A Review of the Method for Setting Interest Rates on Foreign-Funded Sub-Loans to the Regions

A Review of the Method for Setting Interest Rateson Foreign-Funded Sub-Loans to the Regions

Final ReportBuilding Capacity for the Development of

Sub-National Government Capital Market for Municipal BondsApril 2011

Executive Summary

i Final Report (April 2011)

The Minister of Finance plans to revise PMK83/2005, a decree that stipulates

the interest rate to be charged on sub-loans to regional governments that are

financed from foreign sources, such as the World Bank or the ADB. This

report contains a review of the existing rate setting method, and presents

recommendations for improvement.

Key Findings

#1 There is no theoretical basis for the surcharge of 5.02%. PMK 83/2005

states that the interest rate on a Rupiah-denominated sub-loan is the sum of:

(i) the interest rate on the foreign loan from the sub-loan is financed, and (ii)

a surcharge to cover foreign exchange rate (FOREX) risks. The surcharge

that applies to the interest rate on a foreign-financed regional government

sub-loan has been 5.02% for all (of the few) sub-loans proposed to regional

governments since the PMK was issued. The surcharge largely consists of a

provision of 4.42% to compensate MoF for bearing FOREX risks. This

amount is higher than the FOREX risk cover MoF used for the pricing of sub-

loan interest rates before the krismon. It is also higher than the surcharge

imposed by other countries with comparable on-lending systems (see table

below). It is important to know to what extent the surcharge correctly prices

FOREX risks borne by MoF, in order to (i) ensure that the surcharge is not

unnecessarily high, thereby artificially depressing demand for sub-loans, and

(ii) provide regional government with a justification for the surcharge.

KEY FEATURES OF ON-LENDING SYSTEMS IN SELECTED COUNTRIES

Country FOREX Risk

Borne by Interest Rate

Based on Total

Surcharge

Indonesia, pre-krismon Central government Foreign lender rate 3.5%

Indonesia, current Central government Foreign lender rate 5.02%

Brazil State government Foreign lender rate 1.7-3.5%

China End borrower Foreign lender rate -

India (Tamil Nadu) Central government Foreign lender rate 2.5-3.0%

Philippines Central government 91-day T-bills 2%

#2 The existing rate setting method ignores interest rate risk. To date, most

sub-loans to regional governments have been financed from the proceeds of

sovereign World Bank and ADB loans. Most of these loans carry a variable

interest rate, usually based on the 6-month LIBOR. However, MoF charges a

fixed interest rate on sub-loans to regional governments. This means that the

central government is running interest rate risk in addition to FOREX risk.

The surcharge defined in PMK83/2005 does not cover this type of risk.

#3 Sub-loan interest rates are determined by the underlying sovereign loan,

which may result in inequitable treatment of regional governments. The

interest rate of sub-loan to a regional government is the sum of the interest

rate on the underlying sovereign foreign loan and the applicable surcharge.

At present, there is considerable variation in interest rates charged by foreign

lenders. For example, interest rates on JBIC loans tend to be lower than

rates on ADB or World Bank loans. As a result, regional governments may

pay different interest rates on sub-loans used for identical purposes.

A Review of the Method for Setting Interest Rates

on Foreign-Funded Sub-Loans to the Regions

ii Final Report (April 2011)

Recommendations to Improve PMK83/2005

#1 Reduce the FOREX risk cover included in the surcharge from 4.42% to

1.4%. To provide an objective estimate of MoF’s actual cost of covering

FOREX risks, two approaches were considered. The historical approach

suggests a FOREX risk cover ranging from 0.6% to at most 3.0%, assuming

that MoF would not want to include the risk of a monetary crisis in the sub-

loan interest rate. The market-based approach suggests a FOREX risk

cover of about 2.2%. The average of the two approaches is (0.6 + 2.2 =)

1.4%. These estimates are both substantial lower than the 4.42% included in

the surcharge regulated by PMK83/2005.

#2 Include a cover for interest rate risk in the surcharge. The websites of

ADB, the World Bank and other foreign lenders present regularly updated

quotes for variable and fixed interest rates on sovereign loans. The interest

rate differential should be added to the surcharge.

#3 Apply the surcharge to the average interest rate on sovereign foreign

loans, not to the interest rate of an individual loan. This recommendation

is made to prevent potentially large differences between sub-loan interest

rates charged to regional governments. The figure below illustrates how this

recommendation may be put into practice. Foreign sovereign loans would be

pooled into a Municipal Development Fund (MDF), to be established in MoF.

The fund will re-lend the proceeds at uniform sub-loan conditions to eligible

regional governments. The conditions will be updated periodically to reflect

changes in the average financing costs of the Fund.

CURRENT AND PROPOSED LOAN CHANNELING ARRANGEMENTS*

* SC= surcharge

Government (MoF)

Foreign Lender

Regional Govt A

Sovereign Loan (foreign currency)

Sub-Loan (foreign currency

or Rupiah)

3% 3%+SC

Government

(MoF)

Foreign Lender A

Foreign Lender

Regional Govt B

1% 1%+SC Foreign

Lender B

Government (MoF)

Foreign Lender

Regional Govt A

3%

Municipal Development Fund (MDF)

Foreign Lender A

Foreign Lender

Regional Govt B

1% Foreign

Lender B

Ministry of Finance

PROPOSED

CURRENT

2%+SC

2%+SC

A Review of the Method for Setting Interest Rates on Foreign-Funded Sub-Loans

1 Final Report (April 2011)

Background. As part of an ongoing program of activities to encourage long-

term borrowing for public infrastructure by regional governments, the

Government of Indonesia (GOI) has recently revised Government Regulation

54 of 2005 on regional borrowing (PP54/2005).1 Unlike PP54/2005, the new

regulation allows regional governments to borrow long-term for public

infrastructure projects that are indirectly revenue-generating, such as roads

and flood control systems. Until the late 1990s, a major portion of long-term

loans to regional governments was financed by multilateral lenders, mainly

ADB and the World Bank. GOI is currently considering re-opening this

mechanism, which would be managed as a Municipal Development Fund

(MDF) in the Ministry of Finance. To operationalize this mechanism, it is

necessary to revise PMK83/2005, a Minister of Finance Decree that

stipulates the interest rate to be charged on sub-loans to regional

governments that are financed from foreign sources. Against this

background, the Directorate-General of Fiscal Balancing in the Ministry of

Finance (MoF) has requested the Decentralization Support Facility (DSF) to

recruit a consultant to assist the Directorate-General with a review

PMK83/2005, and recommend on improvements.

