The costs of RI's monetary crisis

By C.J. de Koning

JAKARTA (JP): The impact of Indonesia's monetary crisis can be illustrated by some distressing statistics:

* More than 70 million people out of a population of 205 million have fallen below the poverty line.

* Some 30 million of them will experience absolute poverty by the end of 1998.

* Unemployment has risen substantially. Current estimates put the number at 13 million. Under employment is estimated at some 37 percent of about 90 million people in the labor force (33 million).

* About 3.1 million school children are either dropping out of school altogether or not continuing from primary school into junior secondary school.

* Lack of affordable medical care and improper diet will put a substantial group of the population at long term risk.

Some financial statistics are:

* The market capitalization of the Jakarta Stock Exchange has fallen from about US$100 billion in June last year to about $11 billion today.

* The local banking sector -- with the exception of a few banks -- is in deep trouble. The International Herald Tribune quotes statistics that at least 60 percent of loans are classified as non-performing in local banks. Restructuring costs may be between $25 billion and $30 billion.

* The Indonesian Bank Restructuring Agency (IBRA) has already injected Rp 145 trillion ($13.5 billion) into the local banking sector. All bank deposits are guaranteed by Bank Indonesia.

* Current level of assets of local banks is about Rp 1,013 trillion ($68 billion).

* Trade finance provided by international banks to domestic banks has dropped from $14 billion as per end October 1997 to $1.8 billion outstanding currently.

* Many local companies (some 1,800 of them had cross-border loans) saw their equity positions reduced or wiped out by the rupiah depreciation.

* The government has concluded an agreement with the Paris Club for partial deferral of principal of its official debt for a period of two years.

* The government now needs a budget deficit of 8.5 percent of GDP to fund among others, its subsidies on essential items. In the past such subsidies could be met out of a balanced budget.

* The rupiah has dropped from Rp 2,450 to the U.S. dollar per end of June 1997 to Rp 10,700 currently, with a top rate of Rp 17,000 in between.

* Inflation is running at some 80 percent in 1998 and economic growth is expected to drop by some 15 percent to 18 percent this year.

* Nearly all companies find it extremely difficult to obtain any sources of funds, either local or foreign, including for ordinary trade finance.

Is this the best result that the best economic brains in the world can offer Indonesia? If so, then the study of money value at risk, of funding sources, of capital flows, and their causes and its impact is still in its infancy.

Indonesia's economy was funded in June last year as follows:

* $210 billion was put at risk by foreigners, of which $138 billion was in loans to government, banks and companies, $50 billion in shares listed on the Jakarta Stock Exchange (JSX) and some $20 billion in direct equity stakes of foreigners.

* $225 billion plus was put at risk by Indonesians, $175 billion via the local banking sector, $50 billion in shares listed on JSX and an unknown amount in direct equity stakes.

The distribution of foreign/domestic funding was some 48 percent foreign and 52 percent domestic.

The size of the total funding is not extraordinarily large on a world scale. For instance one single bank among the top 10 banks in the world has a total asset base equal to the total funding for Indonesia.

If one knows that one single company, Microsoft, is worth $280 billion in share market valuation (equity side only) then this puts an even better perspective on it.

Why has the character of this crisis been so misunderstood?

There are basically two reasons for it. The first one is related to money at risk, the "funding" of Indonesia's economic activities. This is indirectly related to capital flows and particularly international, not domestic flows. The second reason is related to the first one and lies in the tools that were used to correct the crisis.

If today an estimate is made of the funding still at risk, then on the foreign side $138 billion in loans are still outstanding with a shift from the private sector and banks to government loans. Maybe some $5 billion is still outstanding at JSX and some $20 billion in direct equity. In total $165 billion.

On the domestic side, the local banking sector has shrunk to some $68 billion and a further $5 billion funds value in shares on JSX, in total $73 billion is at risk.

Total funds at risk currently measure some $240 billion, of which now some 69 percent is provided by foreigners and 31 percent by Indonesians.

Over the past 15 months Indonesia has lost nearly $200 billion in funding sources, in money at risk. The composition foreign/domestic funding has strongly shifted towards foreign funding over the same period.

The "international" side of Indonesia's financial crisis, which was caused by foreigners adjusting downwards their risk acceptance for Indonesian counterparty risks in order to avoid losses, was never fully appreciated by economists around the world. Funding disappeared for Indonesia's economic enterprise, due to the expected losses.

This "avoid losses" strategy led to substantial capital outflows which really started to hurt from January this year onwards. Capital outflows reinforce each other in an "avoid losses" strategy. The rupiah drops to unrealistically low levels, compared to its real sector competitiveness level, which is some Rp 5,000 - 6,000 to the U.S. dollar. Financial problems for the government, the banks and companies increase exponentially with each excessive rupiah depreciation.

