Moderate budget deficit acceptable

Anis Chowdhury, Jakarta

Balancing the state budget remains a paramount policy parameter in Indonesia. The House of Representatives (DPR) has penciled at 0.6 percent of gross domestic product (GDP) for the 2005 state budget. This is lower than this year's target of 1.2 percent of GDP. This must be a very happy outcome for any finance minister around the world.

A careful examination of the state budget of the New Order period (1967-1998) reveals that it was never balanced in the true sense. This slight of hand behind a seemingly balanced budget was mainly the inflow of foreign aid. Because of the strategic importance of Indonesia in the context of first the Vietnam war and later Cold war, the donor countries treated the New Order regime very favorably.

Such financial support enabled foreign aid to be treated as a regular revenue source, becoming in time an implicit "guarantee". This in turn helped to generate a balanced budget. The task was made easier by the windfall from the two oil price shocks.

While this was the story from the revenue side, on the expenditure side the civil service pay structure also played a role. The civil servants, including the police and military, were paid what is known as basic pay, and they were allowed to generate additional income from "other" sources. This meant the recurrent expenditure remained low.

Is it possible to do the same trick now? First, although Indonesia may still have some strategic importance even after the end of the Cold war, there has been globally a declining trend in foreign aid. Donor support that came at the wake of the crisis has already tapered off. As a requirement of the numerous letters of intent signed with the International Monetary Fund, the state budget now follows the international practice and no longer treats foreign aid as revenue.

Second, oil price rises that came as a blessing in the past, now have become a curse as Indonesia turned into a net importer of oil. The rise in oil prices put pressure on the state budget due to increased fuel subsidy. The recent oil price rise is expected to increase 2004 budget deficit as the fuel subsidy is projected to triple.

Third, it is widely believed that the civil service pay structure is mainly responsible for sprawling corruption. One of the elements of governance reform thus is civil service pay, including that of police and military. This means the routine expenditure can no longer be kept artificially low for long.

Thus, it is almost clear that the old trick of balancing the budget is no longer possible. Does it mean that Indonesia is heading towards a disaster of the mid-1960s? The answer is, hopefully not.

Indonesia must try to avoid "reckless" budget deficit by increasing its effort in raising domestic revenue. Its tax-GDP ratio is one of the lowest among comparable developing countries, even lower than the Philippines. However, reforming the tax system and improving the governance are a long haul.

In the interim, one should not be upset about the prospect of a moderate budget deficit. Note the use of reckless and moderate budget deficit. International evidence shows that most countries have a budget deficit ranging between 3 percent and 5 percent of GDP. But none of these countries ended up in hyperinflation or economic stagnation. It is not a surprise that the Maastricht Treaty allowed European Union member countries a budget deficit of 3 percent of GDP. The Treaty also allows a higher deficit in the case of emergency.

This brings us to the last question -- is it desirable to hold on to the balanced budget principle at any cost? The crisis dealt a serious blow to the Indonesian society. The infrastructure is in ruin, about one-third of the primary school buildings are not useable, nearly half the population remains vulnerable to poverty and one-third of the labor force is either unemployed or underemployed. The infant mortality rate among the poor is alarmingly high -- about three times that among the rich. The condition of the public healthcare system has created a "health divide". Do not all these fit the definition of an emergency?

No one perhaps would say no. Unemployment, poverty, education, health, infrastructure are all high on the agenda of all presidential candidates. A dogmatic adherence to the balanced budget principle will not see an avalanche of foreign or domestic private investment in order to enable the newly elected president to fulfill his or her election pledges. At least this is the experience of last five years.

Whoever wins the coming presidential election will have to offer the ordinary citizens a relief from the daily worries of life as a dividend of democracy. This cannot be done, at least in the immediate future, within the current macroeconomic policy framework which is driven by the fear of reckless deficit. One can be cautious, but fear cannot be the basis of public policy.

However, while inviting the policy makers to be bold, one needs to keep in mind the golden rule of deficit -- you never borrow to finance your present consumption. If possible, save by limiting consumption. Any sound private sector business or individual follows this rule barring exceptional circumstances. Violation of this rule on a permanent basis brings disaster.

The business and households not only balance their routine budget and even try to create a surplus there, but they are not fearful to borrow to finance investment. If they are unable or unwilling to borrow and try to restrict their investment only to the extent possible from the surplus in the routine budget, then no business will grow beyond a warung (roadside inn)

Balancing budgets sounds like a sensible policy. But balancing the budget can be a dangerously simplistic policy. And it is not always good economics, especially when there are well-known benefits from investing in infrastructure, education, health and public safety. So spending on these sectors can be made without signing up to simplistic balanced Budget proposals.

What is more, economic prosperity brought about by public investment will generate dividend of complementary private investment and increased tax revenue.

The writer is Professor of Economics, University of Western Sydney, Australia and currently is working as consultant at UNSFIR. This view is strictly personal.