Effect of Indonesia’s COVID-19 stimulus packages

Police car in Indonesia

Will Indonesia’s stimulus packages spur its COVID-19 affected economy?

By Associate Professor Pierre van der Eng

Indonesia announced stimulus packages on 25 February13 March and 18 March with a total value of US$12 billion (Rp 181 trillion) aimed at keeping Indonesia’s economy ticking over during the COVID-19 pandemic. This is equivalent to 1.1 per cent of GDP in 2019 and 6.5 per cent of the 2020 state budget, indicating the government’s concern about the impact of the pandemic. A further package is being prepared.

Each package contains detailed measures. But they do not specify how the government expects the pandemic to affect Indonesia’s economy and society.

A few things are increasingly beyond dispute.

The rate of infections and deaths will increase rapidly in the coming weeks. Indonesia’s healthcare system will be under enormous strain to accommodate COVID-19 patients. Most symptomatic people will be cared for at home, where they may infect family members. Indonesia’s poor will lack the economic resilience necessary to self-isolate or heed a lockdown when it is called to contain the spread of the virus.

A strong sense of urgency underpins the stimulus packages. They look impressive and testify to the government’s resolve to mitigate an economic slowdown. They comprise of both fiscal measures, such as tax breaks and specific subsidies for companies and individuals, and non-fiscal measures to stimulate exports and imports.

But two factors limit the ability of Indonesia’s government to stimulate the economy.

First, Indonesia’s state budget (US$180 billion in 2020) for a population of 270 million people is similar to the US state of New York’s budget (US$178 billion in 2020) for 20 million people. Much of Indonesia’s budget is earmarked for subventions to local governments for routine spending, which limits discretionary spending options.

Second, both central and regional governments have limited capacity to raise additional funds at short notice. Efforts by the Ministry of Finance to increase the low tax compliance and low income tax revenues in recent years have not been very successful. The scope for additional local taxation is limited.

A major impediment is the law that limits the annual budget deficit to 3 per cent of GDP. President Joko Widodo announced a raising of the limit to 5 per cent on 27 March to fight COVID-19. Still, the cap limits the fiscal stimulus of decreasing taxation and increasing spending, even though the debt-to-GDP ratio is currently around 30 per cent, which is modest from an international perspective.

Indonesia’s stimulus packages contain a range of measures designed to mitigate the economic consequences of the pandemic given these impediments. Not everything in the stimulus packages is new public spending. Part of it is reallocation of budgeted public spending, particularly to boost healthcare. Other parts are non-fiscal and focussed on trade liberalisation.

In addition, Bank Indonesia (BI) is making changes to monetary and financial policy. As foreign portfolio investors rushed out of Indonesia, BI bought more of the government’s debt to finance government expenditure. It may have to buy even more to finance the additional outlay of the stimulus packages. BI is doing what it can to stabilise the exchange rate in the face of capital flight to help constrain the cost of imports. It is also trying to secure the banking system by lowering the policy rate to encourage bank lending.

On the supply side, the pandemic will force many people to stay at home to contain the spread of the virus. This will disrupt supply chains and the availability of products to consumers and companies.

Food logistics agency Bulog has given assurances that its rice stocks will last until the end of 2020. But rice is just one-third of the average calorie intake in Indonesia. Crucial non-rice food distribution will depend on sustained activity in private sector supply chains.

Most companies will face a reduced workforce and disrupted supplies. When their cash flows decrease, they will run down their reserves and cut costs, including dismissing workers. Several aspects of the stimulus packages aim to reduce the burden on companies, such as reducing corporate income tax, so that they survive the coming months.

This may help the formal sector. But the informal sector still employs large numbers of people. Their employers have minimal reserves and will be forced to take remedial action sooner by firing workers. Due to their informal nature, it is hard for government measures to reach them.

On the demand side, increasing economic uncertainty and unemployment will lead to reduced consumer spending. The mainstay of national expenditure is household consumption. The stimulus packages also aim to increase the amount of money in people’s pockets. For example, there will be a six-month income tax exemption for employees in the manufacturing sector with incomes up to around US$12,500.

Another way to encourage consumer spending that is absent from the stimulus packages is to increase Indonesia’s income tax threshold. This seems appealing, but it would not be relevant to the majority of Indonesian workers who are employed in the informal sector and who generally do not pay income tax. For some 15 million of Indonesia’s poorest households that essentially live hand-to-mouth, the packages contain subsidies for basic needs.

The litmus test of the combined stimulus packages will be whether they can successfully encourage households to maintain consumer spending in the uncertain environment caused by the pandemic.

Pierre van der Eng is Associate Professor of International Business at the ANU Research School of Management.

This article was originally published in East Asia Forum and has been republished here under the Creative Commons license.