Is it enough to keep the economy stay afloat over the pandemic?
IO – The government has decided to pump in more “stimulus” to overcome the negative impact of the COVID-19 pandemic. Total additional budget disbursed reaches IDR 405 trillion, or the equivalent of 2.5% of the Gross Domestic Product (GDP). This additional budget is aimed at health, social protection, tax incentives and national economic recovery goals. Indonesia is thus one of the Asian countries giving the largest incentive. The amount of government fiscal incentives is greater than that allotted by countries such as China (1.2% of GDP), South Korea (0.8%) or India (0.5%), but this figure is smaller than Thailand (3%) or Malaysia (17%) as shown in Graph I.
Even though the budget has been increased to deal with the impact of the COVID-19 pandemic, the government seems to be planning to increase the additional budget to accommodate the scope of its proposal – it is still far from enough. Shopping for social assistance, for example, the government has budgeted IDR 110 trillion for the needs of a social safety net for the poor. However, from the social safety net that is budgeted by the government, assistance provided is still a targeted somewhat at community groups living around the poverty line. Even though the people impacted, which in this case means those who are categorized as ‘almost poor’ and ‘vulnerable to poverty’, they are also numerous. These communities are vulnerable to economic shocks in their present condition, and they need government assistance.
According to the Statistics Indonesia (BPS) records, in 2019 there were around 46.8 million Indonesians who were categorized as ‘vulnerable to poverty’; this number was higher compared to that of 2018, which reached 45 million. The total categorized as ‘almost poor’ in 2019 reached 19.9 million; this figure increased when compared to that of 2018, which reached 19.2 million citizens. The number of poor people alone “only” reached 16.9 million in 2019 (Graph II).
Aside from the poverty alleviation budget, additional government spending is also required for pre-employment card programs. At first, the government targeted pre-employment cards for 5.6 million people; if measured from the unemployment rate in August, which reached 7 million, implementation of the pre-employment cards will cover 80% of the unemployment rate. Even so, the unemployment rate this year has the potential to increase, as more layoffs are carried out by business actors, hence making it necessary to do a review of the target pre-employment card recipients. The two incentive posts above have yet to discuss additional tax incentives which are also being expanded. This means that the nominal government incentives have a great potential to swell.
Unfortunately, the additional incentive expenditure above is projected to not be offset by any increase in state revenues by the end of the year. The growth of state revenue will be much lower compared to that of last year, which was caused by 2 main factors. Abroad, prices of a number of commodities suffered a decline, as a result of slowing global demand, including that of the price of crude oil, which sank below US $ 25.
Apart from weakening global demand, triggered by the failure of any agreement among producing countries, especially Saudi Arabia and Russia, to cut oil production, there was Russia’s refusal to cut oil production by 1.5 million barrels per day, given that world oil demand collapsed once we were into the COVID-19 pandemic. This rejection led to the decision of Saudi Arabia and several allied countries to increase their own production and ultimately led to the downward spiral in oil prices to date.
At home, weakening domestic demand has resulted in slowing activity in sectors contributing to state revenue. Indonesia’s manufacturing Purchasing Managers Index (PMI) which has shown contraction since the middle of last year, in April 2020 dropped even deeper, to a level of 27.5. A stall in manufacturing will have an impact on tax revenue, because this sector accounts for around 30% of the total. Indications of slowing growth in tax revenues have been seen in the release of the realization of state income in March. Tax revenue reached IDR 241 trillion, or 2.5% lower than the growth of tax revenue over the same period last year, which marked IDR 247 trillion. In sectoral analysis, the manufacturing industry which accounts for the largest source of tax revenue, saw a contraction in growth of -9.0%, far below last year’s growth of 6%. Another tradable sector, namely mining, also experienced a contraction in growth of -22%, worse than last year’s figure, which was -14%.
The combination of these two factors is predicted to cut down state revenues until the end of the year. CORE predicts that taxation revenue (tax in a broad sense) will be in a range of IDR 1,452 – IDR 1,514 trillion, considerably lower than last year’s realization, which reached IDR 1,462 trillion.
With more and bigger spending, all while state revenues are petering out, the effect will eventually be a widening of the budget deficit. The government projects the deficit will reach IDR 852 trillion, or equal to 5.07% of GDP. Indonesia is not alone in this situation; other countries are also predicted to experience a similar fate. Our neighbor Malaysia for example, with an additional incentive of RM 250 billion, will have to deal with a budget deficit of around 4.5% of GDP, higher than the deficit last year, which reached 3.4%. France even plans to crank up its budget deficit to a full 7%.
