Will state budget be able to cool economy?

Will state budget be able to cool economy?

The government unveiled its proposed budget yesterday.
Economist Mari Pangestu calls for prudence, transparency and
consistence in the financing of big projects.

JAKARTA (JP): The budget for the 1996-1997 fiscal year was
announced yesterday amid great expectations for its role in
helping to "cool down" the economy. Let us review whether this is
the case.

First, the nominal growth of the budget is higher than the
current one at 16 percent or around 7 percent in real growth.
There had been little real growth in the last two years which
reflected the more conservative fiscal stance. The higher growth
could be prompted by the general elections next year.

Second, of course, what should matter is not the nominal
increase in the budget, but its net impact on the economy, which
at Rp 6.9 trillion (US$3 billion) is indeed more contractionary
than the Rp 5.7 trillion in the current budget. The net domestic
impact is roughly estimated by calculating the difference between
what is pumped into the economy (i.e. routine expenditures plus
rupiah financing of development expenditures minus foreign
expenditures) and what is taken out of the economy (non-oil tax
revenues).

Of course, the assumption here is that one rupiah taken out
and one rupiah pumped in has the same effect on spending. In
reality they could have different effects and each expenditure
and revenue item will have different multipliers, hence,
differing effects on income.

For instance, the expected increase in civil servants'
salaries could have a bigger impact on spending, and possibly
inflation, than the dampening effect caused by tax collection.
The effect on inflation and spending is also compounded if the
increase in civil servant's salaries and the already announced 20
percent increase in the minimum wage, lead to a round of other
wages and prices going up. Given these considerations and the
likely trend that consumer demand will continue to be strong,
inflation could be closer to eight percent in 1996 compared with
the 6 percent to 7 percent targeted.

Steps taken since the mid-1980s to cut expenditures such as
subsidies and government capital participation has done a lot to
trim spending. Therefore, the budget could have been more
contractive by increasing revenues, such as through increasing
the price of fuel and certain taxes such as property taxes,
without increasing spending.

In fact, the budget indicates a decline in profit from fuel
sales, which is indicative that fuel prices will not be raised
even though it was widely expected that it would be raised this
year. If the government had attempted to increase revenues
without increasing spending, the extra government savings could
be put in reserves until such time when the economy is not
overheating.

Similarly it is hoped that should there be extra net revenue
in the 1995-1996 budget (ending in March) it should not be spent
and as indicated in the President's speech but be used to
amortize external debts.

It is not easy to discern whether the budget is going to have
a big impact on cooling down the economy. It is true that the
budget remains one instrument that is directly under the control
of the government, but one should also bear in mind that the
direct impact of the budget on the economy is much less now, with
government investment and consumption accounting for only around
20 percent of national income.

Thus, while a more contractionary budget may supplement the
tight monetary policy in cooling down growth, one cannot expect a
significant impact.

What is more important is to exercise discipline by
prioritizing non-budgetary spending, whether by government
related or quasi government agencies.

A plethora of big projects could have a big effect on
injecting liquidity in the economy, increase imports
substantially without increasing exports or lowering imports in
future. They could also add to the debt burden significantly
since they normally require large amounts of capital, and, to the
extent that they are high cost or become inefficient, also add to
the debt burden. We experienced this in 1983, when a large number
of government projects were postponed or shelved. The same
situation was experienced in 1991 when the government sharply cut
down on foreign borrowing for government related projects.

A similar stance should now be adopted to curb spending on
large government and quasi government projects based on a
transparent and consistent criteria of priorities.

Quasi government projects, evaluated on a distorted set of
cost-benefit analysis because of implicit government backing or
facilities, can easily become significant government liabilities.
Some obvious priorities are export generating, efficient and
sustainable import substitution, and alleviation of crucial
infrastructure bottlenecks.

It is hoped that such a stance, which in fact was mentioned by
the minister of finance in his explanation to the press, is
really taken seriously and acted upon. Otherwise the dire outcome
will surely catch up with us sooner or later.

The writer is a senior economist of the Center for Strategic
and International Studies (CSIS) in Jakarta.