Objective and Contents of this Report

Objective. The objective of this report is to identify options for improving the

method that is currently used by the Ministry of Finance to set interest rates

on sub-loans to regional governments that are financed from foreign loans to

the Government of Indonesia. This method is hereinafter also referred to as

“the rate setting method”.

Structure of this report. The first part of this report first gives an overview of

the current rate setting method, as defined in PMK83/2005, and concludes

that the existing method suffers from several methodological weaknesses.

The second part presents recommendations aimed at improving the existing

method.

Disclaimer. This report has been reviewed by the Directorate for Regional

Investment and Capacity in the Directorate-General of Fiscal Balancing,

which found it satisfactory. It should be emphasized that the contents of this

report do not necessarily reflect the views of the DSF or the Government of

Indonesia.

1 Peraturan Pemerintah 54 Tahun 2005 tentang Pinjaman Daerah




1 Review of the Existing Rate Setting Method

Background

On-lending to regional governments. Historically, the Government of

Indonesia (GOI) has financed a major portion of its investments in public

infrastructure from the proceeds of sovereign foreign loans. Since the mid-

1970s, the Ministry of Finance has on-lent part of these proceeds of these

loans to regional governments (provinces, kabupaten and kota). On-lending

to regional governments can be described as a two-step process:

Step 1. The Government, represented by the Minister of Finance, signs a

sovereign loan agreement with a foreign lender (such as the World Bank or

the ADB). Without exception, sovereign loan agreements are denominated in

a currency other than Rupiah (usually US Dollar).

Step 2. The Minister of Finance re-lends part of the proceeds of the

sovereign foreign loan to a regional government, and signs a sub-loan

agreement with the head of that regional government. To date, almost all

sub-loans have been denominated in Rupiah.

Figure 1

OVERVIEW OF LOAN CHANNELING ARRANGEMENTS

Source: Consultant

PMK53/2006. In July 2006, the Minister of Finance issued a decree concer-

ning the mechanism for the on-lending of sovereign foreign loan proceeds to

regional governments.2 This decree, better known as PMK53/2006, was

issued as an implementing guideline to PP54/2005. According to

PMK53/2006, the Government may on-lend sovereign foreign loan proceeds

to a regional government in the currency of the sovereign loan itself, or in

Rupiah. To date, the Government has almost exclusively on-lent in Rupiah

(indeed, MoF no longer wishes to re-lend in a currency other than Rupiah,

given that regional governments do not receive revenue in foreign currency).3

Article 12(2) of the PMK states that the interest rate on a Rupiah-denomina-

ted sub-loan consists of two elements:

the interest rate on the foreign loan from the sub-loan is financed (as

mentioned in the sovereign loan agreement), plus

a surcharge, set by the Minister of Finance, to cover foreign exchange rate

(FOREX) risks.

2 Peraturan Menteri Keuangan 53/PMK.010/2006 tentang Tata Cara Pemberian Pin-

jaman Daerah dari Pemerintah yang Dananya Bersumber dari Pinjaman Luar Negeri

3 From 1975 to 2004, fewer than 10 of 838 sub-loans to regional governments were denominated in a foreign currency.

Government (MoF)

Foreign Lender

Regional Government



or Rupiah)

1 2 Government

(MoF) Foreign Lender




Definition of the surcharge

PMK83/2005. The calculation of the surcharge to the interest rate on a

sovereign foreign loan, as mentioned in Article 12 of PMK53/2006, is regulated

by Minister of Finance decree 83/PMK.06/2005.4 This decree (hereinafter also

referred to as PMK83/2005) defines three surcharges, the application of

which depends on the currencies in which the sovereign loan and sub-loan

are denominated. The following surcharges can be distinguished:

Sub-loans denominated in the currency of the sovereign loan: 0.5%

Rupiah-denominated sub-loans, financed from a sovereign loan denominated

in US Dollar: 5.02%

Rupiah-denominated sub-loans, financed from a sovereign loan denominated

in a foreign currency other than US Dollar: a figure based on an adjustment of

the 5.02% for the six-month forward rate (but not lower than 0.35%)

Table 1

APPLICABLE SURCHARGES TO THE SOVEREIGN LOAN INTEREST RATE

CURRENCY OF SOVEREIGN LOAN

CURRENCY OF SUB-LOAN

Same as Sovereign Loan Rupiah

US Dollar 0.5% 5.02%

Other foreign currency

0.5% 5.02% adjusted for six-

month forward rate (but not lower than 0.35%)

Source: Consultant, based on PMK83/2005

Surcharge on Rupiah-denominated sub-loans, financed from sovereign

loans not denominated in US Dollar. To date, most foreign-funded sub-

loans to regional governments have been financed from the proceeds of

IBRD and ADB loans, which are all denominated in US Dollar. Nonetheless,

most of PMK83/2005 is devoted to the adjustment of the surcharge of 5.02%

in the event the underlying sovereign loan would be denominated in a foreign

currency other than the US Dollar. The adjustment procedure consists of two

steps, which can be summarized as follows:

Step 1: determine the expected change of the sovereign loan currency

to the US Dollar. This change is measured by the increase or decrease of

the six-month forward rate vis-à-vis the spot rate as reported by Reuters, on

the day closest to (but not earlier than five days before) the signing of the

sub-loan agreement to which the surcharge applies.

Step 2: adjust the US Dollar surcharge for the expected change. If the

sovereign loan currency is expected to appreciate against the US Dollar, the

adjustment will be positive, and the total surcharge higher than 5.02%. If the

sovereign loan currency is expected to depreciate against the US Dollar, the

surcharge will drop below 5.02%.

