Indonesian economy not ruined (2)

Indonesian economy not ruined (2)

By C.J. de Koning

This is the second of two articles on the Indonesian currency.

JAKARTA (JP): Managing risks of foreign currency lending to
Indonesia in general requires across-the-board transparency. The
volume of outstanding loans, for instance, needs to be readily
accessible at any given time. Otherwise, no reliable cash-flow
picture can be drawn up.

The maturity profile of the total portfolio also needs to be
established; a shorter average maturity carries a higher risk for
Indonesia.

Furthermore, a distribution ratio over government borrowing in
the international market versus private sector borrowing from
abroad needs to be established. In general, foreign currency
borrowing by a government contributes more slowly to creating
daily disposable income than private sector borrowing. A 30:70
ratio may be considered. With such a ratio, government companies
should be included under the government sector for firms which
guarantee payments in U.S. dollars on the basis of rupiah income.

A risk-reducing measure would be to limit the total volume of
foreign currency loans taken up by Indonesia at any one time. It
may be considered to link this volume to the export earnings of
the country and decide, for instance, on a ratio of total foreign
currency borrowing at twice the export earnings of Indonesia.

Another risk-reducing measure would be to measure and publish
regularly the volume of foreign loans used for Indonesian import
and export finance and their average maturity.

The second type of risk concerns the foreign currency payment
and settlement. In the past year, many imperfections have
appeared in the Indonesian foreign borrowing markets. Some
companies did not inform their banks of other foreign currency
obligations held by them, thereby increasing the risks for
foreign lenders.

The behavior leads to higher overall pricing for Indonesian
risks and lower levels of available funds. The Indonesian Debt
Restructuring Agency (INDRA) may in the future collect these
types of data and make them available at the request of a
potential foreign lender, with the approval of the borrower.

On the other hand, foreign banks may be requested to register
their exposure on Indonesian corporate risks with INDRA. Again,
an effective database system lowers the risk profile of foreign
lending and borrowing, and strengthens the access of well
performing companies to the relatively cheap international money
and capital markets.

Another aspect of the risk pattern is settlement of payment
difficulties. A new bankruptcy code has been enacted in cases
where the outlook for payments is bleak. There are, however, many
cases where prospects for a company are good but some temporary
liquidity problems occur. In such cases, it would be helpful if
the concept of "wise men" could be introduced. The assistance
could be called for either by the foreign lenders or by the
individual borrower. The aim would be to overcome temporary
liquidity problems rather than seek debt forgiveness; the latter
should only be decided by a bankruptcy court.

The third risk for foreigners in participating in the
Indonesian economy lies in counter-party risks. For example, it
would be helpful if banks which are allowed to deal with foreign
counter-parties were capitalized and audited along international
standards rather than local ones. This would lower the risk
premium for Indonesia and increase the potential to bring in more
foreign funds.

The same applies for companies wishing to have foreigners as
their shareholders -- again, international auditing standards may
be applied. This lowers the risk premium and makes it more
attractive for foreigners to buy such shares.

A third example of lowering risks concerns government. The
International Monetary Fund (IMF) and/or the World Bank may
consider creating a credit risk rating for governments, where
transparency in dealing with foreign funds is rated.

Implementation of all these measures would substantially
reduce the risks of doing business in Indonesia.

Still, much of the motivation of foreigners to keep or
withdraw funds has more to do with their own individual
circumstances. For instance, it is probable a number of Japanese
banks would have withdrawn from the Indonesian market in any
case, due to their domestic situation.

U.S. fund managers may change their current investment
behavior and opt for other markets. The withdrawals may start to
feed on themselves, as we have seen in the past six months.

Risk reduction also means an orderly replacement of one type
of funds provider for another in case such withdrawals threaten
to cause the exchange rate to overshoot.

Two "buffers" may be created, one with the help of Bank
Indonesia and the other with help of the IMF/World Bank and
foreign governments.

The first type may be called the "Liquidity Equalization
Method", under which Bank Indonesia issues promissory notes (SBI)
in dollars for periods of one week, one month and three months as
a premium rate over the London Inter-bank Offered Rate (LIBOR).

This premium would be charged to all foreign currency
borrowers on an equal basis as a temporary equalization tax. The
effects are that lender replacement takes place and the risk of
overshooting of the exchange rate is cut considerably.

The second type may be a general agreement to borrow from
intergovernmental sources. Again, lender replacement is the key
driving force behind this facility. The facility can be a
permanent agreement to cover the situation that Indonesia -- as a
country, having maintained its international risk profile along
the risk management lines set out above and having used the
liquidity equalization method described above -- would still need
some liquidity in dollars to cover short-term liquidity
shortages. The IMF and the World Bank, perhaps supported by a
number of central banks, could agree to buy dollar SBIs from Bank
Indonesia, again at rates well above LIBOR.

Both the private sector variant and the intergovernmental
variant make dollar liquidity available at very short notice and
at the time when the damage of overshooting the currency has not
yet occurred. The price to pay is an extra interest charge rather
than a complete economic upheaval.

Even in the current situation, where the overshoot has taken
place for a short period, the corrective mechanism of the
liquidity equalization method can be applied successfully. Of
course, some structural support measures may also be needed to
shore up the battered equity positions of many companies. But the
Indonesian economy does not need to be ruined because it can be
run and managed.

The writer is ABN AMRO Bank's country manager for Indonesia.
This article is written in his private capacity.