Fiscal distress following the 1997-1998 crisis

Fiscal distress following the 1997-1998 crisis

Anwar Nasution, Senior Deputy Governor, Bank Indonesia,
Jakarta

Part 2 of 2

Over 55 percent of the external debt as of December 1998
(US$83.6 billion) is owed by the private sector and over 80
percent of it was received by the non-bank corporate entities.
The average maturity of this external debt is approximately 1.5
years (J.P. Morgan, Global Data Watch, Jan. 16 1998). A
significant portion of the private sector's external debts become
contingency liability of the government as they are explicitly
and implicitly guaranteed by the government.

Sovereign guarantees not only covered the external debt of the
state-owned banks and non-bank companies. The guarantee also
covered foreign liabilities of the private sector, particularly
the politically well-connected private infrastructure providers.
Afraid of severe damage to international transactions, the
authorities, in 1998, introduced exchange offer scheme and
extended coverage of the blanket guarantee scheme to include
external liabilities of financially distressed domestic banks.

It is true that the bulk of the public sector external debt is
long-term in nature. This is because Indonesia's debt strategy
since the late 1960s has been consistently to maximize the inflow
of development aid from its Western and Japanese creditors. The
"oil boom" enjoyed in the 1970s did not change this strategy:
Together with the resulting rise in real income, it only shifted
Indonesia's position to a less concessional aid package.

The associated principal and interest servicing cost of
Indonesia's external debt, however, still runs high, at some $9
billion a year. To be able to repay its external debt, the public
sector has to accumulate a budget surplus as well as a surplus in
the balance of payments. To ease the pressures on the public
budget and the balance of payments, on Sept. 23, 1998, the Paris
Club creditor nations agreed to reschedule $4.2 billion in
principal repayments of Indonesia's public external debt.

Three institutions have been established to work out private
sector external debt, namely: the Frankfurt Agreement, Indonesian
Debt Restructuring Agency (INDRA) and the Jakarta Initiative. The
private sector external debt is, however, relatively more
difficult to settle as there is a big number of both foreign
lenders and domestic borrowers. Each individual debtor has
distinct willingness and ability to pay which different from one
to another. Foreign lenders include foreign private banks,
institutional investors and other non-bank entities. The progress
of external debt work out, however, is very slow partly because
of weak and inefficient legal and judicial system, particularly
commercial court system and bankruptcy law.

In June 1998, the Frankfurt Agreement was signed by the
government with international private bankers to restructure and
maintain trade credit at the April 1998 level for one year. The
trade credit was fully guaranteed by the government (administered
by Bank Indonesia) and had been extended for another year to
April 2001. The non-bank corporate debt is rescheduled and
restructured along the line of Mexican program.

A trust institution, called INDRA, was established under the
central bank. This institution provides exchange rate risk
protection and assurance to the availability of foreign exchange
to private debtors that agree with their foreign creditors to
restructure their external debts for a period of eight years with
three years of grace during which no principal will be payable.
By the end of 1998, the program only attracted one debtor with a
total debt value of $2.9 billion. As a result, the authorities
have decided to close INDRA.

The Jakarta Initiative Task Force (JITF) is the third
institution to deal with private sector external debt. Modeled
after the London Initiative JITF is a private agency, financially
supported by the government, to facilitate resolutions of debts
among international creditors and domestic debtors outside the
court system. By October 2001, term sheets had been signed for 60
cases totaling $12.4 billion in debt and nearly 50 percent of the
cases have entered the stage of formal documentation and
implementation.

The burden of debt service obligations will likely remain high
in the years to come, particularly if economic growth remains
low. This and uncertain developments in international oil price
requires more efforts to generate revenues from non-oil sources
both through raising taxes and selling of state assets.

The tax efforts to raise revenues include measures to improve
custom and tax administration and to remove VAT exemptions and
reduce tax incentives. The tax ratio (1999: 12 percent of gross
domestic product) and number of individual tax payers (2000: Less
than 1 percent of total population) need to be increased.

To finance the budget deficit, we should continue to maximize
the inflow of development aid from Western and Japanese
creditors. Indonesia should also continue to negotiate for easing
the burden of debt services. In addition, market for the huge
amount of government bonds needs to be created, its
infrastructure needs to be upgraded, institutional investors
(such as pension funds and insurance companies) need to be
created and strengthened. In addition, it should be made open to
foreign investors in order to avoid overcrowding in the narrow
and shallow domestic bond market.

Generating revenues from the sale of government assets is
another option for financing government budget. Privatization of
state-owned enterprises (SOEs) is also part of the process to
scale back the government's role in providing the private goods
and services. The other source of government revenue is from the
sale of assets now controlled by the Indonesia Bank Restructuring
Agency (IBRA). With the injection of government bonds, nearly all
of domestic banks were nationalized.

IBRA's assets include non-performing loans, non-loan assets
and majority equity stakes in 11 recapitalized banks.
Privatization of SOEs and returning back IBRA's assets to private
sector also serve as an instrument to improve the efficiency and
productivity of productive assets and to speed up recovery.

The nascent democracy has strained relations between the
executive and legislative branches and has contributed to
disharmony between central and local governments, along with
increased labor disputes. The investment climate has deteriorated
further as social fabrics have begun to be affected by the
ethnic, religious and separatist violence.

Since the past two years, 16 (out of some 190) non-bank state-
owned enterprises have been announced for sale. Yet in reality,
no transaction has been concluded in the past two years.

The above article is an excerpt of the writer's presentation at
the 14th Pacific Economic Cooperation Council in Hong Kong, on
Nov. 28 - 30.