Current-account deficit and fiscal sustainability Ratih Puspitasari  ;   An economic analyst at Bank Indonesia; She is currently undertaking postgraduate studies at the University of York, UK

JAKARTA POST, 25 Agustus 2014

                                                

Indonesia continued to suffer from a current-account deficit, which amounted to US$9 billion or 4.27 percent of the GDP in the second quarter of 2014. It has been in a state of deficit for the last two-and-a-half years. The current account is a general reference on how much a country consumes and invests compared to how much it produces, with a deficit meaning that the former is greater than the latter. Deficit is only possible if financed by foreigners, hence it is equivalent to capital-account surplus (inflows) at the same time. Capital inflow is basically debt, thus it is not free and is attached with interest. To pay the debt, a country must run a current-account surplus some time in the future, thus, “corrections” must eventually be made following a series of current-account deficits. If a current-account deficit is too large and maintained for a prolonged period of time, the country will find it difficult to pay back. In such a case, the current account deficit condition is said to be unsustainable. Is a current-account deficit necessarily harmful? Not always. Current-account deficit is worthwhile if the extra spending is aimed at funding projects that give positive returns in the future. Spending on infrastructure projects is one justifiable reason as to why a country should run a current-account deficit because it creates jobs and attracts foreign investment, thus increasing economic growth potentials. Spending on education and health sectors is equally important because human resource investment boosts the potential of our future generations. There are, however, some consequences to the current-account deficit. Because imports are higher than exports, the current-account deficit increases depreciation pressures on the rupiah exchange rate and reduces foreign reserves. Reducing a great deal of our reserves is inauspicious as they are our safeguard during a rainy day. A large and persistent deficit may also deteriorate foreign investors’ confidence on the capability of the government to manage fiscal sustainability in the long-run. Furthermore, if the deficit is funded by short-term portfolio inflows instead of longer-term foreign direct investment (FDI), the inflows are vulnerable to a sudden stop and even capital reversal. Most of us have already forgotten that prior to the 1997 economic crisis; Indonesia ran a current-account deficit for a consecutive 15 years when our deficit fluctuated between 2 percent and 7 percent of the GDP. It resulted with a substantial amount of matured short-term debts. Foreign investors’ confidence touched the bottom level, leading to abrupt and massive capital outflows. So, is the existing Indonesia current-account deficit admissible? There are at least two major reasons as to why we are in a deficit state. First, the rising number of middle-class consumers demand more imported goods. The other reason is the inability of the country to increase domestic oil production, causing it to import two-times the amount of oil it exports. What makes matters worse is that much of the imports are paid for by the generous energy subsidy. In two years time, the energy subsidy increased overwhelmingly by 52 percent from Rp 230 trillion ($19.7 billion) in 2012 to Rp 350 trillion in 2014, or around 15 percent of total government spending. The amount allocated for energy subsidy is far greater than the funds allocated for infrastructure, education, and health which have been given Rp 145 trillion, Rp 81 trillion, and Rp 47 trillion, respectively. Therefore the Indonesian current-account deficit entails at least two problems. First, much of the deficit is a result of the import of consumer goods and fuel consumption. Except for manufacturing industries, those two factors are not good reasons for running a current-account deficit. Second, the current-account deficit pushes the government to run a fiscal deficit, which may jeopardize fiscal sustainability in the long run if this problem is not well-addressed immediately. What has the current government done to minimize the deficit? A series of monetary policy tightening measures have been implemented, with a cumulative benchmark rate hike of 175 basis points from June to November 2013 to ease import consumption. Nevertheless, monetary policy alone is far from sufficient because the root of the problem itself is mainly structural. The next administration is therefore in for a bumpy ride ahead. Major fiscal adjustment measures must be implemented before it is too late. An obvious yet very difficult step is to decrease the fuel subsidy. Of course, political pressures, social, and economic consequences from rising fuel prices are inescapable. But the prolonged fuel subsidy policy has not only been worsening the state budget, it is also askew as it is more likely to be enjoyed by the middle-class instead of poor Indonesians. This is a crucial time as the 2015 draft state budget is about to be discussed by the House of Representatives for endorsement. The outgoing government has delivered a clear message that the painful adjustment is being left to its successor to decide. No structural change has been proposed to address the fiscal problem. The House must therefore make fundamental adjustments to the 2015 draft state budget to reflect the long-run gradual plan to reduce the fuel subsidy burden. Some may be skeptical that such a step is viable due to political reasons, but this time around, political interests must take a back seat to macroeconomic considerations for the sake of Indonesia’s long-term sustainability. It may not be clear to us now what a sustained current-account deficit would lead to, but let us not forget our own past experiences and what has been experienced by Greece, Portugal, and Spain. The three countries accumulated current-account deficit for at least 10 years prior to the 2007-2008 crisis, with 10 to 15 percent deficit of GDP by the end of 2007. Not surprisingly, these three countries are those that suffered the most from the 2007-2008 global financial crisis. ●