FInancial Institutions and Policies in Indonesia 9789814345644

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FINANCIAL INSTITUTIONS AND POLICIES IN INDONESIA

FINANCIAL INSTITUTIONS ANDPOUCIES IN INDONESIA .

ANWARNASUTION

The Institute of Southeast Aszizn Studies was established as an autonomous organization in May 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia. The Institute's research interest is focused on the many-faceted problems of development and modernization, and political and social change in Southeast Asia. The Institute is governed by a twenty-two-member Board of Trustees on which are representatives from the National University of Singapore, appointees from the government, as well as representatives from a broad range of professional and civic organizations and groups. A ten-man Executive Committee oversees day-today operations; it is chaired by the Director, the Institute's chief academic and administrative officer.

The responsibility for facts and opinions expressed in this publication rests exclusivery with the author and his interpretations da nat necessariry rdlect the views ar the policy of the Institute ar its supporters.

Published by Institute of Southeast Asian Studies Heng Mui Keng Terrace Pasir Panjang Singapore 0511

All rights reserved. Na part of this publication may be reproduced, stared in a retrieval ~stem, ar transmitted in any form ar by any means, electronic, mechanical, photocopying, recording ar otherwise, without the prior permission of the Institute of Southeast Aszizn Studies.

© 1983 Institute of Southeast Asian Studies

ISBN 9971-902-60-5 (Case) ISBN 9971-902-65-6 (Limp) Typeset by Richard Clay (S.E. Asia) Pte. Ltd. Printed by the Singapore National Printers (Pte) Ltd.

''I have been given authority over you but I am not the best of you. If I do well, help me, and if I do ill, then put me right. The criticism is considered a loyalty and false applause is treachery.'' Khalifah Abu Bakr*

* As quoted by Nafisa, "Law and Social Change in Muslim Countries: The Concepts of Islamic Law Held by the Hanbali School and the Saudi Arabia Legal System" (S.J.D. thesis, Harvard Law School, December 1975), pp. 45-46, and Charles Himawan, The Foreign lnvestmmt Process in Indonesia (Singapore: PT Gunung Agung, 1980), p. vi.

CONTENTS List qf F~gures

X

List qf Tables

Xll

Priface

XV

Acknowledgements

XVll

CHAPTER I AN OVERVIEW OF THE INDONESIAN ECONOMY, 1968-79 Background 1 Inflation and Stabilization 2 The Course and Causes of Inflation and Efforts to Control It 2 Stabilization and Rehabilitation Period, 1967-72 4 Fiscal Policy 4 Monetary Policy 5 Balance of Payments Policy 6 Other Monetary Impacts qf the Stabilization and Rehabilitation Programme Resurgence of Inflation, 1973-7 4 8 The Second Stabilization Programme, 1974-78 9 Budgetary Trend and Policies 13 The Budget as Stabilizer 14 Trends in Government Domestic Revenue and Tax Effort Trends in Government Expenditure 21 CHAPTER II THE BALANCE OF PAYMENTS AND NATIONAL INCOME Balance of Payments Developments 26 Current Accounts 26 Capital Flow 31 Exchange Rate System and International Reserves 34 Vll

8

16

26

Content;

Vlll

Trade Policies

37

Level of Output and Structural Change of the Economy

40

CHAPTER III THE INDONESIAN FORMAL FINANCIAL INSTITUTIONS Introduction

50

50

Distribution of Bank Offices Bank Indonesia, the Bank Indonesia Bank Indonesia Bank Indonesia

52

Central Bank 58 under the Bank Indonesia Act of 1953 under the Guided Economy 60 under the "New Order" 61

Other Banks 63 Savings and Development Banks 63 State-owned Commercial Banks 66 Some Measures to Improve State Banks' Efficiency Private Banks and Branches of Foreign Banks Private National Banks 69 Branches of Foreign Banks 72 The Non-bank Financial Institutions (NBFis) The Money and Capital Markets 76 The Jakarta Interbank Money Market The Jakarta Stock Exchange 78 The Bond Market 80 The Jakarta Dollar Market 80

58

68 69

72

76

CHAPTER IV MONETARY INSTRUMENTS TO CONTROL MONEY SUPPLY AND CREDIT, AND INTEREST RATE POLICIES Introduction

86

86

Reserve Requirement Policy 87 Paying Interest Rates on Demand Deposit and Excess Reserve Credit Ceiling 91 A. Assets rif the Central Bank 93 B. Assets rif Deposit-money Banks 93 Controls on Capital Flows 94 The Volume and Rate of Growth of Credit, 1967-78 95 Selective and Direct Credit Control 99 The Shortcomings of Credit Ceilings and Selective Credit Controls Interest Rate Policies and Monetary Savings 107 Time, Savings, and Demand Deposits 109 Certificate Deposits and Other Savings Schemes

113

90

101

Contents

IX

CHAPTER V A SHORT-RUN MONETARY MODEL OF THE INDONESIAN ECONOMY, 1971:2-1979:4 Introduction 117 The Money Market 118 The Demand for Money 118 Main Issues in the Demand for Money Specification 118 The Supply of Money 120 Government Budget 124 The Balance of Payments 126 Aggregate Demand 127 The Complete Model and Its Working 128 Monetary Sector 128 Demand for Real Balance 128 The Supply of Money 128 The Balance of Payments 128 Government Non-oil Revenue 129 Aggregate Demand/Real Income 129 Indentities 129 Inflation Identity 12 9 Nominal Income Identity 129 Reserve Money Identity 129 Working of the Model 130 Empirical Evidence of the Model 131 Results of Estimation 131 Simulation Exerci~es 133 Comparison with Other Studies 158 CHAPTER VI EVALUATION AND CONCLUDING REMARKS Evaluation on Indonesian Macro-economic Management Model as a Guide to Policy 163

117

161 161

Appendices I. Data Sources and Definitions 165 II. Selected Empirical Studies on the Indonesian Financial Sector, 1969-79

165 167

Select Bibliography

175

A bout the Author

182

LIST OF FIGURES 4.1

Volume of Credit and Interest Rate under Credit Ceilings

106

5. 1

Flow Diagram of the .Monetary Model

131

5.1a

Time Series Plot of Actual and Simulated Prices, 1971:2-1979:4

136

5.1b

Time Series Plot of Actual and Simulated Supply of Money, 1971:2-1979:4

137

Time Series Plot of Actual and Simuiated Values of Non-oil Tax, 1971:2-1979:4

138

Time Series Plot of Actual and Simulated Values of Non-oil Export, 1971:2-1979:4

139

5.1e

Time Series Plot of Actual and Simulated Values of Total Imports

140

5 .lf

Time Series Plot of Actual and Simulated Values of Real Income

141

5.1g

Time Series Plot of Actual and Simulated Values of Reserve Money

142

5.1h

Time Series Plot of Actual and Simulated Inflation Rates

143

5.2a

Time Series Plot of Actual and Simulated Prices, 1971:2-1980:4

144

5.2b

Time Series Plot of Actual and Simulated Supply of Money, 1971:2-1980:4

145

Time Series Plot of Actual and Simulated Values of Non-oil Tax, 1971:2-1980:4

146

Time Series Plot of Actual and Simulated Values of Non-oil Export, 1971:2-1980:4

147

Time Series Plot of Actual and Simulated Values of Total Imports, 1971:2-1980:4

148

Time Series Plot of Actual and Simulated Values of Real Income, 1971:2-1980:4

149

5.1c 5.1d

5.2c 5.2d 5.2e 5.2f

X

List

of Figures

XI

Time Series Plot of Actual and Simulated Values of Reserve Money, 1971:2-1980:4

150

Time Series Plot of Actual and Simulated Inflation Rates, 1971:2-1980:4

151

5.3a

Simulated Price under Various Policy Shocks

153

5.3b

Simulated Money Supply under Various Policy Shocks

154

5.3c

Simulated Non-oil Tax under Various Policy Shocks

155

5.3d

Simulated Value of Non-oil Export under Various Policy Shocks

156

5.3e

Simulated Value of Total Imports under Various Policy Shocks

157

5.2g 5.2h

LIST OF TABLES 1. 1

Selected Indicators of the Indonesian Economy, 1966-79

1. 2

Government Finance, 1969/70-1978/79

14

1.3

Government Revenues, 1966-1978/79

16

1.4

Government Revenues as Percentage of GDP, Their Rates of Growth and Elasticities, 1966-1~78/79

18

1.5

The Structure of Government Revenue, 1966-1978/79

20

1.6

Government Expenditures, 1966-1978/79

21

1.7

The Structure of Government Expenditures, 1966-1978/79

22

1.8

Increase in Government Expenditures Divided by Increase in Its Revenue

23

2.1

The Balance of Payments, 1966-78

27

2.2

Commodity Composition of Exports by Value, 1966-78

28

2.3

Rates of Growth of Exports by Value and Volume, 1966-79

29

2.4

Composition and Rates of Growth of Imports by Value, 1966-79

30

2.5

External Public Debt Outstanding, 1970-79

32

2.6

Indonesia's Debt Service Ratio, 1966-79

33

2. 7

Net International Reserves

36

2.8

Effective Rate of Protection for Selected Manufacturing Sectors in Indonesia, 1971-78

39

2. 9

Gross Domestic Product by Industrial Origin at Current Market Prices

41

2.10

Composition of GDP by Industrial Origin at Current Market Prices

42

XII

3

Lzst

of Tables

Xlll

2.11

Real Rate of Growth of GDP by Industrial Origin, 1967-79

44

2.12

Distribution and Size of Work-force in Indonesia, 1930-76

45

2.13

Expenditure on GDP at Current and Constant Market Prices, 1967-79

46

3.1

Money Supply in Indonesia

51

3. 2

Total Assets of Selected Indonesian Financial Institutions

53

3.3

Number of Selected Financial Institutions in Operation, 1967-78

54

3.4

Commercial Bank, Population, and Area of Indonesia as of 31 December 1979

56

3.5

Total Assets of the Indonesian Banking System, 1978-79

58

3.6

State-owned Commercial Banks

66

3. 7

Capital Requirement for a Commercial Bank Office by Cities, 1968-78

70

Combined Balance Sheet of Development and Investment Companies, 1975-78

74

The Volume of Transactions and Interest Rates at the Jakarta Interbank Money Market, 1974-79

77

3.10

Transactions at the Jakarta Dollar Market, 1968-79

83

4.1

Required and Free Reserves of Banks, 1968-78

89

4.2

Bank Credit in Rupiahs and Foreign Exchange by Group of Banks, 1968-78

96

4.3

Distribution of Credit by Group of Banks, 1968-78

97

4.4

Distribution of Credit in Rupiahs (Rp.) and U.S. Dollars (US$) by Group of Banks, 1973-78

98

4.5

Annual Rate of Growth of Credit by Group of Banks

99

4.6

State Bank Lending and Re-discounting Facilities Provided by the Bank Indonesia, 1972-78

102

Interest Rate Structure of Time and Savings Deposits with the State Commercial Banks, 1968-78

110

Demand Deposits, Quasi-money, and Real Rate of Return on Time and Savings Deposits, 1968-78

112

4.9

Certificates of Deposit Outstanding

113

4.10

Interest/Discount Rates on Certificate Deposits, 197 5-78

114

5.1

Indonesia: Multivariate Regression Results of Individual Parameters

132

5.2

Structural Equation Estimates

134

5.3

Statistical Results of Dynamic Simulation for the Sample Period, 1971:2-1979:4

135

3.8 3. 9

4. 7 4.8

Li,-t of Table,-

XIV

5.4

Qualitative Effects of Changes in Macro Policy Variables

5.5

Comparison of Individual Parameter Estimates on Price (Demand for Real Balances) Equation in Five LDCs

A.1

Indonesia: Multivariate Regression Results of Individual Parameters

A.2

Main Characteristics of Econometric Models of the Indonesian Financial Sector

152 159 166 173

PREFACE In his book Economic Development (New York: W.W. Norton, 1968), Benjamin Higgins labels Indonesia as ''the number one failure among the major underdeveloped countries''. Since then, however, the present New Order regime has turned Indonesia into a very different country. The regime has shown a remarkable record of success in formulating financial policies that have brought the country out of a period of economic stagnation, financial repression, and instability. Government policies reduced the inflation rate (which raged at 650% in 1967) to 9% in 1970, reformed the exchange rate system, and established the full convertibility of the rupiah in international transactions. The restoration of stability was the result of greater control of growth of money supply through the avoidance of budget deficits financing, decontrol, and return to a more market-oriented economic system. This helped to restore the attractiveness of holding financial assets through real positive interest rates, renegotiation of foreign debts, and liberalization of a foreign exchange system as well as devaluation and unification of the exchange rate, and created favourable conditions to attract both capital inflows. In terms of financial development, these reforms reduced the repression of the financial market. As a result of these policies, the ratio of liquid assets (ratio of broad money) to GNP, gross national savings, and gross domestic investment were all increased remarkably during the 1970s. Above all, the economy has been growing respectably. As the economic stabilization programme was successfully achieved, the government turned towards a more diversified development effort with objectives relevant to employment and equity. At the same time, Indonesia's foreign exchange assets were continuously increasing during the 1970s due to an increase in its non-oil exports as a result of a short "boom" in the international economy at the beginning of the decade and an escalation of oil prices since 1973. Most of these foreign exchange assets are in the hands of the government. Government oil revenue from corporation taxes paid by foreign oil companies and other revenues collected from foreign firms and personnel are not withdrawals from the income stream of the domestic private sector (withdrawals from domestic purchasing power), since it would otherwise have been repatriated abroad. On the expenditure side, the government has used some of this foreign revenue in rupiahs to purchase domestically produced non -traded goods for employment and equity programmes. Looking at it this way, the relevant transmission of the mounting foreign assets into the economy is not the balance of payments but rather the government budget, XV

XVJ

Preface

especially when the government keeps to its balanced budget policy. Under such conditions, to maintain price stabilization, the authorities treated credit of the banking sector as residual. In order to reduce inflationary pressures that come mainly from a government budget, since April 1974 the monetary authorities have been imposing a more complicated and stricter credit ceiling than before. In the past, notably under the IMF stand-by arrangements, the credit ceiling represented no more than a commitment by the central bank to observe a limit to overall credit expansion. Under the new programme, the central bank sets ceilings of total credit and permissible increases in net assets of all banks. With the new programme, credit allocation has moved away from allocation through interest rate mechanisms to a more administratively determined system. In this system, the authorities direct credit towards individual sectors, through a system of programme and non-programme credit. Previously, monetary authorities were being asked to solve problems which they could not solve. They were assigned a civic function to restrict certain credit only to pribumis (indigenous people) and establish credit for pribumis as a priority in order to enhance pribumis' participation in economic activities. The Indonesian financial system is dominated by the government-owned financial institutions. Since all government credit programmes are channelled through these institutions with guaranteed refinancing from the central bank, these institutions have been growing very fast. However, the credit ceiling means maintenance of their status quo, and with some discrimination against private banks, the system prevents competition among the financial institutions to reduce the cost of intermediation. With massive increases in their foreign assets and adequate supplies of refinancing from the central bank discount window, while their credit was subject to ceilings, the state-owned banks were constantly overliquid in the 1970s. Aside from setting the maximum amount of credit expansion thrqugh a ceiling, the Bank Indonesia also set the level as well as the structure of interest rates. During the 1970s their levels, in real terms, were very low or negative. As a result of these repressive policies, most of the excess liquidities owned by foreign exchange banks and domestic savings have been transferred abroad to benefit from the high interest rates in international markets particularly at the end of the 1970s. People kept their savings in the form of imported gold or jewellery, or land and other physical assets. Capital outflow and an increased propensity to import non-essential goods have somewhat sterilized the increase in foreign assets, but in nonproductive ways. A boom in the oil sector reduced the terms of trade of tradable goods relative to non-tradables particularly as extra aggregate demand is confined mainly to the latter. Moreover, as the price of oil rises relative to the price of non-oil exports, the trade balance of the oil sector moves into a surplus and this leads to a combination of nominal exchange rate appreciation and capital inflows. Since the latter are not sterilized, they caused domestic inflation and a decline in non-oil export competitiveness. This so-called "Dutch disease" (Corden [1980] credits the Economist with the invention of the term) was cured by the devaluation of the rupiah in November 1978. This study (a revised version of my Ph.D. dissertation "Macroeconomic Policies, Financial Institutions and a Short Run Monetary Model of the Indonesian Economy") analyses the Indonesian economy and financial sector since 1968, with special emphasis on the 1971-79 period. The study begins with a general overview of macro-economic developments (Chapters I and II), and moves on to a survey of financial structures in Indonesia and the monetary policies which have been followed (Chapters III and IV). Drawing on the literature concerning the role of money in open economies, a monetary model is presented, estimated, and used to simulate policy changes in Chapter V. Chapter VI provides some brief concluding observations.

