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.