Economy still troubled despite sign of recovery

By Reiner S.

JAKARTA (JP): The economy is still facing several critical challenges in 2001 despite continuing signs of the economic recovery process.

Economists said that one of the most important challenges is the restructuring of the country's huge corporate debt which had been progressing at a snails pace so far.

The corporate sector has some US$65 billion in overseas debt, and one third of it will mature between 2001 and 2004, which would pose a serious threat to the rupiah unless the debt is restructured. Most of the debt has not been hedged against exchange rate fluctuation.

The private sector also owes around Rp 260 trillion to the Indonesian Bank Restructuring Agency (IBRA). This debt had turned sour when it was transferred from ailing banks during the height of the Asian financial crisis in 1998 and 1999 to the agency. Restructuring the loan would help resume bank lending to the cash-strapped real sector.

"The slow effort in debt restructuring will affect market confidence in Indonesia's economic prospect which in turn will also affect the exchange rate of the rupiah," said Bank Indonesia senior economist Muliaman Hadad.

The restructuring of the corporate debt is seen to have a multiple impact to the economy. Once debt has been restructured, creditors or banks would also be willing to reopen credit line to allow companies to expand to full capacity and absorb more employment. Companies can also allocate cash for investment instead of fully being used for debt repayment.

Debt restructuring will also help IBRA to recover the huge amount of bad loans, which in turn would lessen the government loss in the bank bailout program.

Experts said that until the country's huge corporate debt problem has been resolved, the nascent economic recovery will remain fragile.

The 25 percent fall in the value of the rupiah against the U.S. dollar late in November to around Rp 9,500 compared to the level in January was partly contributed by the strong demand for dollar to repay corporate overseas debt.

According to Bank Indonesia, the country's private sector foreign debt due in the fourth quarter of 2000 was estimated to be more than $9.2 billion.

"Restructuring the corporate debt is very crucial for the recovery of the economy," said Raden Pardede, chief research officer at Danareksa Research Institute.

But the progress so far has been disappointing.

Debt restructuring

The Jakarta Initiative Task Force (JITF), for instance, had only managed to restructure around $5.3 billion debt as of end of November compared to its target to restructure $8-10 billion in corporate overseas debt this year. Until April 2001, the task force must restructure around $12 billion in corporate debt.

As of November, JITF handled more than 90 debt-restructuring cases worth more than $16 billion.

Both the government and Bank Indonesia don't have any data on the amount of overseas corporate debt which have been restructured outside the facilitation of the JITF. But Coordinating Minister for the Economy Rizal Ramli estimated that around $10 billion had been restructured particularly those owed by local subsidiaries of foreign firms.

JITF was formed by the government in September 1998 to help expedite corporate debt restructuring process. The task force also helps debtors and creditors to talk to the government when restructuring process meets regulatory hurdle.

According to government regulation, JITF only handles debt involving foreign creditors or local debt of more than Rp 100 billion each.

In June 1998, the government launched the so-called Indonesian Debt Restructuring Agency (INDRA) to provide foreign exchange protection for local corporations with foreign-denominated debt, once they have reached debt rescheduling agreement.

INDRA was closed down in June this year with only one debtor, the state-owned securities firm PT Danareksa, participating in the scheme.

There are various reasons causing the slow progress in debt restructuring process.

The poor implementation of the new bankruptcy law as reflected in the various decisions of the commercial court which has tended to issue ruling that benefit debtors has created some kind of frustration among creditors on how to force debtors to repay.

"There isn't any legal certainty. The bankruptcy law isn't working and not a single big debtor has ever been brought to the court so far," said an analyst at a securities house.

There has been a lack of good will from the debtor side to start a restructuring talk. Some debtors have tended to avoid restructuring process because they prefer to resort to the "cheaper" legal process.

In addition, debtors have also always considered that the current corporate debt problem was caused by the fall in the value of the rupiah, which debtors say was the fault of the government.

Experts also said that the country's corporate foreign debt problem was different to the case in other crisis-hit nations like South Korea or Thailand because the corporate debt in Indonesia is owed by around 2,000 indebted companies to hundreds of foreign creditors.

