Access to Trade Finance in Times of Crisis

Book
Chapter

Chapter 4. Indonesia's Experience in Dealing with Trade Finance Shortfalls during Financial Crises

Author(s):
Jian-Ye Wang, and Márcio Valério Ronci
Published Date:
February 2006
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Author(s)
Peter Jacobs 34

The Asian currency crises that began in mid-1997 brought intense pressure on Indonesia’s balance of payments. Although Bank Indonesia intervened in the foreign currency market and tightened liquidity by increasing interest rates, confidence was not quickly restored and capital outflows increased rapidly. As a result, gross foreign assets declined by $4.5 billion from $28.6 billion in July 1997 to $24.1 billion in November 1997.

Depreciation of the currency contributed to high inflation (mostly imported inflation) because of the import content for Indonesian products, either for domestic consumption or exports. At the same time, Indonesian imports declined drastically. The drop was most pronounced for semiprocessed raw materials, spare parts, transportation equipment and parts, and capital goods equipment. Expensive and scarce imported materials caused a number of manufacturers to reduce their imports. The supply of raw materials was also disrupted, as a number of plants closed down their operations. These closures not only disrupted the operations of other domestic plants but also reduced the export of raw materials. 35

Given Indonesia’s high dependence on imports for domestic and export production, the sharp increase in the cost of imports (due to depreciation of the rupiah against the dollar) contributed to a drop in both imports and exports. During the six months after the crisis (September 1997 to March 1998), imports declined by 34.8 percent, while exports also fell by (Figure 4.1). The drop in nonoil/gas imports resulted from a major slowdown in production and investment activities in the country, as well as from foreign banks turning down import letters of credit due to the banks’ reduced confidence in the ability of Indonesian firms to service their debts.

(In billions of U.S. dollars)

Figure 4.1.Indonesia: Non-oil and Gas Imports and Exports

Source: Bank of Indonesia.

The exchange rate crises translated into prolonged monetary tightening and banking crises and affected trade financing operations in several ways:

  • International parties asked foreign banks to confirm letters of credit issued by domestic banks;

  • Opening domestic banks faced obstacles in obtaining letter of credit confirmation from overseas banks;

  • International banks did not allow amendments to letters of credit; and

  • A number of international banks discontinued their credit lines.

As a consequence, national banks become more selective in issuing letters of credit and limited them to sight letters of credit. With increased risks, international banks became more selective in choosing letter issuing banks for letters of credit. Moreover, confirmation fees were raised, while credit lines extended became more limited (Table 4.1).

Table 4.1. Indonesia: Trade Financing
  1995 1996 1997 2002
Interest rate 1 10 percent 9.5 percent 9.5 percent 4.5 percent
Discount rate 2 Libor plus 3 percent Libor plus 3 percent Libor plus 3 percent Libor plus 3 percent
Letter of credit confirmation fee for oil less than 1 percent less than 1 percent 2 percent 0.75 percent
Letter of credit confirmation fee for non-oil 1 to 3 percent 1 to 3 percent 4 to 6 percent 1 to 3 percent
Credit line Unlimited Unlimited Limited 3 Mix 4
Source: Bank of Indonesia.

Libor (USD) 3–6 months plus margin.

Libor (USD) 1996–1997: 5 to 6 percent, Libor (USD) 2002 : 1 to 2 percent.

Credit line opened limited only for existing credit.

Credit line for big banks (mostly state owned banks) are available but not for smaller private banks.

Policy Responses

In view of the important role of trade financing in restoring economic activity and easing balance of payments pressures, the government initiated policies to address the international trade problems and the external debt overhang. This included efforts to (i) expedite flows of trade and provide trade financing facilities to generate foreign exchange earnings, and (ii) overcome liquidity difficulties in foreign exchange through the restructuring of principal and interest payments for maturing short-term external debts.

In November 1997, the ministry of industry and trade announced that exporters of certain products would be designated as “prominent exporters.” These exporters were given priority in financing and expediting procedures for their products. Unfortunately, some countries regarded this facility as a subsidy.

Bank Indonesia, on behalf of the government, also provided some targeted financing and guarantee schemes for exporters through banks. These included the following:

  • A swap and forward facility for prominent exporters. Introduced in November 1998, this scheme was intended to provide a hedging facility for exporters. However, while the facility was needed, Bank Indonesia was not allowed to give a subsidy in the premium. 36 This was the main reason why the scheme was not utilized, and essentially terminated in May 1999.

  • Post and preshipment financing (rediscount facility). To address liquidity problems, banks could issue bank drafts with underlying export transactions to be financed by Bank Indonesia at discount. Most of the exporters that benefited from the scheme were prime customers of some banks, primarily big exporters. Due to problems of nonperforming loans, capital adequacy ratios, and other prudential considerations, Indonesian commercial banks avoided taking the commercial risk involved in financing small and medium-sized exporters.

  • A Bank Indonesia cash collateral scheme. In order to help banks get their letters of credit accepted internationally, Bank Indonesia deposited $1 billion in 12 prime foreign banks to guaranty letters of credit issued by Indonesian banks. The letters had to be import letters of credit s related to exports, and export proceeds had to cover the payment to Bank Indonesia. With this scheme, banks not only enjoyed letter of credit guarantees, but also obtained financing for up to 180 days. The scheme was reasonably successful. Exporters who benefited under the scheme and oil/gas importers also enjoyed the letter of credit guaranty for their critically needed imports. The facility was established January 12, 1998 and terminated June 22, 1999, and there was no default. Total utilization of the scheme was $932 million, DEM 1 million, NLG 36,000, and CHF 130,000.