ACKNOWLEDGEMENTS This study could not have been completed without the generous assistance of my teachers and colleagues. I am particularly indebted to my dissertation committee. Professors Bel\iamin J. Cohen and David 0. Dapice read the entire manuscript and offered valuable suggestions concerning substance as well as style and language. The latter, as a teacher and friend, has shaped my understanding of how the Indonesian economy works. Professor Gilbert DeBartolo has been helpful in building and testing the model. Dr Malcolm Gillis of Harvard University commented on the earlier version of the model. My research in Jakarta (October-November 1980) was assisted by Dr Arifin M. Siregar, Director of the :Bank Indonesia; Dr Hans Roden, the IMF resident representative; Drs H. Omar Abdalla, President Director of PT Bank Bumi Daya, who also introduced me to the commercial banking community; Professor Ralph E. Beals, Economic Advisor, Harvard Institute for International Development; and my many colleagues at the Bank Indonesia and the Ministry of Finance. AID and later MUCIA-AID, through Fakultas Ekonomi UI, provided me with a scholarship during my stay in the United States. The Ford Foundation granted airfares and health insurance for my family, as well as some costs to conduct my research in Indonesia. PT Bank Ekonomi, under the stewardship of its Chairman of the Board/ Minister for Co-operatives, General Bustanil Arifin S.H., and its President Director, Drs Abdulgani D.S., furnished supplemental research costs. The Department of Economics and the Tufts Computer Center gave generous computer time. Revision of my dissertation in its present form would not have been possible without an invitation from Professor Kernial S. Sandhu, Director of the Institute of Southeast Asian Studies (!SEAS) in Singapore, to visit the Institute for a period of two weeks in January 1983. During my stay, !SEAS provided me with accommodation and a living allowance as well as office space in beautiful surroundings and a pleasant working atmosphere. Lee Tucker turned illegible drafts into dissertation at Tufts, and Triena Ong, Editor/Manager, and her staff in the Publications Unit at !SEAS contributed to the reorganization of the chapters and to further improvements in style and language in the process of producing this book. My parents and parents-in-law have always been supportive and encouraging, but it is to my wife, Ayuna, who has shared all the agonies of living abroad as a student's spouse, that I dedicate this work. XVII

CHAPTER I

AN OVERVIEW OF THE INDONESIAN ECONOMY, 1968-79

BACKGROUND When the present regime, labelled as the '.'New Order", came to power in 1966, it inherited a virtually bankrupt nation with an economy near collapse. Production and trade were stagnant, economic infrastructure in disrepair, public administration had deteriorated, and foreign debts were mounting. This was partly caused by economic mismanagement, such as the continuing monetary expansion to finance budget deficits; and partly by other factors, such as supply shocks, natural events, political instability, and the detrimental effects of unfavourable world market conditions. The economy had been suffering from accelerating inflation since the early 1960s, culminating in an increase, measured in the Jakarta cost-of-living index, of over 600% in 1966. Inflation can be analysed as a purely economic problem, but to cure it requires a strong and stable government that will legislate and implement drastic measures and often make unpopular decisions. For the economy of Indonesia in 1966, it was also important to gain support from the international community in the form of postponements of international debt repayment, new economic aid, and technical assistance throughout the stabilization period. The present government, headed by President Suharto, a retired army general, came to power in a political upheaval caused by an abortive coup attempt by the communists on 30 September 1965. Under Suharto's leadership the Army, the moderates, and the religious groups suppressed without any outside help what was then the largest communist party outside the communist bloc. At the same time, the ultra-nationalist and isolationist group also became quiescent because of their long political coalition with the leftists. The power of the New Order government was fully consolidated after the retirement of the late President Sukarno in 1966. A period of relative political tranquility began in which the new government started to establish its legitimacy. Since then political stability has never been seriously threatened. 1 With both its internal and external policies, the new regime has made a complete turnabout compared to the direction of its predecessor. The previous government had taken an anti-Western stance in its foreign policy, rejected Western aid, and withdrawn from the IMF, World Bank, U.N., and other international organizations. Its internal policies included nationalization of virtually all foreign business, extensive price control, deliberalization, and reckless spending on projects conceived in pursuit of national prestige

2

Financial Institutions and Policies in Indonesia

rather than sound economic development. In short, politics came first and economics came later. The New Order, on the other hand, is a coalition of groups, using Higgins' label, ''who attach higher priority to economic and social development of the country, who feel that this development must follow Western lines in large measure, and who are willing to cooperate with the West, at least to the extent of seeking technical and capital assistance from the West, in order to achieve this goal" . 2 As soon as it had consolidated its power in 1966, the new government reorganized the economic system, gradually moving it from etatisme to market mechanism. The new order re-established contact with the West and rejoined the IMF, World Bank, and other international organizations. 3 In September of that year a multilateral meeting was held in Tokyo with Indonesia's Western creditors, later known as the Inter-Governmental Group on Indonesia (IGGI), to discuss its need for new aid and rescheduling of old external debts. In October of the same year, Indonesia launched its stabilization and rehabilitation programme. The programme was designed by a group of U.S.-trained economists who taught economics at the University of Indonesia. Early in 1967 the IMF opened a permanent resident representative office in Jakarta to advise the Indonesians on economic policy. Some of the important elements of the stabilization programme were retained throughout the entire period of this study. In its first five-year economic development plan, 1 April 1969-31 March 1974, the government set as its objectives the pursuit of both economic growth and economic stabilization. Since the beginning of the second plan (1974-79), pursuit of economic equality has been added as a third objective of economic development efforts. The aim of this chapter is to summarize the characteristics of the Indonesian economy and its development throughout this period. The inflation and stabilization programme is discussed in the next section. Budgetary trends and policies are presented in the second section. The balance of payments development is presented in the third section and a general overview of income and its structural change are discussed in the last section.

INFLATION AND STABILIZATION The Course and Causes of Inflation and Efforts to Control It In Table 1.1, data are presented on selected economic indicators for the period 1966-79. The table brings out the marked variation in the course and causes of inflation occurring during this period. Four phases may be distinguished: pre-1967 Hyperinflation due to very large budget deficits financed by bank credit. Velocity peaked in 1966. 4 1967-72 Stabilization and rehabilitation period; inflation rate and velocity declined slowly at first and rapidly after 1968. After 1968, the rate of growth of money supply was higher than the inflation rate and the economy grew at a respectable rate. 1972-74 Resurgence of inflation. Velocity continued to decline at first and then increased in 1974. This period was marked by a shortfall in the rice crop accompanied by increases in the price of non-oil exports in 1972, increases in the inflow of private borrowing, and quadrupling of new oil receipts in 1973-74.

An Overview of the Indonesian Economy, 1968-79

3

TABLE 1.1 Selected Indicators of the Indonesian Economy, 1966-79

Year (1)

y (2)

1966 1967 1968

3

1969~

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979

11 7 8 7 7 10 8 5 7 9 7 5

Annual Averages: 1967-72 1973-74 1975-78 1968-78 Source:

6.7 8.1 6.9 7.0

m (3)

p (4)

764 132 121 61 37 28 48 41 40 33 28 25 24 33

650 112 85 10 9 2 26 27 33 20 14 12 10 24

71 40.5 27.5 44.2

40.7 30.0 14.0 22.5

v (5)

s(d) (6)

p • (7)

m

pex • (8)

PcoT (9)

25.5 23.1 25.4 18.3 15.4 13.3 11.4 11.8 13.3 11.6 10.8 10.5 9.7 10.6

(124) (3) 0 0 2 3 2 1 0.4 0.1 0.2 0.1 0.04 0.02

7 4.7 -35.7 -6.7 14.9 -6.4 10.0 27.0 31.0 9.0 8.0 5.0 8.0 43.0

4 -16 -10 -13 4.4 -1.5 19 50 111 -2 7 14 9 100

1.33 1.33 1.30 1.28 1.67 3 2.21-2.60 2.93 3.73-6.00b 12.60c 12.80d 13.55 13.55 13.55 18.66e

17.8 12.6 10.7 13.8

0.7 0.7 0.11 0.8

-3.2 29.0 7.5 5.8

-2.9 80.5 7.0 17.1

1.9 7.4 13.2 6.7

Columns (2) to (8): calculated from CBS, MSB, vanous issues; column (9): Petroleum Economist, vanous 1ssues.

Notes

• For the period 1966-71 figures are unweighted, calculated from import statistics. The base year for export and import price indices is 1965;

t Prices before 1970 are of Saudi Arabian crude, the quality of which is lower than Indonesian crude. The price differential between the two was about $0.30 per barrel;

t a

Since 1969, the fiscal year has begun on 1 April and end on 31 March. 1971: 1 April : $2.21 1 October : $2.60;

b 1973: 1 April : $3.73 October : $4.75 November : $6.00; 1 July 1974 to 30 September 1975; d 1 October 1975 to 31 December 1976; e Calendar year 1979 as reported in BIES, March 1980, p. 3. The price for 1980/81 was about $33 per barrel; y

-

annual rate of growth of GDP at constant 1973 market prices;

m

-

annual rate of growth of nominal narrow definition of money supply;

p

-

annual rate of inflation (December to December), based on the Jakarta cost-of-living index;

Pm

-

annual rate of the wholesale price index of imported goods;

Pex -annual rate of the wholesale price index of exported goods (including crude oil and petroleum products);

v

-

crude oil export price, Sumatran light, U.S. dollars per barrel;

-

income velocity of money, v1

s(d) -

yt =

Y2(Mt-1 + Mt) ' government budget surplus (deficit), as percentage of total revenue.

4

Financial Institutions and Policies in Indonesia

1974-78

Reinstitution of ceilings on domestic credit and on foreign borrowings by bank and non-bank institutions. Both inflation rate and velocity were arrested. 1978-present: Post-November 1978, devaluation. Inflation, after initial burst, continuing at low levels, but very rapid monetary growth. In the following paragraphs, each phase during the period of study is analysed by focusing on the major economic disturbances over that period.

Stabilization and Rehabilitation Period, 1967-72 5 Fiscal Policy Previous studies of the Indonesian economy recognized that there was a two-way causation between inflation and deficit spending. Budget deficits were a prime cause of inflation during the first half of the 1960s due to the fact that excessive monetary expansion was needed to finance a growing budget and other public sector spending. The 1960s, especially through 196 7, witnessed a decline in real government expenditures accompanied by larger downturns in real revenues. Deficits were caused by increasing government nominal expenditures and subsidies paid to public utilities, the state, and other enterprises. On the other hand, as inflation accelerated, the tax administration deteriorated and the economy stagnated. To protect their well-being from inflation, people went back to barter and reversed the monetization of the economy. To reduce the increasing tax burden caused by inflation, citizens simply did not report their true income to the authorities, and delayed paying such taxes as were due. Inflation accompanied by an acute shortage of foreign exchange and controls had widened the gap between official and black market exchange rates. This produced an incentive to smuggle and resulted in further reduction of the ability of the government to tax the economy. The first part of the new government's economic stabilization and rehabilitation programme, therefore, was to eliminate budget deficits. Fiscal discipline was introduced by instituting a balanced budget policy and quarterly budget programming. In the past, certain departments and agencies had been able to maintain their own budgets outside of the control of financial policy-makers. From 196 7, all budget decisions were centralized at the Ministry of Finance. To balance the budget, current expenditures including wages and salaries of government employees and expenditures to maintain public utilities were kept at an austerity level. Prestige and other non-economic projects were shelved and a special budget to finance them was abolished. Price controls were gradually dismantled by reducing subsidies and letting prices be determined by market forces. Under the standby arrangements, the IMF limited the government's expenditures to no more than 10% of the national income. On the revenue side, concerted efforts were made to increase taxes on international trade, particularly custom duty collections, proceeds from excise and sales taxes, and direct tax revenues. At the same time, efforts were made to rebuild the fiscal administration. As foreign aid became available, the government was able to balance its budget in 1968. Also, starting from that year routine expenditures have been wholly met from domestic revenues. To ensure better synchronization of the flow of government

An Overview of the lndonest(m Economy, 1968-79

5

revenues and expenditures with the seasonal pattern of economic activities, from 1969 the fiscal year was shifted from the calendar year to one ending on 31 March. Since April 1969, the beginning of the first five-year economic development plan, the routine budget has been in surplus. Ever since then, the government has been able to save some of its domestic revenues to finance its development expenditures. However, before 1973, practically all development expenditures were financed by foreign aid. As the result of this way of financing budget deficit, the magnitude of the contribution of the government budget became insignificant to changes in reserve money.

Monetary Policy The second phase in addressing the economic programme was the implementation of a selective credit programme. Bank financing of the budget deficits was eliminated in 1967. The volume of credit was then restricted under a credit ceiling. In order to ensure a quick supply response, credit was made available only to certain economic sectors and activities. 6 In the first two and a half years of the programme, bank credit was extended for current financing (such as rehabilitation of existing production units) and for its working capital requirements. Only a limited amount of investment credit was available through the government's development budget and through the disbursement of foreign aid. The amount of medium-term investment credit increased as the government launched its first five-year development plan. During the period of hyperinflation real interest rates had been negative. Savings deposits were non-existent since savers preferred to hold real assets or foreign exchange. At the outset of the stabilization period on 3 October 1966 the government drastically increased the banks' loan rate from 4% to 6% per month. Interest rates in Indonesia have always been differentiated according to the purpose of loans rather than the credit worthiness of the borrower and the maturity of the loans. This policy is continued by the new regime. Loan categories were defined under the liquidity credit mechanism and in the interest rate and re-discount rate structure on those loans. The government has been actively adjusting the categories of loans and the terms, for example, interest and re-discount rates, as part of its policy to control and channel the banks' credit to its priority sectors. As the inflation rate came under control, and after further liberalization of foreign exchange, savings and time deposits were introduced on 1 October 1968 and savings schemes in 1969. The schemes then offered attractive positive real rates of interest. These programmes proved to be successful in mobilizing savings and directing them to capital and thereby strengthening sources of funds for the commercial banks. Until May 1969, the central bank had to subsidize the interest cost of the savings schemes to commercial banks, because the interest rates paid on savings and time deposits exceeded the average interest rates earned on their loans. Banking institutions were restructured by a series of new laws passed in 1967-68. In May 1965, under a series of Presidential Decrees, the central bank, three state commercial banks, one state savings bank, and state pawnshops had been consolidated into one single institution, called Bank Negara Indonesia (Indonesian State Bank), composed of five units. One of the state commercial banks, Bank Dagang Negara, thanks to the political skill of its director, a former minister for private banks, escaped integration and in the remaining months of the old regime operated with some independence a ''little central bank" with its own foreign exchange. 7

6

Firu:mcial Institutions and Policies in Indonesia

The new banking laws disintegrated the single BNI into six separate banks. There is now one central bank, one development bank, one savings bank, and five state-owned commercial banks. The new laws also defined the major areas of concentration for each bank, and all of them, except the savings bank, were to be engaged in both short-term credit and long-term financing. Foreign banks were permitted to open branches and resident representative offices only in Jakarta.

Balance of Payments Policy

The third element of the stabilization and rehabilitation programme was in the area of balance of payments. During the first half of the 1960s the government had been adopting a complex system of foreign exchange allocation and overvalued multiple exchange rates to cope with the pressures of monetary expansion on the balance of payments. 8 Exports were declining because of high export tax, reduction in production and difficulty in transportation. High export taxes reduced the incentive to export. Export taxes also widened the gap between official and black market rates, and produced a further incentive to smuggle. The proceeds of smuggling flowed to the foreign exchange black market and further reduced both tax receipts and the availability of foreign exchange to the government. During this same period, Indonesia's relations with Malaysia were broken, and the countries were close to a state of war under President Sukarno's "Confrontation'' policy. 9 Since it was impossible to replace Singapore (at that time part of Malaysia) as a port of transit and processing of Indonesian export commodities, the above policy quickly and severely reduced Indonesian exports. Moreovt.r, civilian use of interinsular and ocean-going shipping became more difficult because of the confrontation policy, antiWestern attitudes, lack of spare parts, and diversion of civilian transportation for military use (against the Dutch to liberate West Irian, 1959-62, and against Malaysia, 1963-65). Due to hyperinflation, political uncertainty, and further nationalization of Western properties in 1964 and 1965, capital was increasingly flowing out of the country and new foreign loans and aid were difficult to obtain. Moreover, in the past no effective control had existed over the contracting of foreign debts. Certain ministries and government agencies close to the President were able to make new obligations without the approval of financial policy-makers. At the end of 1965 Indonesia faced external insolvency. Payments falling due on external debts during 1966 would have been 80% of total exports that same year. About 39% of debts outstanding on 30 June 1966 had been incurred to finance the procurement of military hardware for the Irian and Malaysian campaigns. The first step of the new government in the field of balance of payments was, therefore, to seek a moratorium on its foreign debts in order to lift this heavy burden. The first multilateral meeting with Western creditors was held in Tokyo in September 1966. Subsequently, there were annual agreements on the rescheduling of debt maturities falling due each year. Separate agreements with the same terms and conditions as for Western creditors were negotiated later with Indonesia's East European creditors. In addition, new economic and financial assistance was provided by Western creditors, who joined in a consultative group (IGGI) under the chairmanship of the Dutch government to consider Indonesia's annual aid pledge. 10 The group meets periodically

An Overview

of the Indonesian

Economy, 1968-79

to examine the Indonesian need for foreign assistance in the light of their review of the country's economy, IGGI decisions do not bind the members, but its review sets overall goals that each participant works towards in bilateral aid agreements with Indonesia, The machinery for controlling the new foreign debt (except short-term loans), together with guidelines for contracting it were established by the government on 19 January 1967. The guidelines state that foreign credit will not be authorized unless it offers a grace period of at least 5 years and a maturity period of at least 10 years. Throughout the stabilization and rehabilitation period, a large part of the aid was in the form of food and other essential consumer goods, raw materials, and spare parts. However, since 1969, an increasing share of this aid has been earmarked for financing development projects. A large part of the counterpart funds of foreign aid has been used to help attain a balanced budget. The second steps to control the balance of payments were taken on 3 October 1966. The rupiah was devalued, and foreign trade and payments were liberated. At first (with some simplification) the existing multiple rate system was continued. In this system, there were two separate markets for foreign exchange, namely, the BE (Bonus Export) market and the DP (Complimentary Foreign Exchange) market. Each market had a flexible rate. The BE market was the bigger of the two and the supply of foreign exchange in it came from foreign assistance and the government's share of the export proceeds. The supply in the DP market came from the exporters' receipts of "overprices", their receipts when actual export prices of their commodities were higher than official export check prices, and foreign exchange receipts from invisibles in excess of the surrender requirements. Export check prices are set by government and used as a benchmark for splitting the export proceeds between exporter and government. The foreign exchange fund allots, at official exchange rate, 10% of export proceeds, based on "check prices" to regional authorities ("ADO foreign exchange") in order to help them meet their financial needs. Exports did not flow smoothly since provincial governors were putting pressure on exporters to ship from small, local, inefficient ports in order to maximize each region's share of the export tax. The system was increasingly difficult to defend, especially given the low foreign exchange reserves and the need to accelerate exports. However, the complexity of the system was gradually simplified and on 17 April 1970, it was replaced by a unified rate and the ADO tax was abolished. 11 As had always been, the Indonesian rupiah was pegged to the U.S. dollar, and no par value of it has been established with the IMF. A third step in this area was the resumption of diplomatic and economic ties with Malaysia (in August 1966) and Singapore (on 10 September 1966). The restoration of these relationships not only allowed a resumption of regional trade but also reopened the avenues to international markets, finance, and shipping. To develop the country, authorities recognized and tried to overcome Indonesia's constraints in capital and technical skills. In line with its liberalization policy, the government invited participation of foreign investors in a broad range of economic activities. Foreign properties that had been nationalized in the past were returned to their former owners. In addition, the foreign investment law that had been revoked in 1965 was revised and reinforced in 1967. A foreign investment board, later known as the Capital Investment Co-ordination Board (BKPM), was established to negotiate agreements with individual foreign investors. Domestic private participation was also encouraged. The Domestic Capital Investment law was passed early in 1968, providing the same facilities and guarantees offered to foreign investors. These policies have been successful in repatriating old capital and attracting new inflow of foreign capital.

8

Financial Institutions and Policies in Indonesia

Other Monetary Impacts of the Stabilization and Rehabilitation Programme

As inflation came under control, public expectation of future price increases slowed down and confidence in money was restored. These factors caused two things to happen in the Indonesian economy. First, barter transactions, which had flourished throughout the hyperinflationary period, were reduced. Second, there was an increase in public demand for cash balances. The increases in both monetization and public demand for cash balances were also due to increased production resulting from the reopening of the economy to foreign trade, rehabilitation of the existing production capacity, and subsequent economic development. Transactions in foreign trade activities are clearly conducted by using money, while rehabilitation of transportation facilities reopened land-locked areas and increased production and commercialization. As a result of the continuous increase of non-subsistence activities in the economy (defined as the production of goods and services which are sold rather than used by the producers), the public's demand for cash balances increased to finance their transactions and saving activities. The change in people's expectations about future prices, and the pattern of economic growth help to explain the change in the relationship between money and income velocity of money. During the first period of stabilization and rehabilitation, reduction in price expectation may be stronger than the monetization and growth but after April 1969, growth was more important than further declines in expected inflation. It is clear from Table 1.1 that the rate of growth of the GDP dropped to 1% in 1967 from 3% in 1966. Following Dorrance's argument, 12 investment expenditure fell during that year not only because of money and credit restrictions but also because of a change in expectations which altered the relative attractiveness of different forms of investment. In addition, as Gerakis claims, 13 consumption demand was also directly affected due to government attempts to restrain wage increases that reduced the wage share of the national income. Other possible explanations include the argument in the two-gap model which emphasizes the constraint on growth due to the absence of help to meet balance of payment shortfalls. All of these explanations emphasize the impact of the stabilization programme on effective demand. In addition, exceptional growth rate in 1968 was due to favourable weather conditions that had caused a large increase in agricultural output. Also, as the availability of imported raw materials and spare parts increased, it was possible to increase domestic production by using existing unused capacity.

