Political turmoil fuels Indonesia default fears

Political turmoil fuels Indonesia default fears

HONG KONG (Reuters): The risk is increasing that Indonesia will default on its debt obligations and the possibility of a full-scale default will increase for as long as political confusion persists, analysts said.

Although the tension gripping Jakarta seemed to ease slightly on Wednesday, analysts said the uncertain outlook had dealt a blow to Indonesia's ability to survive without loan disbursements from the International Monetary Fund and other agencies.

The political chaos is likely to delay the next disbursements from the IMF's US$40 billion rescue package and capital flight over the past few days has undoubtedly cut foreign exchange reserves from the $14.6 billion reported earlier this month.

"There is a clear danger," said John Seel, sovereign analyst at Bear Stearns in Hong Kong. "The risk (of default) is definitely higher than it was and it will be rising for as long as the political situation stays in turmoil."

Earlier this year, Indonesia's foreign debt was estimated at about US$140 billion, made up of $54 billion in public sector debt and $70 billion in private debt excluding $15 billion in commercial paper.

Indonesia has already effectively defaulted on its corporate debt obligations following a "voluntary" moratorium, and talks to agree some type of restructuring schedule between corporate borrowers and lenders have been postponed.

International banks have started to reveal write-off plans for 100 percent of massive individual exposures over the next couple of years, implying a full default on both corporate and sovereign debt issued by Indonesia.

The IMF made its last $1 billion cash transfer to Indonesia on May 4 and had expected to make a further $1 billion payment on June 4. But last week it pulled its staff out of Jakarta and said a review would not proceed as planned.

Spreads on benchmark sovereign issues have reached into default territory at 1,000 basis points over comparable U.S. treasuries, said Lynn Exton, director of fixed income research at Merrill Lynch Asia-Pacific.

"Clearly, when spreads go out to 800, 900, 1,000 over U.S. treasuries, that is the type of default spread that the market seems to see, and that is the behavior we've observed in the Indonesian paper," Exton said.

Difficult

But Exton said the length of the maturities on Indonesia's benchmark sovereign bonds made it difficult to tell whether the market expected a default on the entire issue, or merely the upcoming interest payment.

"It is an indication of overall sentiment in Indonesia, but it doesn't really assess default risk on that particular instrument on that particular day," she said.

On Saturday, U.S. rating agency Standard & Poors downgraded the Republic of Indonesia's benchmark US$400 million bond due 2006 to triple-"C"-plus from single-"B"-minus.

A triple-C rating suggests a perceived possibility of default, S&P said. It also lowered Indonesia's long-term local currency rating, and kept all these ratings on CreditWatch with negative implications.

Bill Belchere, economist at Merrill Lynch in Singapore, said his first concern was a resolution to the private debt burden.

Servicing sovereign debt would continue to be Jakarta's first priority and right now foreign exchange reserves were sufficient to service long-term sovereign debt, Belchere said.

But foreign exchange reserves are falling, and there is a rising expectation that Indonesia will institute capital controls to protect remaining foreign exchange.

"I don't think at this point capital controls are out of the question," said Belchere. "I just think at this point there's not a lot of things you can rule out."

Indonesia's current account, however, is now in balance, indicating little immediate risk of a balance of payments crisis.

But the improvements are due to a sharp fall in imports rather than an upsurge in cash-generating exports.

Imports have fallen on a sharp decline in domestic demand as the economy has contracted, and Indonesia's credit crunch has prevented some exporters from buying raw materials needed to expand productive capacity.