Risk-taking key to RI's recovery

By C.J. de Koning

This is the second of two articles on the Indonesian economic crisis.

JAKARTA (JP): When a country, like Indonesia, is funding its economic activities for more than 65 percent by foreign sources, then a number of economic textbook applications apply less or not at all.

For instance take Indonesia's balance of payments. Of course the trade and services income and expenses do reflect current cash-flow. But do the capital accounts reflect the international funding levels, both equity and debt, and the changes therein?

Just a simple example: if a foreign currency loan does not get repaid, it does not show up in the capital accounts as a transfer, but it certainly represents a loss for the foreign lender(s) involved. If such a loan gets repaid the interest payment will show up under the current account balance and the principal goes to the capital account. Has such loan repayment anything to do with the financing of the imports or exports in the current period ? Nearly always not.

It is therefore better for risk-taking purposes to separate trade flows from funding sources, especially if the latter is dominated by foreign funding. Trade flows reflect the sales or turnover levels. They belong to a country's profit and loss account. Funding sources should be reflected on a country's balance sheet.

What to think of a budget policy? Indonesia until recently had a balanced budget policy, whereby rupiah tax income was fully matched by rupiah expenditure (including subsidies on essential items). In the first agreement with the International Monetary Fund in January this year, IMF insisted on a budget surplus of 1 percent, which represented an amount of $160 million at the time. Such amount compares to five days interest over Indonesia's external debt. Not an amount of great economic importance or financial relevance. Currently -- due to the circumstances -- IMF has agreed on a budget deficit of 8.5 percent of the Gross Domestic Product.

What to think of monetary targets when some 65 percent of total funding comes in a currency other than the home currency? To have rupiah M1, M2 or Net Domestic Assets as targets only reflect some 35 percent of the money supplied. Again the relevance of setting such targets for the local currency only is overshadowed by the importance of the foreign funding for which there are no targets and no instruments developed.

The IMF and Indonesia have not fully realized what it means when 65 percent of the country's funding sources come from abroad. It is no longer enough to set domestic monetary targets. To some extent it is even irrelevant. However, on the other side of the coin, it is all the more important to develop U.S. dollar related instruments to influence the foreign money supply.

What to think of the government's organization and management? Has it selected and appointed the macro-level "liabilities manager"?

What is important is that a specific group within the government feels responsible and can be held liable for all aspects of macro-economic liabilities management.

Considering that the level of funding to Indonesia's entrepreneurs has dropped by nearly $200 billion, considering that 65 percent of the funds are from foreign origin, considering that Indonesia has -- as yet -- no monetary instruments to increase the U.S. dollar inflows, and considering that the rupiah financial sector cannot generate sufficient funds at competitive interest rates, one has to come to the conclusion that a short term monetary instrument in U.S. dollars could just be the right instrument at the right time.

Such instrument could assist in generating fresh liquidity into the system, increasing the level of funding again. Such instrument could particularly be used for increasing pre-export trade finance via the local banks to the export companies. This assists in export growth and improves cash-flows for the companies involved. It also assists in increasing the U.S. dollar inflow into Indonesia from risk-taking activities.

The same instrument could also be used to replace the rupiah funding (almost Rp 150 trillion) for the non-performing loans parked with the Indonesian Bank Restructuring Agency (IBRA). Non- performing loans would best be funded with the cheapest source of funds, as such loans are non-cash generating. U.S. dollar funds are with a stable rupiah exchange rate, substantially cheaper than rupiah funds. Such U.S. dollar funds converted into rupiah would strengthen the rupiah and at the same time release the funding pressure on the rupiah market. This could enhance further lowering of the rupiah interest rates.

One should not underestimate the importance of funding Rp 150 trillion in the rupiah market. This is already equal to 15 percent of all domestic bank assets as per end of June 1998. Such instrument -- a liquidity raising instrument -- could be Bank Indonesia papers or SBI's in U.S. dollars issued by the central bank.

This instrument would enhance domestic and international market participants also to move into rupiah equity and funding positions, thereby enhancing further interest rate cuts. This liquidity instrument uses increased U.S. dollar interest levels as its attraction, rather than raising domestic interest levels. The potential investor base is much wider than the banking markets alone.

Other instruments which could be considered are more related to the equity level in the overall funding level.

This second type of instrument needs a rethink of the government's role in risk sharing with the private sector, especially the Indonesian entrepreneurs of all origins. There are already precedents of such risk participations, where IBRA has obtained shares from banks and companies in settlement of its claims. This is a type of distress risk sharing.

The proposed equity -- boosting instrument is more positive oriented. It could work as follows: The target group of companies should be companies that -- with additional finance -- could become solvent again.

These companies should be able to generate sufficient cash- flow to reach a 20 percent return on invested capital (for Indonesia a relatively low requirement). Foreign funders can be asked to provide 10 year subordinated loans to these companies. The loans carry a five year grace and five year repayment period (semi-equity). The local company pays for the first five years 20 percent per annum in rupiah interest rates to the government. If it fails to pay to the government, the latter obtains shares in the company.

The government guarantees the funder that he/she receives in U.S. dollars the Indonesian government bond yield for a remaining five year maturity period plus 2 percent risk premium. A risk premium minimum could be set at 10 percent per annum in U.S dollars over this period. After five years the company takes over the U.S. dollar loan obligations. If the company cannot pay the foreign funder receives shares in the company. Companies that participate should be audited by international auditing firms.

Another instrument which can be considered is more related to foreign currency debt and foreign currency cash-flows. Companies operating in Indonesia could be allowed, provided they have sufficient foreign currency cash-flow from exports, to change their accounting method fully into a U.S. dollar based organization.

This means that, retroactively, the balance sheet as per 31 December 1997 can be converted to U.S. dollars at the then prevailing official exchange rate (Rp 4,850 to the U.S dollar). All income and expenses over 1998 have also to be recalculated in U.S. dollars. At the end of 1998 when the tax is assessed, such tax should be paid in U.S. dollars as well. For company risk taking risks would be reduced substantially, for the government it creates a direct tax source in U.S. dollars, which helps in settling its own external debt obligations.

The IMF has arranged a substantial financial package for Indonesia and has now released substantial sums.

In order to understand IMF's role, one has also to state what IMF is not.

IMF is not an instant provider of liquidity as and when such liquidity needs arise. IMF is also not a risk-taker in the sense that it prefers to have its own debt be given the highest priority over all other debt outstanding. The IMF is also not an equity or subordinated debt provider, neither directly or indirectly. The IMF is also not Indonesia's advisor on overall liability management.

For instance when in February this year the Singapore government tried to set up a multilateral trade finance facility for Indonesia, the IMF did not see it as part of its role to assist.

The IMF has played the role of economic advisor to the Indonesian government. In this role it has strongly emphasized domestic fiscal targets, domestic rupiah monetary targets, domestic bank restructuring.

The principal lesson, when a country is funded for 65 percent in foreign currency, is that risk taking does not take place without the sources of funds being available. If foreign funds dominate then a rethink is needed on the reasons why such funds stay or leave, or how government policy measures effect such risk taking.

Internationalization of Indonesia's economy, coupled with domestic oriented economic policies have led to the problems, understanding the issues in risk-taking can also lead to the solutions.

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