Nov 14, 2024
Intro: Professor Eduardo Araral, is a distinguished academic and practitioner with over 30 years of experience in academia and government. His research primarily focuses on institutions for collective action. As a prominent figure in the field, Professor Araral has contributed to significant projects with various governments and international organisations, including the Asian Development Bank and the World Bank. He has engaged in over 250 executive education programmes, sharing his insights with thousands of government officials, business leaders, and NGOs across more than 50 countries.
In this discussion, we explore his perspectives on the pressing challenges facing Indonesia, Southeast Asia’s largest economy as President Prabowo takes over the country’s leadership after being inaugurated as President on 20th October. Professor Araral shares his insights on fiscal policy, infrastructure investment, and the broader implications for governance and public support in a rapidly evolving economic landscape.
David Austin: Okay, thank you. So let's talk about Indonesia today, and I'd really like to hear what you have to say about where you think it's going to go in this new administration. And I'm just going to jump right in and ask you a question. What do you think motivated President Prabowo's administration to consider increasing Indonesia's debt-to-GDP ratio to 50 per cent and budget deficit to 5 per cent?
What's behind that?
Professor Eduardo Araral: Yes, David, thanks for having me. The main motivation I think from President Prabowo, and he has mentioned this repeatedly in public, is that one, he wants the Indonesia economy to grow at least 8 per cent on a sustainable basis. Such that by 2045 - that's the 100 year anniversary of Indonesia as a republic - with that 8 per cent growth, Indonesia would become a middle income country.
So that's the first and foremost motivation, (of) 8 per cent growth. And to achieve that growth, you need to have an expansionary fiscal policy. That means Indonesia will spend more, increase its debt-to-GDP ratio, increase its budget deficit because to achieve that 8 per cent growth requires a lot of spending for infrastructure for the new capital, for social spending, healthcare spending, housing, and all the things that President Prabowo promised during his election.
David Austin: And how does this stance compare to other ASEAN countries and developed economies, especially in terms of the debt-to-GDP and budget deficit?
Professor Eduardo Araral: Among ASEAN countries and OECD countries, Indonesia actually has a very conservative budget deficit and debt-to-GDP ratio. And partly that is, or mainly that is, because of its bad experience in the late 1990s when the Indonesian economy collapsed because of unregulated and uncontrolled borrowing and so on.
So compared to ASEAN, Indonesia has a lot of fiscal space. For example, Indonesia's debt-to-GDP ratio is only about 40 per cent. Compare that to the Philippines, it's close to about 60 per cent.
Indonesia's budget deficit at 2.5 per cent. That's still pretty low compared to the other rates of about 5 per cent in other ASEAN countries. And Indonesia, compared to OECD and EU countries, is still very low. In EU, the debt-to-GDP ratio would be about 80 to 90 per cent compared to France and Italy. Indonesia’s debt-to-GDP ratio looks very small. In short, David, Indonesia has a lot of fiscal space and a lot of room to grow in its fiscal expansion.
David Austin: And you mentioned that 8 per cent growth target. How realistic do you think that is?
Professor Eduardo Araral: It's not impossible, but it's difficult. Because right now Indonesia is only growing at about 5 per cent, and it's a big economy. It's US$1.2 trillion. So anything that grows 8 per cent at US$1.3 trillion is already very significant. But there is room for growth because one, it is a young population.
Number two, it is blessed with a lot of natural resources, especially nickel and all the rare earth that goes into all these cars. Number three Indonesia has a lot of resources for coal, natural resources like oil and gas. I think they have a newly discovered field. And it's also looking to export its industries.
And, Indonesia also has a lot of unicorns, Gojek, Tokopedia and all of this stuff. So the fundamentals for Indonesia's growth would be there. It just needs a little bit more push to move from 5 per cent to 8 per cent.
David Austin: Okay. I definitely get the point that they have that fiscal space to grow compared to other countries but I'd like to ask you now, what are the potential benefits of raising the tax to GDP ratio from 10.6 to 16 per cent? And how does this align Indonesia with its regional peers?