4 Peraturan Menteri Keuangan Republik Indonesia Nomor 83/PMK.06/2005 tentang

Tambahan Tingkat Suku Bunga Penerusan Pinjaman Luar Negeri Pemerintah yang Diteruskan Kepada Daerah. This decree was issued before PMK53/2006, because it was initially used as an implementing guideline to KMK35/2003, the regulatory predecessor of PMK53/2006




Box 1

CALCULATING THE INTEREST RATE OF A RUPIAH DENOMINATED SUB-LOAN FINANCED FROM A SOVEREIGN EURO LOAN (EXAMPLE)

Sovereign loan. In 2010, the Government of Indonesia signs a sovereign

loan agreement with KfW. The loan is denominated in Euro and carries a

variable interest rate of 2.5% p.a.

Sub-loan. In 2011, the Minister of Finance decides to on-lend part of the

proceeds of the KfW loan to Kabupaten ABC. On 15 March 2011, the

Mayor of Kabupaten ADB signs a sub-loan agreement with the Minister of

Finance. The currency of the sub-loan is Rupiah.

Calculation of interest rate on sub-loan. On 14 March 2011, the EUR/

USD spot rate was 1.40. On the same day, the 6-month forward rate was

1.35. This means that the EUR is expected to depreciate against the US

Dollar. The rate of change is ([1.35-1.40]/1.40 =) minus 3.57%. The

applicable surcharge to the interest rate is therefore (5.02 – 3.57=) 1.45%.

Because the interest rate on the sovereign loan is 2.5%, the interest rate of

the sub-loan of Kabupaten ABC is (2.5% + 1.45% =) 3.95% p.a.

Source: Consultant

Composition of the surcharge. The surcharge defined in PMK83/2005

covers:

Bank fees. These are fees charged by channeling banks that MoF employs

to disburse sub-loan funds and collect debt service payments (According to

Article 7 of PMK83/2005, the fees are 0.25% p.a. for Rupiah-denominated

sub-loans, and 0.15% for sub-loans denominated in a foreign currency.)

Service charge. This is an administrative fee charged by the Ministry of

Finance itself (0.35%). This charge is not explicitly mentioned in PMK83/

2005, but can be derived from the surcharge on sub-loans denominated in a

foreign currency (the surcharge of 0.5% includes a channeling bank fee of

0.15% but not a provision to cover FOREX risks, so that the remainder is

available to cover administration costs).

FOREX risk cover. The cost of foreign exchange rate risks arising from

uncertainties in the exchange rate between the Rupiah and the currency of

the sovereign loan. For a Rupiah sub-loan that is financed from a sovereign

loan denominated in US Dollar, the implied FOREX risk cover is (5.02 -/-

0.35 -/- 0.25=) 4.42%.

Table 2

COMPOSITION OF THE SURCHARGE BY TYPE OF SUB-LOAN

Sub-Loan Type Bank Fees

Service Charge

FOREX Risk Cover

Total Surcharge

Sub-loan in same currency as sovereign loan

0.15% 0.35% – 0.50%

Sub-loan in Rupiah, financed from US$ sovereign loan

0.25% 0.35% 4.42% 5.02%

Sub-loan in Rupiah, financed from non-US$ sovereign loan

0.25% 0.35% > -0.25% > 0.35%

Source: Consultant, based on PMK83/2005




Key issues

Key issue #1: there is no known theoretical basis for the surcharge of

5.02%. Historically, most sovereign foreign loans to the Government have

been denominated in US Dollar. In addition, it has been a long-standing

policy of the Ministry of Finance to on-lend sovereign foreign loan proceeds

in Rupiah only. For these reasons, the surcharge that applies to the interest

rate on a foreign-financed regional government sub-loan has been 5.02% for

all (of the few) sub-loans proposed to regional governments since PMK83/

2005 was issued. The 5.02% surcharge largely consists of a provision of

4.42% to compensate MoF for bearing the risk of unfavorable changes in the

exchange rate of the Rupiah vis-à-vis the US Dollar. This amount is higher

than the FOREX risk cover that MoF used for the pricing of sub-loan interest

rates before the krismon (3% per year, at that time the estimated annual rate

of depreciation of the Rupiah against the US Dollar), It is also higher than the

surcharge, which mainly covers FOREX risk, imposed by other countries with

comparable on-lending systems (Table 3). For two reasons, it is important to

review to what extent the surcharge correctly prices FOREX risks borne by

MoF: (i) to ensure that the surcharge is not unnecessarily high, thereby

artificially depressing demand for sub-loans, and (ii) to provide regional

government with a justification for the surcharge.

Table 3

KEY FEATURES OF ON-LENDING SYSTEMS IN SELECTED COUNTRIES

Country FOREX Risk

Borne by Interest Rate

Based on Total

Surcharge

Indonesia, pre-krismon Central government Foreign lender rate 3.5%

Indonesia, current Central government Foreign lender rate 5.02%

Brazil State government Foreign lender rate 1.7-3.5%

China End borrower Foreign lender rate -

India (Tamil Nadu) Central government Foreign lender rate 2.5-3.0%

Philippines Central government 91-day T-bills 2%

Source: Consultant

Key issue #2: the method for adjusting the surcharge of 5.02% is

flawed. If the underlying foreign sovereign loan is not denominated in

Rupiah, then PMK83/2005 requires an adjustment to the surcharge of

5.02%. The adjustment is equal to the six-month forward rate vis-à-vis the

spot rate of the sovereign loan currency. This method is flawed for two

reasons. Firstly, the six-month forward rate is not a reliable indicator for the

changes in the exchange rate of the sovereign loan currency vis-à-vis the US

Dollar during the remainder of the sub-loan repayment time (which typically

ranges from 15 to 20 years). Secondly, the surcharge is highly sensitive to

changes in the forward rate. For example, if the six-month forward rate of the

sovereign loan currency is 5% higher than the spot rate (so that the currency

is at a swap premium), the surcharge to the interest rate is (5.02+5=)

10.02%. Conversely, if the forward rate is 5% lower than the spot rate (so

that the currency is at a swap discount), the surcharge drops to the minimum

threshold of 0.35% (Figure 2). In summary, the existing method produces a

surcharge on a long-term fixed Rupiah interest rate that is highly dependent

on short-term developments in foreign currency markets.




