## wp1797

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### Macroeconomic context and corporate vulnerabilities
- Real GDP growth decelerated from 6.4 percent year on year in 2010 to around 5 percent in 2016.
- Indonesia’s export prices were pushed by nearly 15 percent from their peak in end 2013/early 2014.
- Since 2014, the exchange rate has remained broadly unchanged in real effective terms but depreciated more than 10 percent against the U.S. dollar.
- Despite weakened growth, aggregate corporate leverage increased, notably in foreign currency.
- 5.3 percent.

### Key corporate-sector facts and indicators
- Net income was about 14 percent of total assets in 2014, the highest among the EM peers referenced.
- Indonesia’s liabilities-to-asset ratio is below that of many EM peers (Figure 2).
- Many corporates rely on internal cash flows rather than external financing.

### Foreign-currency (FX) debt exposure and composition
- FX corporate debt (including that owed to domestic banks) doubled from 2010, reaching around 20 percent of GDP in the second quarter of 2015.
- Around 90 percent of debt securities issued in 2014 were FX denominated.
- FX debt now accounts for around 60 percent of the total corporate debt.
- FX corporate debt is concentrated in the commodities and selected non-tradable sectors.
- Two-thirds of non-bank private corporates’ external debt maturing within a year is owed to affiliates.

### Risks identified and their drivers
- Currency mismatches:
  - Some portion of FX debt is estimated to be unhedged, partly because hedging costs are generally high.
  - Bank Indonesia’s hedging regulations have helped corporates manage currency risk, but many corporates have only partial hedge positions or use derivative instruments with knock-out features, making exposure sensitive to rupiah depreciation.
- Refinancing risk:
  - Rollover needs of FX debt securities were set to rise in 2016 and a large proportion of maturing debt is leveraged or high-yield.
  - Bank Indonesia’s new requirements that only corporates with investment grade credit ratings can issue FX debt starting from 2016 could affect issuance capacity.
  - Despite peaking, rollover needs within a year appeared manageable.
- Default risk:
  - The interest coverage ratio (ICR) has fallen sharply, with a fifth of the sector witnessing the interest coverage ratio falling below 1.
  - Corporates in the resource sector were under the most pressure.
  - A recent rise in nonperforming loans (NPLs) and special mention loans in the banking system mirrors increased default concerns.

### Analytical approach and overall assessment
- The paper applies the Bottom-Up Default Analysis (BuDA) framework (Duan, Miao, and Chan-Lau, 2015) that exploits equity prices together with balance-sheet indicators of profitability and liquidity to estimate firm-level probabilities of default (PDs).
- The BuDA framework complements debt service capacity analyses and other market-based approaches.
- The analysis suggests that risks in the corporate sector are manageable even under a protracted recession accompanied by a large currency depreciation, reflecting a relatively low ratio of aggregate corporate debt to GDP.
- On a system-wide basis, near-term refinancing risk is characterized as low.

