Bonds to revive banks

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.