Resolving SME bad loans

The government will most likely resist strong political pressure to take populist measures against restructuring bad small and medium enterprise (SME) loans, thereby refusing to unilaterally set across-the-board discounts on debt principals and interest.

The final draft of the presidential decree that will be issued soon and will serve as the legal framework for the restructuring of more than 414,700 SME debts worth about Rp 39 trillion (US$4.3 billion) demonstrates a strong policy consistency and will enhance credit culture among the business community.

The presidential decree will outline only the basic principles on restructuring SME debts, defined as loans below Rp 5 billion, and set the timeframe in which the debt workout process has to be completed. It will authorize the ministers of finance and state companies to iron out the technical guidelines for banks and the Indonesian Bank Restructuring Agency (IBRA) on how they should go about resolving bad loans.

Had the government succumbed to political lobbying to unilaterally set big discounts on the debts and apply them across-the-board for all SME debtors, the policy would have boomeranged on the SMEs, because banks would refrain from extending new loans to them.

That would have also amounted to excessive intervention into banks, which would be in contravention of the November 1998 directive of the central bank's board of governors on the basic guidelines for loan restructuring.

Such a populist measure would have also damaged credit culture among the business community and dispirited other SME borrowers who have worked hard to meet their obligations.

Yet more damaging is the fact that automatic and across-the- board haircuts on debt principals and interest payments would not be fair to taxpayers, who would have to bear the losses resulting from such a discount policy because quite a number of the bad debts are consumer loans owed by rich debtors.

In fact, since almost all of the SME debts were extended before the November 1997 banking crisis when the rupiah exchange rate was still around Rp 2,400 to the U.S. dollar, quite a portion of them were not SME loans by Indonesian standards. Moreover, in view of the go-go lending practices that were quite common among the banks before the banking crisis, many of the SME loans presumably went to well-connected businesspeople who used them for such consumptive spending as buying luxury cars or property overseas.

For example, Bank Danamon and Bank Artha Graha, which bought SME debts worth Rp 4 trillion through an auction by IBRA in 2000, found that many of the debts were consumer loans related to credit card billings.

Having said all that, we do not mean to argue against granting big discounts on SME debts, nor to belittle the urgency and importance of restructuring SME debts.

On the contrary, quickly resolving the bad loans is crucial to strengthening economic recovery, given the large number and size of the SME workforce.

It is entirely unfair to let them bear the full cost of the political and economic crises that caused bank interest rates to astronomically skyrocket to as high as 80 percent and depreciate the rupiah exchange rate to as low as Rp 15,000 to the dollar in 1998.

Moreover, since IBRA has disposed of hundreds of trillions of rupiah in large bad debts with discounts of more than 70 percent, there is no reason whatsoever why SME debtors do not also deserve haircuts of at least an equal amount.

The key issue here -- and this is the responsibility of the ministers of finance and state companies who will issue technical guidelines within one month for SME debt restructuring -- is to ensure that only SME loans that were used for productive business activities and mortgages for low-cost houses will be entitled to discounts, lower interest rates and longer maturities and, if necessary, refinancing facilities.

Restructuring SME debts into new loans with lower interest rates and longer maturities and refinancing viable SMEs with new working capital loans will help restore these businesses to more profitable operations, increase their production rate and hence spur employment, and consequently empower them to service their debts.