Resurgence of Inflation, 1973-74 The drought in mid-1972 caused a shortfall in domestic production of rice in the dry season of that year. Unfortunately, other parts of the world also suffered from the same bad weather conditions, and therefore rice import programmes could not help to augment immediate supplies. As a result, food prices in international markets steadily rose over this period. There were shortages of rice in several areas of Indonesia and rice prices in Jakarta rose more than 80% in the last quarter of 1972 alone. According to the cost-push theory of inflation, the increase in rice prices might have affected the prices of other goods and therefore the general price level. Rice prices are important not only because rice is

An Overview of the indonesian Economy, 1968-79

9

the main staple in the Indonesian diet, but also because they seem to influence the prices of many consumer goods and services which generally move in harmony. World-wide inflation which began accelerating in mid-1972 and gained momentum in 1973 also contributed to the sharp increase in inflation in Indonesia at the time. As has been pointed out by Salant and Pattison, 14 under a fixed exchange rate system world inflation is directly transmitted to a country through a rise in the prices of internationally traded goods. In Indonesia's case, increased prices of imported and manufactured goods were directly transmitted as higher prices of domestic consumer goods. Higher prices of imported raw materials, spare parts, and capital goods pushed domestic costs and hence prices upwards. As shown in Table 1.1, the price index of imported goods rose more than 2 Yz times in 1973 over that of 1972. A brief economic boom in industrialized countries that began in late 1971 and lasted until the end of 1973 increased demand for Indonesian exports of non-oil raw materials and thus affected domestic income and liquidity (by means of the familiar income and money multiplier effects). Also depicted in Table 1.1 is a comparison of price indices which shows that exports rose by more than 100% in both 1973 and 1974. Improvement in exports in those years was accompanied by heavy foreign borrowings by both the domestic banking systems and various enterprises. This contributed to further increase in domestic liquidity. According to the demand-pull theory of inflation, increases in both income and liquidity resulted in increased prices. In addition, Indonesia raised the prices of its oil exports by 27% in 1972 and 61% (to $6) in 1973 in line with the actions taken by major Middle Eastern oil producers. Table 1.1 shows that the price of Indonesian crude oil in 1973 was more than 259% of the price in 1970. At the same time, the government changed its income-sharing arrangements with foreign oil companies so as to raise its share of total revenues. These developments brought about a large increase in the foreign exchange resources available to the Indonesian economy. As will be discussed in the next section, the role of oil revenues in the government budget became more important. In 1967, they made up 43.9% of the revenue from direct taxes and 12.3% of the domestic receipts of the government. In the fiscal year 1972/73 these percentages were raised to 65.8% and 33.6% respectively. Because of the growing volume of external receipts in foreign exchange passing directly through the government's expenditures (in domestic currencies), the government budget again became the main source of increase in the money supply and, hence, inflation. During the period of hyperinflation in the early 1960s, the budget was the main source of inflation because its deficits were financed by central bank credit. Since 1972, the budget has been inflationary because its receipts are mainly in the form of foreign exchange while its expenditures are mainly in domestic currency. The rising inflation rate also restored expectations about future price increases. This caused further aggravation in inflation as well as increases in income velocity (see Table 1.1). Rising expectations and time lags in imports also induced traders to speculate. Some consumer items and raw materials disappeared from the market entirely and that also produced increases in prices. 15

The Second Stabilization Programme, 197 4-78 The inflation and income velocity rates rose to their peak of 33% and 13.3% respectively in 1974. The initial response of the authorities to this was to attack its symptom by substantial expansion of direct subsidy payments on a wide range of consumer goods. The

10

Financial Institutions and Policies in Indonesia

New Order government has continuously controlled and subsidized several goods such as rice, wheat flour, corn, soya beans, salt, sugar, cotton and yarn, and newsprint. Fertilizers, pesticides, refined petroleum products for domestic use (mainly kerosene, diesel, and bunker oil), bus fares, electricity, drinking water, and user charges for government supplied services in health, education, and other areas have also been subsidized at times. A special Logistic Agency or Bulog (Badan Urusan Logistik) was established to stabilize the prices of subsidized food items, and the state oil company was responsible for a monopoly in the distribution of refined petroleum products throughout the country. Sometimes the government temporarily banned exportation of certain agricultural products which were also consumed domestically, such as copra, cooking oil, and coffee, as an additional effort to curb domestic inflation. A policy of moral suasion to restrain banks' credit expansion was introduced in 1973. Under this policy banks were required to observe self-restraint and to submit their credit programmes regularly to the central bank for review. However, as inflation continued to rise, authorities introduced a package of measures (in April 1974) to control credit expansion by the financial institutions and foreign borrowings of the private sector; and to stimulate time and savings deposits, with the objective of reducing the rate of growth of reserve money. To reduce credit expansion by the banking system, the central bank gave up its indirect control by setting a separate ceiling for each individual bank and for the Bank Indonesia's own direct credit. The ceiling, introduced on 9 April 1974, was different from the previous one in the sense that the authorities not only set the upper limit of the net domestic assets (NDA) of the banking system, as in the past, but also set the maximum allowable expansion oflimit of banks' net foreign assets. Under the IMF standby arrangements over the period 1968-1973/74, ceiling techniques had been used mainly to control the upper limit expansion of the banking system's net domestic assets because the role of private capital inflow in the banks' net foreign assets (NF A) was insignificant before 1972. To supplement the ceilings, authorities doubled reserve requirements against the banks' time and savings deposits to 20%, while all reserve requirements were strengthened by the exclusion of net interbank balances from reserve. Interest rates on commercial bank loans were raised selectively, and categories of loans also changed, together with their liquidity credit mechanism and re-discount rate structure. To stimulate the flow of domestic resources through the banking system, interest rates on time and savings deposits with longer maturity were raised and new schemes of 18-month and 24-month deposits were introduced at state banks. One third of the interest on 18-month deposits and half of that on the 24-month deposits were subsidized by the government. The interest rate on Tabanas, savings under the National Development Savings Scheme, was also raised. Control of NFA was accomplished through ceilings on foreign borrowings by banks, non-bank financial institutions, and private enterprises. The ceiling on foreign borrowings by foreign exchange banks was extended to all liabilities resulting in payment obligations to non-residents other than non-bank financial institutions. Moreover, the reserve requirement of 30% on the foreign liabilities of these banks was strengthened by requiring that all of the reserve be maintained with the Bank Indonesia in interest rate free dollar denominated deposits. The same deposit requirements were also imposed on foreign liabilities incurred by non-bank financial institutions and private sectors. On the supply side, the government increased importation of food items and built a massive "national buffer stock" at the cost of the government budget, to insulate domestic from world rice prices. Although Indonesia has been a big rice buyer, it buys about one

An Overview of the Indonesian Economy, 1968-79

11

third at international market prices; with its oil money it has been able to purchase at the going market price, as a small buyer does, from oil-poor and cash-hungry rice-producing countries. The iron stock also included cement, newsprint, certain types of paper, car tyres, asphalt, cotton weaving yarn, sheet iron, raw materials for maritime industries and for pharmaceuticals. In addition, import duties for a wide range of raw materials and spare parts, as well as domestic sales taxes on basic necessities, were lowered. These supply measures helped to break down people's inflationary expectations. Although this programme did not directly attack the prime source of inflation, namely the budget, the rate of growth of money was substantially reduced, from 40% in 1974 to 33% in 1975. These developments in the monetary sphere were accompanied by a sharp reduction in the rate of inflation, from 33% in 1974 to 20% in 1975. Velocity of money dropped from 13.3 in 1974 to 11.6 in 1975 (see Table 1.1). Unexpected external and internal factors also supported the stabilization measures. As a result of the 1973 energy shock, and the continued high prices of food and other agricultural products accompanied by bad economic management, the economic expansion in industrialized countries began to decelerate in the third quarter of 1973 and finally slid into stagnation in 197 4. The economic downturn in the industrial nations had spread rapidly throughout the rest of the world. Stagnation in industrial countries reduced demand for Indonesian non-oil exports such as timber, tin, and rubber. Reduction in exports affected banks' liquidity positions as well as domestic income and effective demand (through the money and income multipliers mechanism). Early in 1974, developing countries, including Indonesia, faced increasing difficulty in borrowing on the Euro-currency market, and in mid-1974 the market tightened temporarily to consolidate its portfolios after rapid expansion the previous two years. This reduced the capital inflow that also held down the rate of growth in domestic liquidity. The Pertamina, the state oil company, financial disaster surfaced during the last quarter of 1974 when it diverted $820 million of the taxes it collected from foreign oil companies on behalf of the government to pay its short-term debts. Early in 1975 it failed again to repay its debt and creditor banks declined to roll it over. Pertamina is the only state oil enterprise in Indonesia that holds exclusive right over the extraction and sale of Indonesian oil and gas reserves. Besides its activities in the oil business (including supervision of foreign oil companies on behalf of the government) it is also engaged in non-oil ventures such as cattle breeding, airlines, petrochemicals, fertilizer, rice estates, a large steel mill, luxurious real estate, and tourist hotels and resorts scattered in various parts of the country and abroad. Some of these non-oil activities were undertaken, on direct presidential order, without being budgeted for. During its heyday, Pertamina was "a state within a state", had special access to the President, and was beyond the control of economic financial authorities. Pertamina's investment expenditures had expanded rapidly during the previous five years ( 1969-7 4 ). Against Indonesian regulations, its capital expenditures were financed mainly by short- and medium-term foreign borrowing. In 1972 its short-term debt was estimated at about $260 million and by the time the government stepped in (May 1975), it had mounted to $10.6 billion or about one third of the Indonesian GDP for that year. One third of this was domestic debt, another third was foreign debt, and the final third involved contingent liabilities on oil tankers. Because of the size of Pertamina's debt, the government took it over and overhauled the management early in 1975. The government also reviewed Pertamina's investment plans, which resulted in modification and cancellation of certain projects. The government also transferred responsibility for non-oil projects to relevant ministries and public enterprises.

12

Financial Instz'tutions and Pohcies in Indonesia

Some of Pertamina's foreign debts were renegotiated sharply downwards and some of its projects were dropped while for some others, better terms were renegotiated. Since then, Pertamina's functions have been limited to oil and gas-related activities spelled out in its government approved budget. It is also required by the government to obtain explicit permission before it undertakes new borrowing in international markets. The Pertamina debacle had a detrimental effect on the economy because of its size and wide range of operations. To bail it out the government was forced to divert resources from elsewhere which slowed down its development activities since, unlike other OPEC member countries, the level of Indonesia's international foreign exchange reserve was not high. As a result, the real rate of growth of the GDP in 1975 was only 5%, the lowest during the administration of the present regime (see Table 1.1 ). From a monetary point of view, the crisis and unfavourable international conditions reduced the liquidity both from capital inflow as well as from the government budget. It turned out that these external factors were more powerful than the government ceiling programme itself in bringing down the inflation rate in 197 5. The economic slump in developed countries bottomed out some time during the summer of 197 5. After a brief respite, inflation in most of these countries again accelerated in 1976. These developments produced different effects on various Indonesian exports. Terms of trade of petroleum products and manufactured goods were not adversely affected, but non-oil export prices suffered serious deterioration. Moreover, because international demand for non-oil exports was weaker than for oil and for manufactured goods, international economic conditions hit farmers and the agricultural sector while benefiting the oil and manufacturing sectors. At the same time, the exchange rate, stable over the previous seven years, became overvalued. Domestic inflation rates were continuously higher than those of the rest of the world. This and the depreciation of the U.S. dollar further reduced the income of export producers. To correct the overvaluation of the rupiah, the government devalued it on 15 November 1978. In the past the rupiah was pegged to the U.S. dollar, but began from this date to be tied to a basket of currencies of Indonesia's trading partners. To moderate cost-push pressures of the devaluation, the government reduced import duties for a wide range of imported raw materials and spare parts for domestic industries, as well as the domestic sales tax for manufactured goods. The government announced that no salary increases would be given to its employees in the 1978/79 budget year and encouraged the private sector to follow suit. Prices of subsidized goods were maintained at their pre-devaluation levels. To secure its targeted inflation rate, the government did not hesitate to use temporary direct control on prices at the expense of producers or repressive punishment for those who did not follow its price guidelines. To secure a sufficient supply of export items for local markets at prices below the levels prevailing in world markets, in the months following devaluation, certain tradable goods were made subject to export licensing. Domestic manufacturers of over 200 commodities were required to follow the government guidelines and to obtain government approval before they could increase the prices of their products. For those poor people who produce those goods, they not only could not benefit from devaluation, but they also suffered from government control. On the monetary side, the government tightened the credit expansion to prevent the emergence of compensatory price and wage increases in non-traded goods, and sufficiently enough to finance necessary price adjustments for traded inputs in order to avoid contraction of output. The results of these policies are clear from Table 1.1. The money supply increased from 24% in 1978 to 33% in 1979. The inflation rate increased to 24% in 1979 and income velocity of money rose from 9.7 in 1978 to 10.6 in 1979.

An Overview of the Indonesian Economy, 1968-79

13

Column 5 of Table 1.1 shows that, except in the years 1968, 1973-74, and 1979, the velocity of circulation of money declined throughout the 1966-79 period. \Vhile real interest rates were high in the early part of the period, most of the decline is best understood as a return to conditions of relatively low inflation rates. That is, most of the drop in velocity took place from 1966-68 to 1972, a period of rapid declines in the inflation rate. Except for the year 1974, when an inflation rate of over 30% combined with credit restraint drove velocity to over 13, velocity has fluctuated mainly in the 10-12 range since 1972. Thus rapid initial declines represent a recovery to normal use of money in the economy. Since then, the small fluctuations have been better understood in terms of changes in credit demand vis-a-vis supply-changes which are not well captured in domestic interest rates. It is true that money growth has exceeded the product of real growth and the consumer price index in the 1975-80 period. This is largely due to the slower growth of the CPI than the GDP deflator, caused mainly by subsidies to a few goods heavily weighted in the CPl. In fact, there has been a fairly tight relationship in recent years between money growth and nominal GDP growth. Money in December 1979 was 2.05 times its December 1976 level, while GDP in 1979 was over 1.98 times its 1976 level.

BUDGETARY TREND AND POLICIES Many authors have delineated the economic goals of the Indonesian government as well as the characteristics of its fiscal system (for example, Gnossen, Peacock and Shaw, Booth, Glassburner, Lerche, and Booth and McCawley). 16 In order to provide a background for this analysis, the goals and the common denominators of these characteristics are discussed here. As mentioned earlier, strict budgetary discipline in the form of a balanced budget made a significant contribution in the fight against hyperinflation of the early and middle 1960s. However, with the rather sudden and substantial rise in oil revenue, budgetary policy has had a new and crucial role to play in the pursuit of stability, equity, and development. In the fiscal field the goals of the present government have always been (a) to neutralize the demand impact of the budget; (b) to improve tax collection and strengthen tax administration; and (c) to increase the proportion of expenditures towards development. The role of the budget as a stabilizer is discussed below, the trend in tax revenue and tax efforts is analysed, and trends in government expenditures are described. Before we proceed with our discussion, it must be made clear that the government budget in Indonesia only covers the financial transactions of the public sector in the narrow sense. It is limited to the central government's activities and thus does not cover the transactions of regional governments, state enterprises, and autonomous agencies. In a mixed economic system such as Indonesia's, the role of public enterprises is not insignificant and even dominates in some segments of the economy. Due to the lack of information from these "other public sectors", it is impossible to analyse the impact of the Indonesian economic policy on the overall public sector. Moreover, as will be shown later, to maintain a budget balance or surplus, some of the government expenditures are "hiding" behind the Bank Indonesia credit and some in the balance of payments. However, the budget is a very important part of the total financial activities of the entire public sector.

14

Financial Institutions and Policies in Indonesia

The Budget as Stabilizer To pursue its first objective, the government adhered to its balanced budget policy. A balanced budget is defined as one in which total expenditures are equal to the sum of routine (current) revenues and development revenues (foreign borrowing). This prevents significant change in the government's cash balance and thus borrowing from the domestic banking system. The change in cash balance as defined by the IMF is equal to the budget surplus or deficit as formally defined in the budget. The government set its objective to reduce dependency on foreign borrowing and aid, over time. The goal was to finance development expenditures by increasing savings, defined as current revenues minus routine expenditures. Table 1.2, which summarizes budgetary trends, shows that in all years overall deficits were totally financed by foreign assistance or net foreign borrowing; there were only relatively small changes in cash balances. Expenditures in the years 1968-78 were, therefore, financed by means which either reduced domestic purchasing power or added to the real resources of the economy. In this sense, it could be argued that the budget had no significant impact on total demand. However, the picture is quite different from a monetary point of view, especially since the volume of external receipts and payments that passed directly through the budget increased significantly. In order to examine the impact of fiscal policy on the domestic economy, it is useful to disaggregate the government budget into foreign and domestic transactions. Government expenditures abroad, including domestic purchases from importers, do not directly add to the demand for goods that are produced domestically and therefore, do not increase domestic output and employment. Similarly, government receipts from abroad are not withdrawals from domestic purchasing power. Foreign aid and borrowing inject into the domestic economy part of the purchasing power of the donor countries. Government oil revenues from corporation taxes on foreign oil companies and other revenues collected from foreign firms and personnel are not withdrawals from the income stream of the domestic private sector, since they would otherwise have been repatriated abroad.

TABLE 1.2 Government Finance, 1969/70-1978/79 (Billions of rupiahs) 1969/70

1972/73

1975/76

1978/79

A. Revenue

266.3

589.3

2271.1

4339.5

B. Expenditure

342.5

729.6

2676.0

4461.3

C. Deficit (-)/Surplus ( + )

-76.2

-140.3

-404.9

-121.8

1. Net Borrowing (a) Bank Indonesia (b) Foreign

6.6 76.8

77.5 134.6

418.5

0.4 110.7

2. Unused Cash Balance

-7.3

-71.9

-13.6

10.8

E. D.1(a) as % of C

8.7

55.2

F. D.1(b) as % of C

100.8

95.9

103.4

90.9

-51.1

-3.4

8.8

D. Financing:

G. D.2 as % of C

Source:

IMF, IFS, various issues.

