4 - Fiscal Policy in Managing the Economic Recovery

Summary

Abstract

The COVID-19 pandemic has afflicted the Indonesian economy significantly. The first half of 2020 saw a sizeable GDP contraction on the back of disrupted economic activities exacerbated by strict social distancing measures domestically and overseas. Prolonged weaker real sector activities will eventually lead to further distress in the financial sector. Unlike in other episodes of economic downturn that focus on stimulating demand, this unprecedented crisis requires the government to boost resources for pandemic containment measures, health care, and an emergency lifeline for poor and vulnerable families as well as businesses. As a result, the government has to confront unprecedented fiscal pressures from both spending and revenue sides. The fiscal deficit is likely to widen to a historical record in five decades. In this chapter we highlight Indonesia's fiscal policy in responding to the pandemic crisis and managing the economic recovery. More specifically, we underscore three main issues: (1) heightening fiscal pressures on the back of underperformed revenue collection and rising fiscal needs to contain and mitigate the pandemic crisis, (2) government strategies to finance the cost of the pandemic crisis and (3) lessons learned for future reform.

Introduction

Indonesia's economic fundamentals were in relatively good shape at the end of 2019. Higher volatility emerged in the global financial market as the United States – China trade war put pressure on the global economy. At the same time, escalating geopolitical tension created uncertainty over oil prices. Yet global economic conditions stabilised towards the end of 2019, trade tensions eased somewhat, and capital flows started to return to emerging markets, including Indonesia.

Pressures to the financial market eased significantly in the last quarter of 2019. The rupiah appreciated by 5 per cent between 31 May 2019 and 31 January 2020 and the ten-year yield decreased by 138 basis points during the same period. A calmer global financial environment is an important factor for countries such as Indonesia that are highly dependent on foreign flows to push economic growth above its potential.

Several reforms were underway, aimed at higher economic growth to escape the middle income trap by 2045, the anniversary of Indonesia's 100 years of independence.