### Box 1. Bank Indonesia’s Foreign Exchange Regulations on Corporates
- FX regulations (prudential measures introduced October 2014):
  - Objective: Encourage corporates with external debt to enhance risk management.
  - Hedging ratio:
    - Defined as the ratio between the total value hedged and the net short-term foreign liability position.
    - Minimum hedging ratio: 20 percent for 2015 and 25 percent for 2016.
    - Applied to net foreign currency liabilities with a maturity period up to three months, and those that mature between three and six months.
    - Exemptions: Export-oriented corporates—corporates with a ratio of export revenue to total revenue exceeding 50 percent of the previous calendar year—with financial statements issued in U.S. dollars.
  - Liquidity ratio:
    - Defined as the ratio between short-term foreign currency assets and short-term foreign currency liabilities.
    - Minimum ratio: 50 percent for 2015 and 70 percent for 2016.
  - Credit rating requirement:
    - Nonbank corporates should have a credit rating of no less than BB or equivalent issued by an authorized rating agency, including Moody’s (Ba3), S&P (BB-), and Fitch (BB-).
    - The validity of the credit rating is up to two years.
    - Corporates can use a parent company’s credit rating for the external debt of parent companies or external debt secured by parent companies.
    - Exemptions are made for external debt related to infrastructure projects, external debt secured by multilateral institutions, refinancing, and trade credit.
- Reporting requirement:
  - Corporates with external borrowing should submit quarterly reports to BI regarding their hedging and liquidity ratios for each quarter, starting from 2015.
  - The report covers a corporate’s hedging ratio, liquidity ratio, and credit rating, and all supporting documentation.
- Sanctions and enforcement (implementation timeline):
  - Administrative sanctions to be imposed from 2016 in the form of warning letters to “related parties” in the transactions, including:
    - The lenders which are providing the non-compliant debt.
    - The Ministry of Finance.
    - The Minister of State Owned Enterprises (in the case of borrowers that are state-owned enterprises).
    - The Financial Services Authority (OJK).
    - The Indonesia Stock Exchange (in the case of listed-company borrowers).
- Implementation phases and key implementation features:
  - Phase timing:
    - Phase 1: 2015
    - Phase 2: 2016
    - Phase 3: 2017 onwards
  - Object of regulation: Governs all foreign currency debt.
  - Hedge ratio application by maturity bucket:
    - ? 3 months: 20 percent (2015); 25 percent (2016)
    - 3-6 months: 20 percent (2015); 25 percent (2016)
  - Liquidity ratio minimums:
    - 50 percent (2015)
    - 70 percent (2016)
  - Credit rating: Minimum rating of BB- as of 2015:Q4.
  - Counterpart of hedging transaction:
    - Phase 1: Not necessarily be done with a bank in Indonesia.
    - Phase 2 and onward: Must be done with a bank in Indonesia.
  - Sanctions: Administrative sanctions will be imposed (from Phase 3/2017 onwards).

### Scenario projections and key macro assumptions
- Baseline scenario:
  - Unemployment rate: would decline gradually to 5.7 percent.
  - CPI inflation: would fall to 4.4 percent.
  - Rupiah movement: would range between –3 percent to 4 percent year-on-year (y/y) every quarter.
  - One-month JIBOR interest rate: decline moderately to 6.7 percent.
  - GDP growth: implied baseline (text context) with median corporate PD rising somewhat higher than during the taper tantrum in 2013.
- Downside scenario:
  - GDP growth: sharp drop to below two percent y/y.
  - Unemployment rate: would jump to nine percent and return to somewhat above eight percent.
  - CPI inflation: would surge to above ten percent on account of path-through effect before returning to 6 percent.
  - Rupiah depreciation: would depreciate by 14–20 percent y/y for three quarters.
  - JIBOR interest rate: would jump to exceed 12 percent for three quarters and return to 9 percent.

### Projected macroeconomic and firm-specific variables
- Indonesia specific:
  - Real GDP growth
  - Unemployment
  - CPI inflation
  - NEER
  - Short-term interest rate
- Common:
  - Jakarta Composite Index
  - SBI yield, 3 months
- Firm specific variables:
  - Distance-to-default
  - Liquidity (Cash/Total Assets)
  - Profitability (Net Income/Total Assets)
  - Size (relative to median)
  - Market-to-book value
  - Idiosyncratic volatility

### Estimated results — observations
- Firm-specific conditions:
  - Firm-specific factors may have recently taken less supportive values after growth slowdown and rupiah depreciation weakened corporate balance sheet conditions amid rising corporate foreign currency leverage.
  - Under the baseline scenario, the median corporate PD is projected to rise to levels somewhat higher than those during the taper tantrum in 2013 and moderates somewhat toward the end of 2017 (Figure 8, upper panel, red broken line).
  - This occurs despite projected macro fundamentals being broadly comparable to those in 2013—GDP growth is somewhat lower, but the rupiah’s performance is more favorable and inflation is lower.
- Downside scenario impact on PD:
  - Weaker macroeconomic performance would naturally lift corporate PD to higher levels.
  - The median PD under the downside scenario would rise to about one half of the maximum registered during the Lehman crisis (Figure 8, upper panel, green solid line).
  - PD would decline as economic activity regains momentum.
- Extreme distress and spillovers:
  - Corporate distress can worsen materially if weak macroeconomic performance is accompanied by severe financial market jitters.
  - Under the downside scenario, the 95th percentile estimate, with remote chance of occurrence, rises to very close to the maximum registered during the global financial crisis (Figure 8, lower panel, light green broken line).
  - Cross-border spillovers of a negative shock could be large in an environment of elevated uncertainty and financial market volatility.
  - Under such circumstances, what is considered as a low-probability outcome (with a high impact) could become a real threat.