-9.6

0.3

An Overview of the Indonesian Economy, 1968-79

15

As shown in Table 1.3, the government revenue from oil has been higher than the volume of its revenue from foreign aid and borrowing since the "oil-boom" in 1973. Since that time the receipt of oil revenue has become the major factor underlying the rise in foreign assets of the Indonesian monetary system. This receipt has no monetary impact as long as it is placed in government deposits. Only if the government injects this revenue into the domestic income flow, through its domestic expenditures, is the inflow of foreign exchange converted to domestic liquidity. The monetary impact of foreign aid and grants, which are usually in the form of goods and services produced by donor countries, is negligible compared to government revenues in the form of foreign exchange. It is therefore the size of the deficit or surplus of domestic budget that determines the inflationary impact of the overall budget in the short run. In short, as has been correctly pointed out by Morgan, the relevant transmission mechanism in this kind of economy is not the balance of payments but rather the government budget. 17 Although it is theoretically appealing, this analysis is difficult to apply in the real world because no government separates its budget into domestic and foreign transactions. This difficulty was realized by Norris, and Booth and McCawley, when they attempted to apply the analysis in the Indonesian budgetary context. In Norris' paper, foreign revenues of the budget are corporate oil taxes, foreign aid and net foreign borrowing. He realized that a portion of export tax falls into this category but he had no information to trace these data. Foreign expenditures, in his classification, consist of subsidies on imported goods, imports under the development budget and debt servicing on the expenditure side. To estimate imports under development expenditures he assumed that "those imports bear the same relationship to development expenditure (net of fertilizer subsidies) that total Indonesian capital imports do to total investment as shown in the Indonesian national account" (Norris, note to Table 1). In Booth and McCawley's paper, the only foreign revenue is the proceeds from oil company taxes. On the expenditure side they assume that all project expenditures (29% of the total budget) were spent overseas. Other non-project development expenditures ''were allocated on a somewhat arbitrary basis after discussions with various authorities". For example, for 1976-77 Booth and McCawley assumed that 45% of all departmental expenditures and 15% of the regional development subsidies were spent overseas. 18 If we stick to the definition of foreign receipt as not withdrawing from domestic purchasing power, it has to include export tax and other taxes on branches of foreign business and personnel in Indonesia (as discussed above). These revenues, which are not included in Norris or Booth and McCawley's papers, may be insignificant compared to oil revenues but they are significant in the share of non-oil taxes. 19 Secondly, as pointed out by Glass burner, the budget is a poor indicator of the stabilizing effects of the government sector as a whole since the budget does not cover the financial transactions of the entire sector. Foreign transactions of the state's public enterprises (including Pertamina) and extra budgetary expenditures of the Department of Defence and Bulog are not small even when compared to the formal budget. Nevertheless, the message is clear. Since the domestic deficit of the government budget, which has risen sharply since 1972/73, is always financed by foreign surplus, the government budget has become the primary expansionary factor affecting money supply, and hence inflation, in Indonesia. The difference between the present regime's budget and that of its predecessor, is in the size of the conventional definition of the budget and the means of financing it. Compared to previous budgets, the deficits, as a percentage of the total in the present budget, have been reduced dramatically (see Table 1.2). The previous regime financed its domestic budget deficits with credit from the central bank while the present one borrows from abroad and uses budgetary surpluses in the foreign segment of the budget.

16

Financial Institutions and Policies in Indonesia

Trends in Government Domestic Revenue and Tax Effort Government domestic revenues have been steadily rising under the new regime (Table 1.3). This is the case even if the increase in revenues from the corporation tax on oil companies is excluded. During the period of this study, 1968-1978/79, the average annual increase in total revenues in nominal terms was 41.4 7% , and for revenues excluding oil it was 32.2% . These rates of increase in revenue are greater than the average growth rates of the nominal GDP (28.3%) during the same period. This has led to an increase in the domestic tax ratio, including oil, from 7.1% in 1968 to above 18% after 1976/77excluding oil, the ratio has grown from 6% to above 8%. The rise in revenue figures does not alone suggest an excellent revenue performance. An increase in tax revenues could be due to several factors. First, the rise in revenues could be because of an increase in the tax base, be it due to inflation or real growth of the economy. Second, the rise could be due to an introduction of new taxes, reduction in exemptions, or increases in the tax rate. Third, the rise in revenues may be due to improvements in the tax administration, its coverage, and enforcement. The implications of each factor are quite different. It is natural for revenue to rise with an increase in the tax base. An increase in revenue also rises along with inflation and shows the government effort to maintain its revenue in real terms. The fact that the TABLE 1.3 Government Revenues, 1966-1978/79 (Billions of rupiahs)

1966

1969/70

1972/73

1975/76

1978/79

Routine Revenues

13.142

243.704

509.608

2241.850

4266.075

A'. Routine Revenues (excl. oil revenue)

12.531

195.372

391.723

992.791

1957.370

1. 790 640.0

91.468 12.060 15.640 48.332 15.268 168.0

302.229 23.722 30.598 198.885 30.195 18.829

1592.028 61.725 128.136 1249.059 97.308 55.800

2996.286 122.215 226.473 2308.705 232.469 106.524

68.086 15.099 32.090 17.460 3.437

120.007 34.491 47.279 31.563 6.674

231.360 119.231 97.307 -1.078 15.900

491.379 221.079 252.902

80.983 57.671 7.447 15.869 3.167

133.763 73.223 32.739 27.801 34.609

308.053 174.011 61.600 72.442 110.409

586.987 295.287 166.187 125.513 191.423

Development Revenues

91.058

157.800

491.639

1035.501

1. Foreign Credit

65.761

2. Project Loans

25.297

95.500 62.300

20.269 471.370

987.300

334.762

748.408

2733.489

5301.576

A.

1. Taxes on Income (a) Personal (b) Corporate (c) Oil (d) Withholding• (e) Other (incl. land tax) 2. Taxes on Consumption (a) Sales tax (b) Excises (c) Other oil revenue (subsidy) (d) Other 3. Taxes on International Trade (a) Import duties (b) Export duties (c) Sales tax on import 4. Non-tax Revenue B.

611.0 539.0 4.876 1.717 2.220 79.0 860.0 5.655 3.689 1.966 821.0

TOTAL (A & B)

Source:

Bank Indonesia, INFS, various issues.

• See text for explanation.

13.142

17.398

48.201

An Overview of the Indonesian Economy, 1968-79

17

increase in revenues is higher than the GDP growth rate of recent years facilitates a rising level of government budget and its public savings. Failure of revenue to respond to increases in the tax base may reflect weakening administration, or collection lags which are unresponsive to a rising tax base. An increase in revenue due to the introduction of new taxes or to higher rates, and increases defined as the ratio of total taxes to GDP, indicate an increase in tax efforts achieved through improvement in administration and taxpayer compliance. Given the available data, it is impossible to single out the contribution of each of the above factors in increasing revenue in Indonesia. An overall view of tax performance is given in Table 1.4. Column P presents percentages of revenue from various sources to the GDP. Due to several rounds of increase in the price of oil, oil revenues rose from less than 2% of the GDP during the period before 1971172 to a little above 10% of the GDP after 1978/79. The shares of non-oil revenues (to GDP) are relatively stagnant. Percentages of income, corporation and withholding taxes, all as a percentage of the GDP, did not increase along with the increase in employment, growth, and number of business establishments as expected. The share of sales taxes on imports declined after 1973/74; the domestic sales tax revenue increase after the same year may be because more finished goods imported in previous years were assembled domestically. The decline in import duties can be explained by the same reason. As the share of capital goods, raw materials, spare parts, and subsidized consumer goods has increased in total imports, more imports have fallen to lower brackets of duty rates. The rates of growth of each source of revenue are given in the R columns of Table 1.4. The impressive rates up to 1969/70 reflect the improvement in tax collection, introduction of new taxes, and reclassification of import duties during the first years of the present government. Sales tax for import goods, for example, was introduced in 1969. A new tariff, based on the Brussel Tariff Nomenclature (BTN), came into force on 31 January 1973. Increases in export tax revenues in 1967 were mainly due to the effects of reopening the economy to the world community, reducing export tax rates to realistic levels, and dismantling the foreign exchange system. Further increases in export taxes (by 236% in 1973/74) reflect the strong international demand for non-oil raw materials at that time (as discussed earlier). Contrary to expectations, oil revenues show an impressive growth (191%) in 1974/75, the year of the Pertamina crisis. The crisis did not affect the budget since the government financed its oil revenue shortfall (that withheld by Pertamina) by borrowing from the Bank Indonesia which in turn borrowed from abroad. Elasticities of each source of revenue are given in the E columns of the table. The same pattern, as for previous ones, holds here. There was high tax elasticity for major sources of revenues and low elasticity for others. As we will see from the discussion on the structure of government revenue later in this subsection, income, corporation, oil, and withholding taxes are the major contributors to the direct tax group. Import duties, domestic sales tax excises, and sales taxes on imports and exports are the major sources of indirect tax revenues. Variability in elasticities reflects the weakness of the Indonesian tax system. As Lerche has discussed in great detail, 20 tax revenues are collected based on the target system as with a traditional "tax farming" system. In this system, each year when the government prepares its forthcoming budget, it sets a target for tax revenues that must be collected by the Directorate-General of Taxes. The target is set from the top down to lower tax administrative units and is hardly related to the ability of taxpayers to pay or to the economic conditions of various regions. Local tax collectors negotiate tax payments from prospective taxpayers, subject to tax regulations and the target.

o;

TABLE 1.4 Government Revenues as Percentage of GDP, Their Rates of Growth and Elasticities, 1966-1978/79 1967

p

R

E

p

A. Direct Tax 1. Income Tax 2. Corporation Tax 3. Oil Revenues 4. Withholding Tax (MPO) 5. Land Tax (IPEDA) 6. Other

2.0 0.4 0.4 0.9 0.1

839 389 0 1109 0

5.0 2.3 0 6.6 0

3.4 0.4 0.6 1.8 0.6

B. Indirect Tax 1. Sales Tax 2. Sales Tax on Import 3. Excise Tax 4. Import Duties 5. Export Tax 6. Other Receipts from Oil 7. Other

0 0

1972/73

1969/70

1975/76

1978/79

R

E

p

R

E

p

R

E

p

R

E

79 28 65 89 140

2.7 0.9 1.2 3.0 4.7

5.0 0.4 0.5 3.3 0.5

67 36 20 77 23

1.0 0.6 0.3 1.2 0.3

12.6 0.5 1.0 9.9 0.8

29 42 41 28 17

1.6 2.4 2.2 1.2 0.9

13.7 0.6 1.0

19 17 33

0 0

0.3 0.1

0 0

0 0

0.3 0.2

24 115

0.2 0.7 0.4

4.3 0.9 0.6

18 40

0.3

0 0

0 0

5.0 0.5 0

0 0 300 144 0

0 0

1.8 0.9 0

5.5 0.6 0.6

58 65 163

1.9 2.2 5.5

4.2 0.6 0.5

44

0.8 2.0 1.3 0.2

215 358 439 1938

1.3 2.1 2.6 11.5

1.2 2.1 0.3 0.6

94 55 -47 125

3.2 1.8 -1.6 4.2

0.8 1.2 0.5 0.5

17 5 17 12

0.3 0.2

0.8 1.4 0.5 0

0.2

108

0.6

0.3

7

0.2

0.1

-5

-0.1

0.1

16 24

0.1

10.6

18

1.0

15

1.3 1.1 2.2 1.3 1.0

1.3 6.4

0.3 0.2

20 26

1.7

0.9 2.2 0.3

4.9 1.0 0.6

22 9

31

1.7

8 -12 -93

0.4 -0.7 -5.1

1.2 1.4 0.8 0

5

0.3

0.1

5

10

1.3 1.5 0.6 0.6

39 2.6 3 0.2 105 7.0 0 0 39

2.6

~~ ~

[

:::.·

"::;·

. ~

""'~

~

~·

:;;·

"'"

§~

;;;·

:>..

"

f

~·

~

~

"'

!}

~

TABLE 1.4 (Continued) Government Revenues as Percentage of GDP, Their Rates of Growth and Elasticities, 1966-1978/79

p

C. Non-tax Receipt D. Routine Receipt (excl. A.3) E. Routine Receipt (A + B + C) F. Total Revenue (incl. Foreign Aid) Source:

R

E

p

R

§

E

p

R

E

R

E

p

R

E

3.6 1.5

0.9 9.0

33 23

2.2 1.6

1.5

19.5

21

1.4

0.2 6.2

58 322

0.3 1.9

0.1 7.2

-33 57

1.1

1.9

0.6 6.5

26 24

0.4 0.4

0.9 7.9

7.1

358

2.1

9.0

63

2.1

9.7

38

0.6

17.7

28

12.3

12.3

.....

p

6 27

10.0

~

1978/79

1975/76

1972/73

1969/70

1967

o;·

"~

21.6

~ ~

24.2

Computed from Table 1.2.

Notes P: R:

E:

percentage over (calender year) GDP; rate of growth over previous year; AGDP AT elasticity: GDP. T

The figures may not add up equal to total revenue due to rounding off.

..

"0

"' ~

~-

~

~

"'

§..

~

;:;·

r "

~ ._

~

TABLE 1.8 Increase in Government Expenditures Divided by Increase in Its Revenue (Percentages)

Personnel Expenditure Material Expenditure Subsidies to Regions Debt Repayment Other Expenditures Development Expenditure Source: Note:

~

1967

1968

1969/70

1970171

1971/72

1972/73

1973/74

1974/75

1975/76

1976/77

1977/78

1978/79

24.4 17.3 9.8 4.6 5.8 19.2

37.2 18.1 16.6 6.2 1.4 17.9

23.4 7.9 12.4 3.0 -2.0 55.3

21.2 9.4 9.2 8.6 6.6 39.6

32.4 4.6 10.8 21.3 -7.3 26.6

20.0 15.3 9.3 4.2 -0.1 55.4

16.2 3.5 5.8 3.8 35.4 36.1

18.6 8.0 11.5 0.4 -1.2 62.8

23.2 17.4 11.0 0.6 -9.9 58.3

4.5 3.6 3.0 11.6 8.4 68.7

41.5 6.0 26.7 6.3 3.4 16.6

10.9 4.3 4.4 30.8 9.4 40.2

Computed from Tables 1.3 and 1.5. Total of each column may not be exactly equal to 100% due to rounding off.

""""

24

Financial Institutions and Policies in Indonesia

be in conflict with one another. Expansion of welfare programmes and other domesticoriented expenditures for equity and creation of employment are inflationary because of the inability of the tax system to moderate the increase in effective demand, the longer time lag in import, or the inelasticity of supply of both tradable and non-tradable domestically produced goods in non-oil sectors. Slow growth in non-oil production constrains the growth objective. Morgan correctly pointed out that oil producing countries, so far, have only been able to remove one development bottle-neck, namely, that of financial resources. Other limitations to development, such as technical and managerial skills, remain. To remove them requires concerted efforts over a longer period of time. For a vast country like Indonesia, none of these other bottle-necks to development have been removed. Its additional resources from oil revenue ease the financial constraint somewhat, but do not nearly eliminate it. In the case of civil servants, for example, Gray found that increasing salaries and improving the equipment they have to work with alone have hardly improved their attitude and performance towards promoting development. 23 Pursuing growth only by using more imports in the development projects may have helped to sterilize the foreign surplus of the budget, but produced little domestic value added and created few new jobs. Some balance must be found between these objectives since it is impossible to achieve them all at the same time. As the now famous Tin bergen law dictates, 24 one needs a number of instruments at least equal to the number of objectives. It is only by pure chance that fewer instruments can influence all objectives in the desired direction.

NOTES 1. The coup attempt and its aftermath have been described in detail in J. Hughes, Indonesian Upheaval (New York: McKay, 1967). 2. Benjamin Higgins, Economic Stabilization and Development in Indonesia, Secretariat Paper No. 8, Institute of Pacific Relations, 1954. This paper and Benjamin Higgins and Jean Higgins, Indonesia: The Crisis of the Millstone (Princeton, N.J.: D. Van Nostrand, 1963), describe the failure of efforts to stabilize and develop the economy of Indonesia during the 1950s due to an endless bitter struggle for power between political groups of the country. Valuable study of the interaction between political and economic developments in Indonesia is to be found in Hans 0. Smitt, Foreign Capital and Social Coriflict in Indonesia, 1950-58 (University of Wisconsin: Social System Research Institute, 1961). For the period 1959-66 see J .A. C. Mackie, Problems of the Indonesian Inflation (Cornell University, Southeast Asian Program, Monograph Series No. 42, 1967). A valuable review of the economy during recent years is in David 0. Dapice, "An Overview of the Indonesian Economy", in The Indonesian Economy, ed. Gustav Papanek (New York: Praeger, 1980), pp. 3-55. 3. Indonesia withdrew from the IMF and the World Bank group on 17 August 1965 and rejoined the IMF on 21 February 1967 and the World Bank on 13 April 1967. 4. Studies of monetary development in Indonesia covering the period before 1968 are Douglas S. Paauw, "From Colonial to Guided Economy", in Indonesia, ed. Ruth McVey (New Haven, Conn.: Yale University Press, 1963); J.A.C. Mackie, ibid.; H.W. Arndt, "Banking in Hyperinflation", BIES, October 1966; R.M. Sundrum, "Money Supply and Prices: A Reinterpretation", BIES, November 1973; and Bijan B. Aghevli and Mohsin S. Khan, "Inflationary Finance and Dynamic of Inflation: Indonesia, 1951-1972", AER, June 1977. 5. The elements of the stabilization programme in Indonesia during the period 1966-69 have been discussed in Gunnar T omasson, ''Indonesia: Economic Stabilization, 1966-1969'', Finance and Development, December 1970, pp. 46-53. 6. According to Park: " ... the credit rationing channel is likely to be the most powerful source of transmission of monetary changes to the real economy in LDCs". (Yung Chul Park, "The Role of Money in Stabilization Policy in Developing Countries", IMF-SP, July 1973, p. 394.)

An Overview of the Indonesian Economy, 1968-79

25

7. Arndt, op. cit., p. 75. 8. Exchange rate systems during the pre-1966 period have been discussed in detail in W.M. Corden and J .A.C. Mackie, "The Development of the Indonesian Exchange Rate System", Malaysia Economic Review VII, no. 1 (April 1962); and Kanesa S. Thasan, "Multiple Exchange Rates: The Indonesia Experience", IMF-SP, July 1966. 9. The Federation of Malaysia was proclaimed on 15 September 1963. Diplomatic relations were interrupted when Indonesia refused to grant diplomatic recognition and on 21 September 1963 Indonesia announced a prohibition of all trade with Singapore. 10. The group held its first meeting in February 1967 and since then it has been known as the InterGovernmental Group on Indonesia (IGGI). The members of IGGI are Australia, Belgium, France, West Germany, Italy, Japan, the Netherlands, New Zealand (since 1971), the United Kingdom, and the United States of America. Observers are Austria, Denmark, Norway, Switzerland, OECD, IMF, IBRD, ABD, and UNDP. On the IGG I, see G .A. Posthumus, ''The Inter-Governmental Group on Indonesia'', BIES VIII, no. 2 (July 1972). 11. The recent systems are discussed in Bruce Glassburner, "Pricing of Foreign Exchange in Indonesia, 1966-1967", EDCC XVIII, no. 2 (January 1970); and in Lawrence]. White, "The Indonesian Foreign Exchange System, 1966-1971" (Paper presented at the NBER Conference on Exchange Control, Liberalization, and Economic Development, 24-26 February 1972). 12. Graeme S. Dorrance, "The Effect of Inflation on Economic Development", IMF-SP X (1963). 13. A.S. Gerakis, "Recession in the Initial Phase of a Stabilization Program, the Experience of Finland", IMF-SP XI (1964). 14. Walter S. Salant, "International Transmission of Inflation", in Worldwide Inflation, ed. L.S. Kraus and W.S. Salant (Washington, D.C.: The Brookings Institution, 1977), pp. 167-227; and john C. Pattison, "The International Transmission of Inflation", in Inflation in the World Economy, ed. M. Parkin and G. Zis (Manchester: Manchester University Press, 1976), ch. 11. 15. Jack Boorman, "Inflation: Analytical Background, Indonesia's Experience and Current Worldwide Developments" (Lecture Outline, Bank Indonesia Course for Managing Staff, 9 August 1975), p. 23. 16. Sijbren S. Gnossen, The Indonesian Sales Tax: Status and Structure, Technical Features (Deventer: Klewer, 1973); A. Peacock and G.K. Shaw, "Fiscal Measures to Create Employment, the Indonesian Case", Bulletin for International Fiscal Documentation XXVII, no. 4 (1973); Ann Booth, "IPEDA-Indonesia's Land Tax", BIES IX, no. 1 (March 1974); Bruce Glassburner, "Budget and Fiscal Policy Under the Soeharto Regime in Indonesia, 1966-1978", EKI XXVII, no. 3 (September 1979); D. Lerche, "Efficiency of Taxation in Indonesia", BIES XVI, no. 1 (March 1980); Ann Booth and Peter McCawley, eds., The Indonesian Economy in the New Order Period, ch. 5, forthcoming. 17. Theoretical analysis of the monetary implication of the budget in the oil exporting countries is described rigorously in David R. Morgan, "Fiscal Policy in Oil Exporting Countries", IMF-SP 26, no. 1 (May 1979). The application of the theoretical analysis in the Indonesian context is in J .A. Norris, "Expansionary Impact of the GOI Budget", USAID/EA, 10 February 1975; and in Booth and McCawley, ch. 5, op. cit. 18. Booth and McCawley, ibid., pp. 5-47. 19. According to Lerche, foreigners are likely to pay their tax obligations according to the regulations since "they share neither the benefits nor the obligations in the Indonesians' compromise tax system". 20. Lerche, op. cit., pp. 50-51. 21. S. Reutlinger and Marcelo Selowsky, "Undernutrition and Poverty: Magnitude and Target Group Oriented Policies", World Bank Staff Paper No. 22 (December 1975), p. 70. 22. Saleh Afiff, Walter P. Falcon, and C. Peter Timmer, "Elements of a Food and Nutrition Policy in Indonesia", in The Indonesian Economy, ed. Gustav Papanek (New York: Praeger, 1980), pp. 406-28. 23. Clive Gray, "Civil Service Compensation in Indonesia", BIES XV, no. 1 (March 1979). 24. Jan Tinbergen, On the Theory of Economic Policy (Amsterdam: North Holland, 1952).

