Thursday, 3 September 2015

Why financial system stability matters

Arisyi Raz, Jakarta | Opinion | Wed, September 02 2015, - See more at:

Recently, many news outlets, experts and economists have been concerned about Indonesian economic stability. When talking about economic stability, the financial system probably plays one of the most important roles. 

The financial system is crucial because of its dynamic and rapidly changing nature. Looking at previous crises, whether in Indonesia or overseas, most of the economic rises were triggered by the collapse of a financial system. 

Once a financial system fails, the economy will be frozen since intermediation function cannot be conducted properly. Then, it can affect the real sector or external balance, which finally can result in a crisis.

If we are talking about such systems, basic financial theory suggests that intermediation in a financial system can be conducted directly (through financial institutions such as banks) or indirectly (through the market). 

In Indonesia, due to its relatively underdeveloped market, financial intermediation is mainly conducted through financial institutions, particularly banks. 

The Indonesian banking sector controls around 80 percent of the country’s financial system assets, which indicates its dominance and importance in the financial sector, thus making Indonesia a bank-led economy. 

A sound and strong banking sector reflects the resilience of the financial system. 

A frail banking sector, meanwhile, indicates the fragility of the financial system.

Currently, our banking sector is very different from that during the 1997 crisis. Apparently, banks, particularly the largest ones, as well as banking authorities, have learned their lessons from the crisis. 

For instance, currently our banking sector’s Capital Adequacy Ratio (CAR) is around 20 percent, far above the minimum threshold of 8 percent and the figure during early 1997 of 11 percent to 12 percent. 

This indicates that currently our banking sector, from a solvency point of view, has sufficient buffers in anticipating shocks and banking risks, either internally or externally.

Meanwhile from a credit risk point of view, our banking sector’s non-performing loans (NPL) currently fluctuate around 2.5 percent, much smaller compared to the crisis period in which the NPL reached two-digit figures. Liquidity level is also relatively ample as reflected by the sufficient amount of banks’ liquid assets. 

Last but not least, market risk is also well managed. Improved market knowledge as well as better market risk mitigation has made banks better in anticipating market volatility.

Substantial risk mitigation improvement is not only carried out by banks. Financial system authorities (which are often referred to as prudential authorities), i.e. Bank Indonesia and later the Financial Services Authority (OJK) after its establishment in 2013, have taken several measures to maintain financial system stability through macro prudential policy (conducted by Bank Indonesia) and micro prudential policy (conducted by the OJK).

Since the 1997 financial crisis, numerous efforts have been made to restore and maintain financial system resiliency. Banking supervision has been implemented more strictly by supervisory authorities to monitor banking sector stability. 

Banks also have better credit screening (including intragroup loans within a conglomeration) to minimize credit risk. 

Better asset liability management and currency hedging are also enforced to deal with liquidity and market risks. Apart from that, numerous prudential policies have also been implemented in order to maintain the stability of the financial sector, including the banking sector.

Overall, evidence shows that financial authorities and institutions have made substantial efforts to maintain financial system stability. However, there is another player in the financial system that also plays a very crucial role, which is the public. 

The public in the financial system acts as lenders and/or borrowers depending whether they have a cash shortage or cash surplus. 

Lenders and borrowers are only willing to do so if they have faith in the financial system, which makes the financial system one that is built based on trust. If the trust deteriorates due to negative sentiments, they may withdraw their money, which can affect the stability of the whole financial system.

Therefore, in order to prevent any unnecessary consequences, the public needs to know the current situation of our financial system and banking sector conditions before taking any action. 

If decision-making is solely undertaken based on the information that reflects the real condition in the financial system, then noise in the financial system can be minimized and unnecessary financial turbulence can be prevented. 

Unfortunately, in the case of Indonesia, public understanding about the financial system is still insufficient and thus their decision-making is often driven by biased information, which is inefficient and harmful for the whole financial system.

To prevent this situation, financial literacy needs to be improved. In the end, it is every financial system stakeholder’s responsibility, including the media and academics, to improve our nation’s financial literacy, which in the end can affect the wellbeing of our economy.

The writer is a graduate of the University of Manchester, the UK, and a professional in the financial sector. - See more at:

Monday, 29 June 2015

Better economic prospects with a positive outlook?

