Country Experiences of Indonesia on External Debt Management

Abstract External debt has been generally intended to fill saving-investment gap in the domestic economy, but with domestic and international economy and political conditions including arbitrage opportunities it will distort from the original assumption and the result will be unexpected. Highly exposure of external debt is vulnerable to external shock. Once the shock happened, it will disturb the entire economy. This paper deals with the important issue of solving external debt problems in Indonesia. As a starting point, this paper high lights the historical and recent experiences of external debt crisis in Indonesia including its impact to some aspects of the economy. The second part is a description of policy has been taken and their consequences. The third part will be a discussion on policy direction towards a better solution. Before conclusion the paper will briefly discuss the growing concern on public external debt management issue in the country.

1. External Debt Crisis: historical and recent experiences In the early 1960s as a new independent country, government needs fund to finance countrys development. While only limited domestic fund source available with undeveloped domestic capital market, to fill domestic savinginvestment gap external fund was the only available source. It is defined the primary goal of external fund was to accelerate urgently needed economic growth, where the external debt would turn into governments spending which in turn would generate investment and to accelerate the growth. As economy developed, it was expected that the government could earn sufficient foreign exchange to service foreign obligations, to accelerate the development process, and gradually to lessen the countrys dependence on external resources. And still in the 1990s, external public debt actually was not solely addressed to fill the financing gap of the government but rather to fill up budget deficit in order to foster the economic growth rapidly. The huge growing number of external debt used

Presented by Kusumaningtuti S.S, Director of International Affairs, Bank Indonesia, at the Regional Workshop on Capacity-building for External Debt Management in the Era of Rapid Globalization, Bangkok, 6-7 July 2004

however has not always significantly contributed to the growth expected. Its true that the economic growth used to reach the level of 7% in the middle of 1990s. But on the other hand, the debt service also increased significantly. The debt burden indicators proved this phenomenon as the debt level today is almost the same as total GDP amounting to 91% in 2001 and decreased to 66% in 2003, but still the ratio has rising sharply from only 48% of GDP in 1996. One of the reasons is that the external financing was used to finance imports, or exports that dependent on highly import content. Apart from that, the governments effectiveness in controlling the usage of foreign funds had been questioned, while the financed industries were not found to become export oriented although the corporate sectors had been proved to borrow from abroad excessively, particularly during the early 1990s. The increased external borrowing appetites in the early 1990s was encouraged by foreign exchange policy environment, where business entities can easily calculate the possibility of currency risk as the government regularly depreciate the value of Rupiah by around 5% annually against US dollar. The corporate entities particularly simply took the risk by borrowing from abroad and selling their products domestically because Rupiah depreciation was relatively predictable and there was high potential demand from domestic market at that time. To some extent, lack of liquidity of the economy due to tight money policy implemented by monetary authority triggered corporate entities to search for alternative funding from abroad. Likewise, as part of the reason of the excessive borrowing to abroad was the domestic bonds market had not established yet. However, the financial crisis in mid 1997 has led a massive capital flight from Indonesia following a sharp falling down of the value of Rupiah against US dollar. As Rupiah lost its confident, the deterioration of economic fundamentals was further compounded by the slowing down of exports, rising of domestic interest rate, falling down of investments and foreign direct investments, which ended up with enormous contraction of the entire economy accompanied by heightened social and political tensions emanating from massive unemployment and widespread poverty. The adversely impact of the deterioration of economy to the external sector was very clear. Repayment obligation in Rupiah increased due to weakening of Rupiah, which in turn reduced Indonesias government and its private sectors ability to meet their responsibilities. The depreciation of the Rupiah against US dollar means that more of Indonesias exports earnings must be paid as debt pay back rather than being spent on productive social expenditures. Poor management of business entities is among the major factors, which is believed has led the economy into a deepening crisis. The poor management was reflected in the mismatch in the balance sheets of a large number of banks and corporations. This mismatch is classified into two components: maturity and currency. Maturity mismatch refers to the use of short-term debt to finance long-term projects. Currency mismatches points to the use of foreign currency denominated loans to fund Rupiah-generating projects that do not earn foreign exchange.

