Settling the foreign debt snag

Settling the foreign debt snag

By Laksamana Sukardi

JAKARTA (JP): Indonesia's private foreign debt burden must be
dealt with expeditiously. One of the most important prerequisites
for recovery of the Indonesian economy is the settlement of this
debt incubus. It is regrettable that thus far there has been
little significant progress in settling Indonesia's private
foreign debt problem. This is due to the complexity of the
matter, requiring a solution that is acceptable to all parties
involved.

The facts listed below should form the appropriate foundation
in reaching a common framework that can be used to restructure
the private foreign debt:

* Foreign creditor banks will use all means at their disposal in
their effort to get maximum repayment on debt.

* Indonesian corporate debtors are attempting to reduce their
debt burden by claiming there has been a force majeur. Moreover,
they are hoping that foreign creditors will forgive their debt or
that the Indonesian government will bail them out.

* The countries funding the IMF are unwilling to allow the funds
provided to Indonesia to be used to bail out private foreign
debt.

If the IMF and the Indonesian government do not become more
involved in settling the matter of Indonesia's private foreign
debt, it will drag on in such a way that all parties will lose.

The Indonesian people will not accept having private foreign
debt obligations falling on the Indonesian government.

These facts make evident how very difficult the challenge is
to find a solution that will be acceptable to all parties
involved. Therefore, any solution that is fair and workable is
going to have the following characteristics:

- The Indonesian Debt Restructuring Agency (INDRA) must be fully
independent.

- Members of INDRA's facilitating team must not have any
conflicts of interest or vested interests, meaning they should be
neither government bureaucrats nor persons directly involved in
borrowing and lending. This team must be composed of independent
professionals in the areas of finance and banking.

- Loans that were made based on principles of prudent lending
and due-diligence should be handled differently from loans based
on reckless lending involving collusion, corruption, and
nepotism.

- Private Indonesian firms that borrowed in unprofessional ways
or diverted borrowed funds for personal use should be handled
through the proper criminal legal channels, while those that
borrowed in a professional manner and in accordance with
principles of prudence should be given maximum assistance.

There can be no such thing as a free lunch.

If the government guarantees any private foreign debt, then
owners of firms receiving assistance must surrender shares of
equal value to the government in return.

In technical terms, the restructuring of private foreign debt
based on the principles set forth above would consist of the
following:

Classification of Foreign Debt:

Independent audits of the portfolios of foreign debts as well
as the debtors Indonesian companies to determine which ones are
proper candidates for restructuring. These audits should be based
on criteria of how loans were made and used. Based on these
independent audits, all foreign private debt can be assigned to
either of two categories:

Prudent Category: Prudent lending by international banks and
creditors to private Indonesian companies that engage in prudent
management of their loan portfolios. Refers to companies that are
managed professionally and with transparency, and which have
received foreign loans on the basis of cautious principles,
meaning their financial statements and other supporting documents
show the company's use of loaned funds.

Reckless Category: Reckless lending by foreign banks and
international creditors to Indonesian private companies that
manage their loans in unprofessional and non-transparent ways.
In these cases it is evident that corporate managers have engaged
in sight streaming of borrowed funds and creditors have violated
basic principles of due diligence in their credit allocations.

The task of classifying loans into the categories above will
be conducted by highly respected and internationally syndicated
independent auditors.

Auditors that are already in contractual relations with banks
or debtors are forbidden from involvement in the classification
process.

If necessary, the classification process can be accelerated by
establishing standard criteria based on check points that result
in a scoring system. Based on this scoring system, it will be
possible to determine with precision and consistency whether
loans qualify for full or partial restructuring.

The objective of this scoring system is to determine whether
the business activity of the debtor is still viable and whether
the company has the potential to repay its foreign debts. The
three main categories into which corporate debt will fall are:

1. Low Risk: All of the foreign debt qualifies for restructuring.

2. Medium Risk: Only a portion of the foreign debt qualifies for
restructuring.

3. High Risk: None of the foreign debt qualifies for
restructuring.

Restructuring Program: Prudent Category

1. Once the independent auditor has assessed the loan
portfolio and assigned a categorization based on risk, the debtor
shall issue Convertible Bonds (CB/Obligations that can be
exchanged for equity shares).