The Japanese creditor banks and financial institutions are taking the lead, followed by European banks, South Korea, and a small number of U.S. banks.

The fact that many Japanese banks or lending institutions are also facing financial difficulties have further made things more difficult because the Japanese creditors have been unwilling to provide any substantial relief on Indonesian debt.

The volatility in the exchange rate of the rupiah against the U.S. dollar is also seen as creating difficulty for debtors and creditors in designing restructuring scenario.

JITF chairman Bacelius Ruru admitted the trouble created by the volatility of the rupiah , but he warned debtors that delaying the restructuring program would only create greater cost.

In a bid to encourage more restructuring deals, JITF has recently provided various incentives as carrots including a 30 percent tax break on debt restructuring process that include a debt reduction, debt to equity swap or debt to asset swap method. This special tax privilege will only be provided until 2002.

Another incentive is given to local banks to encourage more restructuring deal by allowing them to breach the legal lending limit until December 2002 so that the banks can still provide working capital as a pre condition for reaching restructuring deal with the debtors.

The various incentives are only for cooperative debtors. For the non-cooperative debtors, JITF would provide "sticks" including the risk of legal punishment.

But World Bank country director for Indonesia Mark Baird said that more carrots and sticks are needed to accelerate corporate debt restructuring.

Baird said that the sticks could include the appointment of more ad hoc judges to insolvency cases.

The debt restructuring work at IBRA has raised some controversies.

Although the agency claims to have been able to resolve 70 percent of the debt of its 21 largest debtors by the September target including through restructuring, many including the International Monetary Fund and the World Bank are questioning the quality of IBRA restructuring work.

One example that has drawn the most controversy is the rescheduling of Texmaco's some $2.7 billion debt into 11 years.

Under the restructuring plan, the government would own up to 70 percent of a new holding company that would control Texmaco' various assets. The restructuring plan has been dubbed as a government bailout against Texmaco, an integrated textile conglomerate owned by the politically well-connected businessman Marimutu Sinivasan.

The Financial Sector Policy Committee (FSPC), which groups senior economic ministers plus the Attorney General, has the final say on the major restructuring work of IBRA.

The committee has been criticized for its lack of transparency in handling the major restructuring deals.

Scant details, especially of deals involving conglomerates with close links to former authoritarian president Soeharto has raised suspicions some debtors have received preferential treatment.

The corporate debt problem is very sensitive especially in view of the notorious image of many large indebted conglomerates that thrived under the 32-year rule of Soeharto.

The trouble created by the Texmaco deal had immediately prompted the government to revise the debt restructuring agreement of petrochemical giant PT Chandra Asri Petrochemical Center agreed in June, in which the debt would be reschedule into 12 years with the government via IBRA owning 80 percent of Chandra Asri while the main foreign creditor Japan's Marubeni Corp. ended up with 20 percent.

"We don't want to be accused of making another bailout," said IBRA new chairman Edwin Gerungan. Only after months of tough negotiation, a new deal was reached at the end of November in which IBRA would own 31 percent stake, Chandra Asri founder Prajogo Pangestu 49 percent, and Marubeni 20 percent.

The IMF is now insisting that IBRA should be given the full authority in deciding the future of indebted corporations, not the government.

"As a creditor, IBRA has to decide about the future of Indonesian companies that no government should be asked to make," said IMF Jakarta representative John Dodsworth.

"These decisions should be based entirely on commercial principles. The government cannot get involved in these kinds of practices," he added.

IBRA has received around Rp 260 trillion worth of bad debts from domestic ailing banks. The agency is mandated to recover the debt including through restructuring measure. Bank lending

Lending problem

Another crucial issue that must be resolved immediately is how to fully resume bank lending to the cash-strapped real sector to support the economic growth target of 5 percent in 2001 and create more jobs.

"Resuming the intermediary function of the banking sector will be critical for the economy in 2001," said president of Bank Danamon Arwin Rasyid.

After being hit by massive bank run in 1998 as confidence in the domestic banking industry plunged during the height of the country's economic and political crisis, confidence in the banking sector has returned as reflected in the jump of third party funds to Rp 652 trillion per end of September 2000, twice the level in 1997 when the banking crisis started.

