Dangerous Liaison

SINGAPORE - The largest chalet at the air show, showcase of Indonesia's nascent aircraft industry, sat half-empty.

It was the beginning of a bad week for the Indonesians, who, with help from their friends at Boeing, had hoped to underscore their emerging membership in one of the world's most exclusive clubs: commercial aircraft manufacturing.

Instead, officials from IPTN, the Indonesian aircraft builder, abruptly canceled their press briefing.

Then, Indonesia's three regional airlines went out of business. That nearly dried up most of the firm orders for IPTN's first commercial product, a 70-seat, twin-engine airplane.

A prototype of that plane - called the N250 - flew daily demonstration flights at the Asian Aerospace Show here, but it is still seeking worldwide certification.

Indonesian officials also had hoped to use last month's show to spotlight another ambition: Indonesia - not China, Japan, Taiwan or South Korea - was on schedule to become the first Asian nation to build a medium-range, 130-seat commercial jetliner.

But the economic crisis engulfing Indonesia has blunted the country's entry into this elite aviation club, setting back the government's campaign to create a world-class aerospace industry.

The currency crisis rippling through Asia has put Boeing in an awkward position. Three Boeing 737 jetliners built for Garuda Indonesia Airlines, in a deal related to Boeing's long alliance with IPTN, remain grounded in the U.S. until the Indonesian government can pay for them.

The uncertainty prompted Phil Condit, Boeing's chairman and chief executive, to fly to Indonesia recently. He went to assess the financial crisis and speak to Garuda officials. Condit also stopped in Malaysia for similar discussions with airline customers and partners.

For Boeing, the stakes are high. The company has acknowledged that orders for as many as 60 large jets, 777s and 747s, could be canceled over the next two years by customers in such places as Malaysia, the Philippines, Thailand, Hong Kong and Indonesia.

Indonesia's aerospace drive

Being the U.S.'s top exporter often puts Boeing in the middle of tumultuous events abroad.

And nothing has been more tumultuous recently than the financial crisis in Indonesia, where the drive to build an aerospace industry was part of a national effort to become a technological leader.

The man behind the creation of IPTN and other Indonesian high-tech ventures is controversial nationalist B.J. Habibie, Indonesia's former research and technology minister who became vice president earlier this month.

Many regard Habibie as a visionary, a highly gifted airplane engineer who inspires millions with his grand plan to transform Indonesia into a leader of industry and technology for the next century.

For others, Habibie is a dangerous eccentric who uses his close connection to President Suharto to promote questionable economic theories and ill-conceived projects that drain the Indonesian economy.

Such sentiment has dogged Habibie ever since he boldly decided in 1976 to erect an aerospace industry on vacant land in Bandung, about two hours south of Indonesia's capital, Jakarta.

Suharto had identified aerospace as one of nine key technologies that Indonesia would develop. Habibie and others reasoned that air transport would be the most efficient link in a country that is an archipelago, with 17,000 islands scattered over a wide area.

Habibie began IPTN with 500 people and built airplanes that served Indonesia's unique geography. IPTN began producing small regional commuter aircraft and medium-range military troop transports in a co-production agreement with CASA of Spain.

Today, IPTN employs 16,000 engineers and production workers who design and build aircraft and helicopters.

"Obviously, IPTN is moving beyond co-production and moving into its own design and development with the N250," said a knowledgeable U.S. government official, who asked to remain anonymous. "Again, Habibie chose a niche aircraft that would have specific application within the region and elsewhere in the world."

So far, most of the 34 orders for the N250 have come from Indonesia's three regional airlines. Now, those companies have been grounded by the financial crisis.

IPTN's sole international customer, Air Venezuela, has ordered eight of the twin turboprops. But that sale has raised questions about Venezula's lack of stringent certification procedures. Neither U.S. nor European regulators have to certify the N250 for it to fly in that South American country.

Condit meets Suharto

In Indonesia, Boeing's Condit met with President Suharto and repledged support to IPTN, a Boeing partner and supplier since 1982.

"Our partners and customers in Asia are facing some very challenging times, and I wanted to personally convey our continued support to them," Condit said.

Condit's trip demonstrates the importance of Indonesia and Southeast Asia to Boeing. The economic crisis has reversed the fortunes of a region that was once the hottest growth market for commercial aviation.

