edward: November 2007

Monetary and fiscal policies are a part of the government program in running a nation in the economic development program. The aspects and contents of the monetary and fiscal policies will be explained separately. The role of monetary policy is to set a foundation for the monetary system, determining the interest rate, credit, and money, and a guideline for economic activity. The aim of the monetary policy can be viewed from two perspectives. First is the internal balance. The aim of the internal balance is to create a high job opportunity for labors within a nation. Also, the aim of the internal balance is for the government program to accomplish a high economic growth within a nation and maintaining low inflation rate. Second is the external balance. The aim of the external balance is to maintain the payment balance (Balance of Payment). The aim of the monetary policy is to handle and manage demand and fulfill monetary target which are targeting the amount of money out or spread. One of the actions of monetary policy is to decrease the amount of primary money, increase reserve requirement, and increasing the interest rate. One of the monetary policy instruments that the government uses are market operation, reserve requirement, credit selection, and moral suasion. However the success of the monetary policies conduct are based on the affectivity of the availability of crashed goals, society monetary rate, time lag, financial institution intervention, society expectation, and factors that influence target variable.
Before the deregulation, the environment is in low level of monetization (ration of money supply to GNP), inadequacy of banking network, undeveloped banking technology, and undeveloped capital market. The constraint can result in a less effectiveness of monetary policy such as the inadequate of financial institution system, financial sector dominated by banks, and assets in monetary sector dominated by state banks. The monetary policy in Indonesia can be analyzed from two perspectives which are the old regime and the new regime. In the old regime period the monetary policy was direct, monetary authority are tightly controlled by monetary sector, bank were extended hand from the state, and the state budget deficit was financed by loan from Bank Indonesia. While the new order period consists of money circulation was controllable, investments encouraging, banking operations were based on laws, and the inflation rate was under control.
During the Indonesia crisis in 1997/1998 the Indonesian exchange rate collapsed from Rp 2500/US$ until Rp 15000/US$. The economic contraction was 7.8% in 1996/1997 until 13.2% in 1998. What makes it worse the $ 22 billion reversal of private capital flows from inflows of $ 10 billion (1996/1997) to outflows of $ 12 billion (1997/1998) is nearly as large s total net capital flows in the entire decade to 1985 until 1995. The price of Indonesia’s key export, oil, has fallen to $ 13 a barrel, its lowest level in real terms in 30 years and the domination of enormous political changes. Before the crisis occurrence, IBRA was established in January 1998. Its task was to restructure banks under financial difficulties. It recapitalized Rp 430 trillion. It closed banks that were unable to fulfill the recapitalization standard and merge banks as alternatives in saved most banks. By the year of 2000 there were modest signs of a banking recovery. For instance the NPL have dropped to average 18%. CAR improved to positive of more than 4 and some banks have returned to profitability.
Fiscal policy is defined as government’s policy regarding the level of spending and revenue (taxation). Fiscal policy is also described as the behavior of governments in raising the revenue to fund current spending and the transfer of payments to citizens for which the government is responsible. The revenue can be supported by the raise in taxation or borrowing money from the World Bank. The fiscal policy itself affects the macroeconomic variables such as employment, price level, and the level of GDP. There are fundamental differences between the fiscal policy in pre/post 1966 eras in Indonesia; first the government has ceased to conduct major and direct contributor to inflation, in the new regime the government adopted balance budget principle, and the size of the government have risen sharply and the increase have been essentially revenue driven.
As mentioned earlier about the balance budget, there are rules that must be recognized. First the budget is balance only because the items financing the deficits (aid and external borrowing) are counted as revenue. Balance budget was introduced as a clever and effective political tactic to guard against a recurrence of the financial excess of the early 1960s. What is the impact of the balance budget? Indonesia has achieved normal inflation since the balance budget was implemented in 1967 and the impact was the inflation rate decreased from 639% in the year 1966 to 3.9% in 1971. Whereas the originality of revenue in Indonesia was derived from three aggregates which are oil and gas revenue non oil domestic revenue, and foreign aid. As it can be seen the key role of oil and foreign aid is very imminent. The change of oil price changes the revenue composition. It is the major source of domestic revenue. Especially during the oil boom period aid funded an increasingly small percentage of the development budget. In the 1980s Indonesia underwent tax reform in non oil domestic revenue. The large volume of aid and oil revenue had an adverse effect on NODR from the late 1960s until the mid 1980s. The share of NODR in total revenue halved over the 1968-1979 period (from 65% to 30%) and it fell further during the second oil boom to as low as 25.8% in 1981. The non oil tax revenue is set as a percentage of GDP below its potential. What is the use of tax reform? It certainly simplifies the income and company taxation rates. The investment incentives were largely abolished and since the year of 1990 the capital gains were taxed.
As the opposite of revenue, expenditure increased sharply in the year 1970s giving response to the oil and aid inflows. The rising proportion of funds spent on developing project over this period corresponded to the declining importance of aid as a source of expenditure development. Also during the year 1977 until the year 1981, debt rose sharply. During the Indonesian crisis in the year 1998, Indonesia needed a change in fiscal policy badly. Indonesia was overcome with huge debt, primarily due to the recapitalization of the banking system which cost about half of annual GDP (Rp 650 trillion). After the fiscal policy crisis the government was making hard effort to achieve fiscal sustainability. As a result of the crisis the debt accumulated, increasing fuel subsidy and the impact of decentralization lead to unsustainable budget. The increasing domestic debts mainly were from banking recapitalization and liquidity support.

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