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Indonesia’s Big Procurement Push Is Aided By Lenders

Mar. 31, 2013 - 08:47AM   |  
By PIERRE TRAN   |   Comments
A group of commercial banks has drawn up a loan to fund Indonesia's purchase of truck-mounted artillery from French land systems maker Nexter, sources close to the deal said. Shown is Nexter's Caesar self-propelled guns.
A group of commercial banks has drawn up a loan to fund Indonesia’s purchase of truck-mounted artillery from French land systems maker Nexter, sources close to the deal said. Shown is Nexter's Caesar self-propelled guns. (Nexter)
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PARIS — A group of commercial banks has drawn up a loan to fund Indonesia’s purchase of truck-mounted artillery from French land systems maker Nexter, sources close to the deal said.

The agreement is the latest in Jakarta’s push to “catch up” on defense procurement after what one analyst called “a long period of atrophy.” And by financing the deal through a bank loan rather than paying cash, Indonesia is part of a growing number of emerging defense markets looking to stretch their buying power as they seek to beef up militaries.

“Indonesia is a key target for everyone,” Grant Rogan, chief executive of Blenheim Capital, a specialist in defense offset deals, said March 26. “Our client base, which includes 25 large aerospace and defense companies, all, without exception, view Indonesia as a prime target.”

Jakarta’s short-term high-interest loan will pay for 34 Caesar 155mm 52-caliber guns, the sources said.

Indonesia required a buyer’s credit for 85 percent of the 108 million euro ($140 million) contract, with funding to be delivered to the Indonesian Finance Ministry in April, an executive said.

Indonesia’s request for bank financing is just one of a number of weapons deals for the Asian country, a European banker said.

The Asian market for bank loans “is concentrated in Indonesia,” as other countries such as India, Malaysia and Thailand pay cash, the banker said. Jakarta is in the midst of a procurement drive after staying out of the arms market for years, due to a lack of money and Western sanctions over human rights abuse. Now, the government is trying to “catch up,” said Richard Bitzinger, senior fellow at the S. Rajaratnam School of International Studies, Singapore.

“Indonesia is in the midst of trying to upgrade its military after a long period of atrophy,” Bitzinger said. Jakarta buys weapons from a variety of suppliers, as it seeks to avoid being too dependent on a major foreign arms producer and to find the best value for money, he said.

Despite the rule of paying cash, a market for bank funding is rising, Rogan said. “Many countries are requesting financing.”

Blenheim has added a specialization in financing that complies with Islamic Sharia law, reflecting the rising demand.

Rogan was speaking from the Langkawi International Maritime and Aerospace Exhibition, Malaysia.

Banks Pursue Deals

The pricing of loans is a sensitive issue, and the sensitivity is heightened by the unusual nature of the Indonesian artillery deal.

A source close to the deal said there are not many banks in this group of lenders, which is expected to be composed mainly of French lenders. The term of the loan is expected to be for a relatively short period, under five years.

The margin on the proposed bank loan is estimated to be below 200 basis points, the source said. Banks set the interest on loans using basis points — 1/100th of a percentage point — which are keyed to official interest rates such as the London Interbank Offered Rate.

A financial specialist said the estimated margin on the Caesar deal is relatively expensive, in view of the short loan period and the fact that the deal is backed by a sovereign guarantee from Indonesia.

The margin and loan period indicate France and the bank lenders are essentially taking a short-term view of Indonesia as a financial risk, with a loan covering production and delivery of the guns, and perhaps after-sales warranty, the specialist said.

A lower margin, on the other hand, would indicate a long-term view of Indonesia’s attractiveness as a client.

Indonesia, which sees itself as a regional power and is undergoing a procurement drive to reflect that role, moved last year to holding tenders for bank lending instead of private trade deals, attracting the attention of international and local banks.

Since then, about a dozen big banks expressed interest in arranging loan finance for eight or nine arms contracts Indonesia signed with Brazil, China, France, Russia, Spain and the United States.

The loans range from large orders to small deals of around $10 million.

For instance, Jakarta relaunched a bank tender this year to raise money to buy the Brazilian Avibras Astros B multiple rocket launcher system.

The Astros is capable of firing cluster submunitions. Western banks likely stayed away because the Oslo convention bans these weapons, forcing Indonesia to reset the tender a couple of months ago.

Indonesia reportedly used that type of munition in East Timor when the local population called for self rule in a 1999 referendum.

