Reducing debt burdens

The Indonesian government often looks highly ingenious at simplifying complex problems in a bid to dismiss the great concerns about its distressed financial condition. Its latest idea was unveiled in Minister of Finance Boediono's statement last week that the government would issue treasury bills next year to gradually replace the Rp 674.4 trillion (US$64.2 billion) bonds that start maturing in 2002.

Earlier in September, Boediono said asset sales, privatization and corporate debt restructuring would be accelerated next year to enable the government to retire early Rp 25.8 trillion in bonds, thereby reducing the deadweight costs of the huge domestic debt overhang.

We wish the solutions were as simple and as easy as the government would want us to believe. But harsh reality forces us to treat the concepts with significant reservations and qualifications.

First of all, the revenue targets set for the sale of assets by the Indonesian Bank Restructuring Agency and privatization of state companies next year appear too ambitious, because a portion of the sale proceeds will be used to plug part of the budget deficit. The new targets require a total revenue of Rp 43.7 trillion from the two programs next year, while during the current fiscal year only Rp 20.5 trillion of the Rp 33.5 trillion target had been achieved as of October.

Issuing T-bills, discounted debt instruments of one year or less that pays its face value at maturity, is even more complex and greatly challenging, even though that instrument is badly needed now to help increase the depth of the financial market. Because, unlike the government bonds already in circulation, T- bills will perform the double function of raising funds and setting benchmark interest rates.

Even if the House of Representatives cooperates fully in enacting a bond law sometime next year, legislation alone cannot guarantee the tradability of T-bills. Without a liquid secondary market, this instrument would be very much similar to the medium and long-term government bonds already issued to recapitalize banks and to fund the blanket guarantee on bank deposits and claims.

The outstanding bonds cannot be used as a benchmark because they were issued at par directly to the buyers, instead of being priced against the local bond market. As they were not sold through auctions they do not reflect the sovereign risk from the viewpoint of bond investors and they are held mostly as investments and not as trading instruments. No wonder only about 17 percent of the total bonds have so far been sold on the secondary market.

T-bills will have to be subject to a sovereign risk rating to make them attractive to investors because it is this rating that will primarily set their discount rate. Unfortunately, the sovereign risk is the most worrisome factor, in view of the huge domestic and foreign debt burdens of the government that have exceeded the country's gross domestic product and the very slow pace of its reform program.

Since Indonesia's only credit rating agency, PT Pefindo, has yet to gain much credibility, T-bills will have to be assessed by an international rating agency to make them viable to domestic and foreign investors, notably institutional ones such as pension funds and insurance companies.

Sadly though, the government rates poorly in most of the key factors assessed in the sovereign risk rating: The stability of political institutions and degree of popular participation in the political process, income and economic structure, economic growth prospects, fiscal policy and budgetary flexibility, monetary policy and inflationary pressures, and public debt burdens and debt service track record.

Added to these risks are contingent government liabilities related to the blanket guarantee on bank deposits and claims. Even though the blanket guarantee has still to be maintained in view of the weak banking system, its coverage should be decreased to let the market forces screen out unviable banks. Most urgent is the lifting of inter-bank loans from the guarantee scheme to remove moral hazards in inter-bank lending. If a banker himself is not capable of assessing the creditworthiness of another bank, let him lose his shirt.

Because of the guarantee, many banks now opt for the easy route of plowing their funds into the inter-bank market, instead of venturing out to fund viable corporate borrowers.

Needless to say, the government should work harder to reduce the sovereign risks to facilitate the issuance of T-bills. The most effective way of decreasing the sovereign risks is to accelerate the pace of reform measures, including the cleaning up of the banking industry, asset sales, privatization and stronger law enforcement. Without significant progress in these areas, the economic outlook will remain bleak. Obviously, the market will not buy debt instruments from a government with distressed financial prospects.