2. Foreign debt will be swapped for these Convertible Bonds.
In this way, the fiscal position of the debtor company will be
improved significantly.

3. A bilateral commitment shall be arranged between countries
and multilateral organization such as IMF and The World Bank to
create a secondary market in these Convertible Bonds.

For example: The Indonesian and Japanese governments negotiate
an agreement in which the Japanese government provides a discount
facility to Japanese creditors (Banks or investors who are
holders of the Convertible Bond) through a Special Vehicle
supported by the Bank of Japan and/or the World Bank.

This is feasible because the Japanese government has an
interest in assisting Japanese creditors. The Japanese government
is also in a more advantageous position than the Indonesian
government in mobilizing international funds because the country
risk rating of Japan is much more favorable than that of
Indonesia.

Provisions regarding the conversion rate from debt to
Convertible Bonds shall vary with the categorization of risk.
The discount rate of CBs will also be strongly determined by the
risk category of corporate loans. Through this process the
restructuring of foreign debt can proceed through market
mechanisms, as the CBs that are swapped for debt will be rated
for purposes of trading on the secondary market.

4. Indonesian debtor companies will be obligated to make an
IPO or rights issue once economic conditions in Indonesia improve
or before a pre-arranged deadline. Holders of CBs will then have
an opportunity to exchange their bonds for shares, which can be
sold on the Jakarta Stock Exchange.

5. The management of debtor companies must be fully
transparent. Representatives of creditors or holders of CBs shall
be involved directly in the management of the firm.

Foreign debt classified as "prudent" is defined as debt that
meets the eligibility requirements for restructuring. The
conditions and action plan set forth above represent a common
framework that must serve as the reference point for both
creditors and debtors in all negotiations for restructuring of
Indonesian private foreign debt.

The actual restructuring program for each debtor firm will
vary with the type of debt, the condition of the company, and the
future prospects for the firm. But this "common framework"
represents a general point of departure for achieving a
restructuring of foreign debt in a manner that is fair and
workable.

Foreign debt falling into the "reckless" category will not
qualify for restructuring because the provision of loans was done
in violation of prudent lending principles, meaning they were
problem loans from the moment credit agreements were signed.
Therefore, there is no basis for debt in this category to be
restructured.

Banks or creditors that engaged in reckless lending to
Indonesian firms must bear the risk and write off these loans.
That said, the Indonesian government shall assist banks and
creditors in minimizing their losses. Toward this end, the
Indonesian government shall assist in the following ways:

- Asset repossession: The Indonesian government shall facilitate
and provide legal mechanisms for the repossession of assets
agreed to as collateral by debtors to foreign banks and
creditors.

- Investigation: The Indonesian government in close cooperation
with foreign governments shall investigate the wealth of reckless
borrowers, whether held in Indonesia or abroad. This wealth shall
be used to reduce the losses of creditors as per the agreements
between borrowers and lenders. Investigations shall be conducted
by professional investigators with international networks. The
creditors or banks in question will bear all costs of these
investigations.

- International blacklist: If it is proved that borrowers have
wealth abroad and yet are unwilling to surrender these assets to
repay their debts, it shall be agreed to enter the names of the
individuals in question on a blacklist of economic criminals.

Through this initiative, it is hoped that Indonesia's debt
overhang can be settled effectively and fairly. Restructuring
shall be made available only for borrowers and creditors that
have acted in good faith and implemented principles of caution
and due diligence, meaning prudent lending practices and prudent
loan management. Meanwhile, reckless borrowers and lenders who
violated prudential principles must agree to accept the
consequences and risks they took.

Moreover, by exchanging debt for convertible bonds that are
rated according to their risk, a solution is available to settle
the problem of debt overhang in a manner that is effective, fair,
and firmly grounded in market mechanisms.

It must be recognized that the most important factor in the
success of this initiative is the high level of independence on
the part of the members of the bodies handling the restructuring
of the foreign debt.

This body must be completely free of intervention on the part
of powerful actors who were involved in the collusive, corrupt
and nepotistic (CCN) activities that resulted in the foreign debt
that falls into the "reckless" category.

The writer is CEO of Reform Consulting, Jakarta.

Window: If the IMF and the Indonesian government do not become
more involved in settling the matter of Indonesia's private
foreign debt, it will drag on in such a way that all parties
will lose.