Indonesia also has a tender out for bank loans for 25 Bell 412 utility helicopters for the Army. Jakarta is also spending $750 million to upgrade secondhand F-16 C/D fighters provided free by the U.S. government. That upgrade will be a cash deal through the Foreign Military Sales regime.

The Down Side for Lenders

A bank loan for weapons poses problems for commercial lenders, the defense specialist said.

Lending on civil programs such as a nuclear power plant or a highway is relatively simple because they can generate revenue, part of which can be placed in escrow holding accounts to act as security.

But weapons have no power to raise revenue, and what is worse, might be destroyed. If a country loses use of its arms, it might stop repaying the loan. “What security is that?” the specialist said. Banks are also concerned about how the public views lending on arms deals. One large British bank refuses to lend on arms, two sources said.

Given the size of the Indonesian economy, the 108 million euro purchase price for the Caesar guns “is peanuts,” the specialist said.

A striking aspect of the Indonesian artillery loan is what is seen as the relatively long time between the signing last summer and the financing in April.

That long lead time may signal a slowing of arms deals, perhaps delaying some until 2014. Or perhaps it reflects a lower economic growth rate, or simply a bottleneck in the finance and defense ministries as staff struggle to cope with the volume of orders.

A loan for 85 percent of purchase amount is the maximum allowed under trade rules of the Organization for Economic Cooperation and Development, with the 15 percent paid in cash, an export credit executive based in New York said.

Trying To Catch Up

Indonesia has a robust defense and aerospace industry in place, and the government wants to co-produce and co-assemble to build the domestic base, Rogan said.

Malaysia is the leader in that drive to build the defense industrial base, and wants to take a regional approach with Indonesia. The two countries would avoid product competition, and instead, buy from each other.

That approach drew foreigners’ skepticism three years ago, yet Malaysia is buying six-wheeled vehicles from Indonesia, and Indonesia is buying vessels from Malaysia, Rogan said.

Indonesia is rated the 16th largest economy, with an estimated growth rate of 6 percent in 2012, slowing from 6.5 percent in the previous year, the CIA World Factbook said.

The Indonesian government needs to improve poor infrastructure, which impedes growth, while also dealing with labor unrest over pay and cutting a fuel subsidy amid high oil prices, the country report said. Corruption, poverty and unemployment are also big problems, the report said.

Indonesia is expected to become the sixth or seventh largest economy.

Observers see the recent purchases as an “unblocking” of Indonesian procurement after a fallow period of three or four years. The big orders before the quiet spell were mainly Russian deals, financed by Russian banks.

Russian banks have lent money for Indonesia’s purchase of Sukhoi Su-27 and Su-30 fighters, the European banker said. Russian loans have helped Venezuela buy around $4 billion of weapons. The VTB bank is active in Vietnam, and the Russian lender is understood to have funded military purchases.

U.K. Prime Minister David Cameron visited Indonesia in 2012, looking to drum up defense deals after the previous Labour administration halted arms sales on allegations BAE Systems Hawk jets were used to bomb civilians in East Timor in 1999.

BAE and AgustaWestland executives went with Cameron on the visit.

Indonesia is now seen as an attractive market after a Western moratorium because of its human rights record and brutal put-down of movements for self-determination in Aceh, Papua and East Timor.

Jakarta also has close ties with South Korea, and some of the recent deals are financed on a government-to-government basis, the banker said.

These are understood to include Jakarta’s 2012 $1 billion purchase of three attack submarines — the first built in South Korea with Indonesian engineers on site, part of the second built in Indonesia, and the third built by state company PAL in Surabaya.

Jakarta has also bought 17 of the KT-1B basic trainers.

Jakarta and Seoul share similar ambitions.

“I think the Indonesians like working with the Koreans as they are in roughly the same situation: rising, aspiring regional powers with ambitions to play larger roles in their respective regions, and to also create sophisticated arms industries by which to do so,” Bitzinger said.

“The problem is, the Koreans have a level of technological sophistication and organizational production capability that the Indonesians still lack. So any partnerships with the Koreans still leave the Indonesians in a decidedly junior role,” he said.

Indonesia has also bought Damen missile corvettes from the Netherlands, financed by Dutch banks. Some Dutch banks have a policy of no support for military sales but they are quietly funding the deals anyway.

_________

Andrew Chuter in London and Wendell Minnick in Taipei contributed to this report.

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