Don’t underestimate the Peril of debt

IO – Debts run up over the past three years under the Jokowi government have spiralled by around Rp1,200 trillion, far higher than revenues from taxes, which have stagnated as a measure of the capability to pay down debt. In response to this criti­cism the government always argues that State debts, which now reach Rp4,000 trillion (or around 29.5% of GDP) are still below the level set by the “Law on State Finance”: a maxi­mum limit of 60% of GDP – as well as far lower than the debt ratio of other countries. The debt of Japan is often used as a comparison to the ratio of debt-to-GDP, which is above 200%. Against this we reply that Japan has its own characteristics, namely:

1. Its debts are owed to its own people and the Central Bank, 50-50.
2. Its debts are denominated in its own currency, namely the Japanese Yen.
3. The interest level is quite low – slightly above 1%. Just compare this to the interest rate Indonesia pays on its debt, which is the highest in Asia: most is in 2 digits.
4. The credit rating of Japan is A+, or in a very secure level, while the rating of Indonesia is BBB.
5. Although Japan’s debt level is high, in a real perspective that nation’s economy has a net international investment position of USD2.8 trillion, which means that the country has positive net external assets, what is defined as a “creditor country”. This con­trasts sharply from Indonesia, which currently has a negative net international investment position of more than USD400 billion, signifying its net exter­nal liabilities mean it is truly a debtor country, country with a negative external balance.

We cannot compare the tax ratio of Japan, which stands at 31% of GDP, to the tax ratio of Indonesia, at less than 11% (practically the lowest in the world). What’s more, the govern­ment does not stack up the ratio of the State Budget (APBN) to the GDP of Indonesia, which is really low, com­pared with the ratio recorded by other countries.

The same applies to the debt ser­vice ratio in Indonesia, which stands at 40%, the highest in Southeast Asia, while the ideal maximum limit is considered to be around 25%. Mean­while, around 41% of this country’s foreign debts are in foreign currency. With an average time to maturity of nine years and tenure of five years, amounting to 40% of total debt, this is bound to become a burden for the State Budget in the next five years.

The other concern is the balloon­ing of government debt when the Ru­piah exchange rate tends to weaken; this is when the government needs more income from tax revenues to pay off its foreign debts in dollars or an­other foreign currency. An additional concern is the limited foreign curren­cy available to pay down foreign debt, considering the following five matters, namely:

1. The trade balance, which tends to record deficit in the last three months, namely, from December 2017 to February 2018, with a to­tal deficit of USD1.1 billion or an average deficit of USD364 million per month.
2. The increase of Foreign Reserves is driven by foreign debts and “hot money”, which can squirt out of the country suddenly, at any time.

2. A low tax ratio, which tends to decline, indicating that going for­ward the ability of the government to service its foreign debts obliga­tions will weaken.
3. Industry sector, which contrib­utes 31% of tax revenues, is on a downtrend, due to de-industrial­ization, sliding from 28% (1997) to 20% of GDP (2017).
4. The increase of a 2018 budget allocation for electricity and fuel subsidies, which imposes an extra burden on the State Budget, be­cause President Jokowi wants to curry favor with the electorate, to secure their political support in the run-up to the 2019 election.

Therefore, based on various stud­ies and taking into account a number of variables related to the capability to pay back debt plus interest, the gov­ernment’s debts are indeed a cause for concern, if not alarm. With eco­nomic growth below target and weak trade, the Private sector has started to experience difficulty in servicing their debts. Problem credits in banks tend to increase and restructuring of bad debt is reported to be on the rise.

Therefore, given support from vari­ous academic studies and expert crit­icism by economists, the government should not be furious and condemn such criticism as a “provocative ac­tion”.

Remember that the devastat­ing economic crisis of 1997 started with fear in the market that the In­donesian private sector was facing difficulties in repaying foreign cur­rency-indexed debt. Mounting con­cerns triggered a weakening of the Rupiah exchange rate. Bear in mind that State finances at that time were quite sound, and macro-economic in­dicators pointed upward as well, in­cluding economic growth, inflation, a trade balance surplus and adequate foreign exchange reserves.

At that time (1997), the govern­ment repeatedly stated that the fun­damentals of the Indonesian econ­omy were strong. The way creditors perceived this was quite different, namely, they were focused on wheth­er the debtors had the capability to repay their debt. This is a unique micro issue, which often does not directly relate to macro-economic in­dicators.

It was this central issue – con­cern about debt repayment – which set off the crisis which suddenly hit Indonesia and triggered widespread panic. Therefore, everyone, and the government in particular, should not underestimate this potentially explo­sive debt issue. Also, do not think that the economists who criticize the government fail to understand it, or consider themselves more intelligent. Sooner or later, the market will come to realize (or suspect anyway) that the government is entering a difficult period in meeting its debt repayment obligations, and that will be the be­ginning of a crisis.