Is a stronger rupiah already around the corner?

By C.J. de Koning

JAKARTA (JP): One of the characteristics of some economists is to predict the future on basis of past experience. In other words if the rupiah depreciates toward the U.S. dollar over time then it is an easily acceptable prediction to see the rupiah fall further.

What is harder, is to predict the timing of the turn around point, but if history is any guide to financial markets what comes down must come up again.

In this article I would like to explain why I expect the turn around point for the rupiah to be near.

If Indonesia conducted its international trade relations on a foreign currency cash only basis, its economy could grow but at a lower pace that it did so in the past 25 years.

Indonesia -- just like all developing countries -- is a net capital importer. It uses foreign currency loans for all kinds of economic activities, mostly to invest in factories, power plants, roads, education and in inventories. On top of this, foreigners sometimes buy Indonesian equities and (rarely) real estate.

There is absolutely nothing dishonorable in being a foreign currency capital importer. But capital imports do not come in for free and need to be "serviced" which means that interest and principal need to be paid back at some stage.

Indonesia has built up a foreign currency borrower position. The government has outstanding debt of some US$53 billion and the private sector some $65 billion in bank debt and another about $15 billion in debt arranged via capital markets, the latter include commercial paper, certificates of deposits, medium term notes etc. In total some $133 billion.

Just like a company, once you incur debt it has to be managed. The Indonesian government has handled its own foreign debt extremely well. It attracts funds with very long maturities, often with seven year grace and eighteen year repayments. Its average cost of funds is very low.

It has spread its debt over a number of currencies, including European currencies and the Japanese yen, the latter two have fallen substantially toward the U.S. dollar in the last year.

Over the last couple of years the Indonesian government has prepaid about $3.5 billion in relatively high interest loans mainly from World Bank and ADB.

The government also receives foreign aid to the amount of between $5 billion to $6 billion every year.

Since 1967 the government has maintained a balanced budget. It has no local rupiah debt, a great exception among developing and developed nations alike. There is no government bond market in rupiah.

The foreign currency debt incurred by the Indonesian government has always been used to finance specifically approved projects, rather than for current government expenditure.

The local rupiah budget of the government for fiscal year 1998/1999 is Rp133 trillion which at Rp8,000 to the U.S. dollar translates to $16.6 billion only.

Over 1998 the external debt service (principal plus interest) of the government debt can be estimated at about $7.8 billion. As the debt is incurred in various currencies, currency fluctuations are likely to make this figure even lower in U.S. dollars.

For 1998 total export proceeds (f.o.b.) can be estimated at some $58 billion for Indonesia, imports (c.i.f) are likely to drop due to current circumstances to some $42 billion, and a very healthy trade surplus of some $16 billion can be expected for this year. The service sector deficit (excluding interest payments) can be estimated at some $8 billion which leaves a current account cash flow surplus of some $8 billion before interest settlement. Unusually positive for a developing country.

For the Indonesian private sector, companies' individual decisions have been taken by foreign banks and local companies to borrow in foreign currency, mostly U.S. dollars, to the extent of $65 billion. This debt is predominantly incurred by some 50 conglomerates together with some 100 financial institutions.

On top of this, foreign institutions have bought some $15 billion in short term CP's/CD's. The average agreed maturity for this private sector external debt is about 1.5 years. This implies that in 1998 the total debt service requirement is some $49 billion out of the bank debt and a further roughly $10 billion out of the CP/CD etc. programs.

For a country there are only a few sources of foreign exchange cash which do not represent borrowings. They are export proceeds, foreign direct investments and overseas remittances (workers to families, students and foreign aid).

The foreign currency debt service of both government and the private sector has to be paid out of the same country "earnings". Quite obvious but sometimes forgotten.

So far the current status points quite clearly to the following facts:

There is nothing wrong with the government's external debt profile. It is conservative and well managed. The individual decisions of foreign bankers and local companies and foreign debt buyers and local companies do not add up to a collective sound decision.

Average maturity of debt of 1.5 years is unrealistically short and not in line with the country's forex earning capacity. Collective management of private sector debt has not been practiced, which has led to the currency upheaval.

A few fundamental questions can be raised about this situation.

Is it normal that a developing country has a debt service profile which requires it to pay back $56 billion in principal out of a total debt of $133 billion (about 42 percent) in 1998.

Answer: Of course not. The total level of debt of $133 billion can easily be serviced if a different maturity profile is agreed upon. Why would the world require Indonesia to become a net capital exporter. Illogical and damaging for Indonesia but also for the rest of the world.

The second question: Is the level of external debt not excessive. Compared to Indonesia's riches in mineral wealth, in land and other natural resources, its established infrastructure and real estate, this debt level is extremely small.

Compared to its foreign currency cash flow it is sustainable, but for one or two years the level should not be increased.

In order to talk relative size, compare Indonesia's total external debt with the balance sheet of a major European bank. It only constitutes about 37 percent of the balance sheet of only one of such major European banks.

A third question: Can a new private sector individual as well as collective maturity profile be agreed upon?

Of course it can. It requires the cooperation of about 100 foreign banks and some 50 conglomerates in Indonesia. But is in every one's best self interest to do so, including foreign governments.

Another question: Should Indonesia seek a moratorium as some foreign press reports indicate?

In my view this represents accepting defeat and going into liquidation rather than continuing as a going concern. There is absolutely no reason for Indonesia to liquidate. Its asset values far outstrip its liabilities obligations and the country has a huge "net worth". It needs to readjust its private sector debt individually and collectively, but this can be done and in my view will soon be done under the guidance of Radius Prawiro and his team.

Why do I think that the rupiah turn around is near. It is because I think the problem is -- in world terms -- relatively small. It does not need substantial additional funds, but rather some rearranging of existing debt, which can be done and is highly likely that it will be done in the very near future. Once done the positive interest differentials will again attract investors to the rupiah.

My conclusion is : Do not miss the turn around in the rupiah.

Drs C.J. de Koning is country manager Indonesia of ABN AMRO Bank.