Indonesia's Fiscal Position: Sustainability Issues

Geoffrey Bascand and Assaf Razin

 

Fiscal deficits, largely financed abroad, caused Indonesia's public debt to rise in the early 1980s. It remains high, despite the commendable strengthening of the fiscal position in the 1990s. Meanwhile, the value to government of oil reserves has declined sharply because of lower international oil prices and the ongoing depletion of reserves. Against this background, as well as in light of the region's experience with capital outflows and their impact on the current account deficit, this paper examines whether further fiscal consolidation is needed to reduce possible risks from external shocks, strengthen the resilience of the economy, and sustain growth.

The paper considers three broad dimensions of fiscal sustainability: (i) solvency; (ii) the interaction of the fiscal position with external sustainability; and (iii) the reliance of the fiscal position on inflation. The analysis shows that, even after adjusting for the exhaustibility of oil reserves, Indonesia's fiscal solvency is assured--in the sense that policies can be maintained while meeting debt obligations and without recourse to monetization. However, in part because of declining government net worth (as oil revenues diminish), fiscal consolidation would be prudent both to strengthen external sustainability and reduce Indonesia's vulnerability to external shocks. This could be achieved through broadening the tax base and improving tax administration.

Geoff Bascand is an economist in the Southeast Asia and Pacific Department of the IMF. A graduate of Otago and Australian National Universities, he was previously Director of Macroeconomic and Tax Forecasting with the New Zealand Treasury.

Assaf Razin is a Resident Scholar at the International Monetary Fund. His book Fiscal Policies and Growth in the World Economy (co-authored with Jacob Frenkel and Chi-Wa Yuen) has been recently published by MIT Press.

 

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