IMF-Plus: Crisis management

By C.J. de Koning

This is the first of two articles on the Indonesian financial crisis.

JAKARTA (JP): In one of Asia's main languages the word crisis has two core elements: It constitutes a "threat", but also an "opportunity".

The current Indonesian financial crisis has of course threatening elements like a weak rupiah, lower production, lower exports, higher inflation and higher unemployment levels. Many articles have been written about the threats. Less emphasis has been given to the opportunities which are created by the crisis.

Before opportunities can be managed, one has to agree as to the causes of the financial crisis in Indonesia:

* It is important to state what the crisis was not. It was not a crisis of domestic government spending or excessive government consumption, it was not a domestic inflation crisis, either on the domestic wage front or caused by domestic price developments.

It also was not due to a lack of international competitiveness, which would have made Indonesian exports grow slowly or decline. It was not even a local banking crisis, notwithstanding that some banks were clearly undercapitalized and not always prudently managed. It became a local banking crisis in the later stages of the crisis.

It was also not even a crisis caused by inefficiencies in the Indonesian economy, notwithstanding that greater efficiency is always desirable. Finally it was not even a rupiah crisis, which would have been caused by excessive local rupiah money supply growth, or other domestic factors.

* It was and is a crisis in foreign currency liquidity. It is a crisis with many international dimensions, as such coming from outside the legal borders of Indonesia. It is a crisis of international interaction with domestic players, rather than a purely domestic crisis. It is a crisis in a currency of another country rather than the rupiah.

It is a crisis of short-term capital flows, which got severely disrupted in the last six to eight months. The crisis erupted because of changes in risk perceptions by the parties involved.

Firstly Indonesian corporations started to change their risk perception on the rupiah-U.S. dollar rate once the Thai crisis erupted. More corporations started to cover their open currency positions thereby putting pressure on the rupiah.

Secondly foreign bankers started to change their risk perception on Indonesian borrowers. After July 1997 they became more reluctant to lend new money or to roll-over existing debt. After the closure of the 16 banks on Nov. 1, 1997, short-term credits to the local banking sector became very severely restricted, as many foreign banks canceled their bank lines to all but the strongest banks.

Thirdly foreign banks and local corporations had built up an average maturity of the foreign currency loan portfolio of about 1.5 years. Such maturity is extremely short and is out of line with corporate cash flows as well as out of line with the country's ability to accommodate such debt servicing requirements.

The real conclusion of this crisis description is that it is not a domestic, but an international crisis in Indonesia. It is a U.S. dollar liquidity crisis, not a crisis of the currency of Indonesia, but that of a freely convertible currency from a different country.

It is an international banking community risk perception crisis, whereby less foreign currency funds were made available, causing substantial U.S. dollar demands in Indonesia, and finally it was an Indonesian corporate sector liquidity crisis whereby 80 percent of its borrowings were in foreign currency, with much too short an average maturity, causing severe liquidity strains.

Another important point is that rational individual decisions by Indonesian corporations to hedge their rupiah-U.S. dollar risk, and by foreign banks to accept short maturities on loans, and foreign banks on foreign currency loans to Indonesian banks, do not add up collectively to a picture whereby Indonesia's ability to pay in foreign currency matches its obligations to pay. No country cash-flow projection in foreign currency was ever made. The data to do so was not available at a central level.

If changes in foreign currency cash flows caused the financial crisis in Indonesia, who are the parties involved?

There are many foreign and local institutions involved in the transfer of foreign currency to a country like Indonesia. For instance to start with the one which operates in times of crisis: the IMF. The IMF, together with a number of foreign governments, provides standby and other credit facilities to countries.

In Indonesia's case the latest package consists of about US$43 billion. Such crisis lending comes with conditions attached. The IMF, just like any other financial institution, expects to be repaid in a relatively short period of time.

Other capital providers are the World Bank, Asian Development Bank and Islamic Development Bank. Their foreign currency capital in and outflows are usually linked to segments of an economy to which private banks do not cater, like education, health care and bank restructuring.

Just like the IMF they lend to governments and they also expect to be repaid -- mostly over longer periods. The International Finance Corporation -- the private sector of the World Bank -- lends to private sector companies in Indonesia.

Another group is export credit agencies (ECA's). ECA's sometimes lend directly as some Exim banks do, otherwise they guarantee (part of) the risks of private banks lending in foreign currency to a country. Their exposure is mostly to governments, sometimes banks (rarely possible in Indonesia) and sometimes to private sector companies.

A main group of foreign currency lenders is the foreign banking community especially the commercial banks. They lend to both the Indonesian government, Indonesian banks and to the corporate sector (state-owned, foreign-owned, joint venture and fully Indonesian owned companies). Furthermore investment banks arrange for all kinds of capital market issues whereby the ultimate investor may be banks, but could be fund managers, foreign pension funds, insurance companies and individuals.

Still another group is constituted by fund managers and individuals who like to invest or disinvest in the Jakarta Stock Exchange, or in any capital market paper that may be issued.

Another group of investors are the foreign companies that invest in Indonesia or disinvest in it.

Last but not least individuals may also place their savings in Indonesia or abroad.

So far the lender side. On the borrower side there is the Indonesian government, state-owned corporations, Indonesian banks, Indonesian owned companies, foreign-domestic joint ventures and wholly owned foreign companies. In the international lending-borrowing relationship to Indonesia, Indonesian individuals do not play a significant role.

The writer is country manager Indonesia for ABN AMRO Bank.