In the pre-crisis era, these mismatches did not engender large difficulties for Indonesias economy because of the exchange rate stability and the ordinarily smooth rollover of short-term external debts was a common practise. Nevertheless, when the Rupiah suddenly plummeted, within a short period of time the corporate and financial institutions were confronted with a massive increase in the Rupiah value of their indebtedness. As most of their liabilities had short term maturities, domestic debtors did not have enough time to restructure their debts. Consequently, many corporations fell technically into state of bankruptcy. Even if they managed to survive, their room for movement particularly for investment had been substantially narrowed because of their growing operation costs to restore their balance sheets. The mismatch resulted in a dramatic deterioration of performance of not only the business, but also banks and the overall economy. The governments finances were by no means immune to this effect. As a result, government tax-based revenue from business and banking sectors shrank. At the same time, oil/gas revenue also declined. On the other side of the budget, government expenditures swelled. The increase in government expenditure was primarily driven by the need to ease the burden of the poor hard hit by the crisis through social safety net and subsidy allocation. Therefore, the state budget of 1998/99 ran into a large deficit, which eventually caused the governments ability to service its debt weakened significantly.
Indonesia's External Debt
160 140 Billion USD 120 100 80 60 40 20 1997 1998 1999 2000 2001 2002 2003 Apr-04 Government Private

External Debt to GDP

160% 140% 120% 100% 80% 60% 40% 20% 0% 1996 1997 1998 1999 2000 2001 2002 2003

Since the economy was dramatically hit by the crisis, the external debt then becomes a serious problem to the country. Even, Indonesias external debt problem recently is considered burdensome because the debt has put threatening amounts of pressure on the balance of payments and on the governments finances. During the period of economic crisis, the debt stock increases significantly. Meanwhile, despite the external debt to GDP ratio for the last 3 years relatively decreases from 91% in 2001, 76% in 2002 and 66% in 2003, respectively. But, the ratio is actually rising sharply from only 48% of GDP in 1996. Indonesias heavy debt burdens are a major source of macroeconomic vulnerability, and hence a significant constraint on country creditworthiness. While from different perspective, the scale of Indonesias debt problem is not only resulting in social and political tensions, but high debt repayments are reducing the budgetary and fiscal stability, which Indonesian government needs to allow it to stimulate growth through increased productive investment, and to finance the cost of social safety net measures. The public debt burden reduces budgetary flexibility because a large portion of revenue must be given up for debt repayment (it is estimated that debt service obligations will be over 40% of government revenues for the next few years) while leaving the budget vulnerable to external shocks such as changes in the exchange rate, interest rate and inflation.

2. Debt Resolution and Its Consequences To solve public external debt burdens Government of Indonesia (GoI) has been relying on the rescheduling basis particularly under the Paris Club framework. Under this framework, GoI and creditor countries have agreed to reschedule the amount of USD4.5 billions in Paris Club I with maturity over 11 to 20 years, USD5.8 billions in Paris Club II with maturity over 15-20 years, and USD5.4 billions in Paris Club III with maturity over 18 to 20 years. Unlike the previous Paris Club rescheduling, in this latest arrangement the Government of Indonesia is granted rescheduling from the official

bilateral creditors not only for the principal repayments but also for the interest payment obligations. GoI has also rescheduled its bilateral external debt with non member of Paris Club countries and its cobmmercial external debt to commercial banks under London Club Agreement. In accordance with Paris Club I, as much as USD210 million of syndication loans signed in 1994 was restructured, while in line with Paris Club II, as much as USD340 millions of syndication loans signed in 1994 and 1995 was restructured. Meanwhile, as a consequence of comparability of treatment of the Paris Club III, as much as USD1.3 billions of syndication loans signed in 1995, 1996, and 1997 was successfully restructured. However, the policy taken over rescheduling itself has been intensively debatable. Many critics opposed this alternative to resolve government from its debt burden. It is understandable that a rescheduling relieved a country debt burden only for several years by shifting its current obligation to certain period of time, but the amount is too little compared to Indonesias total debt burden and stock. In this regards, the Paris Club rescheduling will not be able to solve Indonesias debt burden. As the consequence of the rescheduling, the new debt terms are relatively higher than the original debt terms. It is understandable that as debtor that has less bargaining position to accept such treatment. Despite having succeeded to reschedule debt service through the Paris Club and London Club forums, GoI actually still has to pay a large number of its external debt obligation for multilateral debts, which in fact has been the largest debt owed by GoI. As of end of April 2004, the multilateral debts exhibit a number of USD29 billions or approximately 36.8% of total public external debts. Nevertheless, it is no doubt that rescheduling has been one of the most helpful ways to resolve the serious treat of liquidity problem in the state budget deficit for the government. A part from its concern with public external debt, government also has been aware of how important to quickly resolve the debt problem of corporate sectors. And one of the important steps in solving the corporate debt overhang is the Frankfurt Agreement. The agreement was reached on June 4, 1998. A team for private external debt settlement represented Indonesian debtors. The team, founded by the government, managed to reach an agreement with external creditors represented by the Bank Steering Committee. The Frankfurt Agreement covers interbank debt settlement, trade financing and private corporate debt. The interbank debt settlement program proceeded with an exchange offer program that reschedules bank debts. The trade finance program proceeded with reviving credit lines after Bank Indonesia had addressed the overhang of trade arrears. As cited above, to resolve the corporate debt overhang, the government has set up the Indonesian debt Restructuring Agency (INDRA). The government has also

