Indonesia still requires budget support

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.