Bogor, Indonesia -- Indonesia's Bank Mandiri, the country's largest lending institution, in July sold 20 percent of its equity shares in a highly touted public offering. Investors responded enthusiastically, and Mandiri's share sale was oversubscribed by seven-fold, generating $320 million. The Indonesian government, the International Monetary Fund (IMF), and a growing chorus of financial analysts have claimed this is the surest sign yet that Indonesia's economy -- which in 1997 suffered the world's largest banking collapse ever -- is well on the road to recovery.

But for Indonesia's forests, which include some of the most biologically diverse ecosystems on the planet, Bank Mandiri's public offering is bad news.

Bank Mandiri holds at least $1.3 billion in corporate debts associated with Indonesia's forestry conglomerates. Even before Bank Mandiri's public offering, there were signs that the bank would ultimately write off at least 80 percent of these debts -- and in some cases, it may forgive them altogether. With the share sale to international investors, Mandiri is now under added pressure to remove bad loans from its books.

Writing off these debts will effectively pass on to Indonesia's forestry conglomerates -- including some of the Suharto era's most powerful business interests, Mohamed "Bob" Hasan's Kalimanis Group, Burhan Uray's Djajanti Group, and Prajogo Pangestu's Barito Group -- a capital subsidy of $1 billion or more.

Many analysts worry that a subsidy on this scale will encourage these companies to undervalue the forests they are charged with managing, and that this will lead to continued high levels of forest destruction -- paid for with public money.

"Indonesia is currently losing over two million hectares each year -- an area roughly the size of Switzerland," says Longgena Ginting, director of WALHI, Indonesia's largest environmental organization. "Much of this is due to unsustainable logging by timber and plantation companies and to excessive demand for logs on the part of the pulp and paper, plywood and sawnwood industries. By writing off the debts of forestry conglomerates, Bank Mandiri will only intensify Indonesia's forestry crisis."

Suharto's forest subsidies
Bank Mandiri's write-off of forestry debt is the latest in a long series of government subsidies to Indonesia's timber sector that started shortly after Suharto, the country's second president, came to power in the late-1960s. During the Suharto period, the government allocated some 63 million hectares of commercially valuable forests to private and state-owned logging companies in the form of 20-year timber concessions. Many of these were assigned to regional military commands and individual officers to secure their loyalty.

Concession contracts were essentially a license to print money. Timber royalties were low and regulatory controls slight. In many cases, concessionaires cut more trees than their contracts allowed, or logged illegally outside the boundaries of their concession sites.

In the early 1980s, the Indonesian government phased in a ban on raw log exports to encourage logging companies to invest in wood panel production. State banks extended tens of millions of dollars in discounted loans to companies establishing plywood mills. By 1990, Indonesia had 132 plywood producers capable of generating 12.6 million cubic meters of panels per year. Ten large conglomerates dominated the industry, controlling some 27 million hectares of logging concessions and 48 plywood mills with 40 percent of the country's wood processing capacity.

Government authorities gave Bob Hasan -- a close business associate of President Suharto -- far-reaching authority to transform the Indonesian Wood Panel Association (Asosiasi Panel Kayu Indonesia, or APKINDO) into a marketing cartel. Under APKINDO, Indonesian plywood producers flooded strategic markets with low-cost panels to capture 80 percent of the world's tropical plywood exports. Hasan also used his authority to assign monopoly contracts to companies under his own control for the shipping and distribution of Indonesian panels to key markets.

Since the early-1990s, Indonesia's pulp and paper industry has expanded nine-fold and entered the ranks of the world's top 10 producers. The Suharto government subsidized Indonesian pulp producers by allowing them to clear extensive areas of natural forest and to convert these areas to pulpwood plantations, based on vast monocultures of fast-growing species. The companies were required to pay only minimal royalties on the wood cleared from these sites.

Indonesian pulp and paper conglomerates also benefited from the nation's weak financial regulations. Prior to the 1997 financial crisis, each of the industry's major producers had its own bank. Frequently, these banks made loans to affiliated companies that were well in excess of the government's legal lending limits. It was also common practice for pulp producers to "mark up" the cost of their investments by telling banks that a project cost much more than it actually did. In doing so, the borrower was able to obtain significantly greater amounts of finance than it really needed, often generating what is known euphemistically as "profit before operating." This was particularly the case with loans from state banks, which were frequently poorly collateralized and made with the expectation that they would never be fully repaid.

