Should we add more debt?
Retno Maruti ; An observer of development economics at the Finance Ministry
JAKARTA POST, 17 Maret 2014
The government recently announced that its total debts as of the end of January amounted to Rp 2,465 trillion (US$217 billion), consisting of loans and bonds. However, according to the Finance Ministry, the government still needs new financing of around Rp 397 trillion or 3.82 percent of the gross domestic product (GDP) this year to fill in the state budget hole. The debts will be used to cover the budget deficit, finance government investments and service past debt payments.
The government’s debts were larger than last year, but as a percentage to the GDP, total debts showed a steady downward trend to as low as 24 percent this year.
Government debt has always been a controversy. But if we compare the government’s debts to that of developed countries, the debts of the Indonesian government are fairly small.
For instance, the sovereign debt-GDP ratio in Japan is more than 225 percent this year. In the United States, the ratio is 106.3 percent, while the average ratio in Organization for Economic Cooperation and Development (OECD) countries is 110 percent. Among its peers in Southeast Asia, Indonesia’s debt ratio to GDP is the second-lowest after Brunei.
The overall condition of Indonesia’s debt position still is still safe and sound.
Many economists argue that government debt-to-GDP ratio has no effect on growth provided that the level is still below 90 percent. Yet, the most prominent matter in debt management is the capability of the government to repay its debts.
The theoretical framework behind the issue of debt-to-GDP ratio is that a country’s GDP is positively associated with its financial capacity. This particular ratio tells about the country’s ability to pay off its financial obligations within a year, irrespective of the nation’s aggregate assets or total outstanding debts.
The rationale is that the increase of GDP will be followed by the growth of productivity, and in turn, the people/industries that produce the goods and service also receive higher incomes. The higher incomes will contribute to higher taxes, which lead to higher government revenue. And higher revenue builds a higher capacity to meet financial liabilities.
But the debt-to-GDP ratio does not sufficiently describe the government’s financial capacity to pay its debts.
This was elaborated by Bradford DeLong, an economics professor from the University of California, who explains that an efficient taxation system, low inflation, low-interest rates and buoyant stock prices are better indicators of the government’s financial capacity to repay its debts.
So, do we have to stop adding to the new debt? Yes, temporarily. The government has to consider a few other factors. Bearing in mind Indonesia’s current economic situation, garnering additional debt must be the last resort to fill the budget gap.
The main indicators of healthy financial capacity to repay the debts are not strong yet. For instance, tax revenue in the last several years has always been below target while the inflation rate has been relatively high (above 5 percent). Interest rates are also moderately high (the central bank base rate is 7.5 percent) and stock prices are volatile, and highly dependent on foreign short-term (portfolio) capital inflows.
But as a stable economic condition is achieved, new debts can be the best way to accelerate growth. A stable economic condition can be reflected by efficient tax revenue, low inflation (below 4 percent), low-interest rates (below 6 percent) and a buoyant stock market.
Productive financing is where new debts should be spent. Based on an estimated GDP of around Rp 9.084 trillion last year (it is projected that Indonesia will rise to the club of the top five-biggest economies in the world by 2035) and debt ratio of 24 percent, if the government intends to decrease its debt ratio by 2 percent, it will lose around Rp 181 trillion in budget appropriation for development spending.
But if we raise the debt ratio by, let’s say, 3 percent, we will have an additional financing source of Rp 272 trillion to finance development, which will generate GDP growth. The higher GDP will eventually adjust the new debt ratio and restore the previous debt-to-GDP ratio.
However, effective and strong supervision as well as robust enforcement of the Corruption Law is required to ensure sound debt management and efficient and effective use of the debts for development financing.
By spending more on development, economic growth can be set at a higher level.
But how should most of new debt be spent? Certainly, the government should use most of new debt on infrastructure development because doing so would improve overall economic efficiency, reduce logistic costs and strengthen the competitiveness of exports.
Studies have shown that poor and inadequate infrastructure has made logistic costs in Indonesia the highest among ASEAN countries. ●