CHAPTER II

THE BALANCE OF PAYMENTS AND NATIONAL INCOME

BALANCE OF PAYMENTS DEVELOPMENTS Indonesia's balance of payments during the period of study was characterized by sizeable current accounts deficits (except in 1974), and financed by an inflow of foreign aid and borrowing and, to a lesser extent, by private direct investment. The burden on the balance of payments was eased by a rescheduling of old debts, and with new overseas aid and credit, the overall balance of payments has been in surplus since 1969. The surpluses in the balance of payments increased rapidly with a sudden jump in 1972 and in 1975. Gradually the country has been able to rebuild its foreign exchange reserves, which increased sharply in 1972 and declined temporarily in 1975 in the wake of the Pertamina crisis. Balance of payments developments are sketched in the following subsections.

Current Accounts The current account deficit in 1966 was $266 million, about one third of that in 1973 ($805 million); the deficit in 1973 was about half of the one in 1978 ($1,434 million). Throughout the period of study, deficits were between 22% and 58% of annual imports and were financed by official loans, grants, and private capital investment. If we divide the balance of payments between oil and non-oil related sectors as represented in Table 2.1, we can see that the BOP of the oil sector has always been in surplus and the one for non-oil has been in deficit. However, due to the rapid growth of non-oil imports and payments for transportation and travel, surpluses in the oil sector did not match deficits in the non-oil BOP. Despite the series of reforms of the exchange rate, and the reopening of the economy to international trade under the present regime, export of traditional agricultural products did not grow as expected. Many factors contributed to this stagnation. There is a wide body of literature discussing the development of synthetic substitutes for rubber and vegetable oil and low income elasticities of demand in industrial countries for basic foodstuffs such as coffee, tea, and spices. Domestically, replanting of rubber, coconut and other crops had long been neglected. In the case of rubber, about half to two 26

27

The Balance of Payments and National Income

TABLE 2.1 The Balance of Payments, 1966-78 (Millions of US$)

A. Goods and Services (net) 1. Oil (a) (b) (c)

Sector Export (f.o.b.) Import (f.o.b.) Investment income

2. Non-oil Sector (a) (b) (c) (d) (e) (f)

Export (f.o.b.) Import (f.o.b.) Government, n.i.e. (net) Transportation & travel Other services (net) Investment income (net)

B. Capital 1. Net Official Transfer & Capital 2. Net Private Transfer & Capital

1966

1969

1972

1975

1978

-266 107 215 -68 -40 -333 499 -536 -35 -88 -166 -7

-385 174 366 -87 -105 -559 629 -868 -18 -168 -123 -11

-436 429 877 -163 -285 -865 880 -1282 -16 -200 -148 -99

-1164 3212 5052 -870 -970 -4376 1817 -4598 -26 -853 -347 -369

-1434 4794 7361 -1602 -965 -6228 3659 -6780 -42 -1280 -789 -996

174 124 50

355 284 71

805 378 427

1285 1778 -1493

1720 1387 333

30

C. Allocation of SDRs D. Net Errors & Omissions

E. TOTAL A through D F. Monetary Movements

Source:

-9

50

58

-104

-129

-101

20

45.7

17

157

20

-421

983

-157

Bank Indonesia, INFS, various issues.

thirds is produced by small-holders in the outer islands, mainly Sumatra and Kalimantan (Borneo). Because of the booming logging business in the same area since the late 1960s, along with declining international prices for traditional agriculture commodities, rubber farmers shifted to logging. However, the prospects for rubber seems brighter as the cost of producing fuel-based synthetic substitutes has risen along with the price of oil and as radial tyres which use more natural rubber become more popular. Coffee is also produced mainly by small-holders. Other problems such as marketing, processing, and high tax levies also contribute to export stagnation. In the late 1960s timber emerged as a new major export both in value and in volume. Since 1973, its export value has been next to that of oil, replacing rubber as the second most important foreign exchange earner. More than 75% of the timber has been shipped to Japan, Korea, and Taiwan. The latter two countries process it and re-export the final products to consuming countries. Initially, most of the export was in the form of logs, but as more processing plants were developed domestically, the share of fully or semi-processed wood in the total export has been increasing steadily. During the period of our study, the value of Indonesia's exports also became more dependent on oil. (The composition of exports by value is given in Table 2.2.) In 1966, crude oil and rubber contributed about 30% each to the total export value, followed by palm oil, coffee, and copra. At that time, timber contributed no more than 0.5% of the total export value. In 1972, oil contributed a little over half of total export value and timber's contribution (12.9%) overtook rubber's (10.6% ). Contributions of other commodities either oscillate about the same value (coffee and tea) or decline (rubber, copra, palm oil, tobacco, pepper, and tin). Oscillations in the contributions of coffee and

28

Financial Institutions and Policies in Indonesia

TABLE 2.2 Commodity Composition of Exports by Value, 1966-78 1966 1. Crude Oil & Petroleum Products 2. Rubber 3. Copra 4. Coffee 5. Palm Oil & Palm Kernel 6. Tobacco 7. Pepper 8. Tea 9. Tin 10. Timber 11. Others

TOTAL Source:

1967

1968

1969

1970

1971

2.0 4.5

63.9 6.2 0.3 4.2

4.0 1.2 2.0 2.3 4.2 13.1 10.0

2.5 1.7 1.2 1.7 3.6 12.9 9.1

2.3 1.2 0.9 0.8 2.9 17.9 8.6

2.2 0.5 0.3 0.6 2.4 9.8 5.9

2.2 0.5 0.3 0.7 2.0 7.0 5.7

1.6 0.5 0.5 0.6 1.9 9.1 6.1

1.7 0.5 0.6 1.1 2.3 8.8 6.6

1.8 0.5 0.6 0.8 2.5 8.5 10.7

5.6 3.6 2.0 2.6 4.9 0.5 10.9

4.1 2.2 2.7 1.4 7.7 0.9 10.6

3.3 1.9 1.8 2.4 5.3 1.6 7.6

3.4 0.6 1.3 1.1 4.8 3.4 3.4

6.7 0.4

100

1978

67.2 5.4 0.3 5.5

38.7

100

1977

70.3 6.2 0.4 2.8

40.3 22.9 3.3 6.2

100

1976

74.8 5.0 0.4 1.4

45.6 26.9 2.4 7.1

100

1975

70.2 6.5 0.3 1.3

40.7 24.2 5.1 6.1

100

1974

50.1 12.2 0.7 2.4

36.0 25.3 2.5 6.6

1.6 4.8 9.4 4.1

1973

51.4 10.6 1.0 4.3

30.8 31.0 3.1 5.0

0.3

1972

18.0

100

100

100

100

100

100

100

100

CBS, MSB, various issues.

tea reflect the production development in major producing countries. For example, whenever there is frost in Brazil and Columbia (two main coffee producers) the world's coffee production goes down and therefore prices increase. The rates of growth of exports by value and volume are presented in Table 2.3. This table shows that Indonesia's exports are subject to exogenous shocks, both in volume and price. The supply (volume) of most exports is inelastic with respect to price, as for most agricultural and mining products. In 1973, for example, although the value of rubber rose by 107%, its volume rose by only 15%. In general, the rates of growth of export volume for agricultural products, excluding timber, are higher than the rates of growth of its value. This picture is consistent with world trade developments as reported by the World Bank. 1 The increase in both volume and prices for traditional agricultural exports lagged behind the expansion in timber and petroleum. As a result, total exports grew both in price and volume. The export volume of timber grew dramatically in the late 1960s and has since slowed down but continued to grow, at a less rapid rate. The decline in the export volume of crude oil in 197 5 reflected the decline in oil exploration activities of production-sharing contractors, especially in offshore exploration, as their reactions to the increase in the government's "take" (which took effect in the beginning of 1976). To reverse the decline, the government offered a number of additional incentives to oil producers in 1977 and negotiated a series of tax treaties with home countries of oil companies to enable them to offset any tax payments they made to Indonesia, against their tax obligations in their respective countries. Helped by the strong showing of oil and timber, the terms of trade are getting better. However, if we disaggregate exports, the terms of trade of traditional exports declined while those of oil and timber improved. Moreover, since the rupiah was tied to the U.S. dollar until the devaluation on 15 November 1978, depreciation of it did not change export prices, while the prices of imports, mostly originating in Asia and Europe, increased. These external terms of trade cause further deterioration in the terms of trade for producers of traditional exports. Since most of the labour force and population are involved in the agricultural sector, this

29

The Balance of Payments and National Income

TABLE 2.3 Rates of Growth of Exports by Value and Volume, 1966-79 (Percentages) 1967

1. Crude Oil & Petroleum Products 2. Rubber 3. Copra 4. Coffee 5. Palm Oil 6. Tobacco 7. Pepper 8. Tea 9. Tin 10. Timber 11. Others TOTAL Source:

1969

1972

1975

1978

1979 1

Va

Vo

Va

Vo

Va

Vo

Va

Vo

Va

Vo

Va

Vo

17.8 -17.5 -19.3 33.9 -25.2 -38.5 35.8 -44.2 60.3 75.0 -3.1

18.9 -4.2 6.7 35.0 -17.6 -19.2 80.7 -20.9 74.6 97.0

28.7 28.0 -46.3 34.5 18.7 -62.1 -18.3 -48.3 5.7 148.7 -47.9

29.5 11.0 -9.4 50.1 17.4 -38.0 -31.7 -10.2 -8.2 204.7

91.1 -14.8 -28.8 39.4 -9.6 97.4 -13.3 5.9 23.7 41.7 31.8

2.3 -1.8 1.4 44.0 11.8 43.2 6.2 -1.8 -8.6 41.1

1.9 -25.3 8.1 1.7 -7.6 -0.8 -6.2 11.2 -20.3 -31.0 -8.3

-5.9 -6.2 5.0 14.7 31.5 -30.2 -7.6 -17.6 -13.1 -22.2

1.9 21.8 -8.8 -18.0 11.3 -0.5 5.7 -20.1 14.3 4.3 79.6

11.3 7.7 -0.3 34.5 -2.5 -1.1 19.7 9.6 -13.1 2.2

19.1 30.7 21.1 25.1 0.6 3.5 -32.2 -11.0 41.3 84.6 98.5

-10.9 -0.1 -5.4 2.0 -11.3 -9.0 -32.4 -4.6 16.9 -3.4

0.9

18.3

15.1

33.4

44.1

23.1

-4.4

-9.6

7.3

6.3

33.8

-1.3

CBS, MSB, various issues.

Notes

Va: Vo: 1:

percentage of growth by value; percentage of growth by volume; provisional figures.

intensified problems already faced by the government in its efforts to achieve its equity objective. Foreign direct investment has made a significant contribution to diversification of exports. Crude oil, natural gas, copper, nickel, timber, and fisheries are mainly developed by private foreign establishments. Domestic processing of traditional and new export commodities is growing. At the same time, exports of manufactured goods such as textiles, processed woods, electronics, and shoes, produced by cheap Indonesian labour, are also rising. Within two years after it started exporting natural gas, in 1977, Indonesia surpassed Algeria as the world's major LNG exporter. At the moment, the daily capacity of the two existing plants is 1,220 million standard cubic feet. Plans are under consideration to quadruple exports by the end of the 1980s. At that time, earnings from LNG will match, or even overtake, those of crude oil-particularly if crude oil exports continue to decline. The construction of the multibillion dollar Asahan power and aluminium project is also in progress. 2 This project is a joint venture between the Indonesian Government and a group of Japanese trading companies. Start-up of the first stage of operation is scheduled for 1982 and all facilities are to be completed in 1984. This plant will refine Indonesian aluminium and bauxite deposits for export. Table 2.4 shows the composition and rates of growth of imports by value. During the first two years of the stabilization and rehabilitation programme, there were large imports of consumer goods and raw materials. At that time, goods for consumption represented about 40% of total imports while raw materials made up 35% . The rest comprised capital goods. In the era of development since 1969, the percentage of consumer goods in the total import bill continued to decline, except in 1973. Recently, about 20% of the total import value constitutes imported consumer goods, and raw materials and capital goods represent about 40% each. Rice and other cereals are the most important commodities in consumer goods, accounting for about 11.9% of total imports in 1966 and

uo

0

TABLE 2.4 Composition and Rates of Growth of Imports by Value, 1966-79 (Percentages)

Consumer Goods

Rice

Wheat Flour

Raw Materials

Fenilizer

1966:

A B

42.7 100.0

11.0 25.8

0.9 2.2

34.2 100.0

1.8 5.1

1969:

A B

-17.1

5.8 20.4 -53.2

4.1 14.5 -16.5

41.1

c

28.3 100.0

3.9 9.5 -2.2

1972:

A B

16.1 100.0 19.8

3.2 19.7 149.8

0.2 1.0 -83.1

39.6

A B

14.2 100.0 -4.2

6.8 4-8.2 -12.7

0.1

4-1.1

0.4 -84-.4-

1978:

A B

8.8 4-9.4 -12.8

0.2 0.9 5.0

39.8

1979:

A B

17.9 100.0 8.3 16.3 100.0 -1.4

8.2 50.2 0.2

0.1 0.8 -13.3

46.4-

c

1975:

c

c c Source:

CBS, MSB, various issues.

Notes

A: B: C:

27.4 38.3

23.9

8.6

26.1

Cement

Iron & Steel Bar

Petroleum Products

Capital Goods

Iron Pipes & Steel

Total Imports

0.9 2.8

1.5

23.1

1.0 4.4

100.0

0.8 2.0 88.2

1.4

30.6

2.0 6.5 49.0

100.0

3.0 7.9 64.2

1.8 5.2 1.4 3.4 73.0 1.4 3.7 29.4

8.4 20.5 76.6

1.5 3.5 1.6

2.1 5.2 -20.9

0.9 2.1 114.7

0.4 0.9 -8.3

1.1 2.6 -9.3

-20.8

5.8

0.1 0.2 -90.2

0.2 0.5 -32.0

1.0 2.3 11.6

10.9 23.6 36.8

37.4

1.2 3.2 18.5

78.7

25.8

2.0

45.6

49.0

53.3

5.3

44.7

38.5

37.3

8.7

42.3

-4.2

2.6 5.7 80.4

10.2 100.0 41.6

4.7 10.5 172.9

100.0

1.9 4.6 72.0

100.0

1.43.8 -20.8

100.0

24.1

7.4

8.4

f

""'~

[

:::.·

~ !;·

as percentage of total imports; as percentage of total economic group; rates of growth.

~

""'

"'-

d' ~

~·

;;

"'"'

i} ~

;:;·

The Balance of Payments and National Income

31

14.9% in 1973. Sharp increases in 1973 reflect the mass1ve imports for building the national iron stock of basic necessities. The role of wheat flour in the total import bill dropped sharply in 1972 after the completion of domestic flour mills; since that time, Indonesia has been importing wheat grain instead of flour. The role of wheat in the Indonesian diet is increasing, especially for the urban population, as dependency on rice is decreasing. Import of food grains varies erratically from year to year in response to fluctuations in the weather conditions that affect domestic production. Variation in imports of fertilizer, cement, iron, and steel reflects sharp increases in domestic capacity to produce the goods and vagaries in the technical properties of domestic producers. In the case of petroleum products, we observe a steady rise which reflects increasing domestic demand for those goods either in industrial use or for final consumption. Indonesia has been selling its low sulphur content crude oil mainly to the environmentally conscious Japan and California and importing lower quality crude oil from the Middle East for domestic use. To meet the increasing domestic demand for petroleum products, amidst the excess capacity in world refineries, Indonesia is investing heavily to build new oil refineries. 3

Capital Flow The present government inherited foreign debts amounting to $2, 171.4 million on 30 June 1966, of which $1,707.9 million was principal and $463.5 million interest. Debt itself is not bad, and can be useful if used productively. In the past, foreign borrowing had been used to build military muscle for Irian and later on for the Malaysian campaigns. Part of it was also used to pursue the late President Sukarno's ambition in the international world-such as his building of huge modern sports and international conference complexes as well as various monuments. As has been discussed in previous sections, the present government renegotiated the terms of the old debts with its creditors in 1967 to ease the burden on the budget and the balance of payments. Western creditors adopted a rescheduling framework in 1970, based on a report presented by DrAbs, a German banker. According to the framework, Indonesia was to repay its debt incurred before 11 July 1966 over 30 years beginning 1 January 1970. Interest accrued on the rescheduled debt before 1970 would be paid during the second half of the 30-year period. No further interest would be due. Repayments in the 1980s would depend on the development of Indonesia's economy. The same framework was applied to its debts with Eastern creditors. 4 Unlike its predecessor, the new government uses foreign debts to exploit its untapped natural resources and to develop major investment projects that local savings cannot support. During the early stabilization period, this was used mainly to bridge short-term dislocations in the balance of payments. As shown in Table 2.5, Indonesia's external public debt has been increasing dramatically. Foreign debt grew by 74.6% from 1970 to $4,851.1 million in 1974 and by 172% from 1974 to $13,202.6 million in 1978. During the same period, foreign debt committed by the present regime since it came to power in 1966 (new debt) grew by 219% from 1970 to $2,575.4 million in 1974, and by 255% from 1974 to $9,148.9 million in 1978. Before 1973, all assistance from Western creditors was pledged through the IGGI, 5 but since that year the amount of new public debt negotiated outside the IGG I has been increasing rapidly. In 1973 and 1974 the amount of new debt negotiated outside IGGI was less than 2.5% of total new external public debts, but in 1978, it had risen to 24.5%.