Furthermore, Indonesian pulp producers had relatively easy access to international capital through much of the 1990s. The nation's two largest producers placed their pulp and paper assets under Singapore-incorporated holding companies -- Asia Pulp & Paper (APP) and Asia Pacific Resources International Ltd (APRIL) -- to avoid Indonesia's high country risk. They listed these firms on the New York Stock Exchange to access global debt and equity markets. Then the two groups borrowed over $15 billion to finance massive pulp and paper projects in Indonesia and China. They did so by convincing investment institutions that they had access to long-term supplies of very cheap wood and could produce the lowest-cost pulp in the world.

Financial Crisis and aftermath
The Asian monetary crisis, which began in July 1997, had a catastrophic effect on Indonesia. The nation's currency lost 70 percent of its value in less than half a year, inflation almost doubled, and the number of people living in poverty rose dramatically. By January 1998, the world's fourth most populous country was close to defaulting on its balance-of-payments, and the nation's banking system faced systemic insolvency. At that point, the IMF signed a $43 billion loan agreement with the government to bail out the country's collapsing economy. The following May, popular protests led to the end of President Suharto's 32-year rule.

In signing the IMF loan agreement, the Indonesian government committed itself to a far-reaching set of policy reforms aimed at recapitalizing the nation's banking system and restoring long-term economic growth. With assistance from the World Bank, the IMF prominently included in its list of conditionalities a number of policy reforms aimed specifically at restructuring Indonesia's forestry sector. These included increasing timber concession royalties and dismantling the APKINDO plywood cartel.

Whatever success the IMF had in eliminating capital subsidies to the country's forestry conglomerates, however, has been undermined by the bank recapitalization and corporate debt resolution processes carried out by the Indonesian Bank Restructuring Agency (IBRA). The government created IBRA in February 1999, under guidance from the IMF, to refloat Indonesia's failing banking system and to resolve the nation's corporate debt crisis. Placed under the Ministry of Finance, the agency was given a broad mandate to close or take over failing banks, and to determine which lending institutions should qualify for the government's bank recapitalization process.

Under the recapitalization process, the government injected $93 billion into 27 private and state-owned banks to restore their capital assets to commercially viable levels. In turn, all nonperforming loans were stripped from the recapitalized banks' portfolios and transferred to IBRA. The agency also assumed control over all outstanding loans held by banks that were closed or taken over.

In addition, IBRA obtained pledged equity shares in companies owned by conglomerates whose banks had received emergency liquidity credits from Bank Indonesia, the country's central bank, during the early months of the financial crisis. Bank Indonesia had disbursed some $20 billion in late-1997 and early-1998 to prevent depositor runs on the country's private lending institutions. (In several cases -- notably among banks owned by associates of the Suharto regime -- these funds were channeled on to companies affiliated with the banks' owners or transferred out of the country.)

IBRA was charged with securing funds to offset the cost of the government's bank recapitalization process by restructuring and selling the nonperforming loans in its portfolio. It was also supposed to recover the Bank Indonesia liquidity credits by negotiating repayment agreements with the owners of recipient banks or by selling the assets they had pledged.

Forestry Sector Debt Under IBRA
Under the bank recapitalization process, IBRA assumed control of outstanding loans to more than 4,000 private sector companies totaling $50 billion. This represented 32 percent of Indonesia's gross domestic product for 1998, the first full year of the financial crisis. Approximately two-thirds of the loans in IBRA's portfolio were classified as non-performing debt.

Through mid-2002, IBRA held some $3.1 billion in corporate debts directly related to forestry investments. These debts were associated with 128 companies engaged in timber extraction and wood processing, but the lion's share came from only a few producers. Five integrated timber conglomerates were responsible for roughly two-thirds of this debt -- the Bob Hasan, Djajanti, Raja Garuda Mas, Barito, and Andatu conglomerates. Three specific firms were responsible for a third of the total -- the Bob Hasan Group's Kiani Kertas ($400 million) and Kiani Lestari ($320 million), and the Djajanti Group's Nusantara Plywood ($385 million).

IBRA also secured asset pledges from two of the forestry sector's largest conglomerates, the Salim and Bob Hasan groups, in an effort to guarantee repayment of $4.9 billion in liquidity credits that these groups' banks had received from Bank Indonesia. In addition, IBRA held pledged assets valued at $2.6 trillion from the Sinar Mas Group, the parent conglomerate for Asia Pulp & Paper.

IBRA props up the Timber Titans
By late 1999, the large-scale transfer of debt and equity-holdings from Indonesia's failing banks to IBRA had made the agency the single largest holder of corporate assets in the nation's forestry sector. Under government regulation, IBRA maintains authority to assume financial control, if not outright ownership, over virtually all of the companies with loans or pledged assets in the agency's portfolio.

