The Burden of National Debts

KOMPAS/PRIYOMBODO

The monitor shows a trading chart of Government Securities (SUN) at Bank OCBC NISP, Jakarta, on Tuesday (9/8/2011).

Analyses of the burden of debts—those of households, private corporations, state-owned enterprises (BUMN), the government and national debts—have always been interesting.

This topic has again emerged lately in connection with the swelling demand for funds to finance Covid-19 pandemic control activity. I have followed a number of analyses including that of Ginanjar Kartasasmita (Kompas, 11/9), which explained clearly and in detail relevant problems to support his message that the government should be cautious.

I would like to deal with the issue not yet touched upon that I consider relevant to support the message that prudence should always be exercised in the management of national debts or borrowings. This concerns among other things the ratio of debts to gross domestic product (GDP), the construction of which is in fact less appropriate.

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The fact that at present debts constitute part of life from which all economies, business corporations and households benefit, is common knowledge. Even banks considerably rely on debts in their operation. Borrowings in economic and financial academic circles are referred to as the bankers’ new clothes. Prof. Admati from Stanford and Prof. Hellwig from Bonn coauthored a book published in 2014, using the words as its title. It is subtitled “what’s wrong with banking and what to do about it”.

Are our debts safe?

For the national or state economy, the general standard used to determine whether or not debts are safe is the ratio of debts to income (GDP). The European Economic Community since its adoption of the euro as the common currency has adhered to the Maastricht Treaty of 1999, restricting the government debts of member countries to a maximum of 60 percent of GDP, while their budget deficits must not exceed 3 percent. Today, Indonesia’s ratio of around 30 percent is used to argue that the position of government borrowings remains safe.

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Why is this ratio construction less appropriate? In economic analyses we distinguish between the concepts of stock and flow. The former is a variable measuring the accumulation of economic variables from one point of time to another. Flow measures the amount of the variable per unit of time. Stock usually mentions the time when the measurement takes place, normally the end of a period. For instance, our national rice stock was 3 million tons at the end of December 2019. Flow is indicated by the unit of time chosen, for example, money supply in Indonesia is more than Rp 5 quadrillion per month.

Therefore, it is less accurate if the criterion for the safety or hazard of debts uses the ratio between the amount of debts that is stock and GDP that is flow.

In recording government or national debts, the accumulation of debts of the government, BUMN, private companies and households uses the concept of stock, e.g. the position of foreign debts at the end of quarter II-2020 was US$408.6 billion. GDP is an amount of flow, the entire income per quarter or year. GDP is the accumulation of all expenditure or income per time unit, quarter or year. Therefore, it is less accurate if the criterion for the safety or hazard of debts uses the ratio between the amount of debts that is stock and GDP that is flow.

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But this is not a vital error either because the two are clearly related. GDP as flow at the end of a period, quarter or year constitutes the accumulation of flow during the period of measurement. Of course, the amount of flow of funds for a certain period, such as one year, is related to the entire amount (stock). However, for the management of debts, it is flow that’s important rather than stock. Thus, the ratio of debts to GDP is actually the ratio between the amounts of stock and flow, which is less appropriate to be used.

AP PHOTO/EUGENE HOSHIKO

A woman walks past an electronic stock board showing Japan\'s Nikkei 225 index at a securities firm in Tokyo Friday, May 17, 2019. Asian stocks were mixed on Friday amid worries that U.S. economic sanctions on Huawei would put a drag on trade negotiations with China.

If the right ratio is to be created, debts should be compared with the amount of national assets. But national assets may only be apparent during a census and this is not annually conducted, let alone every quarter.

I myself became more aware of and only used it in 1997 when I had to handle a financial crisis in the face of a very drastic rupiah depreciation starting April 1997. Upon checking national debt figures, the records available at Bank Indonesia (BI) were totals of short-, medium- and long-term loans compiled from business companies’ reports. The data were important but they were not what I needed when I had to manage national debts. I needed the amount of debts due to mature tomorrow, in a month, a quarter or a year so as to be able to prepare their payments on their maturity dates.

As governor of BI, I had to seek help along with BI executive directors from the Industry Ministry to gather entrepreneurs in order to report to BI the extent of their overseas exposure in foreign currencies with the details of their maturity.

I think I wasn’t the only one who realized when it was also so late. The IMF also seemed to be aware only when Indonesia, Thailand and South Korea invited them to draw up a program for Asian financial crisis handling through stand-by arrangements. Only since the crisis has attention been paid to calculation of the ratio of short-term debts and its relation to the availability of foreign exchange reserves, both belonging to stock so that the ratio is correctly constructed. Yet what is more widely used has remained the debt-to-GDP ratio.

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What should always be borne in mind is that the debt-to-GDP ratio is just an estimate that should be used as an approximation only, instead of being seen as a solid basis to determine the safety of the amount of debts. If all the debts are utilized to finance consumption, the ratio is between two variables of stock. What is calculated in GDP is the remainder of the total income produced in one period minus what is consumed as accumulated in a quarter or a year. So, it is indeed related to the amount of debts in the sense of stock, but indirectly, so that the ratio is rightly indicated.

Living beyond means

The other issue has to do with a disturbance that can develop into a financial crisis. In the literature on a financial crisis there has never been only one view of the origin of the crisis. President Reagan once made a comment, apparently alluding to economists, more or less, “I need an economist with one hand”. It was joking criticism aimed at economists who were fond of replying to questions by saying, “on the one hand…, on the other hand….”

Economics in fact is not a hard science like some economists think. Nonetheless, in explaining the emergence of a financial crisis practically all economists studying it support the hypothesis that the crisis is always related to high leveraging in the previous period. In simple terms, we call it “living beyond one’s means”, relying on debts to finance a costlier life, which will someday give rise to a crisis. The crisis in the Old Order era with inflation reaching around 635 percent was due to huge budget deficits financed by printing money (deficit financing).

The global crisis of 2008 began with the crisis in the U.S. resulting from uncontrolled housing and property mortgage and becoming systemic after the bankruptcy of megabank Lehman Brothers.

But money is a certificate of debt of the monetary authority (central bank) to all its holders. The crisis of 1997/1998 was basically caused by too big private debts (including to foreign parties). The global crisis of 2008 began with the crisis in the U.S. resulting from uncontrolled housing and property mortgage and becoming systemic after the bankruptcy of megabank Lehman Brothers.

Finally, using or comparing the standard with other economically more advanced countries is the same as the poor imitating the standard of the rich. Wealthy people coming from well-to-do families can be squandering their money without working for quite a long time. It’s not the case with poor people, who despite their income earned as daily workers, for instance, their position is different from the rich in the eyes of other parties, let alone money lenders. This is the message that should be remembered so that we can live with greater prudence.

DOKUMENTASI PRIBADI

J Soedradjad Djiwandono

J. Soedradjad Djiwandono,Emeritus Professor of Economics, Faculty of Economics and Business, University of Indonesia