Anwar NasutionThe Joko “Jokowi” Widodo government is only blaming external shocks for the recent disappointing performance of the Indonesian economy and is making no proper policies to address it.

The popular scapegoats are: first, the slow growth of China that has reduced both demand as well as prices of Indonesia’s exports of primary commodities since 2011; and second, the likelihood of the US Federal Reserve ending the quantitative easing (QE), or tighter monetary policy, that has raised international interest rates and encouraged capital outflows, as well as raised domestic interest rates and weakened the national currencies of all emerging economies, including Indonesia.

On the domestic front, the government has introduced three packages of economic policies over the last six weeks.

But none of them will overcome the present problems on how to stop the depreciation of the rupiah; minimize or stop capital outflows; and reform the real sector of the economy to woo foreign direct investment to the manufacturing sector and create jobs.

The policy measures are also uncoordinated and the generous tax facilities and high interest rate subsidies offered by the packages could further erode the tax base and create contingent fiscal costs in the future.

The facilities are regressive and create further inequality because they only benefit the rich although fiscal burdens are also paid by the poor.

The appreciation of the rupiah during the past week has been caused mainly by the decision of the Fed to postpone the end of the QE. There are two objectives of this US policy, namely to stimulate domestic employment in that country and to prevent further weakening of economic growth in emerging economies that may affect the global economy. The small market intervention of Bank Indonesia (BI) last month only provided a marginal contribution.

There are at least four inconsistencies in the policy packages. First, after 17 years of the Reform Era, institutional building has been very slow to retrain financial managers of the line ministries and subnational governments on how to implement the three modern laws on state finance introduced in 2003 and 2004. Because of this, the government cannot use its budget as a stimulus to promote growth.

The new laws replace the previous antiquated system of cash basis and single entry accounting inherited from the colonial past. The new system uses a double entry, integrated and computerized accrual accounting system, performance base and multi-year budget.

The new system decentralizes the accounting implementation in a hierarchical manner, adopts a single treasury account and uses a tight time frame for accountability reports.

Second, there is a lack of manpower in many districts and municipalities to provide public services — including primary schools, basic healthcare and infrastructure — that have been transferred to local administrations.
Bypassing the provincial government, decentralization programs in Indonesia directly transfer authority and funding to the third level of government: Kabupaten (districts) and kota (municipalities). In some areas, there is popular support to only use local manpower to fill jobs in the public sector.

The third inconsistency is that there are no structural reforms in the packages, particularly on how to improve productivity and efficiency of state-owned enterprises (SOEs) and make them agents of development and engines of growth.

Unlike in China and India, there are no plans in the packages on how to make use of surplus labor — people with minimum education and skills — to become an engine of growth and producer of exports of labor-intensive manufactured goods.

Since 1990, Indonesia’s foreign exchange revenue has been generated mainly by commodity exports and uneducated as well as unskilled labor exports.

Because of the political pressure from both local labor unions as well as from the international community, the government has continuously raised minimum wages higher than labor productivity and real gross domestic product (GDP) growth.

Such a policy deters foreign investors and only benefits skilled laborers who have been working in a modern sector of the economy. On the other hand, such a minimum wage policy creates fewer job opportunities for newcomers and unskilled manpower to enter the formal sector.

The policy packages, which offer generous tax facilities, will further erode Indonesia’s tax base. The taxes are regressive because they only benefit the rich but the fiscal burdens are being paid by the poor.

The present low tax rate, at 13 percent of GDP, limits the capacity of the public sector to service its debt and, therefore, the present strategy to finance budget deficit through domestic and international borrowing.

The tax relief includes long tax holidays for new investment and lower tax rates for interest rates on bank deposits as well as on holding Bank Indonesia certificates (SBI).

To attract short-term capital inflows, BI directly competes with commercial banks in mobilizing deposits by introducing short-term SBI with high interest rates as well as tax incentives.

The introduction of SBI is partly because of the reluctance of the Finance Ministry to issue short-term debt such as Treasury Bonds that can be used by BI an as instrument for open market operations.

To attract foreign tourists, the package provides on-arrival visas for visitors from 90 countries. But tourist infrastructure remains poor, starting from the long and unfriendly immigration and customs process to clogged roads in all tourist destinations.

Outside the policy package, and without permission from the House of Representatives, the Finance Ministry and SOEs Ministry arranged a group of SOEs to borrow three kinds of loans from China. These borrowings added to the foreign external reserve of BI.

It has been said that the credit is not guaranteed by the government and therefore it is not burdening the state budget. However, because the government stands by its SOEs, it becomes a contingent liability to the state budget.

The first recent credit from China is being used to finance the construction of a high-speed train between Jakarta and Bandung. The project is unfeasible because the distance is too short for a high-speed train.

The second credit amounted to US$3 billion from the China Development Bank to Bank Mandiri, Bank BNI and BRI. Each bank received $1 billion for financing long-term projects including infrastructure, which is not their line of business.

The first two banks were established as commercial banks that mobilize short-term funding and lend short-term credit. BRI’s main role is to serve farmers and fishermen in rural areas.

For financing long-term investment projects, the government has recently established Sarana Multi Infrastruktur (SMI), which mobilizes long-term funds such as bonds.

The third credit, amounting to 5 billion yuan, was received by BTN, a state-owned mortgage bank, for the financing of mortgage and housing projects.


Anwar Nasution is emeritus professor of economics at the University of Indonesia. He has served as senior deputy governor of Indonesia.

Source: The Jakarta Post, October 19, 2015, page 6.

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