­­­

The C0VID-19 pandemic has forced economists around the world to adopt an extreme Keynesian view. Governments are upping healthcare and social assistance spending as citizens pin their hopes on the multi-trillion dollar stimulus and recovery programs, that these can reverse the global economic slump caused by the “Great Lockdown”.

The global economy will usher in the new year shackled by an unprecedented amount of debt. The C0VID-19 fiscal responses, combined with the sharp decline in output and government revenues, will push global public debt to around 100 percent of global gross domestic product (GDP) by the end of 2020, the highest ever, surpassing even the leverage ratios since World War II.

Indonesia is no exception to the predicament of rising global debt. For the first time, the country has been forced to revise its legal limit on the fiscal deficit from the original cap of 3 percent of GDP as set in the 2003 State Financial Law in order to make room for its economic recovery program. The gap between revenue and spending is estimated at a fiscal deficit of 6.3 percent of GDP this year.

Consequently, external debt has now climbed to 38.2 percent of GDP compared to 30.5 percent just a year ago. One is compelled to compare this in relative terms, as Indonesia’s 38.2 percent debt-to-GDP ratio is still better than the median 49.7 percent for economies in Fitch Ratings' BBB rating, which includes Hungary, Kazakhstan, Panama, the Philippines, Portugal and Russia.

But the incessant focus on Indonesia’s low debt-to-GDP ratio has taken attention away from an important indicator: Our weak ability to generate revenue for servicing our debts. Even before the pandemic, Indonesia’s tax-to-GDP ratio was already among the world’s lowest at 11.9 percent, far below the average 34.3 percent among members of the Organisation for Economic Co-operation and Development (OECD), 23.1 percent in Latin America and the Caribbean, and 17.2 percent in Africa.

Since Indonesia relies on very few industries for its tax revenues, its narrow tax base means that the plunge in taxes during the 2020 Great Lockdown outpaced the decline in GDP growth, pushing down the tax-to-GDP ratio even further to around 8-9 percent, official statistics show.

This means that, in terms of total revenue, Indonesia’s debt obligation is among the highest compared to similarly rated countries. The government debt interest expenditure in 2020 is projected to account for 16.5 percent of total revenues, up from the average 9.1 percent in 2013-2017. This is twice the 8 percent average for investment-grade economies (BBB), and even higher than the 11.8 percent average in speculative-grade economies (BB+ and below).

Certainly, the high debt service obligation that Indonesia will face in the next few years may restrain its GDP growth outlook, as it will eat up funds that could otherwise be allotted toward productive spending such as education, healthcare and infrastructure.

And the big question mark here is whether Indonesia will enter a period of “fiscal fatigue”, when debts have reached unsustainably high levels that state revenues, and ultimately the primary balance, will fail to keep up with the upward trajectory of interest payments.

In the past, the most notable and constant fiscal challenge has been the unproductive allocation of energy subsidies. But this is likely to shift in the years ahead.

In the 2021 State Budget, for example, interest payments will account for Rp 373 trillion (US$25.7 billion), nearly 14 percent of total government spending. In other words, Indonesia will spend more on servicing its debts next year than the Rp 175 trillion (6 percent of spending) allotted for subsidies or the Rp 247 trillion (9 percent) in capital expenditure earmarked for infrastructure development.

A 14 percent debt-service coverage ratio (DSCR) is high compared to historical standards: The highest level was in 2002, when Indonesia spent 27 percent of government spending to service its accumulated debts after the 1997-1998 Asian financial crisis.

Given the high debt load, one can understand why the Finance Ministry invited Bank Indonesia (BI) to engage in a burden-sharing agreement, both to bear debt interest payments and to finance public goods spending in the C0VID-19 economic recovery program.

However, even this one-off policy raises some questions that must be resolved. How will the Finance Ministry raise Rp 1.655 quadrillion from debts in 2021 with less support from the central bank, which contributed Rp 397 trillion in one-off direct financing this year? And what will the government do next year if commercial banks, which recorded a net buy of Rp 900 trillion in government bonds this year, decide to channel the funds to credit and not to buying safe and high-yielding assets like bonds as the economy recovers?

Still, debt is a commitment, an obligation that cannot be altered. In fiscal policy, the only path forward to budget sustainability is to broaden the existing tax base so that more funds can be earmarked for productive sectors and, ultimately, the debt burden will decline relative to other spending.

This tax intensification effort has been advocated over the past few years, yet the result has been minimal, as evidenced by the nation’s declining tax-to-GDP ratio. In this case, Indonesia might need radical, out-of-the-box reforms. These may include inviting or even hiring major business leaders who can offer an insider’s view on tax evasion efforts, or embracing unicorns like Gojek or Tokopedia to develop a better tax system and diversify Indonesia’s tax base away from commodities and into the booming IT industry.

In monetary policy, BI could still do more to push down funding costs.

Debt discussions in Indonesia have always centered on high funding costs. The cost for the Indonesian government to borrow funds for a decade, as reflected in 10-year bond yields, is around 6 percent. This means Indonesia pays the highest funding costs, or the most expensive interest payments in Southeast Asia: the Philippines pays 2.9 percent, Malaysia 2.7 percent, Vietnam 2.4 percent and Thailand 1.2 percent. Even highly indebted European economies like Greece, Italy,and Portugal can borrow funds for near-zero percent, because the denomination in euro, the world’s second largest reserve currency, effectively diminishes the currency risk of euro-area bonds.

The Indonesian central bank in particular has been way too risk-averse this year: It lowered the key benchmark rate cumulatively by only 125 basis points (bps), far behind the 150 bps rate cuts of the US Federal Reserve, despite BI still boasting higher nominal rates. The BI 7-Day Reverse Repo Rate, the local benchmark for borrowing costs, may already be at a historic low of 3.75 percent, but it is still too high relative to the domestic headline inflation of around 1 percent of this year.

Textbook economists like to stress the need to maintain real interest rate differentials to sustain foreign inflows. However, real interest differentials matter less at a time when global interest rates are already pushed down to near-zero, even negative, territory; or when Indonesia’s quarterly current account balance has swung to a surplus for the first time in nine years, with the trade balance on track to record an annual surplus of more than $20 billion in 2020.

The year 2020 has been tough for both economic forecasters and policymakers. It has been a year when mainstream financial models were thrown out the window; when mom-and-pop investors gained more returns than fundamentalist fund managers; when out-of-the-box policies such as quantitative easing and burden sharing prevailed over the wisdom of conservative economics.

The year 2021 could be a starting point for Indonesian fiscal and monetary authorities experiment more boldly in their macroeconomic policies. The odds are very much in their favor, as policymakers in this country have a proven track record as successful crisis fighters (1966 hyperinflation), reformers (1998 Asian financial crisis) and survivors (2008 global financial crisis).

The passage of important laws, such as the omnibus laws on job creation, taxation and financial institutions, and the establishment of the Sovereign Wealth Fund (SWF), resemble the important and successful reforms following previous crises, which eventually reinforced Indonesia’s economic footing in the years to come.

Yes, Indonesia is likely to come out from the pandemic dragging a higher debt burden. But there are lucrative returns waiting for investors willing to take the bet that Indonesia can deleverage its fiscal posture, push down long-term funding costs and improve domestic liquidity to ultimately emerge stronger from the 2020 C0VID-19 recession.

***

The writer is a capital market economist and a graduate of the University of Indonesia and Peking University. The views expressed here are personal.

Popular

Kadin urges stability after Constitutional Court ruling

Jokowi says transition to new government to begi

BCA loan disbursement surges 17.1 percent yoy in first quarter