Fiscal sustainability: How sustainable will it be?

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.