How to stimulate Indonesia's economy<\/p>\n
David E. Sumual, Jakarta<\/p>\n
President Megawati Soekarnoputri fulfilled the yearly ritual
\nof the address to the nation last week, unveiling the
\ngovernment's draft 2005 budget. Staying with a similar budget
\npolicy that it has had over the last five years, the government
\ncontinues to rely on orthodox fiscal consolidation methods,
\ncalling for further reductions in the deficit from 1.2 percent of
\ngross domestic product (GDP) in 2004 to a more contractionary
\nbudgeted deficit of 0.8 percent in 2005.<\/p>\n
Five consecutive years of uninterrupted fiscal consolidation
\nshow that the government is not comfortable to consider Keynesian
\n(economic model) options to revive the economy. Seemingly based
\non the rational expectations argument, the government argues that
\nfiscal policy is not so effective in boosting the economy.<\/p>\n
Although the credit risk has fallen gradually since 1998 (as
\nseen by upgrades in sovereign credit ratings from triple C to B
\nin 2004), the government also seems to continuously focus on
\nmonetizing its debt, in which total debt to GDP ratio has
\nactually fallen from 98 percent in 2000 to 60.1 percent in 2004.<\/p>\n
The government has set in its 2005 state budget payment for
\ndomestic debt interest at Rp 38.8 trillion and external debt
\ninterest at Rp 25.1 trillion. As such, like the previous budgets
\nin the past five years, the spending plan is likely to have a
\ncontractionary affect on the economy, as a significant portion of
\nthe government's expenditures will be going toward payments and
\nforeign debt.<\/p>\n
Actually, the government may come up with the more \"lean
\nagainst the wind policies\" to shore up the current easing
\nmonetary environment. Without explicit policies to increase
\ndemand, the current slow growth will remain, undermining for
\nlong-term sustainable growth. However, boosting government
\nspending is not the only option.<\/p>\n
Unlike developed countries like the U.S. or Japan, boosting
\nIndonesia's economy through government spending would be
\nineffective due to the higher probability of leakages. As most of
\nIndonesia's institutional arrangements are still susceptible to
\ncorruption, a tax stimulus would be a preferable choice.<\/p>\n
Other than boosting government spending, the government could
\ninstead give a tax stimulus to break the vicious circle of low
\ninvestment spending. Cash in the hands of consumers or
\nentrepreneurs would be expected to stimulate the economy.
\nHowever, such a tax stimulus should be defined with a specific
\ntarget. And what the country needs are actually targeted fiscal
\nincentives to boost the current dilapidated investment spending
\nnationally.<\/p>\n
For instance, the government could give a broad, two-year
\ntemporary investment tax exemption that pays 10 percent of
\ncompany capital spending for equipment and machinery. It would,
\nof course, substantially raise the business spending by making
\nsuch an expenditure 10 percent cheaper today than it would be
\nafter 2006.<\/p>\n
Another similar tax incentive for companies in the form of a
\ndecrease in excise duty for the importation of machinery could
\nalso have a major affect on the country's investment spending. If
\nthese steps succeed in preventing a deep decline in investment
\nactivity, the result could be only a small increase in the size
\nof the budget deficit, or even a small decrease due to higher
\noutput expected.<\/p>\n
To the extent that is necessary to offset a revenue loss, this
\nwould ideally be done by a well-calculated reduction in oil
\nsubsidies, which may explode in the months to come due to higher
\noil prices. This kind of tax stimulus has proven to be effective,
\nas evidenced by the revival of the electronics industry last
\nyear. The economic effect has multiplied more than the Rp 6
\ntrillion tax stimulus given by the government in the form of
\nreducing and canceling several luxury goods taxes (PPnBM) in
\n2003. Analysis by the DRI economic team suggests that the above
\ntargeted tax proposal that focused on companies' capital spending
\nwould be equal to the stimulus of roughly 2 percent of a Bank
\nIndonesia easing of interest rates.<\/p>\n
Obviously, monetary policy is now the sole focus of
\nIndonesia's attempts to breathe life into the economy. The short-
\nterm benchmark interest rate has been driven down to 7.3 percent,
\nbut the room for continued easing might be limited. There are
\nalso fears that the global economy may not be as robust as hoped
\nthis year as the current oil shock may rein in global economic
\nexpansion.<\/p>\n
Domestically, Indonesia also continues to experience slow
\ngrowth. The country's second quarter GDP growth was
\ndisappointing, and in sharp contrast to the strong economic
\nrevivals being witnessed in the economies of neighbors such as
\nMalaysia and Thailand. The economy continues to run on the single
\nengine of private consumption, and even that engine of growth as
\nseen by the latest data is starting to slow down.<\/p>\n
The Central Statistics Agency (BPS) announced that the growth
\nin the second quarter of this year was only 4.32 percent year on
\nyear, down from 4.80 percent in the same period last year. More
\nworryingly, private investment growth was only 5.26 percent year
\non year in the second quarter, down from 5.65 percent growth in
\nthe first quarter of 2004. The same story occurred in foreign
\ninvestment approvals that reached only 3.3 billion dollars for
\nthe January-July period this year, falling 33.6 percent from 4.97
\nbillion dollars in investments pledged in the same period last
\nyear.<\/p>\n
Given the possibility of slowing global growth and the
\ninvestment that continues to remain at sub-optimal levels, the
\neconomy needs a larger fiscal stimulus than the already proposed
\nbudget. To cope with this current development and to meet the
\nassumption of 5.4 percent economic growth, the government needs
\nwhatever economic tools it has at its disposal to revive the
\neconomy. One of the tools should be the tax stimulus that is
\nspecified for boosting the investment climate in Indonesia.<\/p>\n
The writer is an analyst at Danareksa Research Institute. This
\narticle is a personal view.<\/p>",
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