Fiscal stimulus policies, widening deficits and financing are inseparable entities. Stimulus is needed in order to accelerate the amelioration of the COVID-19 pandemic; stimulus provides assistance to affected communities, increases business resilience as well as “priming the pump” for economic recovery when the pandemic is over. The size of the stimulus implies the widening of the deficit, as well as the amount of financing required by the government.
Various forms of financing are planned to patch the above budget deficit. There are at least 3 main forms of financing that have been planned by the government; first is the issuance of global debt securities; second, foreign loans, to the third, financing options from within the country by means of Bank Indonesia printing money – a practice known as Quantitative easing. The government’s choice of any of the three financing options certainly carries its own risks.
The first financing option is by issuing global debt securities. This option was adopted by the government in early April when it carried out a sale of three series of Government Bonds (SUN) with a total nominal value of USD 4.3 billion, consisting of 1.65 billion each for a 10.5-year tenor, USD 1.65 billion for a 30.5 year tenor and USD 1 billion for a 50-year tenor. Government funding by issuing debt with a tenor of 50 years is also a first in the history of debt securities issuance in Indonesia. This step was taken by the government, in consideration of the preferences of global bond investors for a very long tenor, as well as to balance the maturity curve of Government Securities and create a benchmark of new tenors for Indonesia.
The government claims the issuance of global bonds in the form of foreign currencies in financial markets and the global economy in a period of uncertainty is likely to enjoy success. Moreover, this is bolstered by the rating agency and its appraisal of the economic outlook and the government’s ability to manage state finances. In addition, the issuance of debt securities in foreign currencies is expected to be a supporting factor to strengthen foreign exchange reserves in Indonesia.
But behind the claims of success and the potential for increased government foreign exchange reserves, the issuance of global government debt is not without risk. Global debt securities signify the potential for increased foreign ownership of government debt will be even greater. From last year onward, foreign ownership of government bonds has been in a range of 30-40 percent; especially when compared to peer countries such as Malaysia, Thailand, or China, foreign ownership of government bonds is relatively large (Figure III).
This condition makes the structure of budget financing very vulnerable to sudden capital outflows. The latest examples can be seen in February and March, when IDR 145 trillion in foreign holdings of government debt scooted abroad; BI was thus impelled to intervene in the state bond market. The capital flight also caused the Rupiah to weaken to a level of IDR 16,000 per USD. From January to mid-March the Rupiah weakened by 15.4% (chart IV). When compared to other Asian countries the Rupiah has been one of the currencies hit the hardest from February to mid-March. This reality will be faced by the government in the future when choosing financing through global bonds. (Graph IV).
Foreign loans are a next step in financing also being pursued by the government. Besides being used to finance deficits, foreign loans are also often directed to finance priority activities of ministries / institutions, managing debt portfolios, and can also be lent / distributed to local governments / State-Owned Enterprises (BUMN) / Region-Owned Enterprises (BUMD). When compared to other financing instruments, foreign loans, especially those originating from official creditors (ODA / concessional), have relatively longer loan maturities, lower interest rates, and are not limited to financing activities / projects but can also be used for program financing.
However, because they are indexed to foreign exchange, foreign loans carry the risk of exchange differences. Further, the process of withdrawing foreign loans must also get prior approval from lenders. In addition to the multilateral loan exchange rate selection, it is also generally a prerequisite that there is a commitment fee, which is a cost that must be borne by debtors if the loan withdrawal does not conform (is smaller or larger) to the terms agreed at the beginning. This means that if the trend of undisbursed loans occurring in the second quarter of 2019 on the chart V below takes place, then there is the potential for additional costs to be borne by the government in the future. (Graph V)
Potential and Risk of Money Printing Policy
The final choice of securing government funding is through domestic financing, which is carried out through money printing (QE) by the Central Bank. This discussion then warmed up in Indonesia after the House of Representatives gave a signal to support Bank Indonesia in its determination to print in the range of IDR 400-600 trillion. If you look at the history of QE, this is indeed not a new monetary policy globally, despite the debate over who formulated it; the experts agreed that John Maynard Keynes, the Central Bank of Japan, and Richard Werner were people and institutions that are often mentioned by name when speaking about QE.
