Fuel, utility price hikes keep banks `risk averse'

Fuel, utility price hikes keep banks `risk averse'

Fajar Hidayat, Financial Market Analyst, Jakarta,
fajarhidayat@lycos.co.uk

The banking sector is a major player in the Indonesian
financial market worth Rp 1.145 trillion with 91.6 percent of all
shares. This means that financing for the real sector to boost
economic growth is heavily dependent on the ability of banks to
act properly and optimally as financial intermediaries, simply in
terms of moving funds from surplus fund units (lenders) to
shortage fund units (borrowers) in the nature of loans.

Unfortunately, most Indonesian banks presently are "risk
averse", avoiding lending to the real sector and hence unable to
perform optimally as financial intermediaries. In October 2002,
total bank loans outstanding to the real sector (investment and
working capital loans) accounted for Rp 279.4 trillion, or only
34 percent of banks' total liquidity of Rp 821.5 trillion.

Bank Indonesia (BI), as the monetary authority, has made some
effort to improve the banks' performance as financial
intermediaries, such as gradually reducing interest rates. During
2002, the benchmark interest rate (BI promissory note) fell
significantly from 17.62 percent to 12.93 percent.

However, according to BI governor Sjahril Sabirin, the
benchmark rate cut was not followed by a comparable reduction in
bank lending rates. He said that the intermediary role of the
banking industry was not being performed as expected because
banks continued to face internal problems, and because lending to
the real sector was still considered too risky (The Jakarta Post,
Jan. 11)

In 2003 it can be expected that banks will stay risk averse.
The fuel and utility (electricity and telephone) price hike
announced on Jan. 2 is an additional factor heightening the risk
of lending to the real sector.

The fuel and utility price hike will increase production costs
in the real sector, forcing producers to raise the prices of
their products. The hike will also cut domestic consumers'
purchasing power, leaving them unable to absorb domestic
products. Increases in the price of products also will reduce the
competitiveness on the global market of export-oriented
businesses. Inevitably, many producers might face income
reductions or even suffer losses.

Many industrial sectors will feel the negative effect of the
fuel and utility price hike. For example, in the textile and
garment industry, the hike is predicted to affect 18 percent of
the total production costs. Sales in the domestic market might
decrease by 20 percent due to the diminishing purchasing power of
consumers. Exports could also plunge, as it will be impossible
for products to maintain their price competitiveness.

This condition will lead banks to perceive that the real
sector is not eligible to receive loans. The banks will worry
that borrowers from the real sector would face difficulties
paying the loan interest and the principal, due to the
possibility of significant income reductions. The banks would
judge that the lending risk to the real sector is heightened
because the borrowers' cash flow, i.e. cash inflow (sources)
weighed against cash outflow (uses), has become more volatile.

If credit is, as the English philosopher John Locke (1773)
defined, "nothing but the expectation of a sum of money within
some limited time", then a bank's credit decision is a process
that places cash flow analysis as a crucial step. The purpose of
cash flow analysis is to examine the actual and predicted
movements of cash in terms of its sources and uses.

Once past sources and uses have been examined, a reasonable
estimate can be made as to future sources and uses. Based on cash
flow analysis, combined with a bank's deep understanding of a
borrower's business quality, an authorized judgment can be made
to decide the borrower's credit worthiness.

Consequently, if a rise in production costs due to the fuel
and utility price hike leaves the predicted cash inflow of
borrowers unable to bear the increasing cash outflow, banks would
certainly reject credit proposals.

Banks also are becoming more anxious about the quality of
their existing loan portfolios because of the rise of production
costs in the real sector. A deterioration in the business
performance of borrowers because of rising cash outflow that
might not be covered by cash inflow could decrease the ability of
existing debtors to pay loan obligations. This would possibly
increase non-performing loans (NPL). Meanwhile, BI, as the
banking supervisor, insists on imposing NPL regulations requiring
banks to reduce their NPL ratio to a maximum of 5 percent by June
2003.

For that reason, it is understandable that many banks would
stay risk averse by avoiding lending to the real sector. Instead,
some of them prefer to play it safe by investing their liquidity
in safer financial instruments such as mutual funds and T-bonds.

On the other side, it is also understandable why
businesspeople in the real sector reacted negatively and
criticized the government decision to increase fuel and utility
prices.

This reaction reflects their struggle to survive in the
country's unsound business and investment climate. Even before
the fuel and utility price hike, they were tired of dealing with
the high-cost economy, such as the extensive tax policy, long
process of tax restitution, mushrooming illegal levies, rampant
corruption by the bureaucracy, legal uncertainty, etc. The
government treats the real sector as a cash cow through its
extensive taxes, but acts slowly to resolve the other sources of
the high-cost economy.

The implication is, in order to encourage banks to act
optimally as financial intermediaries to boost economic growth,
the government must take care of the real sector. If the policy
of increasing fuel and utility prices is unavoidable, the
government must provide some stimulus to the real sector as
compensation for the unfavorable effects of the policy.

The first fiscal stimulus package, worth Rp 6 trillion and
issued on Jan. 9, is an appropriate policy to help the real
sector cope with the effects of the fuel and utility price hike.
Subsequently, the government must work very hard to resolve the
other sources of the high-cost economy by taking comprehensive
action as soon as possible.

Once the effects of the fuel and utility price hike are
minimized and the high-cost economy eliminated, the real sector
will reach recover and be ready to run on the fast track. If a
real sector recovery can be supported by a stable monetary
situation and proper banking regulations, there would no longer
be a reason for banks to stay risk averse.