Jack:
>>Just imagine that when a lender cannot collect the
money from the borrower (Indonesian corporation), it is the latter who benefits.<<
does this imply someone's bailing out the borrower with other people's money?
No.
I was under the impression that if a borrower cannot pay his loans, he declares bankruptcy and his assets are forfeited.
Correct impression. Suppose a lender, Citibank, takes over a defaulting Indonesian company Indofood, the largest noodle maker of the world. Citibank sells Indofood assets in an auction/open market/private deal. Indofood's current asset value in US$ is less than its debt. The assets will fetch Citibank about 50 cents (say) for every US$ lent. The factory will continue to operate in Indonesia under a new management and continue to employ people (maybe some will lose jobs). But this process will transfer 50 cents to Indonesia. Citibank loses 50 cents; as a cost of not monitoring the Indonesian economy/company.
Actually, even Citibank may not necessarily have lost the 50 cents, if the bank simply short-sold Rp in July 1997 (say), when it lent the money to Indofood. By covering the Rp short, Citibank will now make a (hedging) profit which could match the loss due to Indofood's default which was due to a fall in Rp which was due to such short-sellers (or panic runs). The process simply will enter a new equilibrium if the Indonesian government does not guarantee Citibank's reckless lending and/or Indofood's reckless borrowing. US/Indonesian govt protection of Citibank will create moral hazard and should/would not be allowed.
Now, you can see a very nice thing emerging from this equilibrium. As the creditors resolve their loans to debtors, the local demand for US$ falls and the demand for Rp increases via short-covering, raising the Rp/US$ value. [Of course, such nice scenarios can be muddled by socio-political chaos.]
Sankar |