Figure 2

SURCHARGE FOR SELECTED CHANGES TO SPOT RATES

0%

4%

8%

12%

16%

-10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10%

Swap discount < > Swap premium

Six-month forward rate / Spot rate

Source: Consultant

Key issue #3: the existing surcharge does not provide cover for interest

rate risk. To date, most sub-loans to regional governments have been

financed from the proceeds of sovereign World Bank and ADB loans. Most of

these loans carry a variable interest rate, usually based on the 6-month

LIBOR. In contrast, the Ministry of Finance charges a fixed interest rate on

sub-loans to regional governments. This means that the central government

is running interest rate risk in addition to FOREX risk. The surcharge defined

in PMK83/2005 does not provide for coverage of this type of risk. At present,

interest rate risk is particularly high because 6-month LIBOR rates are at a

historical low (Figure 3). This means that it is highly likely that interest

charges payable by GOI will increase, whereas interest charges payable by

regional governments will remain unchanged because sub-loan interest rates

are fixed.

Figure 3

6-MONTH LIBOR RATES, 2000-2010 (END OF YEAR)

Percent

0%

1%

2%

3%

4%

5%

6%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: British Banking Association (2011)




Key issue #4: sub-loan interest rates are determined by the underlying

sovereign loan, which may result in inequitable treatment of regional

governments. The interest rate of sub-loan to a regional government is the

sum of the interest rate on the underlying sovereign foreign loan and the

applicable surcharge. At present, there is considerable variation in interest

rates charged by foreign lenders. For example, interest rates on JBIC loans

tend to be substantially lower than rates on ADB or World Bank loans. As a

result, two regional governments may pay different interest rates on sub-

loans used for identical purposes (see Box 2 for an example).

Box 2

DIFFERENTIAL INTEREST RATES (EXAMPLE)

Kota ABC and Kota XYZ each want to borrow Rp 10 billion to build a

“Class A” bus terminal. The Ministry of Finance approves both sub-loan

proposals. The bus terminal of Kota ABC will be financed from an almost

fully disbursed Yen loan with a fixed interest rate of 1% per year. The Yen

is expected to depreciate by 2% against the US$ during the six-month

period following the signing of the sub-loan agreement. The terminal of

Kota XYZ will be financed from a newly signed US$ loan with a variable

LIBOR-based interest rate that is currently 3% per year. The interest rates

on the two sub-loans are calculated as follows:

Kota ABC: 1% + 5.02% - 2% = 4.02%.

Kota XYZ: 3% + 5.02% = 8.02%.

In this scenario, the sub-loan interest rate of Kota XYZ is almost twice as

high as the interest rate payable on the sub-loan of Kota ABC. If the

Ministry of Finance would have allocated the Yen loan proceeds to Kota

XYZ instead, the situation would have been reversed.

Source: Consultant

2 Recommended Improvements to the Existing Rate Setting Method

Starting points. This section presents recommendations aimed at improving

the method for setting interest rates on foreign-funded sub-loans to regional

governments. All recommendations are based on two key assumptions:

Rupiah sub-loans only. The Ministry of Finance will continue to disallow

sub-loan agreements denominated in a currency other than Rupiah, not only

because regional governments do not receive income in foreign currency, but

also because regions do not have any experience with managing foreign

exchange rate risks. (For the sake of clarity, it is recommended that revision

to PMK83/2005 will explicitly prohibit on-lending to regional governments in a

currency other than Rupiah, instead of allowing both options.)

Fixed interest rate sub-loans only. Regional governments have a strong

preference for loans with a fixed (as opposed to variable) interest rate,

mainly because such loans do not carry interest rate risk, but also because

fixed interest rates do not require revisions to budgeted interest payments.

For administrative reasons, the Ministry of Finance also prefers to on-lend

against fixed interest rates (among other things, this avoids the need to send

updated interest payment schedules to regional governments).




Concept for improving the existing rate setting method.

Provide a sound theoretical basis for the FOREX risk cover charge. At

present, MoF imposes a relatively high surcharge on the interest rate on

Rupiah sub-loans to regional governments to cover foreign exchange risk,

without providing a justification of the surcharge.

Redefine the composition of the surcharge. This is necessary to ensure

that the rate setting method provides MoF with cover for interest rate risk.

Adjust the base interest rate. It is proposed that the surcharge will apply to

an average interest rate (instead of the interest rate of a specific foreign loan

agreement) to eliminate interest rate differences among regional government

borrowers.

Theoretical basis for estimating FOREX risk cover

Basis for estimating FOREX risk. As was shown in Table 3, MoF imposes

a higher surcharge to the interest rate of (US$-denominated) sovereign loans

than countries with comparable on-lending systems. By itself, this does not

mean that the current surcharge, as defined in PMK83/2005, is unjustifiably

high. It may well be that FOREX risk of the Rupiah vis-à-vis the currencies of

GOI’s sovereign foreign loans is inherently higher than the FOREX risks that

are borne by borrowers in other countries.5 To provide an objective estimate

of MoF’s actual cost of covering FOREX risks, the following two approaches

were used:

Historical approach. This approach assumes that the historical depreciation

of the Rupiah against the major currencies of GOI’s sovereign foreign loans

is a good approximation of the cost of MoF’s FOREX risk cover.

Market-based approach. The approach seeks to identify the cost of FOREX

risk cover by comparing the yields on marketable securities that are traded

both in Rupiah and in a foreign currency, but are otherwise identical.