provided facilities to speed up the negotiation process between debtors and creditors through the Jakarta Initiative Task Force (JITF). Despite the progress of corporate debt restructuring under JITF has been quite positive; however, in general the corporate debt restructuring process is still relatively slow. And this has become a major handicap of corporate sector in Indonesia to return to its normal business activity.

3. Policy Directions on External Debt Experiencing such economic crisis that has led to multi-dimensional crisis, made the government took some curative and preventive policies and actions related to external debt problems. In the short term, resolving debt burden has been the priority of government in a way to ease the pressure over budget deficit. The government in this regards has taken the strategy to re-manage the debt profile in a way to meet the target of short term fiscal sustainability. The most possible way to ease the pressure over the budget deficit on that time was to obtain another rescheduling facility from Paris Club creditors. However, the government has decided to discontinue IMF programme since 2003, so it will eliminate rescheduling option through Paris Club creditors. But in correlation with Paris Club rescheduling, there are options to get debt swap through Bilateral Agreement. The government has started to exercise this option; In 2003 the government have already secured a DM50 million debt-for-nature swap from Germany. The facility is used for assisting water-related projects such as environmental conservation and food security programs. The efforts still continue and expecting to get from England, France, Canada, Finland, New Zealand, Italy and Sweden. Since the option to ease and funding deficit already limited, as a consequence government needs to find another source to fill budget deficit. As a part of the crisis solution, to save banking Industry, the government issued domestic bonds to recapitalize banking industry, which then requires developing of domestic bond market. Currently the government is still continuing develop domestic bond market. Due to the condition of domestic bond market, to fulfill the budget deficit especially in 2004, after considering potential funding sources from domestic bond market, government on March 2004 issued USD 1 billion 10 years global bonds. Other purposes of this issuance are to establish Indonesian benchmark in international financial market objective and to provide diversified sources of fund and broaden investor base. Meanwhile, in relation with corporate external debt problem besides utilizing INDRA that will be ended on 2006 and JITF that have closed on 2003, Bank Indonesia, the Central Bank as preventive policy started on 1997 has initiated to monitor private external debts. The monitor is conducted through monthly reporting system administered

in the central bank. It has evolved to be a sophisticate reporting system using web based reporting system. With this reporting, the picture of private external debt exposure will be captured and so with the debt burden projections. It is hope that the picture will be used as an early warning system and consideration for policy direction. Experiencing the crisis with huge external debt exposure, government strives to lessen the countrys dependence on external resources and achieve save level of public debt to GDP ratio.

4. Indonesias Debt Management: current external debt management and its consequences Despite the fact that government of Indonesia has been relied on the external debt financing since the last couple decades, the role of debt management has been collectively played in a coordinated way by ministry of finance, central bank, the national development planning agency, coordinating ministry, and other ministries concerned. There are two objectives, which will be achieved in conducting such debt management, called ultimate objective and operational objective. The ultimate objective is to maintain the countrys creditworthiness and capability for servicing the external debt. Whereas the operational objective concerns with the following matters: (i) the usage of external debt is directed to the productive sector which generates foreign exchange and match to the development priority, (ii) to maintain an access to the market, and (iii) to keep cost and risk low and favourable. Practically, in managing the external debt, government divides the conduct of external debt management into 6 main steps: planning, negotiating, signing, drawing, repaying, and reporting & monitoring. Planning: government basically designs the needs of external funds to finance the governments financing gap. This stage includes defining the amount, sources, and projects to be financed by external funds. The ministry of finance and national development planning agency are responsible in this regards. Negotiating: Obviously, ministry of finance and Bank Indonesia involve in the process of negotiations. Signing: ministry of finance handles this job on behalf of the government of Republic of Indonesia, and Bank Indonesia under power of attorney given by ministry of finance. Drawing: This process normally consists of 4 types of mechanisms: letter of credit, direct payment, reimbursement, and through special account. The process of drawing involves ministry of finance, Bank Indonesia, and other ministries concerned. Repaying: The process is conducted by Bank Indonesia based on schedule given and formal instruction from ministry of finance.

