Shifting from monetary to fiscal policy<\/p>\n
Hendi Kariawan, Jakarta<\/p>\n
Indonesia began to become more reliant on monetary rather than
\nfiscal approaches in nation economic policy in the early 1980s.
\nIn 1983, the government deregulated interest rate policies and
\nlater in 1988 abandoned its planned restrictions on bank permits
\nto encourage growth in the banking sector. Soon after, new banks
\nmushroomed beyond people's wildest expectations.<\/p>\n
These developments were the embryo of the monetary collapse in
\n1997\/1998. From 1988 to 1997\/1998 connected (intra-group) lending
\nfinancing escalated, often in blatant violations of prudent
\nbanking practices.<\/p>\n
Monetary and fiscal approaches are two different economic
\ntools. The monetary approach emphasizes the money supply, money
\ndemand and the most important variable, interest rates.
\nMonetarists believe that by controlling the supply and demand of
\nmoney, a sustainable growth and an optimal equilibrium level vis-
\na-vis a natural unemployment rate are achievable.<\/p>\n
But this approach is not necessarily applicable in all
\ndeveloped and developing countries. One of the few successful
\nstories of a developed country ever applying this approach was
\nthe Great Britain of the 1980s<\/p>\n
The United States, though arguably unsuccessful in using this
\napproach, has persistently tried to pursue a monetary policy,
\ngiven its huge debt burden that is financed by massive capital
\ninflows and the status of the U.S dollar as an international
\ncurrency.<\/p>\n
Outside the U.S, the monetary approach certainly does not suit
\nthe interests of developing countries as their currencies are not
\na major component of international reserves globally. Applying a
\nmonetary approach without balancing it with a proper fiscal
\npolicy can and will lead to economic turmoil. For countries
\noutside the US, a fiscal policy stance is more appropriate to
\nachieve sustainable economic growth and development; and
\nIndonesia is no exception to this rule.<\/p>\n
Fiscal policy, meanwhile, emphasizes aggregate demand to
\nstimulate economic growth. This approach was used to successfully
\nfix the global economy after World War II and John Maynard Keynes
\nwas its key proponent.<\/p>\n
Indonesia must shift its economic approach from a
\npredominantly monetary policy to one that is fiscally focussed.
\nSince the 1998 crisis, the monetary approach has created a
\nmassive burden on all taxpayers. Currently the government has to
\nspend more than Rp 65 trillion a year to finance bond interest
\npayments. In its 2006 draft budget proposal, the government plans
\nto allocate Rp 73.7 trillion to pay interest on bonds and only Rp
\n60.3 trillion for foreign debt principal repayments. In the
\nproposal, the government is targeting tax revenue of Rp 534.7
\ntrillion or an increase from Rp 508.9 trillion in 2005. Revenue
\nfrom income tax will increase from Rp 176 trillion to Rp 198
\ntrillion and value added tax will increase from Rp 102 trillion
\nto Rp 126 trillion. In addition, import duties and levies will
\nincrease from Rp 347 trillion to Rp 402 trillion.<\/p>\n
The proposed budget shows a deficit of Rp 19.8 trillion (0.7
\npercent of GDP) and to bridge it, the government will borrow more
\nfrom domestic and overseas sources. This is likely to trigger
\nfurther inflation if the government sources are from financial
\ninstitutions; bank or non-bank ones. Overall, the proposed budget
\nwill have a contracting effect on economic development as the
\ngovernment will take from taxpayers rather than inject the money
\ninto the economy.<\/p>\n
On the monetary side, the central bank is tightening its
\nmonetary policy by targeting an inflation zone of 7 percent to 8
\npercent per annum. It is forecast the central bank's short-term
\ninterest rate will stand at from between 8.5 percent and 8.75
\npercent per annum.<\/p>\n
This monetary approach will not be effective in stimulating
\naggregate demand. It is worth recalling that after the 1998
\ncrisis, our economic growth has mostly been spurred on by
\ndomestic consumption.<\/p>\n
Fine-tuning our economy with an emphasis on the monetary
\napproach, rather than on fiscal policies, will not be effective
\nin generating desirable economic growth.<\/p>\n
The current monetary policy is focussed on tightening the
\nmoney supply to check the inflation rate at 7 to 8 percent per
\nannum, while the current fiscal policy aims at increasing tax
\nrevenues, thereby depressing the purchasing power of taxpayers
\nand consequently cutting into the market demand for goods and
\nservices.<\/p>\n
Normally, under such conditions, Indonesia should relax its
\nfiscal policy to stimulate aggregate demand. Lowering tax rates
\nwould spur aggregate demand and this in turn would stimulate
\neconomic growth and development.<\/p>\n
But what the government is doing now is imposing a credit
\ncrunch through tight money policies and at the same time
\ndepressing market demand through heavy tax burdens.<\/p>\n
It is most imperative now to prevent monetary policy from
\ndepressing aggregate demand, because without a reasonable rate of
\nmarket demand, the economy will not expand to create new jobs.
\nThe government now, more than ever, needs to perform a good
\nbalancing act of its monetary and fiscal policies.<\/p>\n
It should provide fiscal pump priming for the economy to
\nenhance equality in income distribution and strengthen the
\nrupiah, while corruption should be limited to minimum levels.<\/p>\n
Shifting from a heavily monetary-focussed policy to a fiscal
\none will require a concerted effort. We urgently need to redraw
\nour economic blueprint.<\/p>\n
Hendi Kariawan is a former director of Bahana Pembinaan Usaha
\nIndonesia, a securities company.<\/p>",
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