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.