Indonesia to call time on tax-free debt for riskiest borrowers

[SINGAPORE] Companies the world over have used interest payments to shrink their tax bills for decades. Indonesia, faced with record private debt, is trying something different.

Southeast Asia's largest economy plans to ban firms from writing off interest costs against taxable income should debt exceed four times equity. If the finance ministry proposal is enforced next year, heavyweights in the economy such as telecommunications firm PT Tower Bersama Infrastructure could take a hit.

Indonesian President Joko Widodo needs to balance reining in surging liabilities with encouraging investment to reverse the slowest economic growth in six years. The central bank said this week it will loosen lending rules, even after credit to non-financial firms breached 4 quadrillion rupiah (US$304 billion) last year. It has sought to curb private external debt that soared to more than half of all foreign dues, after defaults on US$2.3 billion of dollar bonds since 2008.

"We think it's rather a preventive measure, but perhaps there are some local companies whose total debt is reaching this level," said Rosemary Fu, a senior credit analyst in Singapore in the emerging corporate team of Pictet Asset Management, a unit of Banque Pictet & Cie SA. "In terms of Indonesia corporates' foreign currency debt levels presently, they're still much lower than what they were on the eve of the 97-98 Asian financial crisis."

Indonesia was one of three countries forced to seek an International Monetary Fund bailout in the Asian crisis almost three decades ago. The region's companies defaulted on billions of dollars of liabilities, with Indonesia's average 1996 debt levels about 90 per cent of equity, World Bank data show. They're around 80 per cent today, according to Bloomberg-compiled data.

Such leverage makes tax-free debt a prized perk. Its use dates back to the 19th century in the US, according to Emir Hrnjic, director of education and outreach at the Centre for Asset Management Research and Investments at the National University of Singapore. In 2012, an Obama administration bid to cap relief faced stiff resistance from businesses.

"Overleveraged companies may carry risk that can spill over on other companies in down times," Mr Hrnjic said by e-mail. "From the perspective of the companies, this will increase the cost of doing business."

The mining, oil and gas and financial industries would be exempt from Indonesia's proposed new leverage rules, Finance Minister Bambang Brodjonegoro said in Jakarta last week. The plan applies to both local and offshore debt, he said at a press conference on Thursday.

Among listed Indonesian companies affected by the proposed rule, 13 would already be in breach, data compiled by Bloomberg show. The largest is Tower Bersama, which is targeting capital expenditure of 2 trillion rupiah this year and building as many as 2,000 telecommunication towers. It sold US$350 million of dollar bonds in February that now yield 5.32 per cent.

Calls and text messages to Tower Bersama's management weren't returned on Thursday.

PT Solusi Tunas Pratama is the second largest company that would be in breach of the proposal as of Dec. 31. The firm is in the same business as Tower Bersama and also sold dollar notes in February. Its debt ratio has since fallen to about two times equity after a bond repayment and share sale, the company said in a May 20 e-mail.

"This regulation will have different impacts in different sectors," said Vicky Melbourne, senior director at Fitch Ratings in Sydney. "Most infrastructure projects are highly leveraged, and if you say the interest expense will not be deductible, it may stop some from reaching the expected internal return."

Mr Widodo earlier this year outlined plans to build 25 dams in five years, 24 ports and six mass transport systems to spur the economy. Growth slowed to 4.7 per cent in the first quarter from a year earlier, the weakest pace since 2009 and well below the president's target of 7 percent annually within his term.

A softer economy has seen Indonesian companies' credit quality erode in the past six months, Standard & Poor's said on May 19. It also cited the further depreciation of the rupiah, which has dropped 5.6 percent this year, the worst performing among Asia's major currencies.

The central bank announced new rules in October aimed at limiting offshore debt risk for non-bank companies. They stated that 20 per cent of foreign-currency debt must be hedged and assets must comprise at least half of a firm's overseas liabilities from this year.

"Most new financial regulations coming out of Indonesia penalize companies for decisions they have made in the past," said Xavier Jean, senior director at S&P in Singapore. "That retroactive nature of these rules creates an extra layer of operating uncertainty, which is coming at a time of tougher operating conditions domestically."

BLOOMBERG