Fiscal sustainability: How sustainable will it be?

Muhammad Chatib Basri

Looking at the prospects of the world economy in 2003 is like looking at a silhouette. You can see the big picture, but you cannot tell the details. In the big picture we can see that while there are continuing indications that a global recovery is well underway, the details show that the economic recovery is likely to be weaker than anticipated.

The pace of recovery in the United States is now expected to be slower than earlier. In Europe projections have also been reduced somewhat with domestic demand likely to pick up more slowly than previously expected. In Japan, domestic demand remains weak.

The direct effects of the slow world economic recovery will obviously affect Indonesia through trade. In addition, it is likely the growth of the Indonesian economy in 2003 will be affected by the Bali blast.

In this situation, growth will be very much dependent on two major components: private consumption and the government budget. Private consumption will very much depend on the government's ability to keep the inflation rate down. At the same time, any hope of growth can only be expected to come about if the government allocates the budget to sectors that have high multiplier effects.

Our economic simulation shows that increase in government investment by 10 percent can increase economic growth by 0.4 percent to 0.5 percent.

In addition, as pointed out by Ikhsan from The Economy and Social Research Institute at the School of Economy, University of Indonesia (LPEM-FEUI), the cost of poverty alleviation has increased five times compared to the pre-crisis era. In a situation in which the government budget is dominated by repayment of domestic and foreign debts, it is difficult to expect there will be budget expansion that can stimulate the domestic economy and alleviate poverty. As a result, a fiscal adjustment program will be needed.

There are three scenarios for fiscal adjustment. First, if there is no increase in government expenditure. Under this scenario, fiscal deficit and financing gap problems will obviously be overcome. Albeit, this scenario is not consistent with the economic recovery as we cannot expect economic stimulus from this scenario.

Second, if there is a significant increase in government expenditure. This scenario will obviously match the demand for economic recovery. However, it will create a larger financing gap and keep the debt ratio to GDP relatively high. Although it fits well with the economic stimulus, this scenario will harm the sustainability of the government budget.

Third, under this scenario, the government is expected to improve macroeconomic stability and make some adjustments in both revenue and government expenditures. This scenario requires a well targeted subsidy, tax reform, debt restructuring and privatization.

In fact, there is some improvement in the debt ratio. The ratio of government debt to GDP in mid 2002 has been cut to 72 percent from an earlier 106 percent in 2000 and 91 percent in 2001. This is an outcome of prudential macroeconomic policies and successful government external debt rescheduling in the Paris Club III meeting last April. In fact, the government is now trying to obtain loans of more than US$1 billion from the World Bank (high case scenario).

However, in order to obtain this, Indonesia is required to implement the economic reform program.

On the domestic debt front, the government plans to have a domestic debt re-profiling that applies to fixed rate recap bonds. The plan will put in effect recap bonds maturing in 2004 held by main recap banks. For recap banks, it is important to eventually convert the bonds to liquid assets either by direct selling in the market or through an Asset to Bond Swap Program with the Indonesian Bank Restructuring Agency (IBRA). Otherwise, the recapitalized banks would be left with a large amount of non- liquid assets. In this case, banks not only would face a cash flow problem but also can hardly resume their financial intermediary function.

Although some efforts have been done in the debt restructuring, the reverse is true for the case of privatization.

The progress has been very slow. The failure of the government to reach its privatization target in 2001 is an indication of the government's lack of resoluteness in carrying out privatization. Fortunately, the divestment of Indosat has been successful and can contribute around Rp 5.5 trillion to the government's revenue.

In 2002 the Indonesian government has been successful to collect around Rp 8 trillion from privatization which is higher than the initial target Rp 6.5 trillion.

Taken into account the problem of fiscal sustainability, like it or not, the Extended Fund Facility (EFF) program, which has been extended until the end of 2003, will still be needed for two reasons:

First, the main prerequisite for an economic recovery is to implement government policies and discipline. Like it or not, amidst several political interests and the wildly spreading economic interests, the IMF's pressure is needed to remind the government of its target of economic recovery.

Second, to fulfill the requirement of the Paris Club III agreement that the IMF reform program is still in place. However, the legislature has already asked the government not to extend the IMF program after the end of 2003. There is a lingering concern of how the exit strategy will be and how far the fiscal consolidation program has been prepared to anticipate such decisions. To many people's chagrin, so far the debate on the IMF program has only focused on the issue of whether we need the IMF or not, not on the action plan to warrant that our fiscal condition will be sustainable in the future and thus what action must be made to anticipate this.