INDONESIA’S SKYROCKETING DEBT, Can we borrow our way out?

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IO – Government debt revealed a dramatic rise even before the onslaught of Covid-19, with government debt skyrocketing, compared to that of past administrations. During the Sby administration, total government debt was recorded at IDR 2,700 trillion, while in 2021 the Jokowi administration debt has exceeded IDR 6,361 trillion. This signifies that from 2014 to 2021 there is a rise of IDR 3,661 trillion in debt, or 135%. Worse yet, both government and SOE debt will hit IDR 10,000 trillion, an unbelievably fantastic level.

Root of the Problem

A significant increase in debt no longer considered as “leverage” required to increase productivity of the economy. When the government intensively finances infrastructure through debt, it is hoped that multiplier effects will be generated on the economy. In this context, debt is seen as a necessary tool to fuel economic growth, alleviating poverty in developing countries. However, in reality, and reading the data reported by the government itself, debt in the last 6 years no longer serves as leverage but is simply an economic and social burden.

Debt risk must not be underestimated by policymakers. Based on data released by the World Economic Forum, one of the risks to closely control over the next 3-5 years is a debt crisis, as the 5 most dangerous types of risk, and one which must be anticipated immediately. This global debt crisis is showcased by the World Bank, announcing a high increase in debt in developing countries – such unusual growth. The next debt crisis will no longer be a problem for developed countries such as Europe, the US, but will instead erupt in developing countries, including Indonesia.

• FIGURE-1

A debt overhangRea that leads to a debt crisis is a concept in economics that looks very contextual in term of Indonesia’s current debt situation. One indicator to see whether Indonesia has entered into a debt overhang is the performance of the entire economy over the past 6 years. The Covid19 period is an aberration, because in this situation pressure on declining economic activity is evenly distributed in various parts of the world – except for China and Vietnam, which have already struggled out of recession, with positive economic growth in 2020. Meanwhile, to be more objective, conditions before the pandemic indicate that the Indonesian government’s weak growth of around 5%, accompanied by subdued public demand, is a clear warning that a debt overhang may strike, even before Indonesia faces a recession. 

eriving from the pandemic.

The myth that debt faithfully drives a productive sector needs to be refuted. In fact, a greater rise in debt does not necessarily correlate with an increase in the share of the manufacturing industry to gross domestic product. Symptoms of deindustrialization persist, while industry is a critical sector to finance foreign debt obligations, because it generates foreign currency income from exports. Weakening industrialization is an indication of the government’s inability to manage debt well, so that the productive sectors that produce goods or are tradable are weakening. In fact, the share of the manufacturing industry to GDP continues to decline, to 20% or even lower. This development has plunged Indonesia into a “middle-income trap”. While the workforce continues to expand, employment opportunities are drying up.

Debt overhang a drag on economic recovery

A debt indicator as a burden of economic growth is commonly referred to as a “debt overhang”. This theory was developed by Carment Reinhart, a Harvard University professor whose concept was that when the debt burden looms huge, both for government and private concerns, the inflow of capital and business expansion will be disrupted, because the debt interest is too heavy. Another pernicious effect, Reinhart explained, is that a debt overhang can disrupt the rate of economic growth.

Another example of the debt overhang phenomenon is the weakening of the ability to pay off foreign debt, demonstrated by the debt to service ratio (DSR). The ability to pay down foreign debt is recorded at beyond 25% in 2020. DSR explained that the ratio of adding new debt compared to the ability to seek foreign currency revenue from various sources such as exports and tourism does not correlate. Another problem is to what purpose are the proceeds from debt actually used for.

In fact, the government needs new debt to finance spending. Consider, however: did PEN stimulus (Covid19 Govt stimulus) spending raise debt significantly? Don’t be fooled by the term “PEN” and associated debt as a narrative justifying saving the economy during the recession. In fact, the largest portion of Indonesia government spending is still bureaucratic spending, such as spending on personnel and goods, plus the burden of paying interest on debt itself. It is recorded in the 2021 State Budget that the burden of government debt interest payments has contributed 19% to total central government spending

• TABEL-1, TABEL-2

If the burden of bureaucratic spending plus debt interest payments continues to increase, it will have ominous implications for narrowing fiscal space. It could be that in the medium term, government sacrifices social spending, also cuts spending to help SMEs and adjust public health expenditures, which is essential in the context of fighting any future pandemic. With the narrowing of the fiscal space, the government’s efforts to stimulate the real economy also weaken. The goal of debt is not to restore the economy, but rather to serve as a temporary panacea so that the economy seems to be running, even though the debt strategy will impose painful fiscal pressure in the long run.