Historical approach. From 1975 to 2004, the Government of Indonesia on-

lent about Rp 5.7 trillion to regional government borrowers (including munici-

pal enterprises owned by regional governments). Of this amount, about Rp

3.8 trillion was financed from the proceeds of sovereign foreign loans, 63% of

which from US$-denominated World Bank and ADB loans, and most of the

remainder from Yen-denominated OECF loans and loans denominated in

Euro or predecessor currencies (such as the German mark).6 From to 2000

to 2010, the Rupiah has strengthened against the US Dollar (which means

that MoF would have made a net exchange rate gain on Rupiah sub-loans

during this period, even if it had not included a FOREX risk cover in the

surcharge). However, from 2000 to 2010, the Rupiah depreciated against the

Yen and the Euro (Figure 4). The weighted average depreciation of the

Rupiah against the three major currencies (with weights taken from the

5 Because loan administration costs normally do not require an surcharge to the inte-rest rate of more than 0.5% p.a., it is assumed that the of the surcharge imposed by countries other than Indonesia also mainly consists of FOREX risk cover.

6 B. Lewis, On-Lending in Indonesia: Past Performance and Future Prospects, Bulletin of Indonesian Economic Studies, 2007, vol. 43, issue 1, pages 35-58.




historical share in sovereign loans on-lent to regional governments) was

0.3% during the five-year period 2005-2010, and 0.6% during the ten-year

period 2000-2010 (Table 4). These figures are relatively low because of the

appreciation of the Rupiah against the US Dollar. However, also during 2000-

2010 the average depreciation of the Rupiah against Yen and the Euro did

not exceed 3% per year, which is substantially lower than the current FOREX

risk cover of 4.42%. Only during the fifteen-year period of 1995-2010 was the

average depreciation of the US Dollar higher than the FOREX risk cover

(9.5%), but this outlier was entirely caused by the monetary crisis of 1997/98.

Figure 4

EXCHANGE RATE OF RUPIAH VS. US DOLLAR, YEN AND EURO, 2000-2010

(2000 = 100)

0

20

40

60

80

100

120

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Rp/US$ Rp/Yen Rp/Euro

Source: Consultant, based on IMF (2011)

Table 4

DEPRECIATION OF RUPIAH VS. US DOLLAR, YEN AND EURO, 1995-2010

Percent per year

Currency 1995-2010 2000-2010 2005-2010

US Dollar 9.5 -0.6 -1.7

Yen NA 2.9 5.9

Euro NA 3.0 0.7

Weighted average* NA 0.6 0.3

Source: Consultant, based on IMF (2011) * Assumed weights: US$ 63%, Yen 27%, Euro 10%

Market-based approach. In recent years, the Government of Indonesia has

issued several US Dollar-denominated bonds on the international capital

market. In March 2011, the yield on Rupiah-denominated Government bonds

with a term of 20 years (the most common term of Rupiah sub-loans) was

about 10.1%. In that month, the yield on US$-denominated Government

bonds with the same term was about 6.2% (Table 5). At first sight, this

implies an exchange rate risk premium of about (9.8 -/- 6.2 =) 3.6%.

However, this risk premium should be seen as a maximum estimate of the

FOREX risks associated to the Rupiah vis-à-vis the US Dollar, because inter-




national bond holders would also incorporate default risk in the yield. (From

the point of view of GOI, non-repayment risk of regional governments is zero,

because MoF has the right to withhold DAU and DBH transfers in case a

regional government would default on its debt to the Government.) In March

2011, the rate on five-year GOI credit default swaps – a proxy for the price of

default risk – was about 1.4%. This suggests a FOREX risk accounts for

about (3.6 -/- 1.4=) 2.2% of the yield differential on 20-year GOI bonds.

Table 5

YIELDS ON RUPIAH AND US$-DENOMINATED BONDS ISSUED BY THE GOVERNMENT OF INDONESIA

Percent per year

Term (years)

Yield on Rupiah Bonds

Yield on US$ Bonds

Yield Differential

5 7.953 3.045 4.908

10 8.535 NA NA

15 9.437 NA NA

20 9.780 6.162 3.618

30 10.135 6.217 3.918

Source: Bloomberg (7 March 2011)

Summary of basis for estimating FOREX risk. The historical approach

suggests a FOREX risk cover ranging from 0.6% to at most 3.0%, assuming

that MoF would not want to include the risk of a monetary crisis in the sub-

loan interest rate. The market-based approach suggests a FOREX risk cover

of about 2.2%. The average of the two approaches is (0.6 + 2.2 =) 1.4%.

These estimates are both substantial lower than the 4.42% included in the

surcharge regulated by PMK83/2005. It should be noted, however, that the

surcharge does not provide for interest rate risk.

Interest rate risk cover

Description of interest rate risk. In February 2011, the six-month LIBOR

rate, which is the basis for setting the interest rate on most of GOI’s

sovereign foreign loans, was 0.45% p.a. Five years earlier, in February 2006,

the rate was 4.99% p.a. (see also Table 3). If six-month LIBOR rates will

increase, as is widely expected, MoF’s interest payments on sovereign

foreign loans will increase, while its receipts of interest payments from

regional government borrowers will remain unchanged, thereby reducing the

spread on sub-loans in the MoF portfolio. This (to MoF) unfavorable develop-

ment is entirely caused by the fact that the Ministry of Finance borrows at a

variable interest and on-lends at a fixed rate. It is important to note that

interest rate risk is unrelated to FOREX risk. MoF is also exposed to this type

of risk if it would on-lend sovereign foreign loan proceeds in US Dollar.

Pricing of interest rate risk. Foreign lenders usually offer loan products at

variable or fixed rates. The difference between the two rates is, in effect, the

price that a prospective borrower has to pay to eliminate interest rate risk. In

March 2011, the World Bank charged a variable LIBOR-based interest rate

on its sovereign loans of 0.87% p.a. The fixed interest rate of an otherwise

identical loan with a term of 15 years would be 3.87% p.a. which implies an

interest rate risk cover of (3.87 -/- 0.87=) 3.0%. Interest rate differentials on




sovereign ADB loans with a term of 15 years range from 1.5% on Yen loan to

3.6% on US$ loans (Table 6). MoF may consider using this publicly available

information to add cover for interest rate risk to the surcharge.

