapitalization will enable the banks to resume lending shortly because of the illiquidity of the debt instruments. Given the absence of a secondary bond market, the banks, as the bond holders, will get additional liquidity only from the bonds' interest, which will be paid quarterly (for floating-rate bonds) and every six months (for fixed-rate bonds).

The government has allocated Rp 34 trillion in the current 1999/2000 budget to pay the bonds' coupons for one year but this sum will not go only to the 23 banks. The coupon payments will have to be distributed to nine other private and nationalized banks and the seven state banks that have yet to be recapitalized.

Whether the interest income will be enough to meet the banks' need for additional liquidity in order to resume lending or to settle liabilities will depend on how the economy will perform within the next six months. If the economic condition continues to improve as it has done since March, the banks will most likely survive but without much lending activities. But if the June 7 general election does not run smoothly and peacefully, or if its results set off a protracted conflict or controversy or produces a very weak, less credible government, the economic condition may become worse before it gets better. An adverse economic condition could weaken the rupiah, raise inflation and interest rates and would turn current bank loans into bad assets, thereby eroding further their capital.

Hopefully, conditions will improve to facilitate a further decline in inflation and interest rates, reinvigorate business operations and prevent a new wave of bad loans. All this will enable the recapitalized banks to survive with the interest income from the bonds.

The government seems to have realized that the economic and political condition until the end of the year does not augur well for reopening a secondary bond market. Even without the millennium bug or year 2000 (Y2K) computer problem, which Minister of Finance Bambang Subianto cited on Friday as the main reason for not allowing the banks to trade the treasury bonds until 2000, no one will likely touch the debt instrument in view of the overhang of a social and political quagmire in the run up to the June 7 elections and presidential election in November.

In fact, seen from the structure and tenor of the bonds, the debt instruments have, from the outset, been designed to be traded only under a better macroeconomic condition that is expected to take place after the establishment of a credible administration later this year. The coupon rates on the three types of bonds -- fixed-rate, floating-rate and index-linked bonds -- were set at such levels that the instruments will be attractive to investors only under a condition of low inflation and a stable rupiah.

However, getting money is not the only objective of floating bonds, especially in Indonesia, whose capital market still lacks depth. This instrument can eventually function also as a benchmark for a medium and long-term yield curve. After the rupiah bond market became moribund a few years ago, there has not been any benchmark for people to gauge long-term interest rates. It is now almost impossible to project the cost of money within one year, let alone for medium and long-term funds, the main type of financing used for investment.