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Jakarta Post

Managing the stimulus during COVID-19’s second wave

Social safety net programs play a significant role in mitigating the rise in poverty as they cover a lot of beneficiaries.

Winarno Zain (The Jakarta Post)
Jakarta
Fri, July 23, 2021

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Managing the stimulus during COVID-19’s second wave

T

he unrelenting surge of COVID-19 contagion with the deadly Delta variant is testing the government’s competence and leadership as it deals with significant increases in deaths and new cases, the breakdown of the health system, a slow vaccine rollout, popular mobility across Java and Bali and the need to distribute social aid accurately and quickly.

The surge will also deal a major blow to the country’s economic recovery, which had been on an upward trajectory for the last three quarters. The World Bank, in a June 2021 report, projected that Indonesia’s growth would fall by 0.7 percentage points to 4.6 percent in the 2021 to 2023 period, down from an average of 5.1 percent in the 2018 to 2019 period. But that projection came before the second wave of the pandemic, so it is likely growth will be even lower.

The pandemic had also, as of March of this year, increased the number of poor people in the country by 1.12 million to 27.54 million, and according to the World Bank, if the government does not augment social protection programs, another 4.7 million people will plunge into poverty.

Unfortunately, the government cut the budget for social protection from Rp 220 trillion in 2020 to Rp 157 trillion this year. But because of the second wave of the virus, the budget climbed back to Rp 188 trillion.

Social safety net programs play a significant role in mitigating the rise in poverty as they cover a lot of beneficiaries, especially the three major programs of food assistance, cash transfers and the Family Hope Program (PKH) that together cover 10 million to 18 million beneficiaries. Social protection programs have been proven to ease economic pain affecting the poor and the vulnerable during a crisis. Lowering social protection programs while the recovery remains fragile will risk deepening the economic contraction.

The second wave of the COVID-19 outbreak has forced the government to increase fiscal stimulus from Rp 699 trillion to Rp 745 trillion, at a time when tax revenue will be depressed because of lower economic growth. This will push the deficit higher than the 5.5 percent of gross domestic product (GDP) targeted for this year.

Under these circumstances, the government will likely face difficulties in meeting the legally mandated 3 percent of GDP deficit ceiling for 2023.

The deficit is determined by two variables: the primary balance and interest on government debt. In the five years before the pandemic, the government had mostly small surpluses in the primary balance. But during the pandemic, its primary balance turned into a deficit of 4.1 percent of GDP in 2020 and is projected to be 3.3 percent of GDP this year. Interest costs were on average 1.7 percent of GDP before the pandemic but they surged to 2 percent of GDP in 2020 and are projected to reach 2.2 percent this year.

But with rising debt and subdued economic growth for the next two years, interest costs could rise to 2.5 percent of GDP. This means that in order to achieve the 3 percent deficit in 2023, the government has to keep its primary balance no higher than 0.5 percent of GDP.

Unfortunately, in most crises, overly quick fiscal consolidation can undermine the counter-cyclical function of the fiscal policies, thereby weakening the economic recovery. Premature fiscal consolidation risks deepening the economic crisis and, paradoxically, delaying the achievement of the legally mandated deficit ceiling.

From the monetary perspective, this is not a time to consider scaling back the Bank Indonesia (BI) bond purchase programs as the government might still need more support from BI. As of May 2021, BI had purchased Rp 111 trillion worth of government bonds, or 20 percent of the government bonds issued, a significant increase from the 9 percent purchased in 2020.

In conducting its monetary policy during the pandemic, BI has to strike a difficult balance between managing external financial pressures and stimulating domestic recovery. The external pressure is coming from the possibility of an interest rate hike in the United States, as the inflation rate reached a record high of 5.4 percent in June.

There has been a widespread belief in the financial markets that the US Federal Reserve will tighten monetary policy by increasing interest rates and scaling back its $120 billion monthly US Treasury bond purchases.

Higher interest rates in the US would trigger capital outflow, putting pressure on the rupiah, destabilizing the macro economy and, in the end, weakening the recovery. Fed chairman Jerome Powell, however, has insisted that the Fed will not tighten its monetary policy because the rise in inflation will be transitory (a result of short-term supply shocks and pent-up demand) and will fade away in due course, so the Fed will continue its accommodative policy at least until the end of the year.

As the external financial pressure has eased, BI now has more room to focus on stimulating domestic recovery. The risk of higher inflation is muted because, despite BI’s deficit financing, the growth of the broad money supply (M2) has been moderate, as it has been offset by a contraction in private credit growth. In May 2021, M2 grew by 8.1 percent, down from 11.5 percent in April, while bank loans contracted by 1.3 percent.

But the BI monetization of the deficit should be put in a certain time frame, with a clear exit strategy down the road, otherwise it will pose a risk to the credibility of BI monetary policy itself.

In prolonged economic downturns, an obsession with limiting the deficit because of worries about a negative financial market response is self-defeating because it can constrain the fiscal capacity to provide stimulus and to sustain economic recovery. So flexibility in managing fiscal stimulus and deficits during this crisis is needed.

Managing the deficit and stimulus matters for the sake of easing the burden of the people, instead of reducing the deficit itself.

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The writer is an economist and a commissioner at a publicly listed company.

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