Table 6

VARIABLE AND FIXED RATES ON 15-YEAR SOVEREIGN ADB LOANS

Percent per year

ADB Loan Currency

Fixed Interest Rate

Variable Interest Rate

Interest Rate Differential

US$ 4.430 0.862 3.569

Yen 2.230 0.748 1.483

Euro 4.220 1.891 2.329

Source: ADB (11 March 2011)

Application of surcharge to an average interest rate

Towards the establishment of a Municipal Development Fund (MDF). As

described before, as long as the surcharge is linked to the interest rate of the

sovereign foreign loan from which a sub-loan is funded, regional govern-

ments will be charged different interest rates on sub-loans that are used for

similar purposes. This problem can be resolved by pooling sovereign foreign

loans that the Government intends to on-lend to regional governments, and

use the average interest rate on these loans as the basis for setting sub-loan

interest rates. This process is illustrated in Figure 5 below. Foreign sovereign

loans would be pooled into a Municipal Development Fund (MDF), to be

established in MoF. The fund will re-lend the proceeds at uniform sub-loan

conditions to eligible regional governments. The conditions will be updated

periodically to reflect changes in the average financing costs of the Fund.

Figure 5

CURRENT AND PROPOSED LOAN CHANNELING ARRANGEMENTS*

Source: Consultant * SC= surcharge

Government (MoF)

Foreign Lender

Regional Govt A



or Rupiah)

3% 3%+SC

Government

(MoF)

Foreign Lender A

Foreign Lender

Regional Govt B

1% 1%+SC Foreign

Lender B

Government (MoF)

Foreign Lender

Regional Govt A

3%


Foreign Lender A

Foreign Lender

Regional Govt B

1% Foreign

Lender B

Ministry of Finance

PROPOSED

CURRENT

2%+SC

2%+SC




Recommendations for improving the existing rate

setting method

#1 Reduce the FOREX risk cover included in the surcharge from 4.42% to

1.4%. This estimate is the unweighted average of the average depreciation

of the Rupiah against a basket of three major currencies (0.6%) and the yield

differential, corrected for default risk, on 20-year Government bonds denomi-

nated in US Dollar and Rupiah (2.2%). The same surcharge will apply to all

sub-loans, irrespective of the currency in which the underlying sovereign loan

is denominated.

#2 Include a cover for interest rate risk in the surcharge. The websites of

ADB, the World Bank and other foreign lenders present regularly updated

quotes for variable and fixed interest rates on sovereign loans. The interest

rate differential should be added to the surcharge.

#3 Apply the surcharge to the average interest rate on sovereign foreign

loans, not to the interest rate of an individual loan. This recommendation

is made to prevent potentially large differences between sub-loan interest

rates charged to regional governments.

Box 3

PROPOSED RATE SETTING METHOD (EXAMPLE)

Kota ABC and Kota XYZ each want to borrow Rp 10 billion to build a

“Class A” bus terminal. The Ministry of Finance approves both sub-loan

proposals. Both terminals will be financed by the Municipal Development

Fund in MoF, which currently charges an interest rate of 2% per year, plus

a standard surcharge. The surcharge covers bank fees and administration

costs (0.6%), a FOREX risk cover (1.4%), and an interest rate risk cover

(currently estimated at 3%). The interest rates on the two sub-loans are

calculated as follows:

Kota ABC: 2.0% + 0.6% + 1.4% + 3.0% = 7.0%.

Kota XYZ: 2.0% + 0.6% + 1.4% + 3.0% = 7.0%.

Source: Consultant

APPENDIX Powerpoint Presentation


Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

PM

K 8

3/2

005 t

enta

ng

Tam

bahan T

ingkat

Suku B

unga

Revie

w a

nd R

ecom

mendations




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

Agenda

3.

Reco

mm

en

dati

on

s f

or I

mp

ro

vem

en

t

1.

Overvie

w o

f P

MK

83

/2

00

5

2.

Revie

w o

f P

MK

83

/2

00

5




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

On

-Len

din

g o

f Fo

reig

n L

oan

s t

o t

he R

eg

ion

s

1.

Overv

iew

of

PM

K83/2

005

Sovereig

n L

oan

(fo

reig

n c

urren

cy)

Fore

ign L

ender

Govern

ment

of

Indonesia

(M

oF)

Regio

nal

Govern

ment

Su

b-L

oan

(fo

reig

n c

urren

cy

OR

Ru

pia

h)

In

terest

rate

: X

%In

terest

rate

: X

% +

SU

RC

HA

RG

E




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

Su

rch

arg

es

1.

Overv

iew

of

PM

K83/2

005

CU

RR

EN

CY

OF

SO

VER

EIG

N

LO

AN

CU

RR

EN

CY

OF S

UB

-LO

AN

Sam

e a

s

Sovereig

n L

oan

Ru

pia

h

US

Doll

ar

0.5

%5.0

2%

Oth

er f

oreig

n

cu

rren

cy

0.5

%5.0

2%

adju

ste

d for

six

-month

forw

ard

ra

te (

but

>0.3

5%

)

Su

rch

arg

e o

f 5

.02

% =

FO

REX

Co

ver (

4.4

2%

)

+ C

harg

es (

0.6

0%

)




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

Key I

ssu

es

2.

Revie

w o

f PM

K83/2

005

3.

No

co

ver f

or in

terest

rate

ris

k

1.

No

th

eo

reti

cal b

asis

fo

r s

urch

arg

e o

f 5

.02

%

2.

No

co

rrect

ad

justm

en

t o

f 5

.02

%

(ad

justm

en

t n

eed

ed

if

foreig

n l

oan

no

t in

US

$)

4.

No

eq

ual

treatm

en

t o

f reg

ion

al

go

vt

bo

rro

wers




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

Issu

e #

1:

No

Th

eo

reti

cal

Basis

fo

r 5

.02

%

-To

exp

lain

rate

to

reg

ion

al

go

vt

bo

rro

wers

Co

mp

aris

on

wit

h s

urch

arg

es o

f o

ther c

ou

ntr

ies:

Wh

y is t

heo

reti

cal b

asis

necessary?