32

Financial Institutions and Policies in Indonesia

TABLE 2.5 External Public Debt Outstanding, 1970-79 (Millions of US$) 1970

1972

1975

1976

1977

1978

1979

TOTAL

2, 778.1

3,617.3

8, 761.8

10,494.6

11,695.5

13,202.6

13,608.6

A. Public Debt 1. Old Debt*

2,778.1

3,617.3

6,611.2

8,294.5

9,653. 7

11,329.9

11,662.4

1,970.3

2, 116.7

2,210.2

2,158.3

2,077.6

2,181.0

2,110.7

1,500.6 1,500.6 1,500.6 (1,435.2) (65.4)

4,401.2 3,181.1 2,934.1 (2,562. 7) (371.4) 247.0 1.220.1 220.1 1,000.0 (1 ,000.0)

7,576.1 5,646.1 3,927.4 (2,999. 7) (927. 7) 1,718.7 1,930.0 546.6 1,383.4 (1,314.9) (68.5)

9,148.9 6,907.2 5,103.9 (3,947 .8) (1,156.1)

(-)

6,136.2 4,478.4 3,374.3 (2, 744. 7) (630.1) 1' 103.6 1,657.8 312.3 1,345.5 (1,327.1) (18.4)

2,241.7 670.2 1,571.5 (1 ,282.9) (288.6)

9,551.7 7,131.2 5,338. 7 (3,913.1) (1,425.6) 1,792.5 2,420.5 622.7 1,797.8 (1,405.3) (392.5)

2. New Debt! (2(a) & 2(b)) (a) IGGI (i) ODA Bilateral Multilateral (ii) Non-ODA (b) Non-IGGI (i) ODA (ii) Non-ODA Bank syndicate Other B. State Enterprises' Debt 1. Pertamina (a) Short term (b) Medium/long term 2. Other

807.8 807.8 807.8 (802.2) (5.6)

(-) (-)

(-) (-)

n.a.

n.a.

2,150.6

2,200.1

2,041.8

1,872. 7

1,946.2

n.a. (n.a.) (n.a.)

n.a. (n.a.) (n.a.)

2,013.6 (318. 7) (1 ,694.9)

1,944.1 (190.5) (1 ,753.6)

1,955.8 (173.0) (1 ,782.8)

1,808. 7 (164.9) (1,643.8)

1,632.1 (152.8) (1,479.3)

n.a.

n.a.

3. Kaltim Fertlilizer Plant

137.0

160.0

86.0

64.0

314.1

150.0

Bank Indonesia, "Beberapa Indikator Sektor Luar Negeri", July 1980, Table 5.2.2.

Source:

Notes * Outstanding debt inherited from the previous regime (until 11 July 1966);

1

Outstanding debt since 11 July 1966;

n.a.

=

not available.

All foreign debt before 197 5 was on soft terms (ODA) and in 1978, it was 63. 1% of the new debt. The year 1975 marked a new beginning in Indonesia's policies towards external borrowing. For the first time, it borrowed on semi-concessional loans (non-ODA) either through or outside the IGGI. Non-ODA borrowings through IGGI included floating of small amounts of government loans ($100 million) issued in Germany and Japan. 6 Borrowing outside the IGGI was from syndicates of foreign banks, negotiated through the central bank, and mainly to repay Pertamina' s debts. 7 In 197 5, the amount of nonODA debt was $3,101.7 million or 40% of total new debt, and in 1978 it was $6,675.4 million or 73% of total new debt received that year. How did Indonesia, despite its low income per capita (1976: $280), its requested moratorium on public external debts in 1967, renegotiation of Pertamina's loan in 1975, persistent deficits in current accounts of its balance of payments, and high domestic inflation rates, manage to borrow heavily abroad? The answer is that it offers an appealing prospect to foreign lenders. Besides its strategic location, and large market potential due to its large population and political stability, the most important things are its rich national endowments and low debt servicing ratio and currency covertibility. Although oil and natural gas are not the only Indonesian assets, they are the valuable commodities in the market at the moment. As shown in Table 2.6, exports more than doubled from 1970 to $1,210 million in 1972 and grew more than 500% from 1970 to $7,798 million in

~

.,~ " "

~

~

"'

I

TABLE 2.6 Indonesia's Debt Service Ratio, 1966-79 (Millions of US$)

A. Export Oil (net) LNG (net) Non-oil B. Total Foreign Debt Repaym't Principal Interest 1. Public Debt Principal Interest

2. Debt Incurred by State Enterprises Principal Interest

1966

1969

554 55

711 82

-

-

1973

1974

1975

1976

1,210 330

2,173 564

4,368 2,169

4,738 2,921

6,062 3,528

7,933 4,382 40 3,511

7,798 3,934 205 3,659

11,685 5,036 476 5,573

1,219 811 408

1,474 971 503

1,679 902 777

870 (536) (334)

1,148 (730) (418)

1,328 (721) (607)

349 (275) (74)

326 (241) (85)

251 ( 181) (170)

880

62 62

59 50 9

164 116 48

24 (24)

39 (30) (9)

38 (38)

20 (20) (-)

(-)

-

-

-

629

(-)

1979

1972

499

-

""'-"

1978

1977

1,609

2,199

-

-

1,817

2,534

256 175 81 161 (103) (58)

530 359 171

105 (68) (37)

209 129 80 117 (68) (49)

172 (76) (96)

743 453 290 317 (111) (206)

59 (48) (11)

92 (61) (31)

95 (72) (23)

358 (283) (75)

426 (342) (84)

~

§"·

"~

"'

8 ~

C. Ratio of Foreign Debt Repaym't to Export

1. Public Debt

4.3

5.5

8.7

5.4

3.7

3.6

5.2

11.0

14.7

2. Total Debt

11.2

8.3

13.6

9.6

5.9

11.2

12.3

15.4

18.9

Source:

12.0 15.2

Bank Indonesia, "Beberapa Indikator Sektor Luar Negeri", July 1980, Table 5.4.2.

w w

34

Financial Institutions and Policies in Indonesia

1978. Seen at the bottom of the table, its debt service ratio grew from only 11.2 in 1966 to 13.6 in 1972 and 18.9 in 1978, still below the commonly accepted standard of 20% of annual exports. Under the present free exchange system the government has neither control nor records of private capital flow in and out of the country. One can freely transfer foreign exchange without being obliged to ask prior approval from the authorities as long as the loan, for example, does not require guarantee from the government or foreign exchange banks. Indonesian residents may freely transfer, negotiate, import, and export securities in the rupiah or in foreign exchange. As will be discussed in the following chapters, the Indonesian financial market is rudimentary where the process of financial intermediation is limited and at an early level of development. Also, in a credit rationing system which has been practised for many years, banks ration credit mainly on the basis of how credit-worthy and established the customers are rather than through an interest rate mechanism. The foreign exchange market functions mainly through the central bank and a forward exchange rate market does not exist. As a result, short-term private capital flows are less responsive to changes in interest rate differentials and to expected changes in exchange rates. Official development aid and long-term capital flows to and from Indonesia are influenced more by political considerations and expectations of political stability than by pure yield factors. Reporting of private capital flows is encouraged but there is no penalty for failure to do so. At the outset, the system was designed to encourage capital repatriation and to attract new capital inflow. The Capital Investment Co-ordination Board (BKPM), responsible for administering foreign investors, has no records on the actual disbursement of approved investment. Between june 1967 and December 1978 the government approved "applications-to-invest" of 808 establishments with total intended investment amounting to $7,124 million. About 59% of these were for manufacturing. The Bank Indonesia only has records of those credits that required governmental permission (foreign credits guaranteed by the government or by foreign exchange banks), as seen at the bottom of Tables 1.3 and 1.4. As we have seen earlier and will discuss in more detail later on, such an open system also complicates the management of the monetary sector of the economy.

Exchange Rate System and International Reserves In August 1971 the exchange rate was unified at Rp. 378. Between this time and the devaluation of November 1978, the rupiah was pegged to the U.S. dollar. The reasons, according to the public statements of the authorities, were that most Indonesian exports were quoted in U.S. dollars and that the United States is the main contributor of foreign aid pledged through the IGGI. The rate was maintained during this period in spite of the fact that Indonesian domestic inflation far exceeded international and internal U.S. inflation. Rather than directly attacking the sources of the inflation, the authorities only assaulted its symptoms by means of direct subsidy payments on a wide range of basic goods and services and indirect subsidies through pricing policies of public enterprises. In the latter category were included lending rates of the state-owned banks. Partly because of this policy as well as appreciation of the dollar (and the rupiah) against several major currencies in 1977 and 1978, domestic inflation slowed down significantly. Nevertheless, for the whole period between the two devaluations, the rupiah depreciated against all major currencies, including the dollar.

The Balance of Payments and National Income

35

On the other hand, as the price of oil continued to rise relative to the price of non-oil exports, the trade balance of the oil sector moved into a surplus that led to a combination of nominal exchange rate appreciation and reserve inflow. Since most of the oil money was transmitted into the economy through government budget, domestic inflation continued to rise and non-oil exports lost their competitiveness. In recent economic jargon, a condition like this is called the "Dutch disease". The "disease" reduces the terms of trade of tradable goods relative to non-tradables particularly as extra aggregate demand is mainly spent on the latter. Undervalued exchange rate also produces biases in favour of capital-intensive methods since the cost of labour tends to move along with inflation at a faster rate than the change in the cost of imported capital goods. Much literature 8 supports government intervention to stabilize exchange rates, especially for a small less developed country such as Indonesia, where the foreign exchange market is thin and the economy prone to various exogenous shocks. The shocks in question could be from domestic supply problems like crop failure or technical conditions of production, or external shocks such as change of external terms of trade or social and political unrest that usually occurs in politically unstable LDCs. In the current world of floating rates, as has been demonstrated by Schadler, 9 the external terms of trade shocks occur more often as the amplitude of exchange rate fluctuation among industrial countries becomes larger than that of corresponding relative price changes between those countries. By leaving the exchange rate to be determined by the market alone, those shocks will further aggravate each other and can result in unemployment, distortion in income distribution, and reduced rates of economic growth. On the other hand, it is also essentially true, as Friedman has warned us: "Instability of exchange rates is a symptom of instability in the underlying economic structure. Elimination of this symptom by administrative freezing of exchange rates cures none of the underlying difficulties and only makes adjustment to them more painful" . 10 The government intervention, therefore, must be a temporary measure to smooth out transitional disturbances. Besides, the reserve itself is limited in amount, and therefore no country can afford to have deficits in its balance of payments for a long time. By definition, a small country cannot choose its terms of trade no matter what exchange rate system is adopted, since the country is a price taker in both imports and exports. As a corollary, such a country cannot insulate itself from external terms of trade shocks. In the case of Indonesia, when it pegged the rupiah to the U.S. dollar, its export currency, depreciation of the latter caused an upturn in its import prices (mostly originating from Asia and Europe), while its export prices remained unchanged. Pegging the rupiah to one of its import currencies, the yen for example, would not help either. Depreciation of the U.S. dollar in this case causes reduction in both export and import prices, stimulating imports and reducing the incentive to export. The overall effect may be a reduction in local production and employment. To correct the rupiah overvaluation, the authorities devalued the rupiah on 15 November 1978. The timing of devaluation was right since the 1978 rice harvest was very good and external reserves of the country was strong. At the same time, the government changed the external standard of the rupiah from its previous exclusive link to the U.S. dollar to a basket of currencies of Indonesian trading partners. The currency composition of the basket and their weights are undisclosed by the authorities. By changing this standard, the variance of the Indonesian real exchange rate was reduced and the impact of external terms of trade on domestic inflation was moderated. Table 2. 7 shows the development of Indonesia's official international monetary reserves since 1970. Its level at the end of the years grew from 4% of total annual imports in 1970 to 10% in 1975 and 57% in 1979. The figures in the table do not fully

36

Financial Institutions and Policies in Indonesia

TABLE 2.7 Net International Reserves (Millions of US$)

Gross Assets

Gross Liabilities

Net International Reserves

1970 December

204.8

154.9

49.9

1971 December

187.2

150.6

36.6

1972 December

574.4

116.5

457.9

1973 December

805.9

23.1

782.8

1974 December

1,472.5

0.2

1,472.3

1975 December

590.3

100.7

489.6

1976 December

1,493.7

268.2

1,225.5

1977 March June September December

1,794.3 2,076.6 2,413.4 2,493.6

236.9 141.9 166.9 70.4

1,557.4 1,934.7 2,246.5 2,423.2

1978 March June September December

2,280.9 2,132.9 2,401.4 2,652.5

72.9 72.9 72.9 72.6

2,208.0 2,060.0 2,328.5 2,579.9

1979 March June September December

2,988.7 3,225.5 3,330.9 4,167.0

72.6 72.2 2.2 22.2

2,916.1 3,153.3 3,328. 7 4,144.8

Source:

Bank Indonesia, INFS, various issues.

reflect the international liquidity pos1t10n of the country, since the latter should also include holding of secondary reserves by the banking system and the Indonesian unconditional drawing rights, 11 such as the IMF facilities and its swap agreements with other countries. However, for the purpose of this study, we can disregard the latter components of international liquidity since they do not reflect monetary movements in the balance of payments. The secondary reserves holding by the banking system will be discussed further in the next chapter. What are the reasons for holding international reserves? According to Cohen: "Fundamentally, the demand for reserves derives from the commitment of national government to some kind of limitation of exchange rate flexibility .... That need arises only because the national authorities have been traditionally reluctant to leave determination of the foreign currency price of home currency solely in the hands of the private market." 12 From the point of view of positive economics, Indonesia's demand for foreign exchange reserves derives from its commitment to peg the rupiah to the U.S. dollar as

The Balance

of Payments and National Income

37

was the case before devaluation on 15 November 1978. Pegging provides a clear criterion for intervention in the foreign exchange market to maintain the official par value at the prescribing margins. In the current world when the major currencies are floating, the Indonesian need for reserves arises since, in those circumstances, movements in the pegged exchange rate are independent of its own balance of payments development. The movements are rather reflective of the balance of payments development of the United States. Factors affecting exchange rate equilibrium in the United States are totally different from those in Indonesia. As the external standard of the rupiah changed to a basket of currencies after the 1978 devaluation, Indonesia's need for foreign reserves is reduced somewhat. The rate is not completely determined by the market forces, but is still greatly influenced by government intervention. The rapid build-up of Indonesia's foreign exchange reserve, especially after 1973 (see Table 2. 7), was related to the improvements in its export prices, mainly to oil shocks during the 1970s. On the other hand, it was also affected by government policy on foreign borrowing to finance its budget deficits, and on domestic monetary policy. In order to secure continued inflow of low interest foreign loans from the IGGI, the government "hides" some of its acquisitions of international reserves in the form of secondary reserves held by the banking system, particularly by the state-owned banks. As will be discussed further in the following chapters, the size of the secondary reserves since 1976 was nearly equal to the size of official reserves held by the central bank. Under the current ceiling and selective credit system, the Bank Indonesia provides generous refinancing at a low discount rate and at virtually no default risk for rupiah credits given by the stateowned banks to "priority" sectors, the scale of which is determined by the government. On the other hand, the Bank Indonesia encouraged the banks to find outlets for their growing excess reserves elsewhere by setting low interest rate on placement of excess reserves at the central bank. As has been noted by Cohen, if in fact there exists some relationship between the volume of trade (and payments) and the variability of trade (and payments), a country's need for foreign exchange reserves can be measured by its level of annual import. What are the economic costs of hoarding reserves? ''Reserves represent a claim on real resources that might otherwise be employed to expand output, improve the allocation of resources, and stimulate the pace of real economic growth. The hoarding of reserves in excess of a country's needs represents a real sacrifice in terms of consumption and investment forgone" (Cohen, pp. 414-15). Nevertheless, Cohen concludes that none of the experts can provide a satisfactory answer on how much is adequate.

Trade Policies The Indonesian trade policies have aimed to increase government revenues, promote exports, protect domestic import substitution industries, curb the inflation rate, maintain balance of payments equilibrium, promote income redistribution, and sometimes serve as bargaining tools in trade negotiations. Here, too, the number of instruments is less than the number of objectives. The objectives themselves are sometimes in conflict with each other. As a result, some of the policies create inefficiencies and misallocation of resources. Sometimes, the government loses its tax revenues as well. The trade system is basically free, with a few exceptions. As we saw earlier, exports of certain domestically produced commodities are temporarily controlled by

38

Financial Institutions and Policies in Indonesia

means of quotas, in order to maintain supplies to meet domestic demand. The importation of cloves, fertilizers, and some basic foods is restricted to a few approved importers. The rights to import cloves, an important ingredient for Indonesian clove cigarettes, are reserved by the government for two private importers. Import of basic food items is in the hands of Bulog but the government's wheat, imported by Bulog, is milled by private flourmills. Imports of certain commodities for the "national iron stock" are reserved for state enterprises. To protect domestic import substituting industries, the government banned imports of assembled cars, scooters, motorcycles, a wide range of textiles and other manufactured goods, and all assembled electronics. Sole agentship of all imported goods is reserved for Indonesian nationals. To encourage exports of textiles, garments, electronics, and other manufactured and semi-processed goods, the government offers generous export subsidies. A particular trade policy that was in force from 1 January 1977 to 15 November 1978 had special attraction. In order to protect some segments of the domestic industry, the government used monetary instruments for trade purposes, by imposing advance deposit requirements for importation of a range of goods. 13 It was required of importers to place advance payments at the foreign exchange bank at the time of LC opening: a 100% advance import deposit, an additional 100% financial guarantee deposit, and a 100% advance payment of import duty. Banks were not allowed to extend credit for such payments. As a result, import costs for the goods increased dramatically; larger financial resources were necessary to finance any given volume of their import. The advance deposit requirement is similar to that of multiple exchange rates since it increases interest rate costs to import some particular goods while leaving import costs of other goods unaffected. It is usually a monetary policy instrument, temporarily useful for reducing money supply and moderating pressures on the balance of payments. Because it is not comparable to taxes and subsidies, especially when the Indonesian authorities adopted it at the wrong time (the time when it had a healthy balance of payments), the practice was against the GATT as well as the IMF rulings as it created an unfair advantage for Indonesia against its trading partners. On the export side, apart from the temporary restrictions for specific commodities discussed earlier, there was no other institutional restriction for exports. A large segment of non-oil export commodities is subject to a 10% export tax. Crude oil and petroleum products, manufactured exports, and handicrafts are exempted from the export tax. A few other commodities that face weak international demand are subject to a 5% export tax. In previous years, almost all the agricultural products had to pay export taxes, a rehabilitation fund levy, and various regional levies, whether destined for export or for other provinces. The additional 'levies had discouraged export but the authorities did not abolish them until 1 April 1976. In general (excluding the above exceptions and a negative list of" super luxurious" goods), imports are subject to duty rates of 0-30%, raw materials 0-70%, semi-finished goods 30-120%, and consumer goods 30-300% . Basic food items are free from duty. On an unweighted basis, the average import duty in 1972 was 14%; weighted by 1970 imports, the duty rate was 18%. If tax-free items are excluded from total imports, the average duty was 14%. In addition to import duties, import goods are also subject to sales taxes at rates ofO%, 5%, 10%, 20%, or 50%. Domestically produced goods are subject to the same sales tax rates. Table 2.8, which is estimated from the 1975 input-output table at world market prices, shows that the effective rate of protection in Indonesia before the November 1978 devaluation had been biased in favour of import substitution. It shows that six out of ten of the import competing industries received effective protection rates in excess of 100%.