Arisyi Fariza Raz
The Jakarta Post
28 May 2015

Available at:

On May 21, Standard & Poor’s (S&P) rating agency changed Indonesia’s credit rating outlook from stable to positive. The change indicates a possibility that Indonesia’s credit rating may be upgraded to investment grade within a year. Currently, Indonesia’s rating is BB+, a non-investment grade, whereas S&P’s lowest investment rating, BBB-, is just one notch above Indonesia’s current grade.

Based on S&P’s statement, the improvement to positive outlook was mainly underpinned by better fiscal management, because of reformed gasoline subsidies earlier this year, thus giving more room for more concrete fiscal expansion such as infrastructure spending. In addition to better fiscal prospects, S&P also praised Indonesia’s sufficient foreign reserve position, which improved the country’s external resilience.

The market immediately responded to this positive announcement. For instance, the Jakarta Composite Index (JCI) jumped by 0.4 percent to 5,313.21 on the day of the announcement. On the same day, the rupiah also slightly strengthened, appreciating to 13,136 against the US dollar.

In the longer term, this good news could affect the economy positively. The increased probability of receiving an investment grade from S&P will improve Indonesia’s economic atmosphere for investment, particularly from overseas. 

S&P has been widely regarded as the strictest rating agency. In 2013, it downgraded Indonesia’s outlook from positive to stable by stating that Indonesia had failed to gain momentum in reforming its economy. Meanwhile, S&P’s peers, namely Fitch and Moody’s, upgraded Indonesia’s rating to investment grade in 2011.

Therefore, as S&P has improved Indonesia’s outlook to positive again, all stakeholders in Indonesia must utilize this opportunity because even though this has become a very favorable prospect, we have to be aware that nothing will happen too easily. An improved credit rating will only have positive results if it is supported by the existence of continuous favorable economic conditions, both domestically and globally. 

In other words, Indonesia has to convince investors that it is the right place to invest by creating investment-friendly conditions. This includes stable macroeconomic conditions, a sound financial system, the existence of supporting infrastructure and a less rigid bureaucracy. At the same time, global economic conditions are also necessary to support strong investment flows. Currently, however, Indonesia is still facing economic challenges both domestically and globally. 

Domestically, the economy faces the prospects of an economic slowdown. Data published by the Central Statistics Agency (BPS) revealed that the economy only grew by 4.7 percent during the first quarter, the slowest pace since 2009. Another challenge is the external balance. Recently, Indonesia has experienced a current account deficit. Fortunately, the trade balance has been improving in recent months, even though stronger export growth is still necessary to re-establish external resilience.

Globally, the economic environment still has mixed prospects, even though many economists suggest it may fare better in 2015 compared to 2014. For instance, China’s economy, which contributes significant impacts to Indonesia’s external balances (either from trade and investment), is not expected to show, if any, substantial growth acceleration this year.  

The US economy has shown some improvements recently. However, these improvements are still fragile and more supporting data is needed to confirm the robustness of these improvements. A similar situation is also experienced by Japan. The economic prospects in the EU also show some uncertainties. Some stronger economies such as Germany and the UK have better economic prospects.

All these challenges, particularly the domestic ones, have to be tackled. Therefore, all stakeholders, including the government, need to take strong action. Indeed, some attempts have been carried out. For instance, the government recently announced that it would accelerate its fiscal spending throughout the year, which would bolster economic growth. However, more actions are necessary to convince investors to put their money in Indonesia. If they are convinced, then more investment will come to Indonesia, which will bolster economic growth and development.

Another important note to remember is the fact that S&P may not improve the credit rating when it again reviews Indonesia’s 2016 budget in October.

If Indonesia’s macroeconomic imbalances deteriorate or the government’s economic reform does not continue, then S&P will downgrade the outlook to stable again, just like what happened in 2013.

The writer is a graduate of the University of Manchester, the UK, and a professional in the financial sector. - See more at:

Tuesday, 17 March 2015

Why there was a sudden trend reversal in oil prices?

A recent trend shows a continuous fall in oil prices. Brent Crude Oil hit its lowest at US$45 per barrel in January 2015 after fluctuating around $50 the previous months.

In other words, oil prices fell by more than half within six months, since it still fluctuated around
$115 back in June 2014. This sharp trend reversal occurred in late 2014 after a period of oil-price hikes in the past decade.

Prior to 2014, in line with the rapidly growing Chinese and Indian economies, oil producers tried to keep up with the rising demand for oil from China and India.