Professor Eduardo Araral: If Indonesia moves from 11 per cent to 16 per cent tax to GDP ratio, that would align it closely to its ASEAN peers. The average rates will be about 15 to 15.5 per cent for ASEAN. So Indonesia is way below compared to its peers.
In numerical terms, that means Indonesia could earn an additional hundred billion US dollars in tax revenues if it can change its tax to GDP ratio from 11 per cent to 16 per cent. And what that means is that with this additional 100 billion dollars a year, then it could pay more for its food programme, housing programme, water programme, poverty alleviation, programme defence modernisation, the new capital, and all other expenditure items that Indonesia needs to grow at 8 per cent.
David Austin: Definitely real growth potential here. But can you walk us through maybe some different scenarios that you've spoken about in the past for Indonesia's fiscal future? Maybe from the gradual growth to rapid or shock increases in debt and deficit.
Professor Eduardo Araral: So I wrote a paper that was published in a couple of Indonesia newspapers where I laid out three scenarios for fiscal expansion for Indonesia. The first one is slow and moderate expansion, which means a 2 to 3 per cent fiscal expansion on its budget deficit, right? And it's debt-to-GDP ratio.
In this scenario my conclusion is that this is feasible. It will not have any high risk to the Indonesian economy in terms of inflation, in terms of credit downgrade and in terms of weakening the market sentiment. But it would have some effect on pressures on the rupiah.
So a growth of 2 to 3 per cent year in, year out this would be your debt-to-GDP ratio. Currently, it's about close to 40 per cent, so if it grows about 2 to 3 per cent every year or couple of years, then that, that should still be okay and Indonesia would hit its debt-to-GDP ratio of 48 per cent, which is still way, way below compared to what the law says in Indonesia and way below compared to OECD countries and in line with ASEAN countries. So that's the first scenario.
The second scenario, David, is a fast growth, a 3 to 4 per cent growth of debt-to-GDP ratio, which means that within four years’ time the Indonesia debt-to-GDP ratio would grow fast and this would be a bit risky for the economy in terms of inflation, in terms of its currency, in terms of its credit rating and so on. But if this is accompanied by high levels of tax collection, then this is also good for Indonesia. So there's got to be a balancing act between the speed of fiscal expansion and the speed at which they collect new taxes.
Then the last scenario I wrote was about a really rapid increase, which is after 1 or 2 years, Indonesia shoots for a 5 per cent debt-to-GDP ratio. And that would really make it difficult. And the economy really has to grow. Otherwise if the economy doesn't grow very fast, then the debt over the debt growth would overtake the growth of the economy, and that could be detrimental for its inflation, for its currency, its credit rating and market sentiment.
But fortunately I read in the news today that President Prabowo has sealed a partnership with the largest political party in Indonesia. So practically, there are no more opposition parties in Indonesia. It'll become a super majority, which means that the Prabowo administration can push for changing the ceiling on debt-to-GDP ratio, that currently 3 per cent ceiling so that they can probably increase it to 5 per cent. And this will give a lot of space for President Prabowo to push ahead with his fiscal expansionary plans.
David Austin: And you outlined the risks of those different scenarios as you were speaking, but is there any other risk on the horizon for the Indonesian economy that you see as being the main concern?
Professor Eduardo Araral: Yes. One is the oil price shock if this war in the Middle East escalates and oil refineries in Iran would be targeted and shipping lanes in the Persian Gulf would be affected. Oil prices would go up, energy prices would go up and that would have a knock on effect on the Indonesian economy. Although Indonesia also produces oil, that's not enough.
Number two is the continuing war in Ukraine, which means that fertiliser prices would continue to increase because Ukraine and Russia are two major exporters of fertilisers which Indonesia needs as an agriculture dependent country. Indonesia is the world's largest producer of palm oil, which requires all of that fertiliser from Ukraine.
