How far can RI credit crunch go?

How far can RI credit crunch go?

By Eddy Soeparno

JAKARTA (JP): For Indonesia's growing middle class, owning a
private means of transportation, be it a motorcycle or a Kijang
van, was not so much of a dream when consumer financing became
available to a large number of them.

Credit was available for a wide range of consumer products,
from television sets to water pumps, from personal computers to
mobile telephones. Thus the growth in consumer demand was well
supported by the availability of credit lines that came along
with it.

And with steady increases in Indonesia's disposable income
rate, money was made available to finance an extended range of
consumer products at attractive rates.

But just when things were starting to look up, the steep fall
in the value of the rupiah forced the central bank to jack up
interest rates to as high as 40 percent in the first quarter of
1998, and then to 70 percent not so long ago.

This prompted consumers to either prepay their outstanding
loans or try their best to sell the goods previously purchased on
credit. However, in a market that is largely driven by the
capacity to obtain financing rather than personal funds, one can
imagine how these goods would go on the secondhand market.

Nonetheless, it is much easier to dispose off dishwashers and
motorcycles rather than a production plant full of machinery and
state-of-the-art equipment. As such, although consumers have been
affected by the disappearing credit facilities, it is the
corporate sector that is suffering the most from being denied any
form of bank financing.

Loans and other forms of outside funding, as many are aware,
is the lifeblood of an economy, and in today's world businesses
are primarily run by consumer financing, usually sourced from the
debt as well as capital markets.

When these "wells" dry up and internal funding becomes
insufficient to support existing operations, the owner of a
business is obliged to inject additional cash to keep his concern
ongoing. But once a business runs out of funding alternatives it
is faced with the unfortunate reality of having to slow down
operations, if not shutting them down completely. A continuation
of this "credit squeeze" will lead to the selling of businesses
either to new investors or to a number of creditors exercising
their rights to sell the assets they hold as collateral.

But what caused the credit crunch in the first place? Looking
back, the Indonesian credit boom over the past decade contributed
to the economic expansion of the 1990s, generating spectacular
growth in business investments.

However, along with the boom came speculation, especially in
the property sector and other newly developed industries that
sooner than later burdened the economy with oversupply and
overcapacity.

As money became an easy commodity to source, business groups,
even those inexperienced in developing property-related projects,
committed themselves to building skyscrapers and housing projects
in major the cities, knowing that other forms of financing would
be available to support the purchases made by their customers.

A similar picture also appeared in other sectors of the
economy, as more business investments took place in industries
that, for instance, were previously government owned and run,
such as petrochemicals, power, infrastructure and many more.

The fact that the outlook of these investments were bright
came only second to the golden opportunity of getting low-cost
money to fund almost any form of investment. Often it was the
availability of money that led to an investment decision rather
than the economic viability of the project itself.

Of course, banks and other financiers, (especially those who
came to Indonesia only to make a quick buck) were partly
responsible for always offering their debtors more money to
finance never-ending business expansions.

For what? Obviously for the sake of generating business for
the banks, meeting budgets imposed by their head offices and most
importantly allowing the officers to pocket huge year-end
bonuses.

Not surprisingly, the growth of corporate Indonesia was
heavily dependent on the available bank loans that supported it.
And the larger a group grew, the bigger their needs for bank
loans became.

But when banks, one day in mid 1997, decided to pull the plug
on their credit lines after witnessing fleeing investors, not
only did these companies experience difficulties in paying off
their loans, but also paying their suppliers and then a large
portion of employees. It became "crunch time" after that.

Subsequently, the speed of the Asian crisis accelerated in the
final quarter of 1997, as banks and lenders began relocating
their investments and assets in "flight to quality" quests to
investments that were deemed safer, especially in U.S. stocks and
bonds.

And with Asian, in particular Indonesian corporations heavily
dependent on bank rather than capital market financing, the
massive withdrawal of bank lines resulted in an almost immediate
collapse of their businesses.

In the following months, the condition deteriorated further,
both for the economy and the corporate sector. As anticipated,
the situation has not improved much since then.

But how different is the credit crunch in Indonesia compared
to the one in the West? Well, you could say that a credit crunch
is a credit crunch, a condition where external funding sources
becomes scarce.

But in the case of Indonesia, and maybe other regional
economies, the characteristics may look slightly different. While
the fears of a credit crunch in the U.S. and Europe would mainly
be caused by (what Fed chairman Alan Greenspan calls it) "a fear
induced psychological response" and is therefore a shift toward
liquidity protection, it is indeed more investor driven.

However in this part of the world, the liquidity drain is more
lender driven. That is where the similarities end. Usually,
investors need not have in-depth knowledge about a company,
neither do they require past lending relations before extending a
new loan.

As long as the risk assessed by the likes of Moody's or
Standard & Poor are acceptable and the yields remain
satisfactory, most companies or industries would be worth
entering into. But once the ratings flash warning signs,
investors are among the first to knock on doors to demand their
money back.

On the contrary, the type of financing Indonesian corporations
are accustomed to is very much relationship driven, and anything
breaking up a relationship means losing a considerable amount of
money, time and effort used to develop the relationship.

Therefore, breaking up a relationship normally means money
down the drain for banks; and if a bank's customer has an
outstanding loan, it could literally mean just that. Banks are
therefore more hesitant in pulling out of a relationship
completely and all at once, as it would be difficult to reenter
the company in better times ahead.

As a result, banks choose to temporarily freeze their credit
lines to their customers, while restructuring current troubled
loan portfolios. And while the restructuring process is ongoing,
creditors normally refrain from extending any new loans to their
debtors.

Hence, in the absence of any other alternative funding, a
debtor's fate basically lies in the success of restructuring
existing debt with its creditor. Therefore, it remains paramount
that a debtor maintains its existing funding lines in tact, as it
is next to impossible to obtain any kind of new financing at the
moment, even for blue chip companies in Indonesia.

However, going forward, there is light at the end of the
tunnel. A cooperative debtor would obviously be entrusted for new
lines of credit upon the successful restructuring of his loan in
the future, while debtors who were difficult to deal with may
need to convince creditors that it is worthwhile doing business
with them. On the other hand, debtors of doubtful "character and
commitment" to the bank and the business are usually advised to
seek new creditors.

Relationship driven banks would ensure that their cooperative
and well-performing customers receive additional funding so that
existing relationships can flourish even further.

And while touching the liquidity issue, it is important to
mention that the government should also support the much awaited
liquidity flow by lowering interest rates to such a level that
the corporate sector would be able to start borrowing again.

Finally, coming back to the ultimate question: how long will
corporate Indonesia suffer from this prolonging credit squeeze?
Well, only time will tell, but a successful restructuring of the
mounting debt problem could serve as an indication to the end of
this drought.

The writer is a corporate finance director of American Express
Bank, Jakarta.