-To

kn

ow

if

Mo

F h

as s

uff

icie

nt

ris

k c

over

-In

do

nesia

no

w:

5.0

2%

-In

do

nesia

befo

re k

ris

mo

n:

3.0

%

-S

ele

cte

d o

ther c

ou

ntr

ies:

1.7

%-3

.5%

2.

Revie

w o

f PM

K83/2

005




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

Issu

e #

2:

No

Co

rrect

Ad

justm

en

t o

f 5

.02

%

-S

wap

-prem

ium

or d

isco

un

t: b

ased

on

6-m

on

th

In

co

nsis

ten

cy b

etw

een

-S

ub

-lo

an

term

: 1

5-2

0 y

ears

2.

Revie

w o

f PM

K83/2

005

forw

ard

rate




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

Issu

e #

3:

No

Co

ver f

or I

nte

rest

Rate

Ris

k

2.

Revie

w o

f PM

K83/2

005

Sovereig

n L

oan

(fo

reig

n c

urren

cy)

Fore

ign L

ender

Govern

ment

of

Indonesia

(M

oF)

Regio

nal

Govern

ment

Su

b-L

oan

(fo

reig

n c

urren

cy

OR

Ru

pia

h)

VA

RIA

BLE

inte

rest

rate

(b

ased

on

LIB

OR

, w

ill ch

an

ge)

FIX

ED

in

terest

rate

(w

ill N

OT c

han

ge)




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

Issu

e #

3:

No

Co

ver f

or I

nte

rest

Rate

Ris

k (

co

nt'

d)

2.

Revie

w o

f PM

K83/2

005

0%

1%

2%

3%

4%

5%

6%

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

LIB

OR

rate

s w

ill

increase,

su

b-l

oan

rate

s w

on

't…




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

Issu

e #

4:

No

Eq

ual Treatm

en

t o

f R

G B

orro

wer

2.

Revie

w o

f PM

K83/2

005 K

ota

BK

ota

A

Sw

ap

dis

co

un

t

Base s

urch

arg

e5

.02

%

-

8.0

2%

In

terest

rate

Pro

ject

Fu

nd

s n

eed

ed

Fin

an

ced

by

In

terest

on

Fo

reig

n L

oan

3.0

0%

5.0

2%

-1.0

0%

4.0

2%

1.0

0%

Rp

10

M

Term

inal

AD

B

Rp

10

M

Term

inal

JB

IC




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

ySta

rti

ng

Po

ints

3.

Recom

mendations

2.

On

-len

din

g a

t fi

xed

in

terest

rate

s o

nly

Becau

se…

1.

On

-len

din

g i

n R

up

iah

on

ly

-R

eg

ion

al

go

vern

men

t h

ave n

o r

even

ue i

n F

OR

EX

-R

eg

ion

al

go

vern

men

ts p

refe

r f

ixed

rate

s

-Fix

ed

rate

su

b-l

oan

s e

asie

r t

o a

dm

inis

ter b

y M

oF

Key a

ssu

mp

tio

ns




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

#1

: R

ed

uce F

OR

EX

Co

ver f

ro

m 4

.42

% t

o 1

.4%

3.

Recom

mendations

2.

Yie

ld d

iffe

ren

tial

betw

een

Rp

an

d U

SD

,

co

rrecte

d f

or d

efa

ult

ris

k (

2.2

%)

Pro

po

sed

co

ver i

s u

nw

eig

hte

d a

verag

e o

f:

1.

His

toric

al d

ep

recia

tio

n o

f R

up

iah

vis

-a-v

is

US

D/

Eu

ro

/Y

en

fro

m 2

00

0-2

01

0 (

0.6

%)

AN

D




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

(3

1 D

ecem

ber 2

00

0 =

10

0)

#1

: R

ed

uce F

OR

EX

Co

ver f

ro

m 4

.42

% t

o 1

.4%

3.

Recom

mendations




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

-C

over d

ep

en

ds o

n c

urren

cy,

easily a

vailab

le f

ro

m

web

sit

es o

f m

ajo

r f

oreig

n l

en

ders

#2

: In

clu

de c

over f

or in

terest

rate

ris

k i

n s

urch

arg

e

3.

Recom

mendations

AD

B L

oan

C

urren

cy

Fix

ed

In

terest

Rate

Varia

ble

In

terest

Rate

In

terest

Rate

D

iffe

ren

tial

US

Doll

ar

4.4

30

0.8

62

3.5

69

Yen

2.2

30

0.7

48

1.4

83

Eu

ro

4.2

20

1.8

91

2.3

29

Exam

ple

: rate

dif

feren

tial

for 1

5-y

ear A

DB

lo

an

s




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

y

#3

: A

pp

ly t

he s

am

e a

verag

e r

ate

to

all b

orro

wers

3.

Recom

mendations

Govern

ment

(MoF

) F

ore

ign

Len

der

Regio

nal

Govt

A

So

vere

ign

Lo

an

(f

ore

ign c

urr

ency)

Su

b-L

oa

n

(fore

ign c

urr

ency

or

Rupia

h)

3%

3

%+

SC

Govern

ment

(MoF

)

Fore

ign

Len

der

A

Fore

ign

Len

der

Regio

nal

Govt

B

1%

1

%+

SC

F

ore

ign

Len

der

B

Govern

ment

(MoF

) F

ore

ign

Len

der

Regio

nal

Govt

A

3%

Munic

ipal

Develo

pm

ent

Fund (

MD

F)

Fore

ign

Len

der

A

Fore

ign

Len

der

Regio

nal

Govt

B

1%

F

ore

ign

Len

der

B

Min

istr

y o

f F

inance

PR

OP

OS

ED

CU

RR

EN

T

2%

+S

C

2%

+S

C

To

ward

s a

Mu

nic

ipal

Develo

pm

en

t Fu

nd

(M

DF)




Ap

ril 2

01

1 | D

ecen

tralizati

on

Su

pp

ort

Facilit

yTerim

a K

asih

!