So those are just two shocks. The third one of course, is if President Trump wins and he will make good on his promise to impose a 60 per cent tariff for Chinese goods and 10 per cent across the board for every country. That would also affect Indonesia, because Indonesia also exports a lot to the United States.
And when that happens we expect to see inflation go back to the United States. When that inflation goes back, then the cost of borrowing for the rest of the world would also go up. And that would also affect Indonesia. And the cost of borrowing in Indonesia, like any other country, would also go up.
And that would also slow down private sector investments. And that would also crowd out the government or would also be competing with the private sector when interest rates go up. So those are the three scenarios of risks that are highly plausible for Indonesia.
David Austin: Yes, those are very big risks and very dramatic ones. But are there other global economic conditions that influence Indonesia's ability to manage its increased debt and achieve its targeted growth rates?
Professor Eduardo Araral: Apart from those three things that I already mentioned, of course the US China competition would be one thing, but it's not always a negative thing for Indonesia. In fact, Indonesia is now a beneficiary of this US China rivalry as a lot of Chinese companies moved to Southeast Asia and principally to Indonesia.
And so all of this US imposed and EU imposed tariffs on BYD and Chinese electric vehicles. Indonesia is the main beneficiary seeing that a lot of Chinese companies moved down south to Indonesia to set up their plants and take advantage of Indonesia's availability of mineral goods and use Indonesia as an export base to export Chinese cars so that they don't get slapped.
Imagine if President Trump or even President Kamala Harris wins, they would continue with President Biden's 60 per cent tariff on electric cars. But if the cars are produced in Indonesia with a combination of Indonesian content, EU content with Chinese technology and all the stuff, then it's no longer subject to the tariff of 60 per cent. Maybe 10 per cent, yes, but we don't know how that will go, but Indonesia in effect would become a major beneficiary of the US China trade war.
David Austin: That's interesting. They have the US China relationship and then as you were saying earlier, the mineral wealth, the nickel and other minerals that are important for electric cars. So that's an interesting scenario going forward in that space. But you also mentioned that now with the political situation, President Prabowo should be able to increase the borrowing as he plans. But are there measures that Indonesia can take to ensure that this increased borrowing is used effectively for growth enhancing projects?
Professor Eduardo Araral: Yes. There's a lot of things that the administration can do. The first one of course is Minister Sri Mulyani, the current the outgoing Finance Minister of Indonesia, has been very good in shepherding the Indonesian economy. She's a fiscal conservative and she knows that if the fiscal space or borrowing goes up too much, then that would be dangerous for the economy.
So one of the things that the government can do is of course, channel this fiscal space, this extra money into productive investments. One of those would be on this national feeding programme. That was a campaign promise of President Prabowo. If that is done well, that means it would boost the growth of small and medium enterprises with a lot of money, feeding a lot of young children.
This could boost the growth of SMEs and that would be good for the Indonesian economies, which relies a lot on SME growth. And if we have growing SMEs, then you can also increase the taxes paid by these SMEs. It's a positive feedback loop.
Number two is investments in productive assets like transportation, education, irrigation, renewable electricity and so on. And as long as this money is put into productive investments, they will pay for it on their own and it will have a lot of multiplier effect - not just immediately, but even in the long run.
So as long as the GDP is growing at a rapid pace and at the pace greater than you're borrowing that, then that should be also good. I'm only worried about if this exp expenditure goes to elephant unproductive projects or goes to corruption. But I think President Prabowo is watching that he doesn't want to be remembered in Indonesian history as having been given this opportunity to lead the country only to let it go to waste.
So I think he's got an eye for his history, because he's not already young. I think he will try to be seen as the President who delivered on the promise of 8 per cent growth and putting Indonesia on the trajectory as an upper middle income country by 2045.
David Austin: Okay. You laid out quite a few possibilities there, but how do you actually foresee Indonesia balancing this need for aggressive fiscal expansion, but with the necessity of maintaining economic stability? Do you have a prediction?
