Indonesia still requires budget support

This is the second of two articles based on the presentation made by Coordinating Minister for the Economy, Finance and Industry Kwik Kian Gie to the local donor meeting in Jakarta on Dec. 14.

JAKARTA (JP): Indonesia currently faces some difficult fiscal choices. Our bank recapitalization program will require gross interest payments amounting to some 4 percent of Gross Domestic Product, absorbing more than 10 percent of the central government's budget next year.

While privatization proceeds and cash recovery on bank assets could potentially cover almost half of this extra cost, this still leaves a very large sum to be financed from general revenues or from external borrowing.

Other demands on the budget are also mounting. Wages to public servants need to be sharply increased as one step toward creating a more professional civil service with high standards of integrity. Rising energy prices have greatly inflated subsidies and although prices to consumers will be adjusted, economic realities will force us to make this adjustment gradually.

Regional autonomy, if not properly implemented, could cause a loss of central government revenue not commensurate with adjusted fiscal responsibilities. Despite encouraging signs of economic recovery, growth will remain low next year, hence a major increase in domestic non-oil revenue cannot be anticipated. We therefore expect the overall deficit to be around 5 percent of GDP, half of which will be financed by receipts from privatization and asset sales and half from external borrowing.

Unfortunately, public borrowing has already risen to a very high level over the past two years, with the public-debt-to GDP ratio increasing from less than 25 percent to around 100 percent.

Most of this increase has been due to growing domestic debt arising from the bank restructuring process, but external debt has also increased. This large increase in public debt imposes a significant burden on future generations. A top priority of the government will therefore be to reduce the public debt-to-GDP ratio in coming years, both by limiting expenditure growth and by improving our ability to raise revenue domestically.

In the immediate term debt reduction is not possible because a fiscal stimulus is needed to promote economic recovery. Given this need, there are certain advantages to foreign borrowing. For example, interest rates are lower on official foreign debt than on domestic debt, foreign borrowing does not crowd out domestic investment, and foreign borrowing supports the balance of payments, thereby helping to strengthen the rupiah.

However, foreign borrowing also entails greater risk, particularly if the exchange rate depreciates in the future. As long as the economy remains weak it will be necessary to supplement domestic revenue with international support but as the recovery gains momentum we expect to continue the process of paying off the nation's foreign debt that was interrupted by the crisis.

While continued foreign borrowing cannot be avoided, we want to make certain that all funds are used productively. In the past, too large a share of official assistance was wasted, either through poor design and implementation or through malfeasance. One way to reduce wastage is to increase transparency in the budget and to involve civil society in the monitoring of projects and programs. We welcome suggestions and assistance from the international community in improving our efforts in this direction.

Of course, enhancing our domestic revenue base must be a key component of our efforts to maintain fiscal integrity and to limit the growth of public debt. This requires that we broaden the tax base, particularly by raising the share of income tax revenue to GDP. We will also eliminate unnecessary tax exemptions.

In pursuing this objective, however, we must recognize that economic recovery will not be sustainable without strong export growth and that exporters cannot compete on world markets without access to inputs at world market prices. Efforts to eliminate tax exemptions must therefore not impinge on the access of export firms to competitively priced inputs for export production.

Sound fiscal management must be supported by good macroeconomic policies. Although great progress has been achieved over the past year, major problems remain. The bank restructuring process is well advanced but few banks have resumed lending to the real economy.

The biggest obstacle to a resumption of credit flows to the private sector is the enormous overhang of corporate debt. We are committed to an acceleration of the debt workout process. However, we will maintain the position that private debt should not be turned into public debt. This also applies to state-owned enterprise debt. We will uphold sovereign guarantees where they were given but not in cases where the initial loan clearly did not have sovereign backing.

There are other obstacles to a resumption of credit flows to the real economy, including high real interest rates. In 1998, when short-term nominal interest rates were raised to 70 percent, inflation had been running at an annualized rate of 120 percent during the first half of the year, so real interest rates at that time were strongly negative.

By contrast, over the past nine months we have experienced deflation. The Consumers Price Index is now 4 percent lower than it was in February. With short-term nominal interest rates stuck at around 13 percent for the past four months, real interest rates today are far higher than they were prior to the crisis and are the highest in the region. For economic recovery to take root, the trend toward lower interest rates seen recently should be strengthened, in the context of exchange rate and price stability.

Sound economic policies must be supported by a stable social environment and a healthy natural environment. We intend to significantly increase spending on social safety net programs in the coming fiscal year and to overcome the bureaucratic bottlenecks to the realization of past programs.

Monitoring provisions and other safeguards have been developed to prevent abuse and ensure implementation, including frequent reporting on key performance indicators, independent verification and close involvement by civil society. We also intend to arrest the decline in Indonesia's natural environment, which has continued to deteriorate during the crisis.

Particular emphasis will be placed on protecting marine resources and forest resources. This will include greater decentralization in the management of natural resources, with local communities being given more say and a greater stake in decisions affecting our natural resources.

We also plan to improve environmental monitoring and to move toward a pricing structure for natural resources that better reflects their true value. The proposed high-level forestry meeting this coming January is a key element of our overall strategy in this area.

Finally, let me say a few words on external assistance. The next Consultative Groups on Indonesia meeting is scheduled to be held in Jakarta for the first time, in February of next year.

Given the budget outlook described earlier, we will still need significant budget support for the coming fiscal year. Much of this can be financed by commitments already made. While there is likely to be a small residual gap, I am pleased to note that initial contacts suggest this will be covered by the World Bank, the Asian Development Bank and Japan.

Therefore, in February, I would hope we can focus our attention on how to use the available resources well, including better targeting of funds on priority areas and measures to reduce corruption and waste.

We don't expect to receive commitments for subsequent years at the stage. But we do hope we can meet again later in the year, perhaps in September, to discuss financing requirements for 2001 and international support for our medium-term development programs.