Indonesia in debt trap

Indonesia in debt trap

President Megawati Soekarnoputri's appeal to the International
Monetary Fund (IMF) to ease Indonesia's debt burden reflects the
severity of the country's indebtedness.

However, Megawati raised a political issue on Monday in her
Independence Day address when she blamed the debt burdens partly
on what she called some mistakes the IMF made in its policy
recommendations in the late 1990s.

Whether the issue could be turned into a case for sympathetic
treatment, including some debt relief -- that is, forgiveness --
is inseparable from the broader problems of Indonesia's weak
legal system and political culture infested with corruption and
bad governance.

The debt burdens are indeed quite critical. With more than
US$68.6 billion in foreign debts outstanding as of January and Rp
622.7 trillion ($72.4 billion) in domestic debts as of July, the
government is ensnared in the jaws of a tight debt trap. The debt
service burdens have increased sharply, especially since the
government, upon a ruling by the People's Consultative Assembly,
exited the IMF program last December.

This move made Indonesia ineligible for the debt-rescheduling
facility from the Paris Club of sovereign creditors, which
amounted to about $3 billion annually. Consequently, from the
outset of the 2004 fiscal year, the government has had to spend
almost one-third of the state revenue on servicing both domestic
and foreign debts. These heavy burdens will continue to increase
over the next five years as more foreign debts and government
bonds mature.

In fact, these debt service burdens would have been much
larger -- taking up to 40 percent of revenue -- had it not been
for the new government bonds issued to refinance or buy back
mature rupiah bonds. For the 2005 fiscal year, for example, the
government will float Rp 50.2 trillion in new bonds, of which Rp
30 trillion is to be spent on refinancing or buying back mature
bonds.

The debts are not only cutting sharply into budget allocations
for basic needs such as education, health, public services,
utilities and basic infrastructure, as well as poverty-
alleviation programs, but are also exposing the government to
high interest rates and currency risks.

Official estimates show that every percentage point in the
central bank's three-month benchmark interest rate will increase
the interest costs of the Rp 616.63 trillion in government bonds
by Rp 2.3 trillion. Meanwhile, every Rp 100 depreciation in the
rupiah's exchange rate to the dollar will add Rp 9.69 billion to
interest charges on foreign debts.

The debt burdens would not have been so punitively heavy if
the government exited from the IMF program gradually, for
example, by shifting from the extended facility to a
precautionary program. However, the political decision in mid-
2003 favored a clean exit from the IMF program.

Judging from the combination of severe debt burdens, high rate
of unemployment and underemployment, and the more than 100
million people hovering on the brink of poverty with a daily
spending of less than $2, Indonesia should be entitled,
theoretically, to debt rescheduling and even debt relief under
the Heavily Indebted Poor Country (HIPC) Initiative of the World
Bank and the IMF. This initiative has thus far approved $53
billion in debt relief for 27 HIPCs.

The problem, though, is that the government has not been able
to complete its Poverty Reduction Strategic Paper (PRSP), one of
the basic requirements to be entitled to the HIPC Initiative.

Joining the HIPC Initiative would also place the government
directly under the IMF's oversight again -- the very condition
rejected by the Assembly in its 2003 ruling against another
extension of the IMF program.

There is, indeed, no such thing as a free lunch. If the
government intends to ask for some debt relief, it has to meet
the "minimum price" first: A credible PRSP approved by the World
Bank and the IMF, and effective programs in improving governance
and stamping out corruption.

It would be futile to build up the pressure of public opinion
for the IMF to assume "moral" responsibility for its "mistakes"
by helping to reduce Indonesian debts. The government may gain
international sympathy and support only if its ability to service
its debts weakens for reasons beyond its control -- and not
because of corruption and inefficiency, as is perceived
internationally.