During the high-oil-price period, many companies started to find it profitable to begin extracting oil from difficult-to-drill places, which led to the shale-oil boom in the US, adding more supply to the global oil market.

However, by the late 2014, in line with the economic slowdown in China and India, demand for oil decreased and the accumulated oil supply had surpassed its demand.

Usually during this condition, OPEC, the world’s largest oil cartel, would cut back on production to bring prices back up. Nonetheless, Saudi Arabia did not want to cut production to maintain its market share, thus exacerbating the price even further.

Meanwhile, the shale-oil production boom in the US only inflamed this matter even worse. Subsequently, oil prices slumped dramatically through the fourth quarter of 2014.

Over the last couple of weeks, however, oil prices have been recovering again. On Feb. 27, Brent Crude Oil reached $61 per barrel, rebounding almost 16 percent within February and made its first monthly gain since June 2014.

One of the triggers of this trend reversal is the decline in drilling. The recent free-fall in oil prices has hurt many oil drillers.

According to Bloomberg, this condition has caused many drillers in the US to cease drilling, which forced these companies to delay investment plans and lay off workers.

This decline in drilling will result in lower production and signals slower supply growth in the near future. In response to this condition, the US Energy Information Administration reduced its US crude oil production from 9.42 million barrels a day (mbd) to 9.3 mbd by the end of 2015.

On the other hand, demand also shows some improvements albeit tiny. For instance, a report by Reuters suggests that oil demand in China is set to grow 3 percent in 2015, which is above the forecast from the International Energy Agency of 2 percent. Higher demand will potentially be able to push oil prices up.

Nevertheless, plenty of energy analysts suggest that the higher demand is primarily caused by the very low oil prices in January 2015.

In other words, there is a risk that this stronger demand will fade once the prices go up again. Subsequently, it might not be able to bring a robust rise in oil prices.

In short, after hitting lower levels in January 2015, oil started to become bearish again throughout February 2015, spurred by the lower supply growth and slightly higher demand growth. Nevertheless, the current situation still poses some uncertainties vis-à-vis the strength of the oil price recovery considering demand growth could still fall again.

Looking at this condition, overall, it could be implied that oil prices will be relatively higher by the end of 2015 compared to that of 2014 even though a sustainable rise is not expected.

Meanwhile in Indonesia, oil-price fluctuation plays a crucial role in affecting the country’s macroeconomic conditions, whether from the current account in its balance of payments, fiscal balance and inflationary pressure.

The recent drop in oil prices has allowed the government cut the subsidized oil prices, which resulted in relatively better trade balance and milder inflationary risk.

Nevertheless, looking at the sudden change in oil prices in the last couple weeks, the government has to be cautious in anticipating the fluctuations in oil prices in the near future. If the trend continues, the government has to readjust its subsidized oil prices in order to maintain its fiscal room. Otherwise, the government could experience over-spending, which could exacerbate its fiscal deficits.

However, rising subsidized oil prices may put pressures on inflation. Therefore, policy coordination between government agencies has to be strengthened in anticipating the fluctuation in oil prices.

In addition, the government also has to provide policy communication to the public in order to maintain public confidence and expectation. If this can be carried out, the government can anticipate higher oil prices with stable fiscal room and trade balance conditions while preserving price levels and public confidence.
The writer is a graduate of the University of Manchester.
- See more at:

Sunday, 4 January 2015

Year-end global mini turbulence and what to expect in 2015

Arisyi Fariza Raz
The Jakarta Post
29 December 2014

Available at:

Toward the end of 2014, it seems like the global economy wants its own notable ending following the occurrence of some issues.

The first is regarding the possibility of monetary tightening in the US through the US Federal Reserve fund-rate hike next year in response to strengthening US economic conditions. Prior to the Fed’s meeting last week, the global market had feared the Fed rate would increase earlier next year following strengthening US macroeconomic indicators.

As a consequence, hot money flew back to the US from all over the world, resulting in a sharp appreciation of the US dollar against many other currencies. Some fragile emerging economies (those with current account and fiscal deficits) might have experienced much worse than that. Rapid capital outflows might affect their investment accounts in the balance of payments, which corrected their asset prices and further pressured their currencies against the US dollar.

Fortunately, Janet Yellen, the Fed’s chief, expressed a more “dovish” statement during the meeting by saying that the Fed could be patient on the rate rise. This statement finally eased the shock for the time being — at least until next year.