Professor Eduardo Araral: For Indonesia, what President Prabowo needs to do is to assure the stakeholders, global stakeholders, that while he will do fiscal expansion, there will also be fiscal discipline and fiscal consolidation down the road. So not so that people will not be worried that there is no limit, that this fiscal expansion would be unlimited.
In taxation [and] productive investments there has to be some restrictions on how far he could go to borrowing. Probably not exceed 60 per cent. 50 per cent should be okay. And the 3 per cent limit that he will lift, if that goes to 5 per cent, should still be okay. The bottom line, David, is his communications team and himself would have to assure the market that these conditions are in place.
Otherwise, the market would panic. If they're not told what the plans would be, David.
David Austin: You have spoken about where a lot of this money is going to go already, but what role does infrastructure investment play in this whole scenario and the plan to boost productivity and achieve this long-term economic growth?
Professor Eduardo Araral: David, it's infrastructure that really drives the growth of the economy. So you put in your railways, then people can move faster and goods can move faster. You build your seaports and Indonesia is 17,000 islands, if they can improve their seaport, then the cost of logistics and cost of doing business would go down and that would be good for the SMEs. That would be good for inflation and that would be good for economic growth.
You build more roads and highways outside of Jakarta, you build them in the outlying islands or in Sumatra, then that would also spread out growth outside of the Jakarta region. So David, the bottom line is infrastructure investment has a lot of multiplied effect on the economy.
It creates jobs, crowding-in investments. It is a productive investment and it's a main driver for economic growth.
David Austin: Okay. Thank you so much. I think finally, I'd like to wrap it up by asking about the political and social implications of all these fiscal policy changes. Especially concerning the public support and potential economic inequality.
Professor Eduardo Araral: On the inequality part, so President Prabowo promised the feeding programme. So that is really good to help malnourished children improve education, also improve the SMEs. So that's really good. That's front and centre of his campaign promise.
As a military man, he knows logistics. He knows how to deliver goods. And even as we speak, that is already happening. So I think that promise on the feeding programme will be delivered.
On the fiscal expansion side I think he's got a lot of very smart advisors. They know that a 5 per cent shock growth shock fiscal expansion would be risky. So they might probably go for 2, 3 to 4 per cent manageable growth so that it will not really lead to a shock in the system that will lead to inflation, credit rating and market sentiment analysis.
So I think President Prabowo is like a juggler in the circus. He's juggling many things. He's got plenty of smart advisors and he, I think he's willing to listen and they will have to monitor how things are and make some corrections and adjustments as needed.
David Austin: What gives you the most hope about the economic situation going forward?
Professor Eduardo Araral: Of course, Indonesia is the biggest economy in the region, right? USD1.3 trillion economy. If something bad happens to Indonesia, everybody gets sick. So we have to be hopeful and helpful to Indonesia. But being hopeful and helpful are two different things. Whether they can pull off and deliver this, promise things is another thing, right?
And I already said that I think the feeding programme is good to go. It'll happen. The infrastructure spending is already happening. Indonesia is already on a high level trajectory. Indonesia is joining the OECD. Once you join OECD, you are subject to all the requirements, regulations, stipulation and standards of OECD.
That means you cannot have a lack of discipline or fiscal space in all that stuff. You have to be compliant with all OECD rules, and that gives me comfort that, under OECD standards, Indonesia will not become like the old Indonesia before that. There were no limits and restrictions.
And number three, why I'm optimistic, David, as I mentioned, is that President Prabowo has tried three times for this presidency, and I don't think he would like to squander the last opportunity for him to be a great Indonesian leader.
And he's got his plans well laid out. He has thought through this he's got a solid majority in Parliament. There is no meaningful opposition for him. And he has got a lot of very smart advisors. And I think he knows how to listen. So that gives me optimism why these things should go through.
David Austin: Very good. Thank you so much.
That's really a really positive and interesting picture you've painted of Indonesia under this new administration and what we have to look forward to. Thank you so much for joining us.