On the other hand, the government has not succeeded in increasing the recorded tax ratio, which has fallen to 8.3%, or the lowest it’s been in the last 8 years. The declining tax ratio is a problem in itself, for the ability to pay ongoing government debt – apart from the problem of low tax compliance. The existence of bombastic tax incentives without a clear rationale means the government loses an important source of tax revenue. Logically, the government patches the budget deficit from debt, even though the budget deficit is created due to a policy mistake in providing incentives to business actors.

Excessive government debt also endangers the economic sustainability of the next generation, not only the Millennial generation but also generation Z. Angela Merkel, the German chancellor, once pointed out that the debt issued by the current government is actually a burden for future generations. The critical point is the destruction of the fiscal order in the long term, so that for whoever will take over the government in the future there will not be much that can be done, because the budget is already burdened with a debt overhang.

Can the Indonesian government pay down its debt in the near future or not? this question is actually not precisely the right one. The government issues global bonds, with a long enough tenor (up to 50 years or only to be paid in full in 2071). Global bonds with code RI0371 are the longest-tenor debt in history, at US$500 million. This is not proof that Indonesia is trusted by investors but rather proof that the government is carrying a load of debt until 2071. We will suffer the burden of this government debt for a very long time. • TABEL-3

Another problem that arises from the issuance of debt securities is that the government provides quite high interest rates to investors, compared to when the government issued bilateral or multilateral loans. As much as 85% of total government debt outstanding is in the form of debt securities; only 15% is loans to institutions such as world banks and other countries. Issuing debt securities does provide flexibility for the government to be able to spend, without the need to be regulated by creditors. However, unsupervised creditors can also exacerbate the use of debt for bureaucratic and consumptive expenditures.

The government perpetually argues in justification of bloated debt that since Indonesia has increased its economic capacity, it is difficult to borrow bilaterally or multilaterally from foreign creditors. Therefore, the government argues that the best way is to issue debt securities to be sold to the market. This path of action is clearly fatal, because the differential of debt interest between loans and debt securities is clearly quite wide. The spread can be more than 4 to 5%, which means that if the government issues debt, the current interest rate is 6% for a tenor of 10 years; the loan will thus only provide 1-2% interest. The wide spread of the difference in interest on debt borne is a burden on the state budget. The greater the issuance of debt securities, the greater the interest expense to be paid each year.

Criticism of the amount of interest paid by the Indonesian government can also be compared to peer countries, such as the Philippines. With Indonesia and the Philippines sharing the same Fitch rating, namely BBB, there is a considerably different interest rate. Inflation in Indonesia was recorded at 1.68% year on year, while the Philippines marked 2.4%. The yield received by investors when buying Indonesian debt securities was 6.26%, based on ADB bond data online, while the Philippines only gave a return of 2.93%. This indicates that the irregularity related to interest rates is very worrying, as foreign investors will enjoy a real profit of 4.58% if they buy Indonesian government debt securities. In the Philippines investors only get 0.53% yield. Of course, this is a debt securities market game without any consideration of the basic assumptions, namely, inflation and debt rating. Therefore, it can be said that the Indonesia taxpayer subsidizes the bond creditor.

If the payment of debt interest is relatively higher than that of peer countries, even though it carries the same rating, it is certain that the formulation related to the yield given to investors may be termed “overpriced”, an indication that the government is deliberately issuing debt with high interest rates in order to sell quickly, or to be oversubscribed in the market.

Tapper Tantrum and Debt Risk

The current economic situation should be an object lesson for the government. In 2020 there are still many investors who are interested in buying government debt securities. Apart from the large interest offered by the government, their enthusiasm is also a product of the effect of the monetary stimulus carried out by central banks in developed countries, particularly the Fed. Liquidity flowing to developing countries is reminiscent of the 2008 crisis, when investors increased their appetite for assets in developing countries offering high interest. But the situation could turn around like the “Tapper Tantrum” in 2013, when the US central bank began sending signals that it would normalize its balance sheet. These developments put the Rupiah under pressure. Easy entry of foreign funds and easy exit from financial markets in Indonesia greatly disturbs prospects for issuance of debt securities.

In early 2021, unpredictable market signals began to pop up. The party had just begun for the speculators in the debt market. US Treasury yields continued to rise and even broke through 1.7%, which was a relatively rapid increase. This all came to pass because global investor expectations saw signs of demand in the US improving during the Joe Biden era. With a stimulus of US $ 1.9 trillion, it is expected that US inflation will soon rise. Automatically, expectations of rising US inflation will fuel an increase in US Treasury yields. As a result, the spread between Indonesian government debt securities and the US Treasuries is narrowing. On the one hand, Bank Indonesia continues to cut its benchmark interest rate, recently by more than 100 basis points, which creates a risk of deep monetary pressure because so far, foreign exchange reserves can rise, supported by the issuance of government bonds during the pandemic. It is as if we are holding our breath in a fragile house of cards, and any pull of capital outflow will see chaos erupt in the domestic financial market. • FIGURES-3

Help Indonesia evade debt overhang

Then what is the solution? Any debate about debt solutions should start from a fundamental question: why should the government keep increasing debt? If this question is not answered, it will be difficultto find a solution to get out of a debt overhang. The government’s reason for pilling up debt must be accounted for, both rationally and seeing the effectiveness of the debt so far on the economic sector. For example, the government argues that debt is needed to drive the economy. So the most appropriate solution is to reduce expenditures that have no impact on the recovery of the productive sector. For example, personnel and goods expenditures, as well as debt interest payment expenditures itself must be significantly slashed. Meanwhile, expenditures that are directly felt by the business world and society, such as unconditional direct cash assistance, infrastructure spending needed for industry and capital assistance for SMEs, must be immediately increased.

