RI's international stakeholders

RI's international stakeholders

By C.J. de Koning

JAKARTA (JP): When monetary crises are spreading like an Asian
flu, and effecting countries all over the world, it may be
pertinent to study better cross border capital flows and
financial risk taking.

Take Indonesia for example. As at the end of June 1997,
foreign fund providers had made available some US$210 billion,
which consisted of $138 billion in loans to the government, banks
and the company sector.

Some $50 billion in share purchases on the Jakarta Stock
Exchange and some $20 billion in direct equity investments in
companies. By comparison, the total assets of the local banking
sector amounted to about $175 billion by the end of June. The
rupiah stood at Rp 2,450 to the U.S. dollar.

The foreign funds were used by the domestic owner stakeholders
to build factories, chemical plants, coal mines, ports, bridges,
power stations, offices, hotels and many other assets. Sometimes
working capital was also provided, mostly to finance
international trade.

One can easily draw the conclusion that Indonesia's economic
enterprise was funded to a large extent by Indonesia's
international stakeholders.

Such foreign stakeholders provide U.S. dollars and, over time,
expect U.S. dollars in return, not rupiah.

There are two major risks that such foreign stakeholders
experience as cross-border fund providers. One is the risk of a
strong rupiah depreciation and the other is that the local
counterparties -- government, banks, companies -- weaken
substantially as expressed in U.S. dollars.

Everyone knows that the rupiah has dropped from Rp 2.450 to
some Rp 12,000 currently. But does everyone understand how it
happened and why ?

On the Indonesian side a number of initiatives were
undertaken, which had never been tried before. Firstly in August
last year the government introduced a free floating exchange rate
system rather than the previous practice of devaluation and
exchange rate stability at the new rate.

Secondly 16 banks were closed simultaneously on Nov. 1, 1997,
again an experiment never attempted before. On the foreign side
Thailand's monetary crisis made all foreign investors and banks
more careful in keeping or expanding Indonesian financial risks.
This, plus the political uncertainty developing in this country,
turned financial flows into a strong financial Molotov cocktail.

The real explosion occurred in early January 1998 when the
bottom fell out of the rupiah, it peaked at Rp 17,000 to the U.S.
dollar. This was not the result of the Indonesian export sector
suddenly becoming uncompetitive. It was solely due to foreigners
(and some locals) pulling the money they had at stake in
Indonesia out so rapidly.

Such flows are a self-strengthening process, more
depreciation, means more withdrawals. One example is
international trade finance. At the end of October 1997 foreign
banks had some $14 billion in trade finance outstanding to local
banks.

By the end of April 1998 this had been reduced to $5 billion.
Each trade transaction is self-liquidating but the need for trade
finance is permanent. Perhaps this reduction had something to do
with the closure of the 16 banks, with the depreciation process
and with the lack of transparency of the local banks?

Rupiah depreciation -- of the scale experienced -- also wipes
out the equity positions of many companies and banks that have
borrowed in foreign currency and not covered the currency risk.

Also the cash-flow position of the government with a rupiah
tax income and foreign currency obligations is strongly affected.
The consequences are serious: increasing unemployment and severe
poverty, high inflation, especially food prices, and substantial
government deficits to mention just a few.

Such foreign currency capital outflows cause a financial
drought. There is no longer sufficient U.S. dollar liquidity in
the system.

Malaysia has reacted to such undesirable capital outflows by
building a dike around the ringgit and keeping the foreigners out
of the ringgit currency and local stock market.

Money can be compared to water. Money like water makes things
grow. Too much water causes floods, which are harmful and too
little water causes droughts which are also harmful.

In my view to grow the economy rapidly in Indonesia, water
(money) from outside the country can be effective, as long as it
is not too much or too little.

Currently a foreign financial drought is occurring, caused by
the excessive depreciation of the rupiah. Many foreigners have
been pumping foreign currency out of the country. During the last
two months the process has been reversed somewhat.

Many local companies, banks and government entities are in
financial trouble, also caused by the financial drought and the
excessive depreciation of the rupiah. Only the export sector is
surviving and only those companies that still have sufficient
working capital.

Turning the economic tide around can be viewed in the same way
as turning the flow of water around. Pumping stations have to be
set up in Indonesia to pump water (money) from outside the
country back into the Indonesian economy, again as quickly as
possible.

Currently the strategy is to use a high interest rate policy
in rupiah to attract foreign funds. This policy has three
drawbacks. For the foreign fund providers this policy
deteriorates the local company and bank equity positions even
further, making it unlikely that new foreign money will be lent
to, or shares bought from, local banks and companies.

Secondly the foreign fund providers in buying rupiah take
three risks, a currency, an interest rate and a local
counterparty risk (the borrower). If the borrower risk is good,
like Bank Indonesia, then the current interest gain per month of
some 6 percent may easily be lost in a day on currency
volatility. Only the currency speculators are likely to
participate.

Thirdly a high rupiah interest rate regime also stifles the
real sector domestic economy, which was already hard hit by the
foreign currency drought. Furthermore it does not reduce the
local inflation level as this was caused by the difference in
world and local prices (i.e. the exchange rate effect) rather
than by cost-push factors originating from the local economy.

Finally the high interest regime takes funds out of the local
real sector and into the financial sector as it is unlikely that
one can make a 71 percent return per annum on any economic
activity other than short-term promissory notes (SBIs).

Under these circumstances, how can the best pumping station in
the country -- Bank Indonesia -- work? To start with, it could
issue short term U.S. dollar SBI's. Of course at a premium
interest rate in order to attract the funds. One may think of 8
percent over Libor, as this is what state-owned banks pay for one
months U.S. dollar deposits.

Those funds can be used to strengthen BI's foreign exchange
reserves, to replace the expensive rupiah funding for IBRA's non
performing assets with cheaper U.S. dollar funding and last but
not least to help fund the sound local banks with U.S. dollar
funds for international trade finance.

Such pumping coupled with ceilings on future external debt
levels will jump start Indonesia's economic engine again. Local
interest rates can be gradually reduced. The rupiah is likely to
strengthen to some Rp 6,000 or even Rp 5,000 which is the level
it reached as recently as December last year.

The writer is Country Manager Indonesia of ABN AMRO Bank. This
article has been written in a private capacity.

Window: Money can be compared to water. Money like water makes
things grow. Too much water causes floods, which are harmful and
too little water causes droughts which are also harmful.