Reducing debt burdens

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.