### Concluding remarks and policy implications
- Overall assessment:
  - The risk from the corporate sector remains manageable in Indonesia, and the authorities have strengthened the monitoring framework.
  - The aggregate corporate debt-to-GDP ratio remains small, and on a system wide basis, near-term refinancing risk appears moderate.
  - The implementation of the BI’s hedging regulations has helped corporates manage currency risks.
  - Authorities’ ongoing work to upgrade the framework and inter-agency coordination on corporate surveillance is in the right direction.
- Areas warranting close monitoring and action:
  - Close monitoring and granular analysis on maturing FX debt are warranted.
  - A group of corporates faced heightened debt risks, some connected to large business groups.
  - Monitor FX debt of corporates with rupiah income, as well as unhedged, non-affiliated, or maturing FX debt, together with bank linkages.
  - Strengthen policy coordination and continue data analysis to assess the dimensions of debt problems of specific corporates in vulnerable groups.
  - Consider reviewing the corporate resolution framework (including the bankruptcy regime) to ensure it is capable of dealing with large and systemically connected conglomerates.
  - In the medium-term, deeper financial markets will help reduce the costs of hedging and develop domestic corporate bond issuance and trading.

*Source: wp1797 - References (IMF working paper content provided).*

### References .............................................................................................................

### wp1797 - References

### Macroeconomic context and corporate vulnerabilities
- Real GDP growth decelerated from 6.4 percent year on year in 2010 to around 5 percent in 2016.
- Indonesia’s export prices were pushed by nearly 15 percent from their peak in end 2013/early 2014.
- Since 2014, the exchange rate has remained broadly unchanged in real effective terms but depreciated more than 10 percent against the U.S. dollar.
- Despite weakened growth, aggregate corporate leverage increased, notably in foreign currency.

### Key corporate-sector facts and indicators
- Net income was about 14 percent of total assets in 2014, the highest among the EM peers referenced.
- Indonesia’s liabilities-to-asset ratio is below that of many EM peers (Figure 2).
- Many corporates rely on internal cash flows rather than external financing.

### Foreign-currency (FX) debt exposure and composition
- FX corporate debt (including that owed to domestic banks) doubled from 2010, reaching around 20 percent of GDP in the second quarter of 2015.
- Around 90 percent of debt securities issued in 2014 were FX denominated.
- FX debt now accounts for around 60 percent of the total corporate debt.
- FX corporate debt is concentrated in the commodities and selected non-tradable sectors.
- Two-thirds of non-bank private corporates’ external debt maturing within a year is owed to affiliates.

### Risks identified and their drivers
- Currency mismatches:
  - Some portion of FX debt is estimated to be unhedged, partly because hedging costs are generally high.
  - Bank Indonesia’s hedging regulations have helped corporates manage currency risk, but many corporates have only partial hedge positions or use derivative instruments with knock-out features, making exposure sensitive to rupiah depreciation.
- Refinancing risk:
  - Rollover needs of FX debt securities were set to rise in 2016 and a large proportion of maturing debt is leveraged or high-yield.
  - Bank Indonesia’s new requirements that only corporates with investment grade credit ratings can issue FX debt starting from 2016 could affect issuance capacity.
  - Despite peaking, rollover needs within a year appeared manageable.
- Default risk:
  - The interest coverage ratio (ICR) has fallen sharply, with a fifth of the sector witnessing the interest coverage ratio falling below 1.
  - Corporates in the resource sector were under the most pressure.
  - A recent rise in nonperforming loans (NPLs) and special mention loans in the banking system mirrors increased default concerns.

