Fiscal and Monetary Synergy

AFP PHOTO/WORLD HEALTH ORGANIZATION/CHRISTOPHER BLACK

This handout image provided by the World Health Organization (WHO) on May 19, 2020, shows World Health Organization Director-General Tedros Adhanom Ghebreyesus reacting at the closing session of the World Health Assembly virtual meeting from the WHO headquarters in Geneva, amid the COVID-19 pandemic, caused by the novel coronavirus.

The Covid-19 pandemic is a crisis that the modern world has never experienced.

The impacts of the Covid-19 pandemic initially hit the health sector, but because of subsequent lockdowns, business activities in a variety of sectors came to a sudden halt, and the health crisis expanded into an economic crisis. Health spending was increased to cope with the outbreak. The stoppage of economic activities has reduced government revenue. The individual incomes of the public were affected, so social assistance for the poor had to be expanded. Tax and excise incentives also must be provided to support businesses. Due to budgetary constraints, non-priority government spending must be cut. The fall in revenue and increase in spending have ballooned the government’s budget deficit. Furthermore, the higher deficit caused government debts to increase. However, this is a problem a number of countries are also experiencing.

Financing deficits and stimulus

In Indonesia, as a result of the Covid-19 crisis, the State Budget (APBN) revenue for this year is estimated to fall 24 percent, with state spending increasing 8 percent. As a consequence, the state budget deficit is expected to rise from the pre-pandemic figure of only around 1.8 percent of gross domestic product (GDP) to 6.3 percent of GDP (around Rp 1.039 quadrillion). As a precautionary measure, the State Finance Law has capped the budget deficit to a maximum 3 percent of GDP and total government debt to a maximum 60 percent of GDP.

Also read: Special Liquidity Loans

So far, the government has always maintained the budget deficit so it never exceeds the 3 percent cap, and the government debt to around 30 percent of GDP. However, in a crisis, of course a separate policy is needed. That is why the government proposed to the House of Representatives (DPR) to raise the deficit cap to above 3 percent of GDP until the end of 2022. If the deficit cap is not raised, there will be no room to manage the Covid-19 crisis. With government debt at around 30 percent of GDP prior the Covid-19 crisis, raising the deficit cap to 6.3 percent of GDP means that government debt will increase to 36-37 percent of GDP.

KOMPAS/TOTOK WIJAYANTO

Governor of Bank Indonesia (BI) Perry Warjiyo (second from right) accompanied by BI Deputy Governor (from left) Rosmaya Hadi, Destri Damayanti, and Erwin Rijanto, when they wanted to give information to reporters regarding the results of the BI Board of Governors’ Meeting in Jakarta in Jakarta on Thursday (20/2/2020).

This is not a normal condition, especially since the crisis originates from a viral pandemic of which the end is difficult to predict. The budget deficit may still increase if state revenue is worse than expected and government spending for Covid-19 crisis management increases.

The most important thing is that we must prepare a sufficient budget and instruments to handle the economic crisis. We are thankful that the number of patients who have recovered continues to increase and the number of deaths continues to decline.

Singapore’s deficit has worsened to its highest level at 15.4 percent of GDP, whereas its 2019 deficit was just 0.3 percent of GDP.

All countries are seeing higher deficits due to the Covid-19 crisis. The US has had to revise its budget deficit several times. Global securities firm Goldman Sachs estimates that the US budget deficit will jump dramatically from 4.6 percent of GDP in 2019 to 21 percent of GDP in 2020, or equivalent to US$4.2 trillion (in comparison, the Indonesian economy is around $1 trillion). As a result, US debt will increase from 79 percent to 100 percent of GDP. Another example in the context of economic recovery is Singapore, which has also had to revise this year’s budget deficit several times. Singapore’s deficit has worsened to its highest level at 15.4 percent of GDP, whereas its 2019 deficit was just 0.3 percent of GDP.