At first, QE was identical to a policy implemented by the Japanese Central Bank (BoJ), which has been dedicated to it since 2001 after reducing interest rates to zero percent. However, other central banks then implemented a similar policy, including the central bank of the United States (The Federal Reserve). Basically, in QE policy, the central bank will increase the money supply by purchasing various securities, such as bonds, in order to flood the financial markets with cash, thus increasing the liquidity of the country’s currency. Thus, the inflation rate is expected to rise, along with an increase in the money supply; it is also expected that there will be abundant liquidity available for banks to extend credit while boosting economic growth.
The key words from the QE explanation above are “lending” and “economic growth”. We already know how credit can have a positive impact on economic growth. The study of Ross Levine and Sara Zervos (1998) have revealed that over the long run, the stock market and banks exert a positive impact on economic growth, and financial markets have an important role in providing services in the process of providing credit. Similar results were also found in a study conducted by Kpodar and Kodzo (2010) which posit a positive relationship between credit growth and economic growth. In Indonesia, a study on the relationship between credit distribution and economic growth was conducted by Sipatuhar MA, et al. (2016). The results of the study showed that the credit allocation by banks increased business in the real sector and then had an impact on economic growth in Indonesia, and it also had an impact on decreasing levels of unemployment and rates of poverty.
Although it has exerted a positive impact on economic growth, credit disbursement in Indonesia has unfortunately not been optimal thus far. This can be seen from the relatively smaller ratio of credit distribution to Gross Domestic Product (GDP) when compared to other Asian countries. In 2018, for example, Indonesia’s ratio will only reach 38%, less than that of China, which will skyrocket to 161%. Another example can be found in the rising star economy in ASEAN, Vietnam, where the ratio will reach 133%, as shown in the IV chart below. In recent years, the movement of the ratio of credit to GDP has only grown marginally. So no wonder China and Vietnam enjoyed economic growth of 6.6% and 7.1%, respectively, in 2018 when the world was hit by global economic uncertainty as a result of trade wars. (Graph VI).
One of the causes of the relatively low lending in Indonesia is the ineffectiveness of monetary policy transmission in reducing credit interest rates in the country. As an illustration, lending rates in Indonesia in 2018 are in a range of 10%. When compared to ASEAN countries and China, lending rates in Indonesia are relatively high: Vietnam’s lending rates reached 7.4%, Malaysia reached 4.9%, Philippines reached 6.1%, Singapore reached 5.3%, Thailand reached 4.1% and China reached 4.3%.
The above argument tries to show that printing money can be one of the solutions to the tight liquidity in Indonesia, due to the low lending rate here. Of course, with credit disbursement, Indonesia can benefit from higher economic growth, as enjoyed by Vietnam and China. In the context of the handling of COVID-19 pandemic, several countries have also taken QE steps to counter its negative impact on the economy, one example of which is the United States. However, behind the potential that can be obtained from printing money, the government needs to be aware of the risks that can arise from such a reckless policy, especially when considering what happened in the past: Indonesia has had no good experience with the implementation of a money-printing monetary policy .
Historical Review of the Print Money Policy
During the period of guided democracy, namely in 1957-1965, a series of political events led to the formation of an authoritarian economic system. At that time State- Owned Enterprises became the backbone and the central players of the national economy. They received full support from the State Budget and banks to carry out their assigned duties (in the Indonesian Economy book; Boediono 2016). Political developments and programs at that time forced the government to maintain a decline in real revenues. On the other hand, spending on political priorities at the time, which was then used for security operations (the problems of West Irian and Malaysia), loomed larger and consumed almost 40% of the entire budget. This ultimately led to an increasingly larger state budget deficit.
The government finally had no other choice: the wheels of the government had to keep turning and the easiest way that the government finally took at that time was to borrow from Bank Indonesia, which was then forced to print money. This was the main source of increased money supply at the time. Meanwhile, other state companies, which were the main pillars of the guided economic system, also desperately needed additional funding. And the system at the time required the fulfillment of financing by banks (including Bank Indonesia). This policy ultimately led to an increasingly larger State Budget deficit, which was covered by printing money wildly which in turn bloated the money supply, and shot inflation upward and out of control.
