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.