Assumed or actual deficit?

The Jakarta Post ,  Jakarta   |  Fri, 06/30/2006 4:21 PM  |  Opinion

We are sometimes amazed to observe that the government appears to have wondrously found an easy way out of what was previously seen as a complex, formidable problem. The solution, however, often turns out to be artificial or cosmetic in nature.

A recent example is the fiscal problems related to the projected doubling of the budget deficit in the current fiscal year to Rp 42.1 trillion (US$452 million), or 1.4 percent of the gross domestic product, due to higher than expected spending.

Minister of Finance Sri Mulyani Indrawati early last week unveiled a plan to increase the government's net bond issuance (deducted with bonds that will be bought back) this year from Rp 24 trillion (US$2.58 billion), as originally envisaged in the state budget, to Rp 38 trillion.

However, a few days later, Sri Mulyani told the House of Representatives that the government might simply dip into its cash reserves at the central bank, last estimated at Rp 60 trillion, to pay for the higher deficit spending. Anggito Abimanyu, another senior official at the finance ministry, estimated the government's cash reserves at a total of Rp 80 trillion, of which Rp 20 trillion is spread out among various accounts at commercial banks.

The solution, if it were really as easy as what the minister and her subordinate described, would be quite wonderful. The government would not have to issue more debt instruments, which bring higher interest costs. The interest costs of government bonds have steeply increased this year because of the tight monetary stance the central bank has pursued since last October to cope with strong inflationary pressures.

The government itself has estimated that each one percentage point rise in the interest rate on the bonds will increase interest charges by Rp 3 trillion on the Rp 630 trillion worth of bonds already issued. Several other factors that will contribute to the bigger deficit are larger fuel subsidies for the State Electricity Company (PLN) and bigger expenditures on the social safety net and on emergency aid for victims of the earthquake in Yogyakarta and Central Java.

But is drawing down its cash reserves at Bank Indonesia really the best, least costly, least risky solution to the larger-than-estimated budget deficit?

We have to consider the inflationary pressures from such a huge cash withdrawal from the central bank, which, in contrast to cashing deposits at commercial banks, amounts to printing money.

The government also needs to consult with the central bank before drawing down such a huge amount of new money to ensure good coordination of fiscal and monetary policies and to consider the working capital needed by the central bank to finance its open-market operations.

But a more fundamental question is: Will actual deficit spending be as large as the Cabinet estimated last week, given the slow disbursement of budget funds in the first five months?

True, there are no problems as far as routine (operating) spending is concerned. But capital spending has been unusually slow over the past three years. Slow disbursement of the government's capital budget was in fact mainly responsible for the fact that the budget deficit last year was only 0.5 percent, half of the level projected at the beginning of the 2005 fiscal year.

Even this year, the disbursement of the investment (development) budget both at the central government and regional administrations is not much faster. The latest estimates put actual capital expenditures in the first four months at only 10 percent of the budgeted total. Worse still, many regional administrations, which are still grappling with inadequate fiscal management ability, prefer to park their investment budgets at banks to benefit from the high interest rates.

The World Bank estimated regional administrations' deposits at banks at Rp 70 trillion as of March. More recent data at Bank Indonesia quoted by the finance minister at a meeting with the House on Tuesday showed that as of May, regional administrations used budget transfers from the central government to buy Rp 43 trillion worth of Bank Indonesia's debt instruments (SBI), which pay annual interest of more than 12 percent.

If that is the case, what is the point of entertaining the idea of withdrawing government deposits from the central bank if this money would eventually end up in Bank Indonesia's debt instruments or government bonds, and not in development projects?

It would be much better for the government, both fiscally and monetarily, to make a more thorough estimate of its actual spending before dipping into its cash reserves at the central bank.

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