Moderate budget deficit acceptable

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.