The solution to reducing debt interest expenses and principal debt does not rule out debt renegotiation. Several countries in the same position as Indonesia, lower-middle income countries, have opened themselves up to execute debt negotiations with foreign creditors. The IMF itself emphasizes the need for debt relief, so that countries that need support for spending can allocate funds for the purchase of vaccines, for example, or for strengthening hospital facilities. The Indonesian government should not be ashamed (especially since Indonesia is not a developed country) when Indonesia’s status fell from an upper-middle income country to a lower-middle income  country following the economic recession. It is illogical if the poential for debt negotiation is not executed as an executive order. Of the thousands of trillions of debts outstanding, 15% of which is owed to institutional and state creditors, Indonesia can do a debt swap, which is to swap debt for health or environmental programs. This has already been done with Italy and Germany, so debt swaps are nothing new for Indonesia.

We must fight debt abuse, especially if the debt narrative only plays on the extent of the ratio of debt-to-GDP. The government should be honest in including all transparency and debt health indicators, such as the ratio of debt interest to both state revenues and central government spending. With the objectivity of looking at debt risk, the government can control which debt entails the lowest level of risk.

The debt-to-GDP ratio that the government often refers to, comparing us to G20 member countries, is a form of excessive simplification. The concept of the debt ratio as a safe limit for debt issuance can be traced to the Maastricht Treaty, an agreement between EU countries to keep the debt ratio below 60%. However, the Maastricht Treaty itself was shaken during the European crisis in 2013, where the debt ratio could not be used as a main benchmark. There are European countries that ask for a bailout, even though their debt ratio is still below standard, while other countries with debt ratios relatively above 60% do not ask for one. This anomaly is not without explanation, but occurs as a result of the increasingly complex debt and monetary market systems, so other indicators are needed.

Another thing that the government can do is increase the tax ratio so that its ability to pay down debt increases. many practical moves can be started at the Ministry of Finance. first, evaluate all tax incentives, including those doled out to big businessmen, to ascertain which are not positively correlated with economic output. Second, to encourage transparency in the use of tax expenditures, so that there is public oversight of the tax incentives enjoyed by the business world. Third, it is necessary to diligently pursue taxpayers, especially those who fail to take advantage of the tax amnesty, also through the use of Automatic Exchange of Information data, Panama Papers to Fincen Papers, to uncover cross-tax evasion scandals.

Industrialization must be the key. Not only is infrastructure needed, but infrastructure must be correlated with a meaningful increase in industrial output. The current problem is that there is an anomaly through which infrastructure spending continues to increase throughout the year, but efforts to reduce logistics costs are still hampered. Logistics costs are still recorded at 23.5%, or almost 1% decrease in the last 6 years, tracking the incessant campaign for infrastructure development. If the debt used to finance infrastructure does not correlate with any increase in industrialization, it is feared that the opposite will happen, namely, that debt will stimulate imports, especially from China – as can be seen by the way better infrastructure is used to encourage e-commerce to distribute imported goods at low logistical costs to please consumers in Indonesia. In fact, to build logistics infrastructure, the government also borrows money from China. Such a practice of debt between countries is truly ironic.

Back to Political Will

It seems that debt management reform must start from political will and the government’s shrewdness in managing its fiscal realities. In 2014, during Jokowi’s presidential campaign, a commitment to reduce foreign debt was made straightforwardly. At that time the presidential candidate campaign team listened to public complaints that the SBY era debt was a burden and an important topic of debate. The fact is that there is political will only before an election. Pressure from the main circle of the president to recall commitments to reduce foreign debt is very important. The president himself must reprimand ministers who do not comply with directions to control the rate of foreign debt.

Regarding debt, it seems that we are not losing alternatives, but the main problem is to force the government to admit that a massive accumulation of debt will bring financial disaster to the economy. We must act quickly. (Bhima Yudhistira Adhinegara)

Bhima Yudhistira Adhinegara is a researcher at INDEF (Institute for Development of Economics and Finance). He earned his Bachelor’s Degree in Economics from Gadjah Mada University and his Master’s Degree in Finance from the University of Bradford, UK. He is active in financial market, banking, and digital economy research projects.