Secondly, in a different place, the global oil oversupply has caused economic turbulence in oil-dependent economies, particularly Russia. The tumbling price of oil, which is its main export, has affected Russia’s economy severely. Its central bank forecasts that gross domestic product (GDP) may shrink by around 5 percent next year if the price does not show any significant improvement.

Following falling exports, its currency, the ruble, depreciated sharply against the US dollar. To respond to this issue, the central bank raised its interest rate from 10.5 to 17 percent,  hoping that this could stop the falling ruble.

China and Japan have their own problems. China’s economic growth is expected to slow to 7.1 percent in 2015 from an expected 7.4 percent this year. This was mainly propelled by slowing export growth amid the global economic slowdown. Some economists have also recommended the government to cut its growth target to around 7.0 percent from 7.5 percent in 2015.

Meanwhile, Japan is still threatened by economic recession and its re-elected Prime Minister Shinzo Abe has yet to finish structural reform to put its economic growth back on track.

All of these phenomena, albeit happening in the different parts of the globe, are somehow posing the same risks to emerging economies, because of a more interconnected global economy and the influence of global sentiment on domestic markets.

It means that emerging economies will start 2015 with a lot of work to do. First, the Fed fund-rate hike next year will pose another wave of threats to emerging economies. Also, the falling oil price and the condition of oil-exporter economies, particularly Russia, may spread negative sentiment to other emerging economies, which could trigger further capital outflows and depreciate their currencies.

Therefore, emerging economies, particularly the fragile ones, need to pay more attention to these threats. To prevent another shock due to a wave of capital outflows when the Fed fund rate finally increases, emerging economies must strengthen their structural economic conditions. For instance, they have to maintain their trade balance to minimize the risk of sharp currency depreciation.

On top of that, similar to previous years, the global economy is expected to grow very slowly next year. Even though the US economy is showing some improvements, other economic centers (such as China, Japan, the UK and Europe) are still struggling to grow faster.

Hence, the prolonged slowdown of these economic giants may reduce the exports of emerging economies to these economies. Therefore, industrialization has to be carried out immediately to shift from commodity led exports to industry led exports, which have more value-added and export competitiveness. Value-added and competitive exports are expected to improve export performance and the current account balance.

Amid these possible risks, fortunately, falling oil prices might give some advantages to some emerging economies that import oil and/or whose fiscal budgets are burdened with oil subsidies. This will give them some fiscal room and potential to minimize its trade balance.

To conclude, emerging market economies will welcome 2015 with caution due to some possible risks (whether carried over from 2015 or some new threats that will be anticipated in 2015) that are expected to happen throughout the year.

However, they have seen gloomier years. There is a chance that these economies will look better next year compared to 2014.
The writer, a graduate of the University of Manchester, the UK.

Monday, 3 November 2014

Financial Inclusion to Increase Banking Liquidity

Arisyi Fariza Raz
The Jakarta Post
30 October 2014

Available at:

Throughout 2014, the Indonesian banking sector has been facing tightening liquidity. One of the liquidity measurements, the loan-to-deposit ratio (LDR), has been fluctuating a couple percentage points below the minimum reserve requirement-LDR ceiling of 92 percent.

There are many factors that cause this tightening. 

First, a substantial demand for credit that occurred during the economic boom had led to credit expansion, thus undermining the banking sector’s liquidity. 

Second, the global economic slowdown resulted in a capital flight, which, in turn, eroded banks’ third-party funds that are sensitive to short-term returns. 

Third, high domestic demand in the real sector led to increased imports, thus reducing demand for the rupiah. Consequentially, savings could not increase rapidly and deposit growth rates slowly flattened. Many experts and analysts expect this trend to continue until the end of the year. 

Even though, overall, this figure is still within an acceptable level, particularly after gradual improvement in the last couple of months following the government’s fiscal expansion, which increases banks’ third-party funds (particularly those of regional banks and state-owned banks), the banking sector needs to formulate a new strategy to be able to grab more funding in the long run.

Liquidity is a very crucial aspect of the banking business. In the worst-case scenario, if a bank has a liquidity issue, it may not be able to fulfill its obligations to its savers. When that happens, the trust for that bank may collapse, thus resulting in a massive funds withdrawal from that bank. This is followed by an even more severe liquidity issue, which, in the end, could harm the bank’s business sustainability.

If this problem is faced by a big bank (i.e. a domestically, systemically important bank), the problem can cause systemic risk. When that happens the whole banking system could face a bank run, leading to a failure in the whole banking system.

