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.