Is Garuda Indonesia on the verge of bankruptcy?
Author: James Guild, RSIS
COVID-19 has squeezed the earnings of Indonesia’s national carrier Garuda and plunged profits, causing the airline’s shares to stop trading recently after defaulting on payments. CEO Irfan Setiaputra claimed the airline’s total debt was 70 trillion rupees ($ 4.9 billion). This led to a meeting with the Ministry of Public Enterprise, which presented a number of potential resolutions including public capital injections, privatizations or bankruptcy proceedings while the company restructures part of its debt.
Irfan did not detail the figure of 70 trillion rupees, but that of Garuda most recent financial disclosure from September 2020 provides some clues. By the end of 2020, total liabilities had swelled to $ 10.36 billion from $ 9.9 billion in assets, meaning the company was returning negative equity of $ 455 million to its shareholders. With liabilities greater than assets, financial insolvency is a real concern. This is particularly the case in Garuda’s case, as business has been frozen by travel restrictions linked to the pandemic. According to the company operating statistics, the number of international passengers fell from 193,380 in February 2020 to just 8,967 a year later.
This raises the question of whether Garuda’s financial woes should be seen as a referendum on the style of Indonesian state capitalism, or as the result of a major and unpredictable external shock to demand. If Garuda’s business management is not flawless, this last explanation is more convincing.
No airline in the world has enough cash to cope with a nearly 100% drop in international passenger traffic. Even Singapore Airlines, one of the region’s best-run carriers, needed a lifeline from majority shareholder Temasek and recently had to raise funds through a sale and leaseback of several of its planes.
Critics have focused on the 70 trillion rupee debt as evidence of corporate mismanagement and an alleged tendency for Indonesian state-owned enterprises to borrow money irresponsibly. But it’s not quite true in that case. Garuda’s liabilities include a $ 500 million sukuk bond (an Islamic finance tool similar to a bond), $ 922.6 million in bank debt, and a growing backlog of trade debt that has exceeded $ 1.4 billion. Last year.
But its balance sheet problems are mostly the product of a change in accounting rule rather than an explosion of unsustainable debt. The majority of Garuda’s new liabilities come from its finance lease obligations. According to the September 2020 financial statements, lease obligations fell from US $ 52.6 million in September 2019 to US $ 5.1 billion a year later.
Garuda, like many airlines, does not own the bulk of its fleet. Instead, it leases the majority of its planes to third parties. Before 2020, the accounting rules used by the company implied that it had to recognize in operating expenses only the minimum rents when they were incurred. The total value of the remaining leases was not shown on the balance sheet as a liability.
Under the new accounting directives adopted in 2020, the total value of current leases now appears on the balance sheet. And under normal business conditions, with a healthy cash flow, that probably wouldn’t be a problem. For example, in 2019, Garuda generated more than US $ 600 million in net cash from its operations.
But with tight cash flow, that’s a problem. In the future, the management of the Garuda company and the government are likely to use the threat of bankruptcy as leverage as they enter into restructuring negotiations with donors.
This is the same tactic that Malaysia Aviation Group, the parent company of Malaysia Airlines, used in early 2021, and it worked for them. After threatening to declare bankruptcy, a UK court approved an agreement to restructure nearly US $ 4 billion owed mainly to aircraft lessors. Once the agreement was concluded, the sovereign wealth fund Khazanah Nasional Berhad, the group’s sole shareholder, injected $ 890 million to consolidate the airline’s balance sheet. We’ll likely see something similar unfold with Garuda. But first, a credible threat of bankruptcy must be made in order to get creditors to play the game.
This is where the logic of Indonesian state capitalism manifests itself. The state will not voluntarily give up its national airline, either by privatizing it or liquidating its bankrupt assets. It is a function of economic nationalism as well as a desire to maintain some degree of direct control over a key market.
While Garuda’s shares are publicly traded, 86 percent of the company is owned by the government or by Chairul Tanjung, one of the wealthiest people in Indonesia. This insulates the airline from the most capricious vagaries of the market because even if it loses money, it has time to negotiate and consider its options without worrying too much about pressure from shareholders. This is important because the interests of shareholders may not always correspond to the economic or political interests of the state.
Arguably, a strategic asset like a national airline should not be vulnerable to market pressures where, in times of distress, deep-pocketed investors may grab it or shareholders may try to force a sale in order to recover some value. Instead, the state can make sure the airline limps until demand recovers, using the threat of bankruptcy to get more lenient terms from its creditors along the way.
It may well be that the way Indonesian SOEs, including Garuda, manage their debt, will not be sustainable in the long run. But the financial struggles of a state airline during a global pandemic don’t tell us much, one way or another.
James Guild is Adjunct Research Fellow at the S Rajaratnam School of International Studies, Nanyang Technological University, Singapore.