Hence, considering these risks, maintaining liquidity positions, whether that of the whole banking system or of individual banks, has become a very important aspect for the financial system and the economy as a whole.

Looking from the LDR point of view, banking sector liquidity can be affected by deposits or loans. In other words, when liquidity tightens, it can be caused by either higher credit growth, slower deposit growth, or both. When the economy is growing, demand for credit will increase. As a consequence, assuming ceteris paribus, the LDR will get higher. Higher demand for credit is inevitable in a growing economy. Therefore, banks have to seek more deposits from households or corporations to maintain their liquidity.

Higher expenses also reduce the propensity to save. As a consequence, this causes lower deposit growth, which eventually reduces the banking sector’s liquidity.

Generally speaking, financial inclusion is one of the possible solutions to this tightening liquidity trend since banks can find new sources of funding from the previously unbanked market. Currently, access to financial services in Indonesia is still relatively low when compared to regional peers.

As a comparison, statistics from the World Bank’s World Development Indicators database show that Indonesia’s credit-to-GDP (gross domestic product) ratio was only 37.9 percent in 2013. The figure was substantially below Thailand’s (154.4 percent), Malaysia’s (124.3 percent) and Singapore’s (128.9 percent). 

Meanwhile, during the same period, Indonesia’s savings-to-GDP ratio was only 31.6 percent, still relatively below those of its peers, such as Thailand (32.5 percent), Malaysia (35.4 percent) and Singapore (52.1 percent). 

Considering Indonesia’s huge population base and its considerable number of unbanked people, there is still a lot of room to get new sources of funding and increase the liquidity position. For instance, banks can extend their services to previously unreached markets, such as in rural areas. However, expanding access to banks is usually costly and thus it increases the cost of funds and undermines profit margins. However, there are several ways it can be done in order to improve the efficiency of branch expansion. 

First, if service extension is carried out on a massive scale, then economies of scale can be applied and thus the marginal cost of service extension becomes lower. As a consequence, this can push down a bank’s cost of funds.

Moreover, thanks to technological advancement, the costs of branch expansion can be pushed down even farther. For instance, branchless banking can be implemented as a convenient method for banks to extend their services in remote areas without much additional cost.

Financial innovations also matter. Banks need to invent financial products suitable for rural populations. These products should be flexible, particularly in terms of complexity, access and returns, in order to make them suitable for potential rural savers. Moreover, inventing a financial product that is linked to local cooperatives may also make it more attractive for rural dwellers.

Simultaneously, this should be accompanied by socialization. Societies in rural areas are mostly financially illiterate and tend to avoid financial services. Hence, providing education about financial products may persuade them to utilize financial services, particularly savings accounts.

Fortunately, financial authorities have acknowledged the necessity of finding new sources of funding for banks. They have also supported this movement by providing financial infrastructure, formulating accommodative financial regulations and establishing a customer protection framework to encourage banks to extend their services to rural areas.

Hopefully, banks will be able to carry out this program. Extending financial services to rural areas not only potentially increases banking liquidity, but also enhances financial inclusion. From the macroeconomic point of view, this will result in financial stability, as well as enhanced economic development.

The writer, a graduate of the University of Manchester, UK.

Monday, 4 August 2014

Private External Debt and Financial Stability

Recently, there is a growing concern on the news about the ballooning private debt in Indonesia. As of April 2014, Indonesia’s private external debt has reached USD 145.6 billion, exceeding its public external debt amounting USD 131 billion. In terms of growth, it exhibits 12.9% year-on-year growth, higher than 12.2% and 11.6% in March and February, respectively.

The mounting private external debt also increases Debt-to-Service Ratio (an indicator to determine a borrower’s ability to repay its debts), which stood at 46.3% in Q1 2014, higher than 36.8% in Q1 2013.

There are several reasons that cause the ballooning external private debts. First, some companies prefer to obtain external debts due to the cheaper costs since credits in US dollar incur relatively lower interest rates compared to Rupiah. In addition, some firms also usually hedge their external loans to avoid currency volatility risk. As a consequence, these firms could carry out their business plans more efficiently.

Second, Indonesian banking sector’s Loan-to-Deposit Ratio (LDR) has also surpassed 90%, indicating strong demand for local credit. If the ratio is getting closer to 100%, it means that banks already maximize its intermediary function by extending all of their deposits to loans. In other words, current condition shows that local banks capability, particularly medium- and small-sized ones, to extend credits becomes more limited.