### Analytical approach and overall assessment
- The paper applies the Bottom-Up Default Analysis (BuDA) framework (Duan, Miao, and Chan-Lau, 2015) that exploits equity prices together with balance-sheet indicators of profitability and liquidity to estimate firm-level probabilities of default (PDs).
- The BuDA framework complements debt service capacity analyses and other market-based approaches.
- The analysis suggests that risks in the corporate sector are manageable even under a protracted recession accompanied by a large currency depreciation, reflecting a relatively low ratio of aggregate corporate debt to GDP.
- On a system-wide basis, near-term refinancing risk is characterized as low.

### Policy actions and institutional responses
- Authorities have been proactive in monitoring corporate vulnerabilities and encouraging proper currency risk management by implementing hedging regulations (Box: Bank Indonesia’s Foreign Exchange Regulations on Corporates).
- Bank Indonesia implemented a requirement that only corporates with investment grade credit ratings can issue FX debt starting from 2016.

*Source: wp1797 - References (IMF working paper content provided).*

### Box 1. Bank Indonesia’s Foreign Exchange Regulations on Corporates

### Box 1. Bank Indonesia’s Foreign Exchange Regulations on Corporates

### FX regulations (prudential measures introduced October 2014)
- Objective: Encourage corporates with external debt to enhance risk management.
- Hedging ratio:
  - Defined as the ratio between the total value hedged and the net short-term foreign liability position.
  - Minimum hedging ratio: 20 percent for 2015 and 25 percent for 2016.
  - Applied to net foreign currency liabilities with a maturity period up to three months, and those that mature between three and six months.
  - Exemptions:
    - Export-oriented corporates—corporates with a ratio of export revenue to total revenue exceeding 50 percent of the previous calendar year—with financial statements issued in U.S. dollars.
- Liquidity ratio:
  - Defined as the ratio between short-term foreign currency assets and short-term foreign currency liabilities.
  - Minimum ratio: 50 percent for 2015 and 70 percent for 2016.
- Credit rating requirement:
  - Nonbank corporates should have a credit rating of no less than BB or equivalent issued by an authorized rating agency, including Moody’s (Ba3), S&P (BB-), and Fitch (BB-).
  - The validity of the credit rating is up to two years.
  - Corporates can use a parent company’s credit rating for the external debt of parent companies or external debt secured by parent companies.
  - Exemptions are made for external debt related to infrastructure projects, external debt secured by multilateral institutions, refinancing, and trade credit.

### Reporting requirement
- Corporates with external borrowing should submit quarterly reports to BI regarding their hedging and liquidity ratios for each quarter, starting from 2015.
- The report covers a corporate’s hedging ratio, liquidity ratio, and credit rating, and all supporting documentation.

### Sanctions and enforcement (implementation timeline)
- Administrative sanctions to be imposed from 2016 in the form of warning letters to “related parties” in the transactions, including:
  - The lenders which are providing the non-compliant debt.
  - The Ministry of Finance.
  - The Minister of State Owned Enterprises (in the case of borrowers that are state-owned enterprises).
  - The Financial Services Authority (OJK).
  - The Indonesia Stock Exchange (in the case of listed-company borrowers).

### Implementation phases and key implementation features
- Phase timing:
  - Phase 1: 2015
  - Phase 2: 2016
  - Phase 3: 2017 onwards
- Object of regulation: Governs all foreign currency debt.
- Hedge ratio application by maturity bucket:
  - ? 3 months: 20 percent (2015); 25 percent (2016)
  - 3-6 months: 20 percent (2015); 25 percent (2016)
- Liquidity ratio minimums:
  - 50 percent (2015)
  - 70 percent (2016)
- Credit rating: Minimum rating of BB- as of 2015:Q4.
- Counterpart of hedging transaction:
  - Phase 1: Not necessarily be done with a bank in Indonesia.
  - Phase 2 and onward: Must be done with a bank in Indonesia.
- Sanctions: Administrative sanctions will be imposed (from Phase 3/2017 onwards).

