Local debt: Ways of getting the skeleton out of the closet

Berni K. Moestafa, The Jakarta Post, Jakarta

Let the facts speak for themselves and one must concede the sorry state Indonesia is in when looking at its sovereign debt structure.

This is US$129.7 billion in government debt, of which nearly half is made up of domestic bonds deeply locked inside the country's banking sector.

Debt servicing this year amounts to Rp 136.1 trillion (about $13 billion), or 40 percent of the entire budgetary expenditure.

From domestic bonds alone, the government faces a $63 billion fiscal bombshell over the next nine years when these bonds mature.

"The bonds are out there, the question now is how we manage them," said Bank Indonesia deputy governor Miranda Goeltom in a seminar titled Escaping the Debt Trap, which was held by the Center for Strategic and International Studies (CSIS) last week.

Following the financial crisis in the late 1990s, the government raised some Rp 434 trillion in bonds to bail out local banks.

Known as recapitalization bonds, they replaced bank loans that turned sour during the crisis.

The government issued another Rp 164 trillion in bonds to finance liquidity loans for troubled banks, and Rp 53 trillion to cover banks' liabilities such as customers' saving accounts.

In total Rp 653 trillion was raised, with the bulk of the bonds falling due between 2004 and 2009.

Redeeming the bonds in full is unlikely for the cash-strapped government, while restructuring them would further weaken confidence in the banking sector.

To date, the government's options have been to defer payment when the bonds fall due, swap them with assets under the Indonesian Bank Restructuring Agency (IBRA) and redeem them using proceeds from the sale of state assets and enterprises.

However, the three options rest on assumptions that, at a closer look, are by themselves shaky.

Miranda said that deferring payment by refinancing maturing bonds assumed the presence of an active market for government bonds.

Once investors trade these bonds to profit only from the coupon rates and capital gain, the government can skip payment of the principals. This allows it to refinance the bonds, meaning issue new bonds to replace the maturing ones.

"Letting people hold the bonds until they mature is dangerous as this entices bondholders to reject a rollover and demand a payout," she explained.

But development of such a secondary bond market is progressing slowly.

Legislators are in the midst of deliberating a bill on state bonds to allow the creation of a government debt market.

Furthermore, bond trading becomes liquid only if there is a credit-worthy government, a large investor base to absorb the bonds, a supporting tax regime, a primary dealer to move the market and legal certainty for investors, she said.

That might be too many ifs in the three years left until 2004, when the first major payout of over Rp 50 trillion falls due.

Miranda also warned that liquid state bonds might saturate market demands for corporate bonds, and choke off funding for the private sector.

The second option requires that banks swap their bonds with IBRA assets, namely loans that have already been restructured.

But the Federation of Private Domestic Banks (Perbanas) said that only Rp 90 trillion of the Rp 434 trillion in assets IBRA took over was worth enough to be swapped with government bonds.

Perbanas chairwoman Gunarni Soeworo said last week that almost all of IBRA's loans were nonperforming, so that returning them to banks would endanger their financial health.

On the other hand, recapitalization bonds carry zero risk as the government pays their coupon rates in full and on time.

The third option sees the government selling state assets and using the proceeds to redeem some of the maturing bonds.

Bank Central Asia (BCA) is one of the most precious assets and is expected to yield the government Rp 5 trillion to Rp 6 trillion.

But even an asset like BCA pales in comparison to the Rp 58 trillion in recapitalization bonds the bank owns, and on which the government pays out some Rp 7 trillion a year in coupon rates.

Next to the relatively small proceeds asset sales generate, a lousy investment climate and political resistance to foreign ownership are also dampening investors' appetites for local assets.

CSIS senior economist Mari Pangestu said that the key to escaping the country's debt trap rested on economic growth.

Growth in the economy would translate into higher revenue for the government that could be used to pay off maturing debts.