The rigors of debt mousetrap

The rigors of debt mousetrap

By Vincent Lingga

JAKARTA (JP): The rigors of the debt trap, which has gripped
the government since 1998, will steadily and so sharply increase
the portion of inflexible spending items in the state budget
within the next few years that the government investment's
capacity will remain very small.

The 2002 draft state budget clearly shows how two of the most
inflexible expenditure items -- foreign and domestic debt
servicing and amortization and personnel costs -- will by
themselves take up almost 87 percent of total routine spending or
78 percent of total tax revenues.

No wonder, therefore, that the appropriation for the
development (investment) budget next year, though up nominally by
4 percent, will decline by 6 percent in real terms (adjusted for
inflation), despite the urgent need for a larger allocation for
improving basic infrastructure, the maintenance of which has
virtually been ignored since the 1997 economic crisis.

The two expenditure items above are considered the most
inflexible as it will be impossible for the government to
decrease, let alone postpone, them irrespective of the level of
its revenues. Certainly, personnel costs will not decrease but
will instead have to rise, at least incrementally.

Likewise, debt service and installments will steadily mount
until the mountain of debts is cut significantly.

Unlike the period before the 1997 crisis when the government's
liabilities consisted only of foreign debts, the government's
bail-outs of the banking industry in 1998 and 1999 have exploded
its domestic debt (bonds) to a level almost as high as its
foreign debts now, thereby increasing its total debt mountain to
as high as US$150 billion.

Obviously, bond interest payments cannot be reduced, otherwise
all the largest state and private banks, which were recapitalized
with government bonds, would collapse because almost 70 percent
of their revenues are still derived from bond coupons.

The bond interest cost to the budget could become even greater
than that allocated in the budget if the central bank's benchmark
interest rate were higher than that assumed for the budget
estimate.

For the next fiscal year, for example, the Rp 59.6 trillion
($7 billion, based on Rp 8,500 per the dollar) appropriated for
bond interest payments will rise by Rp 2.2 trillion for every one
percentage point increase over the average benchmark interest
rate, which is assumed at 14 percent next year.

Nor can bond redemption be rescheduled, otherwise the public's
trust in the government's creditworthiness would collapse, and
with it the banking industry.

Bond rollovers also will not bode well for the recovery of the
banking industry as these debt instruments are largely illiquid
in the absence of a secondary market.

But the heaviest pressures on the budget will occur between
2003 and 2009 as more bonds become due, starting with Rp 13.5
trillion in 2003, rising to Rp 52.4 trillion in 2004, Rp 55.9
trillion in 2005 and Rp 59 trillion 2006.

Bond redemption will remain large in the three subsequent
years, ranging from Rp 65 trillion in 2007, Rp 66.44 trillion in
2008 and Rp 69.5 trillion in 2009.

Even more depressing is that these annual huge payment
obligations do not yet include bond interest costs, though their
amount will decline steadily as more bonds are redeemed.

Likewise, foreign creditors allow only rescheduling of debt
principals and even this relief is subject to tough negotiations
and stringent conditions.

Moreover, only sovereign creditors grant such relief, while
multilateral agencies such as the World Bank and Asian
Development Bank, which usually account for almost two-thirds of
Indonesia's official incoming aid annually, never grant such a
facility.

The 2002 budget proposal, for example, still allocates Rp 41.5
trillion ($4.8 billion) for the amortization of debt principals,
even though the government has assumed that sovereign creditors
will approve another debt rescheduling (Paris Club III) for debts
maturing between April 2002 and early 2003, in addition to the
rescheduling already approved for $2.8 billion in debts maturing
between last January and next March.

Set against these horrendous debt repayments, it is needless
to reiterate the vital importance of speeding up asset sales, the
privatization of state companies and debt restructuring to allow
for early retirement of a large portion of the bonds, notably the
ones that charge variable rates.

Even if only about 30 percent of the approximately Rp 630
trillion worth of distressed assets now held and managed by the
Indonesian Bank Restructuring Agency (IBRA) could be recovered,
they would still be of great help to the state budget, at least
during the next two to three years until the economy regains its
robust growth.

Without a significant contribution from asset sales and the
privatization of state companies, the fiscal deficit will explode
to an unsustainable level, with a devastating impact on the whole
economy .

It is certainly impossible to meet these bills only with tax
revenues because the tax revenue base cannot be expanded in leaps
and bounds, given the inadequate tax administration capacity and
relatively low economic growth, at least until 2005.

The government's commitment to raising Rp 6.5 trillion from
the sales of state companies and Rp 42.8 trillion from asset
sales and debt restructuring next year is therefore a very bold,
yet strategic move because Rp 24 trillion of the total will be
used to redeem early bonds with variable interest rates. These
are the debt instruments most vulnerable to interest variations.

But these immense debt obligations are not the only threats
that could at any time explode the 'ticking' fiscal time bomb.

The government still faces fiscal risks from its contingent
liabilities related to government guarantees for bank depositors,
state company loans and the exchange rate for corporate debts
rescheduled under the Indonesian Debt Restructuring Agency
(INDRA).

These contingent liabilities are not included in the 2002
draft state budget because they remain potential liabilities for
as long as they do not become actual debts. But these off-balance
sheet obligations will become an additionally pressing burden to
the state budget once they turn into actual debts.

On top of the mammoth figures on actual debt burdens cited
above, these contingent liabilities are potentially another
ticking time bomb in the fiscal balance.

For example, the Rp 40 trillion in new bonds the government
will issue to replenish the reserve fund for the blanket
guarantee for bank deposits and claims will not impose any
interest costs until they are used to settle the obligations of a
failing bank.

But the risk of another wave of bank failure, thought not as
tremendous as that in 1997-1999, is here to stay until
macroeconomic stability is entrenched, and the economic, legal
and security risks are kept to a reasonable degree to allow for
normal calculation of business risks.

Likewise, the government guarantee for the predetermined
foreign exchange rate used for corporate foreign debt
rescheduling under the Jakarta Initiative will not exact any
liabilities on the budget unless the dollar exchange rate against
the rupiah is weaker than the predetermined level.

Yet still more worrisome is the fact that at a time when its
own financing resources are being severely restricted by the huge
sum of its inflexible spending items, the government is required
to play a larger role in developing and maintaining basic
infrastructure, at least until private investment begins to pick
up again.

Businesspeople have complained about higher production and
distribution costs in various provinces due to the lack of
maintenance of infrastructure soon after the 1997 economic
crisis.

The government should act fast to rehabilitate it, otherwise a
crumbling infrastructure could sabotage the recovery process.
But the government cannot afford an adequate investment budget to
improve, let alone develop, basic infrastructure, which is mostly
capital-intensive and has a long gestation (pay back) period.

The problem, though, is that private investment in such basic
infrastructure as roads, seaport, airport, power generation and
telecommunications will not likely return unless the imbroglios
that are now gripping investors in various infrastructure
projects are satisfactorily resolved.

One cannot imagine what would happen to the basic
infrastructure that is so pivotal to sustain the economic
recovery process if private investment did not begin to return to
this sector in one or two years' time.

For the huge debt burden will keep the public sector in a
cash-strapped condition for the next few years yet.

It is therefore imperative that such disputes as those between
the state electricity company (PLN) and independent power
producers and between PT Telkom and AriaWest be settled quickly
and satisfactorily before they degenerate into messy litigation.

The writer is a senior editor at The Jakarta Post.