The Ministry of Forestry and others have argued that IBRA should use its authority to close the operations of forestry companies that fail to repay the debts they owe -- particularly as many of these firms are effectively bankrupt. "IBRA's policy to allow forest companies to remain in business has contributed to the overcapacity that demands more raw materials than Indonesia's forests can supply," says Minister of Forestry Dr. Mohamad Prakosa. "We believe that companies lacking sustainable timber supply should be closed down."

The Ministry of Forestry has committed itself to whittling down Indonesia's forestry industries. The country's domestic wood processing industries consume 55-70 million cubic meters of logs each year. However, ministry officials believe the sustainable maximum harvest is less than 10 million cubic meters. Illegal logging is responsible for much of the excess over sustainable levels.

Defining its fiduciary responsibilities over the corporate assets in its portfolio in very narrow terms, IBRA has refused to reduce wood processing capacity. In interviews, IBRA officials vehemently deny that the agency is effectively the owner of these assets. In their view, the agency's role is essentially that of a creditor -- albeit one with extraordinary legal powers. Like a bank, they maintain, IBRA's responsibility is to collect the outstanding loans and credits in its portfolio. The agency has little concern over how an indebted company is managed as long as it cooperates with IBRA's debt restructuring efforts.

In practice, this has meant that IBRA has left virtually all of the companies with debts in its portfolio under the management of their original owners. IBRA officials have shown no concern that indebted timber companies may be overharvesting their concessions or that wood processing firms may be using illegally harvested logs.

IBRA's efforts to restructure the financial obligations of Indonesia's forestry conglomerates have also produced agreements that are highly favorable to the debtor companies. In October 2000, for instance, IBRA entered into a debt restructuring agreement with the Bob Hasan Group that covered some $478 million in what the agency characterized as "sustainable" and "unsustainable" debt held by PT Kiani Kertas, a company owning a large pulp mill in East Kalimantan. Under the agreement, IBRA agreed to reschedule $226 million in so-called "sustainable debt" with an extended repayment period of 10 years (due in 2010, with a two-year grace period) and a fixed annual interest rate of 12 percent. The agency also agreed to purchase $246 million in mandatory convertible bonds, which can be converted to equity if the company fails to meet its debt repayment schedule. At the time, IBRA officials speculated that the agency would probably only recover $113 million from sales of the restructured debt, or less than 25 percent of the total amount due. Meanwhile, the Bob Hasan Group was allowed to defer debt payments for Kiani Kertas by up to 12 years, and the company was not required to carry out any restructuring of its corporate operations.

At times, the corporate debt resolution process has also been tied to the expansion of activities that place added pressures on Indonesia's forests. In the case of the Raja Garuda Mas Group, the parent conglomerate for APRIL, IBRA and international creditors linked debt rescheduling to the expansion of the group's Riau Andalan pulp mill. Both sets of creditors agreed to waive the group's interest payments for 18 months -- providing a capital subsidy of $165 million -- to help finance the expansion of the mill's processing capacity from 750,000 to 1.3 million tons of pulp per year. Their stated rationale was that Raja Garuda Mas/APRIL will be able to repay its debts sooner by producing a larger volume of pulp.

A Fire Sale on Debt
Through the second half of 2002, IBRA began selling off both restructured and unrestructured debts from its portfolio at fire sale prices -- generally recovering only 20 cents on the dollar. Indonesian environmental groups and concerned international organizations met with the IMF to voice alarm that IBRA would effectively write-off its forestry debts by including them in these sales. IMF officials said they were opposed to such an outcome and would raise this issue with Indonesian authorities. Yet the Fund took no decisive action to halt this process.

The World Bank and international donors did raise the issue of IBRA's forestry debt sales at the January 2003 meeting of the Consultative Group on Indonesia (CGI), which coordinates bilateral and multilateral donor contributions to the Indonesian government. The official statement of the donor working group on forestry points out that IBRA's sale of forestry assets "places pressures on the nation's forests, and creates a climate of moral hazard." Noting that most of the logs used by Indonesia's indebted forestry conglomerates are harvested illegally, the donors point out that, "once sold, the new owners of these loans and of the mills ... will continue to use the same illegal sources of timber." Moreover, the donors noted, "in many cases, the new purchasers of the discounted loans are the nonperforming debtors themselves, who mysteriously claim not to have the money to pay back the loans, but who do have the money to buy the loans back."

What was apparently never mentioned at the CGI's January meeting is that IBRA had already sold most of its forestry assets the previous month. Indeed, information subsequently released by IBRA suggests it sold $2.3 billion in forestry debts, including loans to the Bob Hasan, Djajanti and Barito groups, by December 31 of last year.

