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Jakarta Post

Debt, deficit and road to recovery from COVID-19

Jakarta   /   Fri, June 5, 2020   /   10:47 am
Debt, deficit and road to recovery from COVID-19 Bagged up: A recipient shows off free rice taken from the ATM Pertanian Sikomandan (Agriculture Commander ATM) at South Jakarta Military District Command on Monday. The government, through the Agriculture Ministry, is distributing free rice to help people badly affected by the COVID-19 outbreak in Greater Jakarta. (JP/Dhoni Setiawan)

The COVID-19 pandemic has radically transformed the Indonesian fiscal landscape, as the government battles the impacts of the pandemic on the economy. As fiscal deficits mount from the fiscal stimulus, the era of hard-won fiscal discipline and prudence — the hallmark of Indonesia’s economic fundamentals for many years — has ended. After keeping fiscal deficits below the legal ceiling of 3 percent of gross domestic product (GDP), for more than two decades, the budget deficit in 2020 is projected to rise to 6.3 percent of GDP from 1.7 percent of the original budget approved last October and from 5.07 percent in the first revised budget in April.

Even at this level of deficit, it is not certain whether the Rp 641 trillion (US$42.73 billion) fiscal stimuli that the government has budgeted will be enough to mitigate the economic downturn and to ease the pain of those who are affected. The longer the pandemic drags on, the more costly efforts to contain its impact. The ability of the government to restore its budget deficit to 3 percent of GDP by 2023, as required by Regulation in Lieu of Law (Perppu) No. 1/2020, will be in doubt.

The latest revised 2020 budget projected total government revenue at 10.3 percent GDP, while expenditure is at 16.6 percent GDP. Assuming expenditure is maintained at the current level of GDP, to return the deficit to 3 percent of GDP by 2023 by raising taxes will not be easy, in view of the weakening economy and the declining tax revenue growth. Alternatively, the government could cut spending by the same amount, but this would amount to adopting an austere fiscal policy. Executing budget austerity in the middle of an economic crisis — as history has shown — could backfire and hurt the economic recovery and growth.

The International Monetary Fund, the European Commission and the European Central Bank forced some European countries that were facing debt crisis recently to adopt austerity budget measures as conditions for getting more loans. But these requirements brought more disaster for the economies of Italy, Spain and Greece. While there were some factors that accounted for Europe’s economic demise, one thing stood out. Europe imposed brutal austerity in its budget, through spending cuts and tax hikes even in the face of high unemployment.

According to those who advocated for the austerity doctrine, any negative effects from the budget contraction would be offset by an improvement in market confidence. This confidence theme was also used by the IMF in forcing Indonesia to implement a painful austere budget during the Asian financial crisis of 1998-1999.

According to Stanley Fisher, the then IMF deputy managing director, market confidence would not return to Indonesia unless the country itself demonstrated that it was capable of enduring the economic hardship from the crisis. And history showed that this IMFrecommended policy plunged the Indonesian economy into a deeper contraction.

The other issue on which the Indonesian government has to be careful is to avoid temptation to halt monetary and fiscal stimulus prematurely. In the United States, in the aftermath of the Great Depression in the 1930’s president Herbert Hoover and president Theodore Roosevelt raised tax rates when the economy had not completely recovered from recession, thus ending the fiscal stimulus prematurely. The result was the economic recovery was stifled and the US economy relapsed into more recession.

A similar blunder was made during the 2008 financial crisis. The fiscal stimulus by former president Barack Obama and the US Federal Reserve monetary expansion was halted in 2011 by the Republican controlled Congress, impeding the recovery considerably.

John Maynard Keynes, the great economist who revolutionized economic thinking in the 1930’s wrote in 1936: “It was better to spend money preventing a catastrophe from worsening; balancing the budget could wait until after the crisis passed.” In fact, Keynes believed that a premature return to fiscal discipline would likely throttle any nascent recovery.

In its 2012 World Economic Outlook the IMF acknowledged that Europe’s economic performance was worse than expected because of the austerity programs. The IMF also acknowledged that in the recession the effects of “fiscal multiplier” — the effect of government expansion and contraction on the economy — were much bigger than the IMF had thought.

Fiscal interventions certainly helped arrest the slide toward deep recession. But fiscal policy isn’t a free lunch, and contains some risks and unintended consequences. If the government increases spending and cuts taxes — and doing so during a downturn when tax revenues decline — the budget deficit will soar.

The government will have to seek more debt that it will eventually have to pay.

If the deficit grows larger every year, then it will have to entice investors to buy more debt by raising interest rates. In first quarter 2020, the government issued Rp 221 trillion worth of bonds, triggering an increase in its yield by 80 basis points in the third week of May. The yield could go up higher because the government will issue another Rp 900 trillion in debt papers during the year to cover the rising deficits.

Those higher returns will compete with interest rates of other loans, driving up cost of borrowing for other sectors in the economy, reducing both consumer spending and capital expenditure. For the government, the road to 2023 to achieve a more sustainable fiscal stance will be tricky, so it must navigate very carefully. Otherwise it could make policy mistakes that set the economy on a continued downward path.

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Commissioner at a publicly listed company

Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.