Unresolved banking crisis will become a time bomb

Unresolved banking crisis will become a time bomb

Muhammad Chatib Basri is a lecturer in economics at the
University of Indonesia, Jakarta, who is currently completing his
PhD at the Australian National University in Canberra.

The following is a telephone interview with the economist, who
is also a columnist in several leading publications in Indonesia,
conducted by our Melbourne-based contributor Dewi Anggraeni.

Question: It appears that the government is becoming
increasingly powerless in facing conglomerateurs who have huge
debts. For instance, the government has again postponed the
deadline for MSAA (Master of Settlement and Acquisition
Agreement) debtors to submit more assets. What is happening?

Answer: I see a very big and complicated problem; one that is
related to the country's judicial reform. Take Bankruptcy Law. It
is in place, in operation, with appropriate judges. Yet so far
whenever IBRA (Indonesian Bank Restructuring Agency) has
submitted bankruptcy cases against insolvent companies, it is the
insolvent companies who have won.

So the crux of the problem is in judicial reform. It is no
longer a secret that the existence of a court mafia makes it easy
for those companies to win if their cases ever hit the court.
Unfortunately, the companies cannot be declared bankrupt if the
cases are not processed and finalized in court. That is why debt
restructuring is such a difficult task in Indonesia.

Of course there is another option, which is out of court
settlement. So if the government sees that taking the companies
to court will get it nowhere, it can settle the cases out of
court. However, this puts the government, in this case IBRA, in a
much weaker position, and gives the conglomerateurs big
bargaining power. So IBRA would ask, instead of 100 percent
repayment, a much lower percentage, because it would still be
better than nothing, as may be the case if they went to court.

Q: So that was the reason the Coordinating Minister Rizal Ramli
offered big discounts to the debtors?

A: That is correct. The legal process is so complex and
difficult, that in his frustration, Faisal Basri suggested that
foreign judges be invited to serve in our courts.

Let us have a look at some figures. The bankruptcy law came
into operation in 1998. By 1999, only one-fifth of the 130 cases
processed were awarded to the creditors. The rest went to the
debtors. So people quickly got the picture. Out of court
settlements are the lesser of the two bad options.

That is what the government is facing as well.

Q: That means the government is being held to ransom?

A: That's correct.

Q: What has IBRA achieved so far then?

IBRA has achieved quite a lot, for instance, in asset recovery
and recapitalization. However the process has been much slower
than expected; yet the government is running against time. The
problem is, if the restructuring is not done in time, it is very
likely that banking recapitalization will have to be done from
the beginning, once again.

Q: Why is that?

A: The banking restructuring is now done, and the banks are now
recapitalized, with a minimum Capital Adequacy Ratio (CAR) of 4
percent. That has been achieved. In the meantime, the insolvent
companies who remain insolvent and yet not bankrupt, have a
detrimental impact on their banks, because they still have debts
with the banks but are not paying. So the banks cannot expand
because they cannot lay their hands on the cash owed to them. If
this goes on, it may push the CAR lower, requiring the government
to inject more cash into the banks. Where would the government
get the money from for this second banking recapitalization? The
demand on the budget is already too high.

Q: What about from selling bonds?

A: In the long term, selling bonds will cause more problems,
because bonds are the government's debt to the people.

Q: So is the government trapped in a dead-end?

A: In a vicious circle. If the banks are restructured and
recapitalized, yet the conglomerateurs' companies' debts are not
paid, the banks cannot expand, the CAR will be pushed down, and
another recapitalization will be needed.

If the companies pay up but the banking sector is still in a
mess, there won't be any credit flow. So the ideal solution is to
fix both ends, banking recapitalization and debt restructuring.
But debt restructuring faces a big stumbling block, which is the
lack of judicial reform.

Q: So we are lumbered with corrupt judges?

A: That is a public secret. How can you explain a situation where
a person who borrowed from someone gets away with the money with
impunity while the lender is left with the damage?

Even the IMF didn't expect it. They were used to countries
with workable institutions. They expected normal proceedings,
where if you have a debt and are not paying, they take you to
court and you are declared bankrupt then your assets are
confiscated. Yet in Indonesia it is the debtors who won the
cases.

Q: Do we need a demarcation between government and state
institutions?

A: That is correct. I like that observation. If I can offer my
description of the situation, it is as if we have an economy that
operates using sophisticated instruments, approaching the Wall
Street era, yet our social, legal, and political structures are
still left behind in Jurassic Park. So there is a huge mismatch.

Q: What can we rely on now, then?

A: We cannot very well say that our economy is completely
destroyed. If we look at the indicators, the growth in export,
3.9 percent, is good. Inflation is under control. Consumer
spending is up.

In other words, in the short term, we are okay.

One of the most immediate problems I can see is, if we cannot
overcome the banking problems quickly, it will become a time bomb
in the next few years. Let us use Mexico for comparison. When
Mexico came out of its first crisis, its fragile banking sector
pushed it into a second crisis.