Third, subsidiaries from international corporations residing in Indonesia usually have easier access to obtain parent loans or inter-group loans since they offer relatively cheaper interest rates and less rigid terms and conditions. Therefore, these companies usually use this kind of facility during its early establishment or business expansion.

Fundamentally, the utilization of external debt to finance a firm’s business is totally acceptable. However, it could create a problem if it is not utilized properly. Bappenas (2004) points out three main problems associated with the utilization of external debt: 1) maturity gap, 2) currency mismatch, and 3) non-existent of currency hedging.

First, if a firm obtains short-term debt to finance long-term project, then it will experience maturity gap since its it will incur cash outflows in the short-term to repay its debt, while its cash inflows from the project will come in the long-term, resulting in liquidity problem and difficulty to repay the loan.
Another potential problem is currency mismatch. This problem happens when a firm’s revenues and reporting currency are denominated in rupiah, while it obtains loans in foreign currencies. If rupiah becomes more volatile and tends to depreciate against foreign currencies, then its loan’s current value will soar, undermining leveraging performance.

This issue can be exacerbated further if a firm does not have any currency hedging such as currency swap facility. If a firm does not have hedging facility and depends on external debts as its financing source, then, when rupiah depreciates, its interest expenses will grow since it has to pay in dollar against its rupiah income. As a consequence, its profitability will be impaired and overall business performance will deteriorate.

When this happen at bigger scale, this issue can create a systemic risk. Defaulting firms could disturb financial stability, particularly if they also have loans in local banks. These firms will be unable to pay the loans that they owe to local banks, including those denominated in rupiah. As a consequence, they could disrupt banks’ solvency.

In addition to firm-level problems, external debt can also pose a threat at macro-level. When external debts level becomes too high, their repayments will result in capital outflows, pressuring Indonesia’s Balance of Payments and triggering rupiah volatility.

Looking at current condition, many still believe that Indonesia’s private external debt condition is still within an acceptable level despite showing an increasing trend. Even though it has not created a serious threat yet, serious actions have to be taken by both authorities and firms.

In one hand, related authorities should closely monitor the movements of private debt. More actions can also be taken, such as preparing stress-testing analyses to project the possible outcome of various levels of private external debts in order to formulate the anticipation measures.

On the other hand, firms also have to be aware of their own business conditions. Even though business growth is important, carefulness and prudence are also crucial for business to create a more sustainable growth. Several actions can be taken to minimize the risks caused by the spiking external debt. A way to do this is by carefully examine its project and the type of loan that should be used to finance the project to prevent any currency mismatch or maturity gap. Another possible method is by utilizing hedging facilities such as interest swap or currency swap in order to minimize market risk.

Arisyi Fariza Raz

Thursday, 3 July 2014

Why Indonesia needs to borrow (a little) more, not less

Renan Raimundus
The Jakarta Post
3 July 2014

Available at:

Most news stories about public debt in Indonesia are quite negative in tone, portraying that increasing government debt is taboo. Critics attacked the rise in public debt from Rp 1.6 quadrillion (US$134.31 billion) to Rp 2.4 quadrillion from 2009 to 2013, creating the impression that public debt is getting worse every year. On the contrary, Indonesia’s public debt to gross domestic product (GDP) ratio has significantly decreased to 24 percent of GDP as of April 2014 from more than 150 percent almost one decade ago.

The ratio is far lower than most developing countries, such as Vietnam (54.9 percent), Thailand (45.27 percent), the Philippines (49.2 percent), India (67.7 percent) and most Latin American countries. The government even plans to further reduce the public debt ratio to 16.9 percent by 2020. It is not too much to say that Indonesian public debt discipline is among the strongest in the world. The steady decrease in the public debt as a percentage of GDP ratio suggests that Indonesian public debt is on a sustainable path, giving big room for more fiscal stimulus.

On the other side, many perceive Indonesian economic growth as unsustainable. Relatively high growth above 6 percent has already caused the economy to overheat, with imports rising steeply to meet domestic demand for consumer goods, basic materials and capital goods, while export revenues depend mainly on primary commodities whose prices tend to fluctuate. The economy has been driven mostly by strong domestic consumption, but production capacity cannot keep up with the strong demand. 

