Sustainable debt management

Sustainable debt management

Chief economics minister Dorodjatun Kuntjoro-Jakti and Finance
Minister Boediono are quite right in making the observation at a
seminar here on Wednesday that fiscal sustainability and debt
management will continue to be the greatest challenge facing the
government due partly to the explosion of government domestic
debts to as large as Rp 670 trillion (US$71 billion at the
current rate) from nil before the 1997 economic crisis.

The variable interest-rate domestic debts (bonds) not only
have changed the structural underpinnings of the state budget,
making it highly vulnerable to interest-rate fluctuations, but
also threatened the government with default as a larger portion
of the bonds start maturing next year.

Their interest burdens alone are estimated at almost Rp 60
trillion in the current fiscal year, assuming that the central
bank benchmark rate will average 14 percent throughout the year.
That does not include the repayment of mature bonds which will
increase steadily from Rp 19 trillion this year to as large as Rp
52.3 trillion in 2004 and to a range of Rp 55 trillion to nearly
Rp 70 trillion a year until 2010.

The high-level indebtedness that constitutes the cost of the
economic crisis is now a potential cause of economic instability
as the huge burdens exert strong pressure on the government's
ability to meet essential spending on development and poverty
alleviation, increase the country's sovereign risks and adversely
affect investor confidence.

The Five-Year National Development Program (Propenas 2000-
2004) rightly makes debt reduction to a sustainable level a
central focus of economic policy. Several of the programs being
taken to eventually cut down the debt level to 60 percent of
gross domestic product by 2004 from as high as almost 100 percent
now include such standard policies as prudent borrowing, tax
reforms and a steady cut in subsidy spending.

However, these measures will generate only an incremental
increase in state revenue that is certainly not sufficient to
meet the astronomical rise in debt service burdens within the
next five years. Moreover, the outcome of the measures will still
depend a great deal on the level of economic growth, which is
predicted by most analysts to remain below the precrisis growth
of seven percent, the minimum level of expansion required to
absorb new entrants into the labor market, at least until 2008.

Both ministers came up with an alternative short-cut to
resolve the huge debt burdens, saying that the government would
issue new bonds with longer maturities to replace the mature
bonds in order to spread the burdens over a much longer period of
time. The net result though is only rescheduling, similar to the
deal the government made with the Paris Club of sovereign
creditors in April. It will not reduce the pileup of debts but
will only carry the payment burdens over to the next decade.

In addition, the government also plans to issue Treasury Bills
(T-bill), a short-term discounted debt instrument of one year or
less that pays its face value at maturity. But the floating
process of this instrument will be much more complex. Because
unlike the outstanding bonds, which were issued at par directly
to the buyers, instead of being priced against the local bond
market, T-bills will have to be subject to sovereign risk rating
to make them attractive to investors. It is this rating that will
primarily set their discount rate. But the benefit of this
instrument is that it will help increase the depth of the
financial market through its double function of raising funds and
setting benchmark interest rates.

True, despite their limited effect, these bonds will still
help the cash-strapped government to match its payment
obligations with its cash flows until its resource base is large
enough to sustain its debt burden.

However, these debt instruments would not be able to resolve
the debt overhang once and for all without a higher rate of debt
amortization. And debt reduction can be accelerated only with
high economic growth. But robust economic growth cannot be
attained without a more vigorous recovery of the distressed
assets held by the Indonesian Bank Restructuring, a faster pace
of corporate debt restructuring and privatization of state
companies.

Faster sales of the distressed assets will generate additional
cash to enable the government to early retire bonds, thereby
reducing interest costs. A faster workout of the huge corporate
bad debts not only will enable these businesses to regain access
to new credit lines to increase operating rate. The restructured
loans can be used to early retire the bonds now held by all major
banks as their primary capital. Likewise, privatization will
generate additional cash for the government to early retire
bonds, thereby reducing the stocks of debts and interest
payments.

Most important, though, is that investor confidence will
increase as the compound effect of these measures and will
generate a virtuous circle within the economy, fueling higher
growth, generating more resources for the budget, creating
investment opportunities and expanding the public sector's
resource base.