Indonesia's Garuda Airlines is struggling to finance a $1.6 billion order for 23 jets placed with Boeing in 1996. Before the financial crisis, Boeing delivered five 737s to Garuda. And, this year, Boeing was scheduled to build another dozen of the popular single-aisle airplanes for Garuda.

But the three completed Garuda 737s are mothballed in Arizona as the Indonesian airline struggles to cough up the cash for those planes, the rest of the 737s on order and six 777-200s. The airline already has canceled options it had reserved for six 747-400s.

A further pullback by Garuda could strain the partnership between Boeing and IPTN, likely hurting Indonesia's fledgling aerospace industry more than Boeing's balance sheet.

Even so, both sides have a stake in keeping the partnership going. Indonesia, with the world's fourth-largest population, will need more airplanes in the future. Boeing will need the Indonesian market.

Messy realities of global market

Condit's trip reflects the sometimes messy reality of conducting business in the global marketplace, where swapping technology and expertise for cheap labor and airplane orders is commonplace.

The practice of subcontracting aircraft component work to low-wage countries such as Indonesia and China has long frustrated members of the International Association of Machinists and Aerospace Workers, the largest union at Boeing. Boeing counters that such subcontracting is the price of entry into many foreign markets.

In a partnership that could be described as an implicit quid pro quo, Boeing and the Indonesian government established a formal relationship in 1982 that exchanges technology for the sale of Boeing jets.

Boeing has sent nearly 50 technical advisers to the IPTN aircraft factories and trains IPTN engineers in Seattle. It buys component parts from IPTN that are assembled on 737s, 747s, 767s and 777 jetliners.

In return, Boeing has delivered to Garuda Airlines two dozen Boeing 747s and 737s since 1980. And it sold the Indonesian carrier an additional 23 Boeing jets two years ago. That is the order now being nervously renegotiated.

The plunging rupiah

When Suharto picked the 62-year-old Habibie to be his vice president and possible successor, the Indonesian rupiah plunged against the U.S. dollar.

International experts have sharply criticized Habibie and Indonesia's decision to build an aerospace industry from the ground up. Begun in the 1970s, Indonesia has sunk $1 billion into IPTN's development and an additional $650 million into the N250 project.

"It's a wasteful project - especially when there's no running toilets, no proper telephones and unpaved roads throughout the country," said a knowledgable U.S. aircraft salesman, who asked to remain anonymous. "IPTN is a self-promoting project that feeds Habibie's ego."

A cash shortage threatened the project three years ago, and the government dipped into its reforestation fund, giving IPTN a $40 million interest-free loan that later was converted to equity.

IPTN officials insist the money was returned. "The government has made a commitment to fund the programs, and from time to time, the government could not get the money and got it from the reforestation fund," said Jean-Marc Eloy, vice president of Amrai, the U.S. marketing arm of IPTN, and a Habibie adviser. "The money was returned."

But experts on Indonesia remained unconvinced, questioning Habibie's integrity.

"He's venal and corrupt, but he gives the impression of being a visionary," said Eugene Galbraith, head of research in Hong Kong for securities firm ABN Amro Asia, who spent 16 years in Indonesia. "I think he is a very complicated figure. The key to his current position and, indeed, to his career, is the support of President Suharto."

`Terribly inefficient' venture

The aircraft industry in Indonesia has many of the characteristics that sparked the financial crisis in Asia, said Karl

Jackson, director of Southeast Asia studies at Johns Hopkins University.

"IPTN is a technologically very impressive project but is one that would never survive scrutiny in a U.S. economic system," Jackson said. "And it functions only through the huge subsidies from the Indonesian government. It's terribly inefficient."

As part of its condition for approving emergency financing to Indonesia, the International Monetary Fund required Suharto to cut off the massive state subsidies to IPTN, about $250 million annually. The IMF also required the government to stop shifting reforestation money to IPTN.

IPTN officials are scrambling to find new funding.

They need enough cash to meet a monthly payroll of $4 million. And they need $100 million to complete the development and certification of the N250.

Even more challenging is raising the $2 billion needed to continue developing IPTN's 130-seat jet aircraft, known as the N2130.

So far, officials say they have raised $500 million through a separate company personally backed by Suharto. Industry observers say Suharto demanded Indonesian companies purchase $1,000 bonds to finance the program.

Despite the financial setbacks, IPTN officials insist they will find a "risk-sharing" partner to continue operating. The wealthy Sultan of Brunei has been mentioned as a potential investor, as well as several other smaller aerospace companies. Boeing is not considered one of the candidates.