The second element -- the tools to solve the crisis -- is related to the first element: the funding sources. On Nov. 1, 1997 the first tool was used. This was the closure of 16 banks. Small in size ($2.8 billion in total assets altogether) but big in impact.

Firstly Indonesia has many small independent traders and shopkeepers. They -- in particular -- had accounts with the liquidated banks. While a $5,000 equivalent was covered by deposit insurance, most traders and shopkeepers had -- and needed -- substantially more in working capital with these banks. Suddenly they saw their total livelihood and life savings disappear. Later on this error of judgment was corrected by repaying the depositors of the 16 banks and by extending a guarantee to all depositors in other local banks. However the harm had been done.

Secondly about $60 million was outstanding in international trade finance transactions in the 16 banks. Indonesian importers had paid, exporters had shipped goods and documents had been delivered to the liquidated banks. Foreign banks had funded. By the end of 1997 the matter was not settled, which forced foreign banks to make a 100 percent provision on trade finance, a rarity in international trade finance.

The impact effected trade finance and the local banks tremendously as can be deduced from the past and current outstanding balance. In June this year the $60 million outstanding was settled as part of the Frankfurt agreement. But again the harm was already done.

The second tool which was used was the high rupiah interest rate policy. Such a policy increases counterparty risks and causes foreigners to attempt to reduce their funding to domestic counter parties even faster. Only short term foreign currency speculators will be left who want to make money in the financial sector flows, rather than in the real sector. The wrong type of risk takers for Indonesia.

The high rupiah interest policy is furthermore based on another misunderstanding of the facts. As we have seen, a rupiah depreciation shifts the composition of funding towards the stronger currency: the U.S. dollar.

To assume that high rupiah interest rates in the weaker currency can attract sufficient funds to maintain the overall level of funding -- at competitive prices -- to Indonesia's counterparts (Government, banks and companies), is a contradiction in terms. First of all sheer size.

The rupiah sector would have to grow by the same amount that has now been lost in overall funding over the last 15 months: i.e. $200 billion. This is about three times more than the total funding currently provided by the Indonesian side.

Foreigners take risks -- and make funding available -- on the basis of local equity positions. To expect them to come up (in U.S. dollars converted to rupiah) with three times the total local funding, including local debt, goes against any grain of common sense. Secondly the "cost" factor.

Interest rates are a cost factor and high interest rates deteriorate sales, profit levels and expectations. With a declining outlook on sales and profits, foreigners would still have to increase their funding of the weaker currency to a level three times that of domestic involvement. There is no chance that this will happen.

A final argument used to justify high rupiah interest rates is that it combats inflation. Again a misunderstanding of the facts. There are world price levels for rice, rubber, coffee, tea, oil and gas, cement, cooking oil and timber, to mention just a few (i.e. U.S. dollar prices). There is certainly no inflation in those U.S. dollar prices, rather the opposite.

In Indonesia the domestic price levels for these goods are expressed in rupiah, but of course if local price levels are -- at the current exchange rate -- cheaper than elsewhere in the world, exports become a very logical option. This causes inflation in local currency terms and of course shortages. Indonesian prices adjust to world levels and not the other way around. High rupiah interest rates cannot change U.S. dollar based world price levels.

A conclusion is that liability management, which is managing the sources of funds for Indonesia's economic activities, has been the least understood aspect of the current monetary crisis.

Secondly, the motivation by foreigners to participate or to withdraw from Indonesia has also not been well studied. Those foreigners currently account for 69 percent of the total funding sources. Thirdly the tools used to combat the crisis actually aggravated rather than solved the funding crisis.

Once it is understood that the level of funds available to Indonesia's domestic economic partners has dropped substantially (by some $200 billion), then the first conclusion is that an immediate liquidity injection is required.

To try to do this in rupiah with a high interest policy does not work because of the size of the rupiah sector versus the U.S. dollar sector, the costs involved and the other negative consequences of such policy.

The logical consequence is to do this in U.S. dollars at market risk rates for Indonesia. Bank Indonesia can issue promissory notes (SBIs) in dollars. As soon as the market expects an appreciation of the rupiah it starts to act simultaneously with the U.S. dollar inflow via SBIs in U.S. dollars.

The stock market will also pick up. U.S. dollar funding combined with a rupiah appreciation is also much cheaper than rupiah funding. When liquidity levels are restored to more normal levels, then Indonesia could look at its overall external debt level and the debt ceiling it wishes to operate. This is a sound solvency measure.

Finally, to reduce risks further and to manage such an external debt ceiling, the Indonesian Debt Restructuring Agency (INDRA) could be used to let all debt-related cash flows run via it, it could be the cash-flow administrator, while foreign banks, local banks and companies remain the risk takers. The downturn has been severe, but this provides ample opportunity for the upturn to be strong.

The writer is Country Manager of ABN AMRO Bank. This article has been written in a private capacity.