Optimizing Govt Debt

KOMPAS/ELSA EMIRIA LEBA

Aviliani

President Joko Widodo, in his state of the nation address in the financial note for the draft of the 2020 state budget (APBN), emphasized that fiscal management would be carried out with caution. Government debt will be managed effectively and be productive so as to minimize the risk of economic instability.

Over the last five years, the Indonesian government’s debt has increased significantly. In the first semester of 2019, government debt reached Rp 4.57 quadrillion. The nominal jumped almost double from 2014, which was recorded at Rp 2.6 quadrillion. This increase helped raise the ratio of government debt to gross domestic product (GDP) projected in the 2019 state budget to 30.4 percent.

When viewed from a legal point of view, referring to Law No. 17 of 2003 on State Finance, the Indonesian Government\'s debt position is certainly not a problem considering the debt to GDP ratio is still below 60 percent. The APBN deficit is also maintained below 3 percent of GDP. Moreover, the debt position of the Government of Indonesia is relatively low compared to the debt position of ASEAN countries.

However, from an economic perspective, this indicator cannot be used as the sole measure of a country\'s ability to face the risk of default. The European debt crisis has provided valuable experience where Spain and Ireland, which respectively had a debt to GDP ratio of 39.5 percent and 42 percent in 2008, were included in the International Monetary Fund (IMF) rescue program. Meanwhile, countries that had a debt to GDP ratio above 100 percent, such as Italy and Belgium, did not become IMF patients.

In the event of economic shocks such as in 2018, foreign investors will easily let pass their SBN ownership so that capital outflows become unstoppable, which results in depreciation of the rupiah and the depletion of foreign exchange reserves. Different from Japan, although the ratio of government debt to GDP reaches 245 percent, as much as 90 percent of the debt papers are owned by the public and its central bank. Therefore, the minimal portion of foreign investors causes the yen exchange rate to be relatively stable.

We need to realize that a storm of crisis can hit a country if the increase of a country\'s debt is high, but not followed by an increase on the economic condition.

On the other hand, Indonesia\'s debt to services ratio (DSR) -- the ratio that compares the principal value of loans and interest to the current account balance income -- is still in the range of 27 percent, where this figure exceeds the IMF threshold of 25 percent. The high DSR signals that government debt is still less productive to boost Indonesia\'s export performance. This will eventually lead to public discourse on the effectiveness of government debt to create a multiplier effect on the national economy, as since 2014 the average government debt has risen by 14 percent each year. However, economic growth is still experiencing a stagnation at the 5 percent level. We need to realize that a storm of crisis can hit a country if the increase of a country\'s debt is high, but not followed by an increase on the economic condition.

This could undermine fiscal performance because of the existence of the strong correlation between economic growth and the government\'s ability to boost state revenue. In 2015, for example, when the Indonesian economy grew only by 4.79 percent -- the lowest since 2010 -- the realization of state revenues was only 81.5 percent, causing the state budget deficit to touch almost 3 percent of GDP.

The shadow of fiscal performance that still could not improve starts to haunt the 2019 State Budget. In the first semester, the realization of state revenues only reached 41.5 percent, lower than the previous year which reached 44 percent. If the state revenues miss the target, it is certain that the APBN deficit which was initially projected to be 1.84 percent of GDP -- the smallest since 2013 -- will widen and the primary balance deficit will rise again.

The condition of the primary balance deficit must be a serious concern of the government because it indicates that the debt interest expense is paid by adding new debt. Especially with bond yields that are relatively high at an average of 7 percent compared to neighboring countries such as Malaysia and Thailand. For the record, debt interest payments in the 2019 APBN have increased, both in terms of nominal and portion of total expenditure. This year, the government must prepare at least Rp 275.9 trillion -- 11 percent of total expenditure -- to pay debt interest. This figure is equivalent to half the education budget allocation. If debt interest continues to increase without being followed by significant improvement in state revenues, it is certain that the government\'s fiscal space will be increasingly narrowed.

Standard and Poor\'s (S&P) has issued a warning regarding Indonesia\'s debt rating downgrade if in the next two years the interest expense still exceeds 10 percent of total government revenues and the debt to GDP ratio is still above 30 percent.

Optimization of debt

Amid the limitation of fiscal space and the prudent principle in managing government debt, improvement in the quality of spending and the use of debt is a crucial point in boosting the national economy. The results of a study by the National Development Planning Agency shows that an increase in government spending by 11 percent in 2017-2018 was only able to contribute to economic growth by 0.24 percent. In fact, the potential for state expenditure on Indonesia\'s GDP is 0.66 percent. Therefore, the large difference between the potential and reality of the impact of state spending on economic growth shows that there are still many APBN allocations that are not yet on target.

This condition is also reflected in Indonesia\'s incremental capital output ratio (ICOR) -- a ratio that measures the efficiency of investment in a country -- which has increased since 2014. This is reasonable given the government\'s priority program is infrastructure development. However, the infrastructure that has been built by the government in nearly five years has not been able to show a positive thing in reducing Indonesia\'s ICOR which is at the level of 6.3 percent. In fact, the average ICOR for ASEAN countries is currently only 3 percent.

Moreover, the use of debt in covering the state budget deficit can also be trapped in inefficiency because there is no specific obligation to issue debt securities in Law No. 24 of 2002 on the sovereign bond papers. Debt can be freely used to finance government spending, both productive and non-productive.

However, the contribution of sukuk to total sovereign bond papers (SBN) is still very small, around 18 percent.

This is different if the government issues debt in the form of sukuk (sharia-compliant bonds), which is regulated in Law Number 19 of 2008 on State Sharia Securities, where each issuance must have underlying assets. Therefore, the government spending has been bound in the activities of projects (project based sukuk), such as the construction of roads, bridges, and schools. Sukuk funds also cannot be used for other spending. However, the contribution of sukuk to total sovereign bond papers (SBN) is still very small, around 18 percent.

Therefore, the government should implement the concept of the issuance of debt securities using the project bonds scheme not only limited to sukuk, but also in state debt securities, where strategic projects are collaterals of the debt securities. Through this scheme, the use of debt can be controlled and monitored easily, both by investors and the public. Thus, the quality of government debt increases and not only creates a multiplier effect on the growth and stability of the Indonesian economy, but also makes the state budget more sustainable.

Aviliani, Senior Economist of the Institute for Development of Economics and Finance (Indef)