Liquidity matters in the end

Liquidity matters in the end

By Eddy Soeparno

JAKARTA (JP): It is now clear that relying on foreign money
has its costs. The Asian miracle, characterized by the economic
boom in the region over the past two decades was undoubtedly
nurtured by unprecedented flows of capital.

Even U.S. Federal Reserve chairman Alan Greenspan confessed in
retrospect that "it is clear that more investment monies flowed
into these economies than could be profitably employed at
reasonable risk".

In addition, Massachusetts Institute of Technology's Paul
Krugman agreed that "enormous inflows of capital allowed
Indonesia and Asian countries to spend far more than their
incomes".

Unfortunately, much of that money was in the form of short
term investments, and could flee as quickly as it arrived. Right
up until the eve of the crisis, Asian economies could do no
wrong, in the eyes of investors and creditors.

It was an absolute win-win situation for investment houses and
banks, especially since opportunities seemed endless and
continued arising almost every day.

Look at Asia at that time: Inflation was under control, it had
none of the excessive budgets that Latin American countries had,
labor costs were considerably low and savings rates were at high
levels. As such, money kept pouring in.

In 1996 alone, foreign banks lent the countries currently in
crisis more than US$100 billion, while nonbank investors poured
in tens of billions more. And as soon as speculative attacks
against their currencies commenced in the second half of 1997,
those same banks called in more than $50 billion worth of loans.

Soon afterwards, the whole house of cards fell apart and the
Asian miracle became a major debacle. Investors, foreign and
domestic, rushed to the exit doors, leaving governments powerless
to defend the currency as well as the economy.

In trying to hold back the stampede of runaway investors,
Indonesia continually restated that its economic fundamentals
were strong and different from those of Thailand and Korea.

These supposedly encouraging remarks apparently did not stop
the capital outflow, until the government realized that it was
not fundamentals that investors were so concerned about, but
market confidence.

Therefore in its quest to bring market confidence back to the
country (and at the behest of the International Monetary Fund of
course), the government responded by raising interest rates to
30, 50 and 70 percent to stabilize the currency, not realizing
that its private sector was up to its neck in foreign debt.

This in turn pushed even the soundest corporations into
bankruptcy, increasing the bank's nonperforming loan portfolios,
provoking devastating bank runs and finally plunging the economy
into deep recession.

It is only modest to say that many of the now debt ridden
companies in Indonesia, were previously lectured by aggressive
creditors that "borrowing money is a good thing to do and that
the more loans a creditor is willing to make is an indication of
his confidence in ones business".

In the beginning, some twenty years ago, most business
families were opposed to the idea of leveraging themselves with
bank loans, as it was viewed as costly, thus cutting a portion of
their bottom line earnings.

In most cases, businessmen could also not accept the idea of
"working for the bank", by continuously having to service debt.

It was simply against their entrepreneurial principles.

Moreover, most business people were liquid during those days,
as the attitude of not borrowing money discouraged them from
going into any form of business they were not capable of self-
funding.

But soon after the concepts and benefits of "using other
peoples money" were familiarized in the seventies, Indonesian
businesses started to look for bank financing whenever possible.

At the same time, government directed and sometimes guaranteed
borrowing also encouraged Indonesian businesses to fund
investments and expansions through either the debt or capital
markets.

Thus its reliance on self financing slowly became of lesser
importance, as the ability to source third party financing became
more of a priority.

Approaching the nineties, most of Indonesia's new breed of
conglomerates became familiar faces to a large and growing number
of domestic and foreign banks eager to finance any new
activities, knowing that the returns would be profitable.

And with more banks and investment houses struggling to obtain
a thin slice of the cake, borrowers became not only more hungry
for external financing but also more aggressive in entering new
and frequently unknown business territories.

With the continuous flow of credit and investment, corporates
grew to become business groups and business groups demanded more
money, while conditions attached to financing became less
stringent.

Slowly and almost unnoticeably, a shift in the entrepreneurial
paradigm had occurred, as bank loans walked hand in hand with
entrepreneurship in the development of corporate Indonesia.

And as almost endless amounts of money kept pouring into the
private sector, businesses had practically very little incentive
to maintain self liquidity to wholly finance its operations.

At times, internally generated cashflows were not even
sufficient to cover basic operational needs, such as the purchase
of raw materials. But as financiers stood eagerly at the
sidelines waiting to extend more money, who needed self liquidity
anyway? Even if one creditor was limited to increasing his
exposure to one debtor, other creditors were already in the queue
with ready-to-spend money in their pockets.

During the months preceding the crisis, Indonesia's corporate
sector was floating in an ocean of debt. Businesses were highly
dependent on bank loans and other external forms of financing,
therefore the financing and refinancing markets became central to
the continuation of ones business.

But who could ever predict a crisis of this magnitude,
catching the banking and business sector totally by surprise?

As soon as the rupiah depreciated and borrowers debt levels
increased by fourfold overnight, the much needed financing and
refinancing markets disappeared, in line the reluctance of
financial institutions to make new loans or even roll existing
ones over.

As the self-inflicting panic waves reached the boardrooms of
the financiers head offices, orders to "pull the plug" on these
companies followed soon afterwards. But with loans primarily tied
up in fixed assets, none of the borrowers could make good the
payments when demanded.

Today, while loan restructuring becomes a daily routine
between borrower and lender, almost no new lines of credit are
being extended to the business sector. The result is predictable:
with hardly any internally generated liquidity in place, the
business sector lacks the essential "fuel" to run its operations.

And until liquidity flows back into the real industry, the
economy will remain dormant, leaving the banking sector totally
defunct.

But certainly, even during these difficult times a handful of
business entities are bound to pull through, especially those
with low leverage and high liquidity.

These companies are viewed to be more vulnerable to market
demand rather than credit supply, as they are more or less self
sufficient in providing their internal needs for cash.

However with lower than ever consumer demand (except for maybe
offshore demand), how much longer can say retailers, dairy
producers and pharmaceutical producers sustain the pains of
depressed demand? As Paul Krugman explains, even the soundest
companies are at risk of being wiped out by the crisis.

However one thing remains certain, businesses with high
internal liquidity and little reliance on bank financing are the
ones who stand tall and are likely to survive as well as be the
first to recover from the crisis.

These are also the ones that banks and other financiers will
be targeting and insist on handing money to in the future,
knowing that its management successfully made its way through the
cirrhosis.

One thing they may choose to overlook is the fact that future
unnecessary credit flows into these companies could make them
vulnerable in facing the next crisis.

It is therefore important to remember that liquidity got these
companies out of the crisis and will further serve the same
purpose in similar conditions in the future. After all, having
liquidity is what counts in most situations.

The writer is a corporate finance director of American Express
Bank.