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Indonesia pushes on with bank bailout

Australian Financial Review - January 16, 1999

Greg Earl, Jakarta – The Indonesian Government has warned domestic critics it would be courting disaster to back away from a 300 trillion rupiah ($50 billion) bank recapitalisation program which is about to begin.

The Government-funded plan has come under strong criticism this week from parliament members who say it is too expensive and economists who say it should be more targeted. But after many delays, concrete details on how the country's devastated financial sector may be resuscitated have started to emerge with a new law on an independent central bank, new prudential regulations and a plan to sell the bank recapitalisation bonds to the central bank rather than the market.

And the Government has had a timely reminder about the fragility of the recovery program, with the rupiah suddenly falling sharply to trade around 9,100 on Friday to the $US, compared with a budget full-year average projection of 7,500. The currency has been buffeted by new fears of political instability, a year after the unit plunged after last year's budget, and also the depreciation of Brazilian currency.

The Government plans to recapitalise the State banks and development banks by the end of the month, which will allow them to begin restructuring debts.

As part of the clean-up, the central bank this week tightened the net open position allowed for foreign exchange positions to 20 per cent of bank capital from 25 per cent. But the legal lending limit to non-affiliated companies had been allowed to increase to 30 per cent of capital from the existing 20 per cent in an acknowledgement of the weaker capital position of banks. It will progressively be returned to 20 per cent.

At the same time, the central bank said it has repaid nearly all outstanding trade finance debts of local banks to foreign banks under an agreement reached several months ago to restart the trade credit system. Under the deal the repaid foreign banks are meant to maintain their trade finance exposure to Indonesia at the same level as last April in what will be a significant test of sentiment towards Indonesia as it moves towards a tumultuous election.

The Government sought to boost its reform credentials this week by unveiling a new law on central bank independence which will confine the institution to monetary policy management and overseeing the payments system. Subsidised credit creation and bank oversight will move to new institutions and the Government will only have the right to put its views to the bank at a monthly meeting. But Bank Indonesia is being called on to do one final rescue mission and buy the bonds issued to recapitalise the banks, which will save the Government from a failed effort to sell them in the market.

Finance ministry officials say the central bank will buy the bonds in instalments to avoid an excessive impact on the money supply. In a bleak assessment, National Development Planning Minister Mr Boediono said that if the Government closed all bad banks not only would it bear a large deposit insurance burden but the few remaining banks would not be able to service the economy.