In accordance with its mandate, BI must stabilize the exchange rate by using its foreign exchange reserves. When stabilizing the exchange rate, BI actually absorbs rupiah liquidity because it must sell dollars to buy rupiahs. To prevent liquidity from tightening, BI reinjected the rupiah into the market by buying SBNs on the secondary market while restraining the deterioration of SBN yields at the same time. The government was helped when the SBN yields did not soar, while banks were helped because BI reinjected rupiah liquidity. As a result of these efforts to stabilize the exchange rate, foreign exchange reserves in March fell $9.4 billion, equivalent to Rp 140 trillion in liquidity contraction. To neutralize liquidity, according to information published in the media, BI bought around Rp 166 trillion of SBNs on the secondary market.

Also read: Enforcing New Normal

Apart from stabilizing the exchange rate and the SBN market, synergy between fiscal and monetary authorities is needed in order to finance the swelling fiscal deficit. Under normal conditions, the budget deficit is funded by a combination of domestic investors and foreign portfolio investors. However, in an abnormal situation like now, foreign investors are greatly reduced in number. Who can fund the increase in the budget deficit?

The central bank and its monetary role

The banking sector has limited financial capacity because the loan-to-deposit ratio (LDR) is 94 percent, meaning that 94 percent of deposits has been distributed as credit. Pension funds, insurance, and mutual funds make up only about 40 percent of bank deposits, and these funds have already been invested. So sourcing the funds needed to raise the budget deficit relies on the central bank. Without central bank funding, the economic crisis cannot be managed. This is why BI has been granted the authority to buy SBNs from the primary market under the recently issued regulation in lieu of law (Perppu).

When BI purchases SBNs on the secondary and primary markets, this is what is called “printing money”. Abroad, this is called quantitative easing (QE) that the central banks of the US, Europe, Britain and Japan impose by buying securities in order to generate economic stimulus. Therefore, the term “printing money” does not actually refer to printing paper money, but to the central bank creating demand deposits. To restore the economy, BI has lowered the interest rate to 4.5 percent. With current inflation of around 2.5 percent, it appears that there is still room for a rate cut, as long as there is a positive difference of 1 percent above inflation. As a country with a current account deficit (CAD), the rupiah must be made attractive and the interest rate must be above inflation.

AP PHOTO/AHN YOUNG-JOON

A currency trader watches monitors at the foreign exchange dealing room of the KEB Hana Bank headquarters in Seoul, South Korea, Monday, June 10, 2019. Asian financial markets advanced on Monday after China released better-than-expected trade data for May. Gains were reined in by worries over where the world’s two largest economies stood on trade negotiations.

The central bank must finance the fiscal deficit by remaining within the corridor of prudent monetary policy. Do not let additional money supply cause inflation and weaken the rupiah. BI and the government should together calculate the inflation and the CAD for this year and the next. However, in an economy that is still in recession in 2020, it seems that the increase in money supply will not be used as credit, so it will not cause inflation or worsen the CAD in 2020-2021.

Monetary policy results are not an exact science, and are highly influenced by the expectations of the public and the business world.

BI will gradually withdraw excess rupiah at the right time. The interest on the national debt should receive support so as to avoid a significant increase. The common goal is to support fiscal funding while maintaining Indonesia\'s credit rating, especially this year. Monetary policy results are not an exact science, and are highly influenced by the expectations of the public and the business world. This is where integrated communication between the fiscal and monetary authorities is needed, so that the synergy of the two institutions remains in the prudent corridor.

KOMPAS/IWAN SETIYAWAN

Mirza Adityaswara

Lowering the budget deficit cap to below 3 percent of GDP by 2023 is a challenge because this requires more revenue from tax and excise. Therefore, the efforts to recover the economy must be accompanied by continued encouragement of deregulation so many new businesses can grow and enter Indonesia. We are grateful that financial markets have responded positively to good coordination between the fiscal and monetary authorities. In the first week of June, the yield on the 10-year government bond dropped to 7.2 percent, foreign investors started buying SBNs, the exchange rate improved significantly to Rp 14,200, and the stock market is enthusiastic again. Let us speed up economic recovery together while maintaining health protocols.

Mirza Adityaswara, Economist and President Director of Indonesian Banking Development Institute (LPPI)