Indonesia’s COVID-19 crisis tests fiscal discipline commitment Reuters

Authors: Gayatri Suroyo and Tabita Diela

Jakarta (Reuters)-Indonesia’s worsening COVID-19 crisis is increasing the government’s pressure to increase spending and expand budget deficits, despite the warnings from rating agencies that any relaxation of the country’s hard-won fiscal discipline could cred it The rating is unfavorable.

The world’s fourth most populous country has the second highest number of pandemic deaths and cases in Asia, and a slow vaccination schedule means it is not ready to reopen at the same rate as other countries.

This has increased the vulnerability of economies that have been hit hard by capital flight and financial crises in the past.

However, there is now increasing political pressure to resolve the growing economic difficulties, and the influential chairman of the budget committee of the parliament has called for legislative reforms to allow the fiscal deficit to expand in 2023.

“The law still allows this, so our goal is to reach 5% of (GDP) by 2022. If we reach 4.5%, the economy will not improve,” Abdullah said in an interview with Reuters. The government currently forecasts a deficit of 4.51% to 4.85% in 2022.

According to the law, Indonesia’s annual fiscal deficit is capped at 3% of GDP, but it will be exempted from 2020 to 2022 in order to make room for pandemic relief measures and will need to be exempted again in 2023 according to Abdullah’s proposal.

“Even after the COVID disappears, we cannot give up the social protection program. People are not ready yet.”

President Joko Widodo extended mobility restrictions until at least August 2 on Sunday to control the spread of the virus, but restrictions on some small businesses have been relaxed. Since the beginning of July, broader restrictions have been put in place.

Standard & Poor’s, Moody’s (NYSE:) and Fitch have stated that the growing COVID-19 crisis has increased the risk of credit conditions and may force the government to increase spending to protect the poor as taxation is hit.

These three agencies give Indonesia the second lowest investment grade rating. Although the rating outlook of Fitch and Moody’s is “stable”, the outlook of Standard & Poor’s is “negative”, which indicates that the next step may be to lower the rating.

The government has increased its relief budget to more than $51 billion, expanding cash transfers, electricity discounts, and tax relief. It also lowered its 2021 GDP growth forecast from 4.5%-5.3% to 3.7%-4.5%.

Last year’s 6.1% deficit was the largest in decades. Although the country’s debt-to-GDP ratio is lower than other emerging markets, its tax revenue is the lowest in the Asia-Pacific region, and the ratio of debt interest payments to income is high.

Chart: Indonesia’s fiscal deficit-https://graphics.reuters.com/INDONESIA-ECONOMY/BUDGET/zgpomwkdlpd/chart.png

Although Abdullah agreed that the government should aim for stricter fiscal discipline, he expressed his willingness to support an exemption to allow the deficit to rise to more than 3% in 2023.

He said: “The parliament and the government can decide…but we can’t play with this. It must be calculated carefully. I will only tolerate an increase of 3%, not more than 4%.”

Test limits

To be sure, the government, which has greater influence in determining policies, has stated that it will stick to the existing proposals and maintain the deficit target.

Last week, Luky Alfirman, head of the debt office of the Ministry of Finance, said that he believes the country can quickly control the coronavirus, allowing the authorities to stick to their fiscal plans.

Nevertheless, the rating agency expects this year’s fiscal deficit to exceed the government’s 5.7% forecast.

Fitch also pointed out that the central bank may need to finance the fiscal deficit, which may undermine market sentiment, policy credibility and sovereign ratings.

The Bank of Indonesia (BI) directly purchased government bonds last year, and at the same time gave up interest payments. Governor Perry Warjiyo said that such unconventional measures will not be repeated.

However, Nomura analysts expect that the central bank’s support in the bond market may be needed again. This will increase downward pressure on the Indonesian rupiah, which is already vulnerable to the risk of tightening US monetary policy.

At present, bond investors are not too worried. The benchmark 10-year Treasury bond yield hit a 5-month low this month, mainly due to the government’s decision to cut the bond issuance target for the rest of the year.

Desmond Fu, a portfolio analyst at Western Asset Management, a professional investment manager at Franklin Templeton, said: “Although the outlook for expenditure and income is still uncertain… the epidemic is far from being contained, the risk of an out-of-control fiscal decline is still low.”