Other Initiatives

Due to the success of Bank Indonesia’s placement scheme, the government signed a loan agreement in 1998 with the Japan Exim Bank (JEXIM) 37 to provide a collateral/financing scheme of $1 billion (JPY 138.75 billion) to guarantee and finance imports related to exports. The scheme was not popular because banks that wanted to benefit from the facility were required to use the guarantee as well as the financing. Banks could not benefit only from the guarantee, as was the case in Bank Indonesia’s cash collateral scheme. Besides, banks also need working capital (preshipment financing) to purchase raw material from the domestic market, which was not possible under the JEXIM scheme. Therefore, until December 1999 there was little use of the fund, at only $132.2 million (or 13 percent of total funds).

Also, the government and Bank Indonesia made efforts to arrange cooperation with international institutions as well as to provide guarantees for trade finance, in particular through letters of credit guaranteed by the government. The cooperation has produced several guarantee schemes, such as the Export Finance and Insurance Corporation (EFIC, Australia), the GSM-102 (Commodity Credit Corporation—U.S. Department of Agriculture), U.S. Exim Bank, Export Credit and Guaranty Department (ECGD, England), Kreditanstalt fur Wiederaufbau (KfW, Germany), Export Development Canada (EDC) and the Canadian Wheat Board (CWB). The schemes were designed to smooth exports to Indonesia.

When crises occurred, a large amount of trade financing arrears arose because the banks could not honor their obligations. Foreign banks tightened their credit lines, thus aggravating the liquidity problems of Indonesian banks. In this context, the Indonesian government made an agreement with a group of bank creditors in June 1998 to secure a trade finance credit line (the Trade Maintenance Facility–TMF), restructure interbank debt (the Exchange Offer Program), and establish the Indonesian Debt Restructuring Agency (INDRA). The precondition of the agreement was that Bank Indonesia (on behalf of the government) had to settle all the trade arrears so that the trade credit lines would be opened and the interbank debt structured. The amount of trade arrears paid by Bank Indonesia amounted to $1.4 billion.

The settlement of trade arrears enabled the country to obtain credit lines of $2.76 billion from 104 international banks. Of the total, 63 banks submitted their respective confirmation letters that were endorsed by Bank Indonesia to obtain a government warrant worth $2.28 billion (80 percent), and the national banks realized an amount of $1.37 billion (60 percent).

The TMF was initially scheduled for one year but was then extended by two more years. The government extended the program because international banks could not provide credit without guarantees from the government. The TMF was terminated in June 30, 2001. The large size of the unused resources was primarily attributed to uncertain expectations regarding the rupiah exchange rate and the high risk premium carried by the banks in the face of concentrated commercial risks that had not been adequately diversified. Another cause was an unfortunate mismatch of import products between those that were guaranteed and those needed by domestic exporters.

Since 1996, Bank Indonesia has sought to establish an export credit agency to help maintain export competitiveness, mainly against countries that have benefited from the support of a specific institution specializing in export financing. Realizing the urgent need to promote exports, the government in 1999 established such an export credit agency, which was later called Bank Ekspor Indonesia (BEI). The establishment of the autonomous BEI was in line with the new law of Bank Indonesia, which required that the function of supporting exports be removed from the central banks. The transfer included the JEXIM TSL 7 scheme on December 23, 1999.

Lessons Learned

The Indonesia experience offers several lessons for countries in financial crisis. First, in times of crises, when international confidence collapses, the government can play a major role in helping banks and exporters/importers continue carrying out external trade without disruption. The government should provide temporary financing during the crisis and work toward restoring international confidence through transparency in policy and information.

Second, the timing in coming up with proper policy response is very important. Slow responses can worsen the situation, while quick and decisive actions may make a difference in mitigating the worst aspects of the financial crisis.

Third, while the government’s capacity to provide interventions may be relatively limited, its willingness and seriousness to cope with the disruptions in trade finance provides a conducive atmosphere for investors and creditors to restore their financing.

Fourth, government must prioritize any schemes or facilities that support export. At the same time, a government must be very critical and cautious of foreign creditors’ demand for guarantees. For example, an export credit agency may demand government guarantees to cover consumption exports from the agency’s country, while the government should focus on imports needed as inputs for exports to allow for a buildup of reserves.

Fifth, government intervention, where warranted, should be designed in such a way to minimize loopholes or the potential for abuse. In Indonesia’s case, to rescue banks from short-term liquidity problem, Bank Indonesia provided liquidity support, which was later financed by the government through issuing government bonds (recap bonds) amounting to Rp144.5 trillion. The state auditor later found some errors that led to a government agency and some private sector borrowers being taken to court.

Finally, bilateral swap arrangements, either between central banks or commercial banks, can be used to bridge confidence gaps when they arise. In this regard, Indonesia’s recent bilateral swap arrangements with Japan, China, and Korea are intended to prevent and address any future temporary trade finance and balance of payments shortfalls.