*Source: Bank Indonesia.*

### 5.3 percent. The unemployment rate would decline gradually to 5.7 percent, while

### wp1797 - 5.3 percent. The unemployment rate would decline gradually to 5.7 percent, while

### Scenario projections and key macro assumptions
- Baseline scenario:
  - GDP growth: implied baseline (text context) with median corporate PD rising somewhat higher than during the taper tantrum in 2013.
  - Unemployment rate: would decline gradually to 5.7 percent.
  - CPI inflation: would fall to 4.4 percent.
  - Rupiah movement: would range between –3 percent to 4 percent year-on-year (y/y) every quarter.
  - One-month JIBOR interest rate: decline moderately to 6.7 percent.
- Downside scenario:
  - GDP growth: sharp drop to below two percent y/y.
  - Unemployment rate: would jump to nine percent and return to somewhat above eight percent.
  - CPI inflation: would surge to above ten percent on account of path-through effect before returning to 6 percent.
  - Rupiah depreciation: would depreciate by 14–20 percent y/y for three quarters.
  - JIBOR interest rate: would jump to exceed 12 percent for three quarters and return to 9 percent.

### Projected macroeconomic variables (Indonesia specific and common indicators)
- Indonesia specific:
  - Real GDP growth
  - Unemployment
  - CPI inflation
  - NEER
  - Short-term interest rate
- Common:
  - Jakarta Composite Index
  - SBI yield, 3 months
- Firm specific variables:
  - Distance-to-default
  - Liquidity (Cash/Total Assets)
  - Profitability (Net Income/Total Assets)
  - Size (relative to median)
  - Market-to-book value
  - Idiosyncratic volatility

### Estimated results — observations
- Firm-specific conditions:
  - Firm-specific factors may have recently taken less supportive values after growth slowdown and rupiah depreciation weakened corporate balance sheet conditions amid rising corporate foreign currency leverage.
  - Under the baseline scenario, the median corporate PD is projected to rise to levels somewhat higher than those during the taper tantrum in 2013 and moderates somewhat toward the end of 2017 (Figure 8, upper panel, red broken line).
  - This occurs despite projected macro fundamentals being broadly comparable to those in 2013—GDP growth is somewhat lower, but the rupiah’s performance is more favorable and inflation is lower.
- Downside scenario impact on PD:
  - Weaker macroeconomic performance would naturally lift corporate PD to higher levels.
  - The median PD under the downside scenario would rise to about one half of the maximum registered during the Lehman crisis (Figure 8, upper panel, green solid line).
  - PD would decline as economic activity regains momentum.
- Extreme distress and spillovers:
  - Corporate distress can worsen materially if weak macroeconomic performance is accompanied by severe financial market jitters.
  - Under the downside scenario, the 95th percentile estimate, with remote chance of occurrence, rises to very close to the maximum registered during the global financial crisis (Figure 8, lower panel, light green broken line).
  - Cross-border spillovers of a negative shock could be large in an environment of elevated uncertainty and financial market volatility.
  - Under such circumstances, what is considered as a low-probability outcome (with a high impact) could become a real threat.

### Concluding remarks and policy implications
- Overall assessment:
  - The risk from the corporate sector remains manageable in Indonesia, and the authorities have strengthened the monitoring framework.
  - The aggregate corporate debt-to-GDP ratio remains small, and on a system wide basis, near-term refinancing risk appears moderate.
  - The implementation of the BI’s hedging regulations has helped corporates manage currency risks.
  - Authorities’ ongoing work to upgrade the framework and inter-agency coordination on corporate surveillance is in the right direction.
- Areas warranting close monitoring and action:
  - Close monitoring and granular analysis on maturing FX debt are warranted.
  - A group of corporates faced heightened debt risks, some connected to large business groups.
  - Monitor FX debt of corporates with rupiah income, as well as unhedged, non-affiliated, or maturing FX debt, together with bank linkages.
  - Strengthen policy coordination and continue data analysis to assess the dimensions of debt problems of specific corporates in vulnerable groups.
  - Consider reviewing the corporate resolution framework (including the bankruptcy regime) to ensure it is capable of dealing with large and systemically connected conglomerates.
  - In the medium-term, deeper financial markets will help reduce the costs of hedging and develop domestic corporate bond issuance and trading.

*Sources: NUS; CEIC; and authors' calculations and estimates.*

---


_Source: https://www.imf.org/-/media/files/publications/wp/2017/wp1797.pdf_