IMF funds for Indonesia a 'buy-in', not a bailout

IMF funds for Indonesia a 'buy-in', not a bailout

By James Castle

JAKARTA (JP): One reason the market dipped after Indonesia
announced its comprehensive and constructive reform package
agreement with the International Monetary Fund on Jan. 15 was
because the government, consistent with earlier statements, said
there would be no bailout of the private sector.

While the government can hardly be criticized for this
ideologically correct position, the market reasonably responded
that, if there was to be no help for the private sector, then
recovery prospects might be even bleaker than expected.

The government is rightly afraid of the political consequences
of providing special aid to large businesses at a time when the
average Indonesian sees only roaring inflation and job losses.

Furthermore, the debate currently raging in the U.S. Congress
about whether IMF funds should be dispersed to troubled economies
further undermines the concept of a bailout for the private
sector.

But the problem, to a great extent, is one of terminology. We
need not be talking about a bailout of troubled companies.

Surely, what we should be talking about is an investment in a
troubled economy, a threatened society of great geopolitical
importance and a growing market for products of IMF member
countries, the U.S. not least of all.

We should be investing in a troubled economy and troubled
companies at what are highly likely to prove to be bargain
prices. And, as attractive as this is financially, the even
greater purpose is to stabilize an important market and mitigate
the impact of severe economic trauma on tens of millions of low
and middle income people who were just beginning to share in the
fruits of economic progress.

What we should be talking about is a "buy-in", not a bailout.

After all, the money the IMF, the U.S. and others provided to
Mexico at the time of its economic troubles in 1994 was repaid in
a timely fashion with interest. Clearly that money was not a
bailout.

It was a buy-in, a very wise investment which not only
provided an attractive return to investors on the capital
deployed, but also saved thousands of jobs on both sides of the
border. It hastened the recovery of the Mexican economy, creating
numerous profitable business opportunities for all IMF members
and other investors.

In addition to the necessary structural and regulatory reforms
agreed to in the latest IMF-Indonesia package, why can't a kind
of venture capital fund be created? Any practical obstacles to
such a package would be surmountable.

Call it what you like -- a Resolution Trust Fund, a Clinton
Coupon or anything else that catches the public fancy. The point
is that it would be a relatively simple matter to create a $10
billion buy-in fund for the country.

What would be the purpose of this fund and how would it be
structured? The fund could quite simply be established to provide
liquidity to otherwise creditworthy borrowers squeezed by the
economic contraction brought on by the unprecedented
depreciation of the rupiah.

To have credibility, the fund must include money from the
Indonesian government, the IMF, U.S., Japan and any other
countries or private financial institutions willing to
participate. It could be overseen by representatives of the
specific investors, but must be managed by an independent board
of professionals backed by Indonesian and international
accounting firms selected on a competitive basis.

It should be staffed by foreign and local financial experts
who have lost their jobs because of the imprudence of their firms
in the current market glut.

Any bank or bank consortium, domestic or foreign, with a
foreign currency loan in arrears to an Indonesian company, or any
company with such arrears, could apply. This would be done
through providing complete financial data certifying that the
borrower in default was otherwise creditworthy, but was being
bankrupted, for example, by liquidity problems due to lack of
working capital available from the banking system.

This application would be evaluated by the aforementioned
independent board, which would approve a capital injection only
if it deemed the borrower salvageable.

Neither party gets a free ride. It will be made clear to any
bank consortium which applies that maximum repayment amount will
be 90 percent, and could well be substantially less. It could
even require that part or all of the debt be converted to equity.

Any borrower or bank applying would have to accept the fact
that money made available to the company would be in the form of
a convertible bond or debenture, which the fund could convert to
equity at a time of its choosing. Depending on the size of the
problem, this could be any appropriate investment number, but
would in most cases be a minimum 25 percent or 30 percent

Ideological objections? This program avoids the moral hazard
of a free lunch. Any bank going to the fund would know in advance
that it was going to get a substantial haircut for its decision,
proven unwise by events, to lend to the troubled borrower.

The owners would also accept that, in return for having new
life breathed into their company, they would lose a substantial
portion of their equity. This eliminates the moral hazard of
repaying banks and investors for poor decisions.

Once the bond is converted to equity, the company would be
floated on the Jakarta Stock Exchange. This would have the added
benefits of reducing the concentration of ownership in Indonesian
companies, expanding the stock exchange and providing a handsome
return to the fund investors.

The investment produces added social good of saving jobs and
helping to reflect the Indonesian economy faster than would
otherwise be possible, while also providing a handsome return to
the countries and investors who took the risk.

All in all, it's a buy-in, not a bailout.

The writer is chairman of Castle Group consultancy and past
president of the American Chamber of Commerce in Indonesia.