April 2011 | Decentralization Support Facility

PMK 83/2005 TentangTambahan Tingkat Suku Bunga

Kajian dan Rekomendasi


Agenda

3. Rekomendasi untuk Penyempurnaan

1. Sekilas PMK83/2005

2. Kajian Mengenai PMK83/2005


On-Lending Pinjaman Luar Negeri yang Diteruskan ke Daerah


Sovereign Loan(mata uang asing)

Pemberi Pinjaman Luar Negeri

Pemerintah RI (Kemenkeu)

Pemerintah Daerah

Pinjaman yang Diteruskan(mata uang asing atau Rupiah)

Tingkat Suku Bunga: X%

Tingkat Suku Bunga: X% + Tambahan (Surcharge)


Tambahan (Surcharges)


KURS SOVEREIGN

LOAN

Kurs Pinjaman yang Diteruskan

Sama denganSovereign Loan

Rupiah

US Dollar 0,5% 5,02%

Mata uang asinglainnya

0,5%

5,02% disesuaikanuntuk tingkat suku

bunga 6 bulan kedepan(tapi > 0,35%)

Tambahan 5,02% = FOREX Cover (4,42%) + Biaya lain (0,60%)


Isu-isu Utama


3. Risiko tingkat suku bunga tidak di cover

1. Tidak ada landasan teoritis untuk pengenaantambahan 5,02%

2. Tidak ada penyesuaian yang benar dari 5,02%(perlu dilakukan penyesuaian jika pinjaman luar negeri tidak dalam US$)

4. Tidak diberikan perlakuan yang sama bagipeminjam dari kalangan pemerintah daerah


Isu #1: Tidak ada landasan teoritis untuk pengenaantambahan 5,02%

- Untuk menjelaskan tingkat suku bunga ke pemerintah

daerah

Perbandingan tambahan negara lain:

Mengapa diperlukan landasan teoritis?

- Untuk mengetahui apakah Kemenkeu sudah mempersiap-kan risk cover yang cukup

- Indonesia saat ini: 5,02%

- Indonesia sebelum ‘krismon’: 3,0%

- Negara-negara lain: 1,7%-3,5%



Isu #2: Tidak ada penyesuaian yang benar dari 5,02%

- Premium-Swap atau diskon: berdasarkan tingkat suku

bunga 6-bulan kedepan

Inkonsistensi antara

- Periode pinjaman yang diteruskan: 15-20 tahun



Isu #3: Risiko tingkat suku bunga tidak di cover


Sovereign Loan(mata uang asing)

Pemberi Pinjaman Luar Negeri

Pemerintah RI (Kemenkeu)

Pemerintah Daerah

Pinjaman yang Diteruskan(mata uang asing atau Rupiah)

Tingkat Suku BungaVARIABEL

(berdasarkan LIBOR, akan berubah)

Tingkat Suku Bunga FIXED

(TIDAK akan berubah)


Isu #3: Risiko tingkat suku bunga tidak di cover (lanjutan)


0%

1%

2%

3%

4%

5%

6%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Tingkat LIBOR akan meningkat, sementara tingkat pinjaman yang diteruskan tidak…


Isu #4: Tidak diberikan perlakuan yang sama bagipeminjam dari kalangan pemerintah daerah

2. Kajian mengenai PMK83/2005

Kota BKota A

Discount Swap

Tambahan dasar 5,02%

-

8,02%Tingkat Suku Bunga

Proyek

Kebutuhan Dana

Dibiayai oleh

Suku bunga pinjaman luar negeri

3,00%

5,02%

-1,00%

4,02%

1,00%

Rp 10M

Terminal

ADB

Rp 10M

Terminal

JBIC


Titik Awal

3. Rekomendasi

2. On-lending pada tingkat suku bunga fixed saja

Karena…

1. On-lending dalam mata uang Rupiah saja

- Pemerintah daerah tidak memiliki pendapatan dalam bentuk mata uang asing

- Pemerintah daerah lebih memilih tingkat suku bunga fixed

- Pinjaman yang diteruskan dengan tingkat suku bunga fixed lebih mudah untuk dikelola oleh Kemenkeu

Asumsi-asumsi Utama


#1: Kurangi FOREX Cover dari 4,42% menjadi 1,4%

3. Rekomendasi

2. Yield differential antara Rp dan USD, dikoreksi untuk default

risk (2,2%)

Cover yang diusulkan adalah rata-rata tak tertimbang dari:

1. Depresasi historis Rupiah vis-à-vis USD/Euro/Yen tahun 2000-2010 (0,6%)

DAN


(31 Desember 2000 = 100)

#1: Kurangi FOREX Cover dari 4,42% menjadi 1,4%

3. Rekomendasi


- Besarnya cover tergantung pada mata uang, informasi tersebut tersedia di situs-situs pemberi pinjaman luar negeri utama

#2: Tambahkan risk cover untuk risiko tingkat suku bunga kedalam tambahan nilai

3. Rekomendasi

Mata uangpinjaman

ADB

Tingkat SukuBunga Fixed

Tingkat SukuBunga Variabel

Selisih Tingkat Suku Bunga

US Dollar 4,430 0,862 3,569

Yen 2,230 0,748 1,483

Euro 4,220 1,891 2,329

Contoh: Selisih tingkat suku bunga untuk pinjaman 15-tahun dari ADB


#3: Kenakan tingkat suku bunga rata-rata yang sama kepada semua peminjam

3. Rekomendasi

Government (MoF)

Foreign Lender

Regional Govt A



or Rupiah)

3% 3%+SC

Government

(MoF)

Foreign Lender A

Foreign Lender

Regional Govt B

1% 1%+SC Foreign

Lender B

Government (MoF)

Foreign Lender

Regional Govt A

3%


Foreign Lender A

Foreign Lender

Regional Govt B

1% Foreign

Lender B

Ministry of Finance

PROPOSED

CURRENT

2%+SC

2%+SC

Menuju Municipal Development Fund (MDF)


Terima Kasih!

Date post:	22-Mar-2016
Category:	Documents
Upload:	decentralization-support-facility
View:	213 times
Download:	0 times

A Review of the Method for Setting Interest Rates on Foreign-Funded Sub-Loans to the Regions

Documents