But the amount of outstanding bank lending has been small, which according to Bank Indonesia only reached Rp 280.6 trillion. The central bank said that new lending in the first nine months was only around Rp 15 trillion.

The non-optimal bank lending is also reflected in the relatively low loan to deposit ratio (LDR) of around 30 percent in compared to nearly 80 percent in December 1999. The ideal LDR figure according to Bank Indonesia is between 85-110 percent.

Experts said that the "credit crunch" condition could continue in 2001 unless the government and Bank Indonesia take remedial action to restore the bank intermediary function. Some have even warned that the problem could continue until 2004 if the causes of the problem are not resolved in 2001.

According to some estimate, third-party funds by end of 2001 would reach around Rp 751.60 trillion assuming a growth rate of 10-11 percent, while bank credit would only reach around Rp 286.98 trillion.

The new bank lending has been largely channeled to the consumption and retail sector, leaving the corporate sector to be unable even just to obtain working capital credit. "The banking industry has not yet resumed its intermediary function although interest rate has been in the low range for quite sometime," Bank Indonesia's Muliaman said.

"Bank liquidity has shifted into investment in SBIs causing the burden of monetary control to be even heavier," he added, referring to the Bank Indonesia SBI promissory notes.

The absence of new loan from local banks, have provided an opportunity for foreign banks operating in the country. The share of foreign and joint venture banks in the domestic credit market has grown to 26.23 percent in July 2000, which means that more than a quarter of lending channeled in the country is provided by foreign and joint venture banks.

"We have continued to provide credit to our traditional customers even during the bad times," said one foreign banker in Jakarta.

There are various reasons for the slow growth in the bank lending.

The government has just recently completed the recapitalization program of the country's banking sector boosting the banks' capital adequacy ratio (CAR) to beyond the minimum 4 percent level.

The new lending has been largely made by private-owned banks because this group of banks were the first to be recapitalized by the government.

But even after the recapitalization program has been completed, banks are still facing difficulties to make new lending as most of their assets are in the form of government bonds.

Instead of injecting cash to recapitalize the banks, the government issued bonds worth around Rp 430 trillion. The government initially expected the banks to be able to sell the bonds in the secondary market to raise cash in order to resume their lending business, but it turns out that the investors have no interest in the bonds partly due to the relatively low coupon rate compared to the interest rate offered by the SBI notes.

Around 70 percent of the revenue of the recapitalized banks has come from the interest rate of the government bonds.

The government has just launched a new policy to fix this problem by allowing the recapitalized banks to exchange part of their bonds carrying 12 percent coupon rate with a new government bond carrying a higher interest rate of around 16 percent and lower interest rate of 10 percent. This is called the stapled bonds. The recapitalized banks would be able to sell the higher yield bonds to investors at par to raise liquidity to finance lending activity.

Some 14 banks have agreed to exchange part of their recapitalization bonds worth around Rp 60 trillion with the stapled bonds. Bank Indonesia expects the banks to be able to raise around Rp 20 trillion in fresh money to finance lending.

But the huge non-performing loans which have yet to be resolved and the remaining domestic political instability would be a major factor that may discourage banks to channel new loans.

The banks would have to be really extra careful in managing their assets because the banks must have a minimum 8 percent CAR level by the end of 2001 or would risk closure. The banks' non- performing loans must also be less than 5 percent by the end of the year.

"Most banks think the default risk is still high because economic conditions have not yet recovered due to various factors, including social and security conditions," said senior economist at state-owned Bank Mandiri Martin Panggabean.

Another internal problem inhibiting banks to lend money to their customers is the legal lending limit ruling. Because of the sharp depreciation of the rupiah against the U.S. dollar, the banks dollar-based lending portfolio have automatically breached the 20 percent legal lending limit.

Banks have to settle this problem by May 2001. It will be difficult for the banks to channel more money to their traditional borrowers, while they have to settle the legal lending limit problem. Other banks which have not yet breached the limit tend to avoid lending more money to escape the problem.

Banks would also be reluctant to borrow their money to new customers because they don't have the track record yet.