Reporting and Monitoring System: Bank Indonesia and ministry of finance share this job altogether. A part from that, in reality, Bank Indonesia has become far more involved in public debt management. The contribution of the bank in managing public external debt includes giving advice on policy direction of public external debt, recording and maintaining external debt statistic including external debt of private sector, drafting of loan agreement, negotiating i.e. Paris Club and London Club, conducting repayment and disseminating external debt data. However, many people questioned the conduct of the existing system. This group of people argued that a scattered institution conducting debt management will easily get trap into bureaucratic problems including lack of coordination among institutions, weak of responsibilities & policy direction toward the objective, and weak of control on the usage of funds. Likewise, it is cited by this group that in fact there has been no institution managing the countrys debt (public and private external debts, and domestic debt) simultaneously. Consequently, they curiously questioned whether the conduct of public debt management, particularly public external debt management has been effective. The history has given the evidence that non integrated debt management system adopted by the government of Indonesia has brought serious handicaps in managing Indonesias external debt, including in the area of implementation of objective and strategy, the conduct of risk management, and the duplication of job. As a result, the external debt, which initially addressed to filling up the financing gap in order to foster economic growth, has left a serious burden to the economy from time to time. From the explanation given above, it is clear as well that poor debt management is one of a major problem that exacerbate financial crisis in this country. Therefore, for a country like Indonesia improving its debt management capacity, particularly its external debt management, is becoming very important and urgent. The country should reinforce its debt management capacity by carefully reassess major aspects of existing system such as legal basis, authority, human resources, organizational structure and management, and system. 5. The challenges in setting up sound external debt management External debt management is a multi dimension task involving the formulation of transparent strategy for managing the level of debt, and establishing an appropriate institutional framework (DMO). Indonesia case is rather to put the priority in establishing the framework (DMO) than redefining strategy formulation of external debt management without seeing the latter as less important issue. Establishing an independent, effective and efficient debt management office (DMO) in Indonesia is not an easy work to do. It involves many parties and institutions with different background of corporate culture, experience, capacity building, vision and interest. Despite building an efficient DMO in Indonesia will have many challenges but, this should be given a priority because the debt crisis is ongoing problem and with a clear and direct consequences for the economy of the country. An efficient DMO is believed to 8

be one of governments vehicles to break through the wall of debt crisis which remain unfavourable to the economic recovery for the last couple years. It is mentioned above that current framework of Indonesias external debt management is scattered among some institutions. Consequently, beaurocracy battle regarding to any effort of integrating process of different institutions to be an independent DMO will be unavoidable. Even, once this initial challenge has been resolved, the process will face further challenges including: deciding the location of DMO (inside or out side the government), filling up the position with right person (expertise) based on his competency, picking up a current and user friendly technology information, operational budgeting issue, and building a new corporate culture to support organisational dynamic toward vision and objective of the institutional framework. In the context of human resource for example, debt management needs staff with wide range of financial and analytical skills, and a competency of macroeconomic knowledge. Since these requirements are also demanded by other government and private sector, it is essential for management to attract and retain highly skilled staff with appropriate remuneration, a clear career path and mandate, including responsibilities and access to relevant training in a way to improve job qualification and anticipate future challenges. Currently, the government is aware to continue carefully manage is external debt to minimize the cost of borrowing, consequently to ease the pressure of external debt burden to budget over the long run. In order to achieve such objective Government put priority on the following direction: gradually reduce budget deficit to achieve balance budget on 2005-2006, reduce public sector debt to GDP ratio to the save level, tax policies reform, improve government spending efficiency and develop effective public debt management. At the lower level the government needs to: implement sovereign debt law, clearly define debt borrowing policy and reinforce the external and domestic debt management under one roof with reorganization within Ministry of Finance.

5. Conclusion Indonesias external debt problem is considered burdensome because the debt has put threatening amounts of pressure on the balance of payments and on the governments finances. Many of us believe that poor debt management is one of a major problem that exacerbate financial crisis in this country. Therefore, for a country like Indonesia improving its debt management capacity, particularly its external debt management, is believed to be a key element of the country strategy for ensuring a robust and sustained exit from unsustainable debt burdens, to foster economic growth and sustainable development without creating external payment difficulties.