The government made an effort to control this money supply in the form of “sanering” and reductions. In the sanering system, the government seeks to stem the money supply by suppressing the value of paper money, while freezing deposits and demand deposits in banks until the exchange rate is settled. The second step by redenomination is to reduce the exchange rate. Unfortunately, the two monetary policies above fail to have the effect of stemming the problem of money supply because the main sources of the deficit, namely, the State Budget and SOEs, continue uncontrolled; in doing so, the process of creating new money in ever-growing volumes accelerates.
The worst possible result finally came to pass. In 1961 ordinary inflation finally degenerated into raging hyperinflation, marked by an inflation rate in the range of 100% or more. Note that there is a fundamental difference between hyperinflation and inflation. Hyperinflation is always marked by a loss of trust in those citizens holding money. Once an alarmed recipient gets cash, he will immediately spend it, to avoid cascading losses from a rapidly-devaluing currency. These psychological symptoms are difficult to measure directly but can be detected from a more frequent movement of money. A simple way to detect an increase in money circulation is by looking at whether the inflation rate speeds up faster than the rate of increase in the money supply, as Table 1.
An increase in the money supply also erects paradoxes: even though the money supply continues to grow rapidly, economic actors always feel a lack of liquidity. This condition can occur because in an environment of hyperinflation, the real value of money actually decreases, so people feel the money in circulation is never enough to support a volume of transactions, and all the transactions activities they are attempting. A more rapid increase in prices of goods undermines the ability of money in circulation to support transactions. This symptom of lack of liquidity results in a stalled transaction process and ultimately impedes production and economic activity in general (Boediono, Indonesian economy, p. 102).
What should be done?
The above lesson can certainly stand as a foothold as a material consideration for the government, if it wants to realize a monetary policy discourse in the form of printing money. Then, looking at the advantages and disadvantages of the three financing options elaborated
is very poor. The issuance of Global SUN in the midst of these conditions will force the government to increase incentives in the form of higher coupon interest and/or very long tenors. Therefore, the issuance of domestic SUN with a purchase pattern by BI is needed by the government, which should set a lower interest rate or SUN coupon with a reasonable tenor. That way the government will not be burdened by high SUN interest payments over a long period of time. Monetary expansion in the short term that occurs through the purchase of Domestic Government Bonds (SUN) by BI also needs to be accompanied by a count of inflation that can still be tolerated by the community and businesspeople. In the midst of a pandemic this option is still possible to implement due to lower inflationary pressures, the result of weak demand caused by slowing purchasing power.
Second, although the Indonesian Rupiah (IDR) currency is under pressure, due to uncertainty in global financial markets, the government does not need to rush to increase the supply of dollars by issuing Global Government Bonds. The current position of the Foreign Reserves is large enough to finance Bank Indonesia interventions in the context of exchange rate stabilization. In addition to foreign exchange reserves, Bank Indonesia also has a second line of defense, in the form of IMF loan facilities, swap arrangements with several central banks, and finally, the Repo Line facility from the Fed. Aside from the repo line facility, in order to increase foreign exchange reserves, the government can push through foreign loans with lower interest rates. This certainly needs to be done with a hedging scheme to anticipate future exchange rate differences. A detailed plan for the use of loans also needs to be implemented by the government, to avoid the potential for issuance of future commitment fees.
Third, although Global Government Bond issuance is needed because we are short of dollars (due to declining exports), Global Government Bonds issuance can be attempted when the Covid-19 pandemic has subsided and market sentiment is starting to recover. In the midst of a global monetary policy that tends to push down interest rates, Global Government Bond issuance has a high demand potential for better coupon interest, along with a reasonable tenor.
Last but not least, in the long run, the discussion about money printing plans needs to be kept alive. However Indonesia needs additional liquidity to move its economy, and by learning from the experience of other countries, this policy can actually be an alternative. The key is in further studies related to how the money supply influences inflation by adjusting the development of Indonesia’s current economic dynamics. It is hoped that by increasing liquidity, Indonesia’s economic growth will be higher, thus exerting a positive impact on the welfare of its citizens. (Yusuf Rendy Manilet)
Yusuf Rendy Manilet is a researcher at the Center of Reform in Economics (CORE). He earned a Bachelor of Economics from Universitas Islam Nasional Syarif Hidayatullah Jakarta. At CORE, Yusuf’s focus is on analysis and research of Macroeconomics, fiscal policy, government debt and poverty. Before joining CORE, Yusuf worked at several leading banks in Jakarta.