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.