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.