"We have money that will carry us for one year," Eloy said."It's not a fire sale.

"I believe we have been very misrepresented in the media, (which have suggested) that money is going down the hole," he said. "We know there is an impact. But we are optimistic."

Then, referring to the Sultan of Brunei's interest in investing in IPTN, Eloy added: "I don't believe the Sultan would put his money in a hole. He is not dumb."

World of cozy relationships

As details of Indonesia's financial crisis emerge, they are sure to increase criticism of the country's modernization plan and the way it conducts business.

The improbable rise and likely fall of IPTN is a cautionary tale, one that reveals the seamier side of doing business in Asia. It is a world based on cozy relationships, murky financing schemes and corrupt business dealings.

Like events in Thailand, South Korea, the Philippines and Malaysia, Indonesia's story begins in the secretive world of banking and finance.

Too much money was chasing too many marginal investments with little or no open accounting or auditing of the deals, Jackson said.

Ventures such as IPTN could not generate the cash flow necessary to pay back loans - usually in U.S. dollars - and that helped trigger the financial crisis, he said.

"IPTN has been producing high-cost aircraft, and it's not a sustainable industry," said Anil Deolalikar, professor of Southeast Asian economics for the University of Washington. "It has not been able to compete effectively."

One of the reasons, said Deolalikar, is that Indonesia lacks the skilled labor and scientific manpower to be competitive with other countries. Its low wages fail to offset the shortage of highly skilled people - a key requirement for aircraft manufacturing.

China, India and Japan can draw from large pools of scientific and technical people, so it might make sense for them to launch their own aircraft industry. But Deolalikar said it makes no sense for Indonesia.

"Habibie has had a long career in making planes and has a grand vision for Indonesia," Deolalikar said. "Unfortunately, that vision is very unrealistic."

`Cold day in hell'

For IPTN to sell the N250 in many developed countries it must win certification from the U.S. and European regulators. One top Federal Aviation Administration official, who asked to remain anonymous, said it would be a "cold day in hell before they certify" that airplane.

Several U.S. regulators and aerospace executives have questioned the level of quality control inside the IPTN factory.

But Condit said IPTN has provided FAA-certified parts for several Boeing jets.

"Their work is high-quality and meets our stringent quality standards," Condit said.

During Condit's recent meeting in Jakarta, Habibie sought Boeing's help in getting FAA certification for the N250. Condit agreed to help.

"Boeing is providing IPTN advice about the FAA and its guidelines and practices for certifying commercial airplanes," Condit said. "Boeing has long provided assistance to IPTN in preparing for such reviews and has helped IPTN understand a myriad of design, manufacturing and certification-related issues as they develop their aerospace industry."

Such help reflects the customer-partner relationship that Boeing formed with Habibie and IPTN in 1982 - one that Condit said "provides solid economic benefits to both parties."

Boeing technical experts support IPTN's N250 and its N2130 projects as tutors or consultants. At the same time, Boeing trains IPTN employees in Seattle.

The most notable participant was Habibie's son, Ilham Akbar Habibie, who spent two years performing a wide array of engineering assignments.

Habibie's son is now the head of the team designing IPTN's first commercial jet. Delivery of the N2130 still is scheduled for 2004, though whether that is likely to happen now is anybody's guess.

As part of their agreement, which was reaffirmed by Condit and Habibie in Seattle in 1993, IPTN is also a Boeing supplier.

It makes trailing edge flaps for the 737 and interior components for the 767. The Indonesians fabricate 747 window doublers for Mitsubishi, and they make 777 keel beams for Fuji Heavy Industries. And IPTN has a Boeing contract to modify three 737s into Surveiller aircraft for the Indonesian Air Force.

In return, Boeing has delivered two dozen 747 and 737 jetliners to Garuda Indonesia since 1980. Garuda still has 18 aircraft on order.

"This is the type of involvement that helps build relationships," Condit said. "For Boeing, this also translates into a stronger relationship with Garuda."

For others, the benefits aren't so clear.

"For Indonesia to go ahead with this is essentially a triumph of will over economic reality," said Wolfgang Demisch, an aerospace analyst for BT Securities. "I'm not so sure Indonesia can afford such triumphs."

Stanley Holmes' phone message number is 206-464-2732. His e-mail address is: shol-new@seatimes.com