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.