One of the key purchasers of the debt has been Bank Mandiri, which purchased half of the forestry debt sold in late 2002. In buying a company's debt from IBRA, Bank Mandiri has typically established a consortium with a private sector investor. In most cases, Mandiri has put up 70 percent of the capital for the debt purchase and the investor has contributed 30 percent. The consortium has then purchased the indebted company's total obligations to IBRA, including its "sustainable debt" -- that is, the amount the company is believed to be able to repay -- its "unsustainable debt," and any collateral held by the agency. The transaction price is normally defined by the face value of the "sustainable debt."

Bambang Saptono, a senior credit officer with Bank Mandiri, explained how these debt purchases work: "It is generally the case that only 30 percent or less of the total debt owed to IBRA by an obligor is classified as �sustainable debt.' If, for instance, a company owes Rp 100 billion [$12 million], the sustainable debt might be approximately Rp 30 billion. The consortium between Bank Mandiri and the investor then purchases the entire debt load for Rp 30 billion. Mandiri ends up with Rp 30 billion of debt that it has a reasonable chance of collecting, along with the collateral. The investor, which has contributed only Rp 8 billion to the purchase, ends up with Rp 70 billion in debt that it can convert to equity."

Many analysts are concerned that the investors collaborating with Bank Mandiri in these debt deals are front companies for the original owners of the indebted enterprises, many of whom have strong political connections. Through these purchases, they would be able to erase the vast majority of their outstanding debts and regain firm control over most of their companies' equity. It is also likely that Bank Mandiri will end up selling the "sustainable debt" under its control to these companies' owners, quite possibly at a further discount or with soft financing. Few investors will be interested in buying debt that IBRA, with its far-reaching legal powers to nullify contracts and to seize assets, was not able to recover.

The fact that IBRA has been able to sell its forestry debts without informing the Indonesian public or the IMF is a clear violation of all the agreements about transparency and accountability established when IBRA was first created. That the sales were to Bank Mandiri, a government-owned bank, shows the importance of these principles. Rather than officially writing off forest debts from IBRA's accounts, the government disappeared them by making a "market sale" from itself to another of its own entities. the cycle continues

IBRA's sale of its forestry debts to Bank Mandiri and other buyers will help determine the fate of Indonesia forests. IBRA's asset sales are facilitating a large-scale write-off of these debts, and providing the nation's forestry conglomerates with a capital subsidy amounting to several billion dollars.

By subsidizing the activities of Indonesia's forestry companies on this scale, IBRA and Bank Mandiri are enabling the timber, plywood and pulp industries to continue, or in some cases to expand, their unsustainable and often illegal logging.

The fact that these sales occurred as part of the IMF-sponsored bank recapitalization program suggests that they were indirectly supported by the Fund and ultimately may be underwritten by donor country taxpayers. Through late 2001 and early 2002, a host of Indonesian nongovernmental organizations and international agencies repeatedly alerted IMF officials to the fact that IBRA's sale of forestry debt would be bad for forests and bad for the nation's economic well-being. However, the Fund chose not to use its leverage with the government either to block the sales or ensure they occurred in a transparent and accountable manner.

The CGI's donor working group on forestry expressed its frustration over IBRA's forestry debt sales in a statement prepared for its meeting with the government this past June. "Indonesia's forests continue to be lost at astronomical rates with no real sense of responsibility and urgency on the part of those who have the authority to manage them sustainably," the donors stated. "Unfortunately, the best opportunity to manage debt in the forestry sector in a manner that would contribute to achieving sustainable forest management has been lost. [IBRA's debt sales to Bank Mandiri] effectively mean the government has bought the debt twice for no real apparent economic, social or forest management advantage."

One potentially positive development has arisen, however, with the government's passage of a revised anti-money laundering law in September. The new law includes "forest-related crimes" and "environmental crimes" in its list of predicate offenses for money laundering. This makes Indonesia the first country in the world to treat illegal logging or forest-related corruption as money laundering offenses in the same way that narcotics trafficking is treated under most jurisdictions. If Bank Mandiri and other financial institutions with forestry loans fail to ensure that they are not financing illegal forestry practices, they may now be prosecuted for money laundering. Whether the government -- which for decades has facilitated expansion of the forestry sector and turned a blind eye to its illegal practices -- will enforce this law, however, remains to be seen.

Christopher Barr is a policy scientist and Bambang Setiono is a policy and financial analyst at the Center for International Forestry Research (CIFOR). Both are based in Bogor, Indonesia.