Sander Thoenes, Jakarta – Indonesia will need to use taxpayers' money to bail out some of its banks, further depleting a budget already saddled with an 8.5 per cent deficit, according to a senior International Monetary Fund official.

Hubert Neiss, director for Asia-Pacific at the Fund, said public funds would be needed both for recapitalising troubled banks that have been taken over by the bank restructuring agency and for banks that are relatively healthy but could go illiquid for lack of capital.

Any public bail-out of private banks is bound to be costly and controversial as many of the banks are linked to former President Suharto and close associates, who used much of the deposits to fund their own projects. Foreign banks have been invited to invest but few are likely to do so soon. "I'm sure public capital will be needed," Mr Neiss said. "It's a price worth paying for a functioning banking sector." Mr Neiss said the government could also offer matching funds for any outside capital, most likely foreign, that would be injected into viable banks.

It is unclear where such funds would come from. Outlines of a draft budget, approved by the IMF on Wednesday, already allow for Rp15,000bn (£633m) this year alone to pay interest on government bonds that should finance some Rp144,000bn in central bank loans extended to banks. That Rp15,000bn equals 1.6 per cent of gross domestic product, and this figure could easily rise if, as expected, banks fail to pay back their loans. This could boost the forecast budget deficit of 8.5 per cent of GDP, which the IMF is trying to finance with foreign loans.

Mr Neiss said funding for much of this deficit had already been provided for in funds promised earlier to Indonesia, but added that the IMF was still seeking to obtain another $4bn to $6bn in loans. He said Indonesia could not dip further into its useable reserves, already down to $12bn. Mr Neiss said the IMF expected the central bank and the bank restructuring agency, which have been slow to move against banks they have been supporting with loans, to act on the first six audited banks by mid-July by suspending operations, merging banks or bailing them out. Audits on other banks should be completed by August.

The suggestion by Mr Neiss came as the government started revealing the dismal results of audits on the first six of 54 banks that have been put under the bank restructuring agency. It said last week that Bank Umum Nasional, linked to a close associate of Mr Suharto, had overvalued its assets by 38 per cent. Earlier leaks of audit data indicated substantial misreporting among other banks as well, boosting the cost of the rescue of Indonesia's banking sector.

Government officials have been coy on announcing any pending closures, following runs on banks that were caused in part by misinformation. They have only committed to closing banks which fail to meet a capital adequacy ratio of 4 per cent by the end of the year. But using taxpayer money to rescue banks that have been used as cash cows by a handful of wealthy and well connected entrepreneurs will be hard to sell.