39

The Balance of Payments and National Income

TABLE 2.8 Effective Rate of Protection for Selected Manufacturing Sectors in Indonesia, 1971-78* I-0 Codet

77

78 80 81 83 91 110 111

120 123 128

Sector Spinning Weaving Batik Knitting Wearing apparel Pulp, paper, & cardboard Tyres & tubes Other rubber products Cutlery, hand tools, & general hardware Other fabricated metal products Accumulators & dry batteries

1971

1975

1978

134

56 192 -35 331 110 46 4,315 406 36 66 116

71 117 -23 403 124 50 1,415 226 85 76 112

Neg. IVA

-38

Neg. IVA

197 67

Neg. IVA

195 77

50 193

• In its simplest formulation the effective rate of protection is calculated according to the following formula: EPRi

=

DVAi- IVAi. lOO IVAi

where EPRi is effective protection of industry or sector i; DVAi is domestic value added of ith activity or industry; IVAi is international value added of ith activity or industry. In estimating DVA and IVA it is assumed that the country is a small country and is therefore a price-taker in the international market both as an importer of the inputs used in domestic production and finished goods, and as an exporter of all kinds of goods to the world market. t I-0 code is code number in Indonesian Input-Output (I-0) table.

On the other hand, batik that can be classified as an exportable sector had to pay severe tax since it received negative protection rates. Sectors that had the lowest protection in 1975 had increased protection in 1978. Some of the sectors such as motor vehicles and tyres and tubes are subject to quantitative restrictions and. not imported in finished forms. The above trade policy has provided strong incentives to invest in the heavily protected sectors of the economy, which resulted in over-investment and excess capacity in some of those activities. This trade policy also helps to explain why manufacturing grew faster than the rest of the economy during the 1970s. Moreover, the policy tends to inflate the share of import competing industries (1975: 65.4%) in total domestic value added, while the share of exportables was only 31.4% during the same year. The devaluation in November 1978, the introduction of the export certificate scheme, and the reduction of the tariff rates for some of the imports have checked the protection trends of the manufacturing sector. These measures have produced incentives for many firms to export their products. High statutory import duties and export taxes (including regional levies) do not necessarily mean higher revenue collection or a high protective wall for domestic industries. The ability of the government to enforce these laws and regulations is also important. As suggested by Cooper, 14 high duties and taxes induce smuggling, as expected profit from it becomes higher. In an archipelago with long coastlines, such as Indonesia, with its proximity to the great trading centres of Singapore and Hong Kong, and with a small inefficient fleet of patrol boats, smuggling is relatively easy. It is impossible to know the exact value of goods smuggled into Indonesia, since Singapore does not publish its trade

40

Financial Institutions and PoliCies in Indonesia

record with Indonesia. However, from complaints expressed by local manufacturers and from casual comparison of the prices of luxury items in Jakarta and other big cities in Indonesia to the prices of the same goods in Singapore and Hong Kong, the amount of smuggled goods must be substantial. Smuggling might be beneficial in one sense since it lowers prices and thereby increases consumer demand. However, it can also disrupt domestic production, causing a reduction in employment and government revenue and other ill effects on the economy. Under the Preferential Trading Arrangement of the five ASEAN members (Indonesia, Malaysia, Philippines, Singapore, and Thailand), a preferential duty of 10% came into effect on 1 January 1978 for imports of certain goods grown or manufactured in its member countries. On 1 September of the same year, tariff reductions were announced on 138 imports from ASEAN countries. The Association also established joint committees to promote export from the region, to co-ordinate and synchronize their economic planning and investment, and for other areas of economic co-operation. As pointed out in the literature, the Preferential Trading Arrangement member countries give small tariff preferences to each other, keeping their original tariffs against the outside world. Distribution of gains and losses from the preferences to each member are not known due to the lack of data.

LEVEL OF OUTPUT AND STRUCTURAL CHANGE OF THE ECONOMY In previous sections we have seen that Indonesia's savings-investment gap or foreign exchange constraint has been met or relaxed by foreign aid. And, as its exports, especially oil, have risen continuously ever since 1972, the foreign exchange constraint has been further eased. This improvement in Indonesia's acquisition of resources has increased its ability to grow. According to economic development literature, 15 exports can be used as an engine of growth and foreign aid as a supplement to it. Exports stimulate the economy through their direct contribution to the GDP. The spread effects include the Hirshman type of linkages, which can be broadly considered as a sequence of multiplier-accelerator mechanisms. These indirect effects can continue to accrue long after some export stimulus on the economy has occurred. The overall impact of an export stimulus on the economy has many determinants including technology, the propensity to import, the extent to which induced investment opportunities are exploited domestically, the ability to attract foreign factors, amongst others. Foreign factors are needed not only to supplement the savings-investment gap and for further relaxation of the foreign exchange bottle-neck, but also to ease the country's insufficient supply of human resources. Provided that investment opportunities generated by the growth of the export sector are exploited, the theory predicts that economic growth will be a process of diversification about the export base and structural change in the economy. As efforts to diversify the export base have been sketched out above, the remaining task in this section is to review the structural change of the economy during the period under study, 1968-78. The levels of income of industrial origin in current market prices for the period 1967-79 are presented in Table 2.9. Shares of various components of income are shown in Table 2.10.

;;;:l

" ~

"

";?"

TABLE 2.9 Gross Domestic Product by Industrial Origin at Current Market Prices Industrial Origin A.

Agriculture 1. Farm food crops 2. Farm non-food crops 3. Estate crops 4. Livestock products 5. Forestry 6. Fishery

B.

Mining & Quarrying

C. D.

Manufacturing Electricity, Gas, & Water

E.

Construction

F.

Commerce, Hotels, etc.

G. Transport & Communication H. Banking, etc. I.

J.

Ownership of Dwelling Public Administration & Defence

K. Other Services Gross Domestic Product

Source:

"'-,

1976*

1977*

1978t

1979t

4003 2555 358 184 303 413 191 2485 1124

4812 3044 481 213 346 513 215 2930 1463

5906 3660 762 326 305 525 328 3600 1817

6706 3991 801 405 463 653 393 3869 2185

9145 5365 1112 624 550 942 552 5172 2825

52 406 1775

70 590 2104

98 812 2552

106 1023 2959

116 1242 3450

130 1844 5601

257 83 143

442 113 194

521 151 258

663 207 319

821 236 542

980 396 671

1383 641 906

290 197

405 264

585 380

864 473

1074 547

1394 607

1685 668

2180 835

4564

6753

10,708

12,643

15,648

19,011

21,968

30,662

1974

1967

1968

1969

1970

1971

1972

1973

457 301 46 19 33 6 54 23 62

1069 726 133 47 53 35 75 87 179

1339 823 199 69 89 59 101 129 251

1575 962 214 83 103 102 112 173 312

1655 962 206 105 124 142 116 249 356

1837 1071 226 118 135 173 114 491 448

2710 1573 323 152 173 355 134 831 650

3497 2096 386 191 223 422 179 2374 890

3 14 149

9 45 356

13 75 476

15 100 619

18 128 712

20 174 769

30 262 1118

19 4 17

57 12 41

77 22 53

96 33 66

162 45 74

182 53 103

41 59

116 125

136 147

183 169

214 181

848

2097

2718

3340

3794

1975

"'§ 1:;

§ "-

~

!;·

"~

~

"~

CBS, MSB, various issues.

• Revised figures;

t Preliminary figures.

::

...

"" TABLE 2.10 Composition of GDP by Industrial Origin at Current Market Prices (Percentages) Industrial Origin A. Agriculture, Forestry, & Fishery 1. Farm food crops 2. Farm non-food crops 3. Estate crops 4. Animal husbandry 5. Forestry 6. Fishery

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

64.5 35.5 5.4 2.2 3.9 0.7 6.4

51.0 34.6 6.2 2.2 2.5 1.7 3.6

49.3 30.3 7.3 2.5 3.3 2.2 3.7

47.2 28.2 6.4 2.5 3.1 3.1 3.4

43.6 25.4 5.4 2.8 3.3 3.7 3.1

40.1 23.3 4.8 2.3 2.6 5.3 2.0

32.7 19.6 3.6 1.8 2.1 3.9 1.7

30.8 19.5 3.1 1.4 2.2 3.3 1.4

31.1 19.3 4.0 1.7 1.6 2.8 1.7

30.5 18.2 3.6 1.8 2.1 3.0 1.8

29.8 17.5 3.6 2.0 1.8 3.1 1.8

12.3

22.2

31.7 20.2 2.8 1.5 2.4 3.3 1.5 19.7

18.7

18.9

17.6

16.9

9.6

8.3

8.9

9.3

9.6

9.9

9.2

B. Mining & Quarrying

2.7

4.1

4.7

6.6

C. Manufacturing

7.3

8.5

9.2

5.2 9.3

40.2 23.5 5.0 2.6 3.0 3.8 2.5 10.8

9.4

9.8

D. Electricity, Gas, & Water Supply

0.4

0.4

0.5

0.4

0.4

0.5

0.6

0.6

0.4

2.1 17.0

2.8

3.0

3.8

3.9

3.8

4.7

5.2

0.6 5.4

0.5

1.6 17.6

0.5 3.4

0.4

E. Construction F. Wholesale & Retail Trade

5.7

6.0

17.5

18.5

18.8

16.8

16.6

15.6

15.7

2.2

2.7

2.8

2.9

4.3

4.0

3.8

16.6 4.1

16.3

G. Transport & Communication

16.6 4.1

4.2

4.3

4.5

18.3 4.5

H. Banking & Other Financial Institutions

0.5

0.6

0.8

1.0

1.2

1.2

1.2

1.1

1.2

1.3

1.2

1.8

2.1

Ownership of Dwellings

2.0

2.0

1.9

2.0

1.9

2.3

2.1

1.8

2.0

2.0

2.8

3.1

2.9

Public Administration & Defence K. Services

4.8

5.5

5.5

5.6

6.4

6.8

6.9

7.3

7. 7

7.1

[;::_.

6.0

6.1

4.8

4.3

6.0 3.9

5.4

6.9

5.0 5.4

3.5

3.7

3.5

3.2

3.0

2.7

7.13325 Maximum

LNOEX stands for logarithmic value of non-oil export and LNOEXS for simulated value of LNOEX. 15 stands for 1971:2 and 49 for 1979:4.

"' ·~

-

FIGURE 5.1e Time Series Plot of Actual and Simulated Values of Total Imports (LIMP plotted with •; LIMPS plotted with 0)

;:; Maximum 7.28461

Minimum 4.61813

•• ' • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • ! ••

I •

15 16

I I I

17 18 19

•

o •

I 0

0

0

I I I I

0 0•

20

21

22 23

I

0

I I

0 0 •

24

25 26 27

28 29

30

0 •

0

I I

0

o

0

0

•

o

0

31

32 33

37

I I I

• •

I

I

• o • •0

34 35 36

0

I

I I I I

•

2

0

I

I

•

0

•0

o

0

o

I I I I

•

o

0

I

•

I 0

o

•

o • • o

•

o

·· ·'················································· ··················································' .4.61813 7.28461 Minimum Notes:

•0

I

•

•o

38 39 40 41 42 43 44 45 46 47

48 49

•

I I I I I I

Maximum

LIMP stands for logarithmic value of total imports and LIMPS for simulated value of LIMP. 15 stands for 1971:2 and 49 for 1979:4.

~

i

~

:::.·

!;.

:s·

~

""-"' ;]:> ~

5"

;;

?

~

"~-

FIGURE 5.1f Time Series Plot of Actual and Simulated Values of Real Income (L YR plotted with *; L YRS plotted with 0)

~

g, ;:; " ~

""

Maximum 4.31583

Minimum 3.50683

~ ~ q

• • t • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • A• •

15

0

16

17 18 19

20

21

22 23 24 25 26

0

0

~

0

!t

2

•O 0 0 • 0

29

0

r"

0 0 0

~._ \Q

~

0.

2

30

31

•O

0

._I

....~

• 0 0

0 •

0•

0

37

38 39 40 41

42 43 44

•0

0

0

0

0

O•

• 0

45

46

2

•0

0 0

47

48 49

i(, \Q

0

32 33 34 35 36

"'

~o;·

0

28

~

!}

0

27

~

0

..' ...................................................................................................' ..

•

4.31583 Maximum

3.50683 Minimum

Notes:

0

LYR stands for logarithm of real income. LYRS is simulated value of LYR. 15 stands for 1971:2 and 49 for 1979:4.

:;:

.

FIGURE 5.1g Time Series Plot of Actual and Simulated Values of Reserve Money (RESMON plotted with *; RESMONS plotted with 0)

""

Minimum 365.352

Maxin1urn

..........................................................................................................

15 16 17 18 19

2

*0

2 2

•0 •0

0•

2

20 21 22 23

2

2

•0 •0 •0

0• •0

24

25 26

27

28 29

•0 2

0•

•0 •0

2

32 33 34 35

•0

.o 2

30 31

•0

•0 •0 2

36

37

0·

•0 2

*0

•0

* 0

38 39 40

2

•O

0• 2

41

42

43

44 45

46

•O * 0

•0 * 0 0*

~

K

:::·

•0 •0

" ""'-"'

•0

..365.352 ' ................................................................................................... ' ..2 Minimum Notes:

~

"'[:;

~ ;::_.

* 0

47

48 49

8282.31

8282.31 Maximum

RESMON stands for reserve money and RESMONS for simulated value of RESMON. 15 stands for 1971:2 and 49 for 1979:4.

•O

~

~

~·

s

"' §-

~

s·

FIGURE 5.1h Time Series Plot of Actual and Simulated Inflation Rates (INFLR plotted with *; INFLRS plotted with 0)

::..

~ ~

:':,

Minimum -10.1415

Maximum 15.5642

.. ,.....................................................................................................,..

15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

I I I

0

~

;.;;

"~

~

•

0

.

0

. .

I

0

~

~

*

*

0

";:;~ "

0

~

5

0

*

*

::;-

§-

0

0 0

0

*

*

0

0

:Sl

._ \Q :::;

0

'._I'

0

*

\Q

~

0 *

0 0

0

&

0 0

30

31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49

""

0 *

~

0

*

()

* 0• 0

* ()

0

* 1 I

I

I

0

0 0

*

0 ()

() *

* ..-10.1415 ' ................................................................................................... ' .. I

()

15 5642 Maxin1urn

Minimum Notes·

INFLR stanrls for inflation ratt> anrl INFLRS for simulatt>d va!tw of INFLR. 15 stanrls fiJr 1971:2 and 49 fiJr 1979:4.

.... w

FIGURE 5.2a Time Series Plot of Actual and Simulated Prices, 1971:2-1980:4 (LPRI plotted with •; LPRIS plotted with 0)

t

Minimum 4.15352

Maximum 5.99158

.. ' ...................................................................................................•.. 0 0

15

16 17 18 19

0

•0

20

21

22

23 24 25

26

27 28 29 30

31 32 33 34 35

36

•0 0

• 0

• 0

0

• 0

2

0

•0 2

0

•0

0 •0

• 0 • 0

o•

0.

0.

o•

• 0 •0 •O

37 38 39

40

41 42 43

45 46 47 48 49 50

51

•0

2

2 0• 2 0• 0 •

44

52 53

2

•O •0

0•

"

0

~

0

~·

0.

g-. • 0

~

• 0

0

.. '· ..................................................................................................' ..

4.15352 Minimum

Notes:

~

"'~"'

0

5.99158 Maximum

LPRI stands for logarithmic value of price level and LPRIS for simulated value of LPRI. 15 stands for 1971:2 and 53 for 1980:4.

""'"'-

:Jl

~

..., ""

s·

:.--

i}

" §.

FIGURE 5.2b Time Series Plot of Actual and Simulated Supply of Money, 1971:2-1980:4 (NM plotted with •; NMS plotted with 0)

"'"" ~

";:[

;);,

Minimum 291.450

""'

Maximum 5011.00

~

..•...................................................................................................' .. 2 2

15

16

17

•0

•0

18

•0

19 20 21 22 23 24

2

2

2

•0 •0 •0

•0

2

o•

2

25 26

27

28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46

•0

•0 2 •0 •0

•0 •0

47

q

~

ft

~

if

~

§-

~

;:;·

" t; 5

~

._ \Q

2

.o

•0

O• •O

~

;.;, ._I \Q

0 • 2

~

0 • 2

•0

"-

•0

0 •

0

48 49 50 51 52 53

~

•0

0

0.

2

2

0.

•0 •0 2

o•

•0 0.

•0

0

•O

0 •

0

................................................................................................... ' .. 5011.00 291.450 Minimum Notes:

()

Maximum

NM stands for supply of narrowly defined money in billions of rupiahs. NMS is simulated value of NM. 15 stands for 1971:2 and 53 for 1980:4.

.... ~

....

FIGURE 5.2c Time Series Plot of Actual and Simulated Values of Non-oil Tax, 1971:2-1980:4 (LNOTAX plotted with *; LNOTAXS plotted with 0)

Oo

Minimum 3.91260

Maximum 7.32484

.. ,...................................................................................................' ... I I I

15

16 17 18

•

I I

19

I I I I I

20 21 22

23

24 25 26

I I

o

0

I

0

I

0

I I I I

0

* 0 2 0 0

I

0

I I

0

I

I I I I

28

29

30

31

I I

32 33

I I I l

34 35 36 37 38 39

40

0 •

0

0• 0

0

42 43 44 45 46 47 48 49 50

I I I I

2 0 0

0

41

I

I I l I I

0 *

0 •

I

27

0

I

0•

0• 0

0

0

I

I I I I

0

0

I I I I

0

0 0

I

0

0 0

I I • I I I

.. ...................................................................................................' ..

53

'

3.91260 Minimum

Notes:

•0

I I

0•

0

51 52

•0

0

I

7.32484 Maximum

LNOTAX stands for logarithm of non-oil tax and LNOTAXS for simulated value of LNOTAX. 15 stands for 1971:2 and 53 for 1980:4.

~

i;

~

"'::.·

'""' :;. s· ;';

"

""';):l ~

5• s· §}

'"~""' -

0)

c

0

3.6

~

::0 t::

z

u '§

-5

·;:::

'C 8.. ..§

.../ .....

7.0

.......

'0

E -5

·c

~

.

...........

0

....:l

.·

.....

6.8

6.7

6.6

,/

.·

69

·············· ·······

-- --

I

I

I

I

I

I

/

/

/

/

I

....

....

.... .·

//

/

.......

.

/

/

/

/

/

I

I

I

I

I

/ cs /

/

/

//

.·

";::l

.. ·····

BR

/

/

/

I

///

/

6.5

II

III

IV

II

III

IV

II

III

IV

- - - - 1 9 7 8 - - - - - - - - 1 9 7 9 - - - - - - - - 1980---Year and Quarter

158

Financial Institutions and Policie,- in Indonesia

the ones that should be achieved without devaluation. The effects of devaluation on the endogenous variables are shown in Figures 5.3b to e.

