Is a stronger rupiah already around the corner?

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.