At the heart of these problems is poor infrastructure development. Average travel time in Indonesia is 2.6 hours/100 km, compared to only 1.1 and 1.35 hours/100 km in Malaysia and Thailand, respectively. Average dwelling time in an Indonesian seaport is eight days, far longer than Hong Kong (two days) and Singapore (1.1 days). Indonesian rural electrification ratio is only 32 percent, compared to 65 percent in the Philippines, 85 percent in Vietnam and 99 percent in Thailand. Other infrastructure indicators also suggest poor conditions in Indonesia, compared to regional neighbors.

One might question why Indonesia has two contradictory stories — the story of a healthy fiscal condition and the story of poor economic and infrastructure development? One of the fundamental impediments to infrastructure development is a lack of funding for projects. The government identified the need for infrastructure investment of up to Rp 1.9 quadrillion between 2010 and 2014. However, state and regional budgets could cover only Rp 914.6 trillion of the total investment needed. 

There are two reasons why Indonesia needs to raise public debt for the necessary funding. First is that many necessary infrastructure projects to develop the country simply are not attractive to the private sector. These projects, such as non-toll roads, public transportation networks, water treatment facilities and public hospitals, are called public goods. 

As public goods, they do not give sufficient investment return to private investors, because the cost of provision is very high and the payback period is quite long. Hence, the government should step in to finance infrastructure to provide such public goods. If the government budget is not sufficient for such investment, it can borrow from domestic or foreign markets.

Second is that public debt, both domestically and internationally, is the cheapest way to raise the necessary funding for development. As government obligations are perceived as risk free, the cost of borrowing is far lower than that of commercial banks and equity investors. Foreign currency denominated loans from foreign government agencies are much cheaper. 

The MRT Jakarta project is financed with a loan from the Japan International Cooperation Agency (JICA) at an interest rate well below 1 percent and with a much longer maturity period than a typical commercial loan. If the government chose to finance the MRT project with private investment or borrowing from financial markets, the cost could be 10 times higher or more, and Jakarta might not be able to afford the project. 

Given the importance of public debt for economic development, why does raising the debt considered taboo?

One reason is that after the Asian Financial Crisis 1997, Indonesia has been struggling to increase its credit rating, and the rating indeed has improved. Fitch Ratings finally upgraded Indonesia from Junk to BBB- in 2011. Moody’s also upgraded the rating from Ba1 to Baa3, and S&P increased the rating from BB to BB+. 

It is, however, interesting to observe that given Indonesia’s significant improvement in the level of its public debt, its credit rating improvement has not been significant. The investment grade is still lower than that of Thailand, the Philippines, India, Malaysia and many other developing countries with significantly higher debt to GDP ratios. This is because even though we improve significantly in public debt discipline, we fail miserably in many other aspects of the economy, such as infrastructure development, fuel subsidies, bureaucratic reform and corruption eradication. 

Another reason is the public perception that increasing public debt, especially internationally, equals selling the country’s freedom and control to foreign interests. It is therefore politically costly to reach a political consensus on new public debt from foreign countries. 

In reality, every country borrows internationally, and there is hardly any serious issue regarding national integrity arising from those borrowings. China has been borrowing heavily from the World Bank to finance its phenomenal growth, and so are other developing and developed countries around the world. The United States borrows internationally as well, and China is the US’ largest creditor. 

Indonesia is no different from the rest of the world. If loans can be negotiated fairly for Indonesia, it is a win-win solution. Foreign countries might benefit by providing loans to Indonesia in one form or another. But in the end, if the debt is used properly, the biggest beneficiaries are Indonesians themselves, through better infrastructure provision and economic growth.

No country in the world runs without debt, and raising debt is not necessarily a bad policy. It is important to differentiate the purpose of debt, whether it is for consumption or investment. Borrowing for the purpose of consumption will create a burden for the country. 

Therefore, borrowing to finance the fuel subsidy, for example, cannot be justified. On the other hand, borrowing for investment will generate a multiplier effect for the economy, stimulate growth, create employment, increase income, generate more tax revenue in the future and finally pay off the debt itself. 

Thus, what Indonesia needs is not less debt, but a better allocation of debt, shifting away from consumption toward investment. That way, more public debt can be justified for the sake of development and prosperity.

The writer is a graduate from the University of Tokyo Graduate School of Public Policy. He is currently an associate at PT Tusk Advisory, an advisory firm specializing in infrastructure delivery.