COMPARISON WITH OTHER STUDIES Our model is similar to Aghevli's (1977) and to Boediono's (1979) in the sense that ours, as well as theirs, is a monetary model. Our and Aghevli's model use the same standard demand for money function. Boediono's model contains no such equation. All models derive money supply from reserve money identity; our and Aghevli's model use the Koyck lag adjustment mechanism while Boediono uses money multiplier identity simpler than our failed money multiplier. Each model has its own way to specify prices, government sector and the balance of payments as well as different treatments of real income, and generation of quarterly income. Our non-oil tax revenue is a function of the same variables as in the total government domestic revenue (including oil tax) in Aghevli's model. In addition, we add quarterly dummy variao\es wb.icb. were not in b.is mode\. Our import and export ratios to C.TY£> are functions of relative price only. Our import equation is also specified with a lag. In Aghevli's model, both equations are functions of relative price, as in ours, and GDP. Aside from quarterly dummy variables, Boediono adds more dummy variables to many of his equations; to capture the effects of many exogenous international events (such as increase in the price of oil) as well as government domestic policies such as changes in import tariff and the anti-smuggling campaign. Real income is exogenous in Aghevli's model although nominal income is endogenous due to endogeneity of the price level. In our model as well as in Boediono's, both real and nominal income are endogenously determined in the systems. In our model real income is equal to aggregate demand by assuming instantaneous equilibrium in the goods market. In Boediono's, real GDP (in 1973 market prices) is a weighted average of current price deflated by the current general price index and of a lagged value of real GDP in 1973 prices. Aside from a constant term, general price index in Boediono's model is a weighted average of cost-of-living index as well as price indices of goods that are consumed by the government, of investment goods, of consumer goods, of non-oil export, of oil export, and of total imports. Unfortunately he does not mention how he generates and from what sources he obtains these indices. Quarterly nominal GDP in our model is obtained by regressing annual nominal GDP series with current export, import, and average supply of money. Using the coefficient estimates and known quarterly values of the explanatory variables, we generate our quarterly nominal GDP. Aghevli and Boediono derive their quarterly nominal GDP series from annual figures by the linear interpolation technique as first popularized by Adolfo C. Diz (1970). In this technique, the quarterly nominal GDP series is derived by taking a linear interpolation of the annual series for real income subject to the condition that their sum for each year should add to the corresponding valw-~. While it is appealing mathematically, it has no economic meaning. Our data on the wholesale price indices of non-oil export and imported goods are obtained from Monthly Statistical Bulletin published by the Central Bureau of Statistics, while in Aghevli's study they were calculated based on a value weighted index of non-oil exports and imports. In this technique it is implicitly assumed that composition of export and import are constant throughout the period of his study.

A !Short-Run Monetary Model of the Indonesian Economy, 1971:2-1979:4

!59

In Table 5.5, we compare our finding of demand for real balances with other studies on the same subject both in Indonesia as well as in some other less developed countries. The adjustment coefficient (w) is higher in our study than in other studies; this implies that the average time lag in the adjustment of actual demand for real balances to its desired level is faster in our study than in others. Inflation elasticity in our system is much lower than in other studies. As noted before, our results will not change significantly if insignificant nominal interest rate elasticity were excluded from the demand for money equation. The long-run income elasticity ( a 1) in our study is lower than that of the coefficient in Aghevli's (1977) study for Indonesia, and in about the same order of magnitude with the coefficients for Columbia and Thailand. The short-run income elasticity in our system is lower than but of about the same magnitude as in the Aghevli study, and much higher than the same coefficients for other countries. Selected previous studies on the Indonesian financial sector are presented in Appendix II. TABLE 5.5 Comparison of Individual Parameter Estimates on Price (Demand for Real Balances) Equation in Five LDCs Indonesia Parameter*

Anwar Nasution

0.537 (5.421)

w

-2.352 ( 4.958)

0

(8)

Actual revenues are assumed to be adjusted to the difference between desired revenue and the actual revenue obtained in the previous period:

!J.R1

=

T(ln R~ -In R~ 1 )

(9)

where T is the adjustment coefficient and 1 > T > 0. From equations (7) and (8) we obtain: In R 1

=

Tt 0 +

Tt 1(ln

Y 1 + ln P 1 ) + (1-T)ln R 1_1

(10)

Since in this model the government is assumed to be committed to meet certain real expenditures, the government nominal budget deficit becomes a function of the inflation rate. The government nominal revenue in less developed countries usually lags behind the increase in nominal income because of low nominal income elasticities of their tax systems and long lags in their tax collections. As a result we expect the adjustment coefficient of the revenue (T) to be less than the adjustment coefficient of the government expenditure (Y) even though the coefficients of revenue elasticity (t) and of government expenditures (g 1), both with respect to income, are equal. The money supply is a multiple of the monetary multiplier (m) times the monetary base (B). The monetary base consists of government deficit plus changes in the central bank's claims on commercial banks and the private sector and changes in international reserves (DP) plus the previous year's monetary base (B 1_1): ( 11) In this system, therefore, it is assumed that government deficits are financed by the creation of money, to represent the inability of less developed countries to raise revenues from issuing government bonds. In logarithmic form, equation (7) can be written as: ( 10) where the parameters k 0 , kt, and k 2 are all functions of the sample means of In G, In R, and In E. The Aghevli and Khan model explains the situation in Indonesia well before the year 1968 in the period when the government monetized its budget deficits. As we saw in Chapters I, II, and III, since 1968 the government has been balancing its budget with the help of foreign borrowings and since 1973 the budgets have always ended up with small surpluses which are made possible by continuous increases in oil revenues. Nevertheless, the model makes sensible policy recommendations to reduce inflation; the government has to decrease its budget deficit by increasing revenues that are related to real income to keep pace with its target real expenditures. In addition, it also has to

170

Appendices

reduce the supply of money either from domestic credit creation or from foreign sources of the monetary base that the government can control such as neutralizing the oil revenues or reducing foreign borrowings. Schydlowsky's short-run deterministic macro-economic model (1981) was intended as an aid for policy-makers in formulating short-run ''monetary and fiscal policy management to protect a country's balance of payments and price stability". 7 He resolves the price stability problem by a perhaps oversimplified argument based on textbook assumptions: by assuming the country as a price-taker in the international market for both exportables and importables. By this assumption the domestic price of traded goods is simply equal to the world price plus freight, insurance, import tariff, and port charges. He talks about exportables, importables, services, and non-traded goods but his model has no explicit price equation. The model contains six independent accounting equilibrium identities: income, import, export, accumulation of time and savings deposits, stock of liquidity, and the balance of payments. The whole story can be told by the income and the balance of payments identities because the other identities are incorporated in these two equations. Equilibrium income is a product of an income multiplier coefficient and a set of exogenous variables in traditional Keynesian formulation. The multiplier coefficients depend upon the marginal propensities to save in the form of bank deposits, to absorb export and import competing commodities; the ratio of currency to money; the ratio of money to liquidity; changes in liquidity reserves requirements against rupiah demand deposits and against foreign exchange deposits. The exogenous variables are real output (export, agriculture, and industrial sectors), foreign private investment, credit to the private sector, and central bank and foreign !endings to the government including semi-official entities. Import is a summation of increases in food stockpiles, impact multipliers of financial increases both domestic as well as foreign credits, impact multipliers of domestic value added to the agricultural sector, domestic value added of the manufacturing sector, impact multipliers of foreign investment projects, and impact multipliers of production of export goods. Export is a summation of impact multipliers of production of export and import multipliers of value added in agricultural and manufacturing sectors and the financial sector plus annual loss of the Logistic Agency (Bulog) which monopolizes importation, storage, and distribution of foods. Identities for accumulation of time and savings deposits and stock of liquidity are impact multipliers of domestic value added in the real sectors and changes in the financial sectors. The balance of payments is a summation of reserves against rupiah savings and time deposits plus reserves against foreign exchange deposits minus central bank credit. Since the only variables that are under government control to affect income are domestic credits of the banking system to both public and private sectors, then only money matters in this model. Contrary to the monetarist model, an increase in domestic credit does not affect price because of price-taker assumption, but the central bank's credit expansion directly deteriorates the balance of payments. Aside from credit, the model does not specify where the growth comes from nor does it tell the story of how the short-run equilibrium affects long-term development as it originally was intended to do. The monetary sector affects income through the following channels: increase in credit is an injection to the income stream since it directly increases private and government expenditures. On the other hand, increase in quasi-money, mainly time and savings deposits, represents a leakage from the income stream and thus checks the increase in aggregate demand.

Appendices

171

Because the model is both static and deterministic it neither tells how the economy moves from one to another equilibrium position nor does it address the problems of uncertainties that may occur during the movements. The whole system of identities relies on simple ratios and none of them is specified as a behavioural function of economic aggregates. Since the behaviour of economic agents is not static and no room is allowed to predict them in the identities, the model is hardly useful in making predictions about the future unless the user invents his own data based on his own value judgment as the author tested the validity of his model. Due to the model's reliance on the reserve requirement ratios, he ignores the important facts in the Indonesian monetary sector during his calibration exercise, 1969-7 3: namely, credit ceiling and selective credit policies. Under these policies the authorities set the multiple of money multiplier and monetary base. In such a case, reserve requirement ratios are meaningless since the banking system is always in excess liquidity. On this line it also fails to recognize the impact of a balanced budget policy on money supply. As noted above, the model does not address price stability as it intended to, a short-run problem that is very crucial in Indonesia, especially after 1971, as has been discussed in Chapter I. Another monetarist macro-model constructed by Aghevli 8 in 1977 had the main purpose of predicting the appropriate rate of monetary expansion that is consistent with the targeted rates of growth of real income and prices. The model starts with a specification of demand for real money balances as a function of real income and the expected rate of mflation which is adjusted adaptively. Originally the interest rate paid on savings and time deposits was included as an argument in the demand for money function, but he dropped it later because of statistical insignificancy in its estimated coefficient. Real income and interest rates are assumed to be exogenous, the latter being determined by the monetary authorities. Monies are defined in the narrow and broad senses. Narrow money consists of currency and demand deposits, while broad money consists of narrow money plus quasi-money. The latter is made up mainly of time and savings deposits at the state-owned banks. He tried two specifications of supply for both definitions of money. In the first specification, money supply is equal to simple multiplication of constant money multiplier with reserve money. The money multiplier is a function of the ratios of demand deposits to currency, of quasi -money to demand deposits and of total deposits (demand and time deposits) to reserves. The second specification is that money supply is a Koyck transformation of the reserve money. As in the first one, the money multiplier is assumed to be constant in the second formulation of money supply. Reserve money is defined as a summation of the deficit in the domestic component of the government budget, the private sector's balance of payments, and changes in credit to the private sector. As noted in Chapter III, "the balanced budget rule" in Indonesia means that the government finances deficits in the domestic component of its budget with the surplus in the foreign component of the same budget. Total government expenditures, domestic and abroad, and government foreign revenue are assumed exogenous; then, the only estimable equation is government domestic revenues. As noted in Chapter I, government foreign revenue consists of foreign borrowing and revenues in foreign exchange which are not withdrawals from domestic purchasing power, such as oil revenues. Aghevli specifies domestic revenue as a function of real income and the inflation rate. The balance of payments consists of imports, non-oil exports, oil exports, and capital accounts. Oil export and capital account are assumed to be exogenous. Export is a function of export price relative to home prices and nominal income. Import is a function of total demand for goods and services and the price of import relative to domestic prices. Aghevli tested his model empirically from the fourth quarter of 1967 to the first

172

Appendices

quarter of 1973. With its simplicity the model captures the essential characteristic of the Indonesian monetary sector: the money supply and inflation rate are interdependent and reserve money is a function of expansion in domestic credit and the way government finances the domestic components of its budget via the balance of payments. I~ his 1979 article, Boediono 9 developed a quarterly macro-economic model of the Indonesian economy. The model consists of 32 equations of which 18 are semilogarithmic behavioural equations and 14 identities. Government revenue is estimated by five equations, and each of them is to estimate the following sources of tax revenue: oil tax, indirect tax on non-oil import, other (domestic) indirect tax, direct tax, and total domestic revenue. Oil tax is a function of net oil export, which is equal to its export minus its import, and two dummy variables. The first dummy is to detect the effect of oil contract renegotiation in 1975 and the other is to observe the effect of oil price increases since 1973. Import tax is a function on non-oil import value and two dummies, each of them to represent import tariff revision in 1973 and the anti-smuggling campaign in 1976. Other indirect tax and direct tax are functions on non-oil GDP and their respective previous values. Total government revenue is a linear function of the first four sources of tax revenue. Real government expenditure is a function of total annual budget multiplied by a quarterly index and a dummy variable to represent increases in the price of oil since 1973. Money supply is equal to the product of the money multiplier and reserve money. The money multiplier is an implicit function of some other variables, namely, GDP at 1973 market prices, ratios of government expenditure and of value of non-export to money supply, and some dummy variables. There are ten price equations in Boediono's model, of which five are price identities. Four identities are to convert foreign prices into domestic currency and one to construct the GDP price deflator to base 1973 = 100. The general price index is a function of price indexes of goods that are consumed by the government sector, of consumer goods, of investment goods, of oil export, of non-oil export, and of total imports. The price index of goods that are consumed by the government sector and the price index of consumer goods are functions of the cost-of-living index only. In turn, the cost-of-living index is a negative function of domestic supply at 1973 market prices and a positive function of current money supply, price of imported consumer goods, previous cost-of-living index, quarterly dummy variables. Price of investment goods is a positive function of general price index of total import. Boediono divides both export and import into two components. Export and import of oil are assumed to be exogenous, while export and import of non-oil are endogenous. Non-oil export is a function of the price index of non-oil export relative to the cost-of-living index, non-oil GDP at 1973 market prices, the price of non-oil exports in a previous period relative to the current price index of exported goods in international markets, one dummy for non-oil export and three quarterly dummies. Non-oil import is a function of domestic general price index of imported goods, private consumption expenditure, change in the central bank's direct credit and dummy variables to show the effect of import tariff revision in 1973 and the anti-smuggling campaign in 1976. Besides these two behavioural equations, there are three additional identities for foreign transactions. Identities for total export and import simply say that total export is equal to export of non-oil plus exogenous export of oil and total import is equal to import of non-oil plus exogenous oil import. The last identity is the balance of payment identity which is defined as equal to total export minus total import plus net exogenous private and official capital flows, plus exogenous services, and error and omission.

:..

~

:J

~

TABLE A.2 Main Characteristics of Econometric Models of the Indonesian Financial Sector Data Used No. of Equations Year Published

Total

Gurley Sundrum Aghevli & Khan

1970 1973

1 1

1 1

1977

4

3

4

Schydlowsky

1980

7

5

Aghevli

1977

12

6

Boediono

1979

32

No. 1 2 3

Author(s)

Behavioural

No. of Variables

Sample

-------

Function(s) or Sector(s) Included

tities

Total

Exogenous

Estimation Technique

none none

4 4

3 3

graphic OLS

17 11

1953 1967

1969 1971

annual annual

Md Md

1

8

3

FIML

22

1951

1971

annual

7

28

22

?

4

1969

1973

quarter

9

3

17

5

2 SLS

56

1960: 1

1973: 4

quarter

18

14

74

43

OLS(?)

29

1969: 2

1976: 3

quarter

P, Gov't. sector, MS Y, IM, EX, IM, CMD, I, B Md, MS, IM, EX, GDR, MS Y, C, EX, IM, MS, Md, p Government

none

Iden-

No. of Observ.

From

To

Base

sector

"w

174

Appendices

Private consumption expenditure is a positive function of current disposable income and the previous period's private consumption expenditure. The last six identities are expenditure, income and supply identities. Current GDP is a summation of current private and government expenditures, export, investment, minus import, and plus statistical errors. Disposable income equals GDP minus oil and other direct taxes, minus factors' payments abroad and depreciation, plus statistical errors. GDP non-oil is equal to GDP minus value of oil export. Domestic supply at 1973 market prices is equal to GDP minus all export plus total import, all at 1973 prices. GDP non-oil at 1973 prices is equal to GDP minus value of export at the same market prices. Real GDP at 1973 market prices is a function of current GDP over general price index and of the previous period's GDP at 1973 market prices. The flaws of Boediono' s model are apparent from its specification and empirical findings. First, as has been discussed in Chapter I, about half of the government budget is for development expenditure and some of it is expenditure for investment goods, as well as for raw materials or intermediate goods since the government in Indonesia not only produces "public goods" but also "private goods". Even for provisions of "public goods" such as roads and dams, the government needs to buy investment goods. As a result, Boediono's specification that the price index of goods that are consumed by the government is only a function of cost-of-living index, is false. Second, the multiplier effect of an exogenous increase in government spending, according to the result of his first simulation, has yielded a negative GDP at current prices since the 17th quarter and at 1973 market prices since the 14th quarter. These results are contrary to multiplier theory which says that multiplier effect of an increase in exogenous variables always yields a positive effect on income. Third, the same holds true for the result of the multiplier effect of devaluation in his second simulation. According to it, a 10% devaluation yields positive effects on current price GDP until the 11th quarter, on GDP at 1973 market prices up to the 4th quarter, and on export of non-oil up to the 5th quarter. After those periods, devaluation yields negative effects on those variables. These results are diametrically contrary to the established J curve in international trade theory which says that devaluation will deteriorate the BOP and income in the earlier periods after devaluation and improve them in later periods . 10 The main characteristics of econometric models of the Indonesian economy that have been discussed so far are summarized in Table A.2.

NOTES 1. John G. Gurley, "Notes on the Indonesian Financial System" (Paper presented at the Dubrovnik Conference of the Development Advisory Service of Harvard University, 20-26 June 1970). 2. Sundrum, op. cit. 3. Aghevli and Khan (1977), op. cit. 4. Ibid., p. 185. 5. Phillip Cagan, ''The Monetary Dynamics of Hyperinflation'', in Studies in the Quantity Theory of Money, ed. Milton Friedman (Chicago: University of Chicago Press, 1970), pp. 25-117. 6. Bijan B. Aghevli and Mohsin S. Khan, "Government Deficits and the Inflationary Process in Developing Countries", IMF-SP 25, no. 3 (September 1978). 7. Daniel M. Schydlowsky, "A Short Macroeconomic Model of the Indonesian Economy", in Gustav F. Papanek (ed.), ibid., ch. 7, pp. 185-277. 8. Bijan B. Aghevli, "Money, Prices, and the Balance of Payments: Indonesia 1968-73", The Journal of Development Studies 13, no. 2 (June 1977). 9. Boediono, "Sebuah Model Makro Triwulanan Untuk Indonesia", EKI XXVII, no. 3 (September 1979). 10. I am indebted to Dr David 0. Dapice on this point.

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Abbreviations AER AJAE BPEA BIES EDCC EKI IER IMF-SP JMCB JASA JPE JET QJE

American Economic Review American Journal of Agricultural Economics Brookings Papers on Economic Activity Bulletin of Indonesian Economic Studies Economic Development and Cultural Change Ekonomi dan Keuangan Indonesia International Economic Review IMF Staff Papers Journal of Money Credit and Banking Journal of the American Statistical Association Journal of Political Economy Journal of Economic Theory Quarterly Journal of Economics

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THE AUTHOR Anwar Nasution, Ph.D., teaches at the Faculty of Economics, University of Indonesia, and is Research Associate at the Institute for Economic and Social Research at the same Faculty. From 1966 to 1968 he was Chairman of the Task Force Ekonomi KAMI (Indonesian Student Unity Action), and from 1968 to 1975 held a second appointment at the Ministry of Finance in addition to his teaching post. In this capacity, among others, he was assigned to attend OPEC meetings during 1974-75. He obtained a Doktorandus Ekonomi degree from University of Indonesia (1968), an MPA from Harvard (1973), and a Ph.D. in Economics from Tufts University (1982). His interests are mainly in the field of macro-economics, money and finance, and international trade. His publications appear regularly in journals and newspapers both in Bahasa Indonesia as well as in English.