Indonesia - No way around an external liquidity crisis

Indonesia''s continued spat with the IMF and doubts about its economic policy formation are jeopardizing its access to foreign capital.

Reduced access to foreign capital

Indonesia’s access to overseas capital is being steadily reduced: question marks over the efficacy of economic policy formation are souring the appetite for private sector foreign investment in Indonesia; relations between Jakarta and the IMF have cooled once more, as the Fund delays the latest $400 million loan until some of its concerns over monetary management have been addressed.

The IMF’s concerns, and in part the reticence of foreign investors, reflect the long, drawn-out saga of President Wahid’s battle with the central bank. He wants to curb the independence of the institution and replace the board and the governor. The battle for control of Bank Indonesia (BI) has seen the current Governor, Sabrin, arrested for five months. Upon his release last month, Wahid pledged to secure both his dismissal and his rearrest for alleged corruption. The battle is also reopening old wounds between Wahid and Indonesia’s parliament, as the president has tried to push the legislature into passing bills that will force Sabrin’s dismissal - by stating that any board member unable to perform their duties for three months (he was in jail for five!) must be replaced.

External flexibility remains fragile

Unfortunately, Indonesia can ill-afford a continued spat with the IMF since the need for capital inflows is as acute as ever. Indonesia’s external liquidity position is fragile, whereby only a fraction of the countries outstanding $152 billion (face value) foreign debt, which exceeds 100% of GDP, can be repaid. Of this total, government debt is around $77 billion, which compares with $29 billion in foreign exchange reserves, most of which are loans from multilateral institutions anyway.

Indonesia, unfortunately, faces the prospect of a succession of sovereign debt reschedulings over the coming years, assuming of course the government does not try to crush domestic demand and thus finance debt repayment via a larger current account surplus. (Ethnic tension and the fragility of the concept of “statehood” itself, suggests debt rescheduling is a more viable policy option than a renewed bout of austerity.) Hence, the current account surplus is expected to have peaked at 6.1% of GDP in 2000, when it benefited from high oil prices.

Too early to “buy” the recovery story

The destabilizing battle between Wahid and BI in terms of private sector foreign capital inflows is made all the more worrying since the underlying weakness of Indonesia’s economy suggests that even a sudden outbreak of peace between the two parties would not necessarily usher in the large capital inflows Indonesia requires in the absence of IMF funding.

While real GDP growth improved to around 5% last year, the output gap still measures 12% of GDP. Closing this chasm will be a glacial process, given that faster economic growth is constrained by an unresolved crisis in the financial system, which has effectively ceased to intermediate: 70% of bank assets are government bonds, and of the remaining 30% of assets (a large proportion) are non-performing.

The rupiah takes the strain

The weakness of the rupiah over the past 18 months clearly reflects this underlying fragility to Indonesia’s balance of payments position. Rather than implementing economic policies aimed at securing a steady inflow of multilateral and private sector capital, Wahid’s presidency has been characterized by political infighting with the various institutions of state, and with unpredictable macroeconomic policy settings. After all, before the latest spat between Wahid and BI, the government was prone to airing views over the desirability of capital controls.

Go for the unorthodox financing route

In a move that is entirely consistent with this unorthodox approach to economic management, latest talk from Indonesia suggest that the government is looking at an alternative method of accessing foreign capital, one that does not require Wahid to kiss and make up with Sabrin. A $400-500 million (the sum of the delayed IMF tranche) bond issue is apparently being mulled, one that would be backed by liquefied natural gas (LNG) assets. Finance Minister Rammli is reported to feel that the deal could “double or triple Indonesia’s investment rating” from its current B- level. However, this would not be expected to solve Indonesia’s immediate funding problems.

Backing a bond with assets is a flawed concept in Indonesia, a country where seizing assets is always a difficult process. The problem is compounded by the fact that as of 1 January this year, Wahid’s controversial plan to allow provinces greater autonomy by keeping a large proportion of their revenues from mining, gas and oil industries, came into effect. This will only add to regional tensions and complicate any efforts to back a bond with LNG since each province claims rights to its natural resources, unless security is from $400 million of LNG shipments en route to North Asia. The deal does not seem feasible and the market is unlikely to price it tighter than a straight sovereign.

Rupiah remains vulnerable

For the rupiah, there appears little reason for optimism near-term. The underlying weakness of Indonesia’s balance of payments position is being reinforced by the delay to IMF funding and by the lack of significant private sector foreign investment. Rather than addressing these problems by smoothing relations with the central bank, adopting more transparent and consistent macroeconomic policy settings, and repairing relations with the IMF, Indonesian policy seems to be focused on finding unorthodox methods of attracting foreign capital (the LNG-backed bond.) Hence, the highly undervalued IDR appears poised to fall further, and over the coming months a move higher in USD/IDR towards 10,000 appears likely.

As for the current benchmark sovereign bond, however, Indonesia will remain an example of how overpriced Asia is within a global emerging market context: the Indonesian sovereign bond due in 2006 is currently  trading at 690bp over Treasury's, which is tighter than Argentina's. As with Thailand, the overvalued benchmark reflects a lack of liquidity as local financial institutions buy sovereign USD-debt and swap it back into local currency, in preference to extending credit to local firms.

Desmond Supple is Head of Credit Research for Barclays Capital. Email: [email protected]

 

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