This is what worries me might happen with Indonesia. We may be
able to fix the present problems without really curing the
illness. We may see economic improvement as shown by the usual
indicators, but we don't know if it is sustainable at all.

Q: Are you saying that if we had a second crisis, it would be
worse?

A: Yes, much worse. So the government has to handle the private
sector's debt carefully and thoroughly.

As you know, IBRA wants to sell the assets recovered from the
debtors, but they are faced with the option of waiting for the
right time and the right price, or selling them at sale prices.
These are not very good options, obviously.

If IBRA waits too long the economy will deteriorate quickly,
while it is not known when the right time and price will come.

It would be better to sell them to businesses who needed them
to get the economy going, whereas in the hands of IBRA they would
lie idle. If IBRA sells them quickly but at low prices, foreign
investors might come and buy them for as low as 20 percent of the
original value. Either option has a price.

Q: What would you do?

A: My assessment is, we cannot afford to keep waiting. Our
objective should not be getting the highest price, but getting
the economy going again. The IMF also prefers IBRA speed up the
sale of recovered assets.

However this also entails its own dilemma. If this is done, it
is inevitable that foreign investors would buy big. Then we are
very likely to face a nationalist backlash. Would we be able to
accept that our companies are bought by foreigners at very low
prices?

Q: There have been reports that some former owners are trying to
buy back their assets at largely discounted prices...

A: That is right. This has touched people's sense of justice. But
technically it is not hard to do. Supposing there is law against
former owners buying back their assets. When the assets are sold
to the public, the former owners can use a particular agent to
buy them. Then the former owners will buy them from the agent,
still at much lower prices than their original value.

Q: Are we still very dependent on foreign investors to get our
economy going again...

A: I think so. Let us say that we finish up having a second
banking recapitalization, who is going to extend the cash? The
government won't be able to afford it. Domestic investors have
just begun again, they won't have the kind of money for that. So
we just have to rely on foreign investors. However, the foreign
investors naturally might try to push the prices further down.

We also need certainty in law and regulations. As we know, one
thing Gus Dur's government is well known for is its consistency
in being inconsistent. If I were a foreigner with investment
aspirations, I would first see the country's rule of law, so that
I would know what to plan and how to plan. But if the regulations
change every three months, how could I plan my strategy? I would
retrace my steps and wait.

This also happens in our banking sector. People look at Bank
Bali irregularities, where some cash has allegedly finished up in
Golkar's coffers, and understandably shrink back.

Q: CGI (Consultative Group on Indonesia) has approved a new loan
of US$4.8 billion and a grant of US$500 million. Is it good news
or bad news?

A: It is both good news and bad news. The good news is, it is
going to be of great help fiscally, in the short term. We hardly
have a choice. Our three conventional sources of income are oil,
taxes, and privatization of state enterprises.

Now, oil is still good, as the price is good at the present.
But we can't expect too much from taxes in present circumstances.
And privatization of state enterprises is not going very well. So
we can only pin our hopes on oil.

In the meantime, expenses are huge. We have recapitalization,
public service salaries, interest on debt, and others. All these
expenses have to be met. So in the short term, yes we do need
that loan. However do we need US$4.8 billion? It is debatable. We
could rely more on oil. We could cut subsidies, for instance the
fuel subsidy.

Q: Would that not cause social unrest?

A: We don't know that. It is a popular myth that we cannot do
without fuel subsidy. If we pay attention more closely to the
question, who are the real consumers of fuel? The answer is,
those in the middle and upper middle class.

According to official data, among those in the lower socio-
economic groups, 66 percent use firewood as a fuel source, not
kerosene. It is the urban dwellers who buy kerosene. They are
mostly middle and upper middle class.

However, because they are vocal, they may come across as
representing the whole of the population.

Now to return to reducing the budget shortfall, if we couldn't
reduce the fuel subsidy, we would need the loan.

However in the long term, the prospects tend to be gloomy,
because here we have to look at the fiscal sustainability,
whether we will be able to overcome our massive debt problem,
whether we should restructure our debt again, and all that. So
to answer your question, it is both good news and bad news.

Q: How will regional autonomy affect the nation's fiscal
situation?

A: The problem is more administrative than fiscal. New laws can
be introduced to address ways of sharing revenues. We have to be
wary of the likelihood of shifting corruption from the central to
the regional governments, because the regional governments will
suddenly have so much power.

Then there is a likelihood of trade barriers in various
regions, where one product might be free of tariff in one region
but not in another. Problems like this might be more serious.

I am not saying that regional autonomy should not go on. But
the process has to be done with care and extreme consideration.
If that is not done, foreign investors will have untold problems
dealing with each region, and they usually don't like
uncertainties.

Q: So you think the next two years will be crucial in addressing
the broader future?

A: Yes, we will need to finish the debt restructuring and the
required bank recapitalization during that time. If we achieve
that, we can be more optimistic. We already have good
infrastructure. We have banks, we have built roads, we are
relatively better off than say, in 1966.