Development Financing
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Last week, in the dry winter in Cusco, the capital of the ancient Peruvian Empire of the Inca, several central bank governors from Latin America met with a group of economists. The limited meeting discussed new challenges of global economic integration.
In the limited meeting, world economist Nouriel Roubini, in an anxious tone, talked about productivity, which is still low, and his concern on the reverse flow of globalization. Specifically, he mentioned that globalization can only work if it provides opportunities for all groups, including those who fall behind as a result of globalization. He advised on making efforts on improving education, health and social protections, saying that those who are marginalized should enjoy the benefits of globalization.
I think Roubini is right. Not only that, senior economist Jonathan Ostry from the International Monetary Fund (IMF) reminded that financial liberalization can encourage economic inequality. That is why an inclusive growth is needed. In this context, I was asked to speak in the limited discussion about inclusive economic growth from the Asian perspective.
Low growth threats
The discussion in Cusco was a bit gloomy. Jose Ocampo, the former finance minister of Colombia and professor at Columbia University, warned about limited fiscal and monetary instruments in boosting growth in emerging market (EM) countries. Not all countries have space for fiscal expansion, while on the other hand monetary expansion is also limited because the US Central Bank (The Fed) will speed up normalization of its monetary policy.
Global trade? No less cloudy. It has slowed down and is aggravated by the protectionism of US President Donald Trump. The remaining option to boost economic growth is structural reform. However, as I disclosed in Cusco, structural reform is, politically, not easy. The benefit of reform is frequently felt in the long run, while the people have to sacrifice instantly. This is politically difficult. Economic reform has to take into account the political cycle in order to get support. Its implication is that the space for structural reform is easier said than done.
Therefore, there is a risk that the EM countries will enter a low growth era. A sad message. In fact, Indonesia is still excited with its economy. In this context, Indonesia\'s economic performance is actually quite good.
Felipe Larrain, the former finance minister of Chile, delivered praise, saying Indonesia could still grow 5 percent, better than many natural resource-producing countries. I agreed. However, we have to be honest: 5 percent economic growth is far from enough. We need faster economic growth. The demographic bonus will end in 2050. Without high growth, there will be a risk of getting old before we are rich.
The government is trying hard for it. We note positive steps from the government\'s economic packages and of course infrastructure development. Therefore, the budget deficit has to be raised. We all agree about the importance of infrastructure development, access to education, health and social protection for the poor. Without that, the poor will be marginalized in globalization. This is part of inclusive growth. Fiscal policy has to be designed to address this issue.
The direction of government policy has actually been correct and will benefit Indonesia in the future. Unfortunately, in the short term, growth seems to have stagnated. Data from the Central Statistics Agency shows only a slight decline in the number of poor people over the last several years. So then why does fiscal expansion, with additional debts, not encourage growth or reduce the poverty rate sharply?
First, of course, we cannot separate the Indonesian economy from global conditions. Sluggish world trade and falling commodity and energy prices have hit our economy. However, we cannot always be apologetic. Exports of Vietnam and Bangladesh have grown rapidly. Even Bangladesh, a country with a very severe infrastructure problem, has managed to have a high growth rate of exports. It means infrastructure constraints are not the only explanation as to why the economy grewby only 5 percent. In the future, the transformation has to be carried out to change the economic structure from one focused on natural resources to manufacturing, which is supported by the quality of human resources. Unfortunately, this takes a long time.
Second, the strategies of infrastructure development and basic needs need a long time to show results. A long-term strategy is clearly necessary, but as the greatest twentieth-century economist,Keynes, puts it, there is no use in a long-term economic policy if it is unable to address the short-term problems. Therefore, the government\'s steps in infrastructure development must be combined with the short-term efforts to promote the welfare of the people. With this, demand will increase. The problem, though, is that the budget is limited.
Third, consider this fact: The ratio of domestic savings to the gross domestic product in Indonesia has continued to increase, but, strangely, growth in third party funds (savings) in banks have tended to slow down, especially after 2014. Where do the savings go? The data shows that the growth of government bonds has increased in line with the rising government debts.
What does this mean? We see that the symptoms of budget deficit financing through domestic debts (bonds) have transferred the savings in banks to the government bonds. Its implication is that the supply of loanable funds has become limited, so private investments, which can be financed by the banking industry, are limited. Therefore, the private investments stagnate or slow down. This is called the crowding out effect.
My initial study supports this hypothesis. Of course, an in-depth study is needed to analyze it in detail, but the initial findings seem to support such a view. Interestingly, the relationship between the budget deficit and banking liquidity is not linear.
To a certain extent, deficit financing through domestic bonds has a positive effect on the growth of third party funds in banks. The reason is that the government bonds enable people to have an investment option so that there is mobilization of public savings. This happens without gravely disrupting banking credit expansion. As a result, private investments can still increase -- of course if there is demand from the public.
Here, the budget deficit plays its role as a stimulus to increase people\'s consumption and, at the same time, private investments (crowding in). However, after passing through a certain level, the budget deficit financed by domestic debts absorbs third party funds in the banks. Because the amount of liquidity is limited, the large budget deficits only move savings deposited in the banks into the government bonds. As a result, private investments are stagnant (crowding out). Ultimately, the economic growth also stagnates.
In short, budget deficits are needed to boost domestic demands but have to be maintained at an optimal level. They cannot be raised continuously. If the deficits are too big, private investments will be hampered. If so, why not simply take the source of financing from abroad? Here we have to be careful. If the government bond market is dominated by foreign investors, the Indonesian economy will be vulnerable to the capital flow disturbance because they can go away any time. What has to be encouraged is the potential for community savings. Without it, the risk of crowding out happens.
The need for priority
So what is the solution? Larry Summers, a professor of Harvard Kennedy School, said that the fiscal policy has to align with TTT (temporary, targeted, timely). It means: priority is very important. Infrastructure development needs to be prioritized, which is the most important one. Moreover, the fiscal stimulus has to be directed to people who have a high and immediate tendency to consume (marginal propensity to consume).That means raising income for the middle-lower groups. If they get income, domestic consumption can be encouraged. This is what will push the economy in the short term.
What about the policy? I wrote in this daily last year: expand on theConditional Cash Transfer, such as the Prosperous Family Program from 10 million to 15 million or 20 million households. Implement a cash for work or labor-intensive program. Because financing sources of the State Budget are limited, the priority of spending is very important. Inefficient spending allocations, such as energy subsidies that start to swell again, should be reduced and allocated for the productive sector. Of course, it should be done by compensating the poor. It would be very unfortunate if the government\'s excellent policy to reduce energy subsidies does not continue. Moreover, we have to seek a new source for growth, and that is in direct foreign investments (PMA), not a portfolio.
We do live in a limited world. In such a situation, priority is the keyword. In Cusco, in a territory above the sky, many things are still faded. One thing, however, is very clear: the importance of priority.
MUHAMAD CHATIB BASRI
Chairman of the Advisory Board of Mandiri Institute
