Risk-taking key to RI's recovery

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.