Indonesia's Monetary & Fiscal Policies Require More Harmony

However, Indonesia's lender of last resort did not agree and left rates untouched as it "detected improvements in the transmission of earlier interest rate cuts". However, Bank Indonesia also indicated that it fears a global economic recovery that will fall below previous projections in the aftermath of the Brexit case (Britain's decision to leave the European Union through the referendum that was held on Thursday 23 June 2016). Brexit has been the new center of focus of investors and the new source of global uncertainty.

However, Brexit also had one positive effect (on the short-term that is) for capital markets worldwide (excluding the UK), namely it makes it very hard for the US Federal Reserve to raise its Fed Funds Rate on the short-term. Due to this delay of further monetary tightening in the USA capital either remains in emerging markets for the time being or is still able to flow into emerging market assets, especially given that the European Union and Japan remain in 'stimulus-mode'.

But we should not forget that we continue to live in uncertain times, economically. We have been living in a remarkable high degree of uncertainty since 2008 when the financial crisis broke out in the West (while uncertainty reached its peak in the months after May 2013 when the US Federal Reserve started to hint at winding down its generous quantitative easing (QE) program.

Being the world's largest economy, policy changes in the USA will not only affect the USA but it basically affects all countries around the world. Expectation of tightening US monetary policy in the second half of 2013 implied serious consequences for Indonesia. Southeast Asia's largest economy was plagued by capital outflows, saw its rupiah depreciated sharply, its foreign exchange reserves decline, and interest rates rise rapidly (all these matters curtailed Indonesians' purchasing power). Indonesia was one of the worst affected emerging market economies as investors were particularly concerned about the country's wide current account deficit. This deficit showed investors that the nation is highly dependent on foreign capital inflows.

After the Brexit there also occurred chaos as investors moved their capital away from the UK to the USA, Japan and emerging markets. Despite the strengthening US dollar, this chaos actually had a positive impact on Indonesian assets: capital inflows into Indonesia emerged as the nation is considered a stable emerging market now several macroeconomic indicators - inflation and the current account deficit - have improved markedly over the past two years, partly due to high local interest rates and a weakening rupiah between 2013 and 2015 (the weak currency had a positive impact on Indonesia's trade balance as imports become more expensive while exports become more competitive). And secondly, as mentioned before, chaos will delay another interest rate hike in the USA, implying that capital will remain and find its way into the riskier, yet more lucrative emerging market assets, including those in Indonesia.

After initially depreciating heavily in the days surrounding the Brexit case, the rupiah rebounded remarkably in the weeks after Indonesia's House of Representatives approved the the government's tax amnesty program in late June. Although it remains highly uncertain whether this program will be a success, it sure boosted investors confidence in Indonesia's fiscal and financial fundamentals: both the rupiah and Indonesia's benchmark Jakarta Composite Index are trading close to a 14-month high.

And this is actually what causes confusion about Bank Indonesia's decision to leave interest rates unchanged at its July policy meeting. It can be understood a signal that the central bank doubts whether inflows on the back of the tax amnesty program will be able to offset the capital outflows caused by global uncertainty in the post-Brexit period.

Indeed from the start the central government of Indonesia and Bank Indonesia held different expectations of the tax amnesty program. While the government targets to see the repatriation of IDR 1,000 trillion worth of offshore funds and IDR 165 trillion in additional state income (from taxation), Bank Indonesia estimates that the tax amnesty program will bring home about IDR 560 trillion in offshore assets and IDR 46 trillion in additional tax revenue. Thus, there exists a wide gap between both assumptions (which Bank Indonesia explained by stating that both institutions use different data as the starting point and therefore the outcome differs).

After running for three weeks (the tax amnesty program was launched on Monday 18 July 2016) the central bank's estimate seems more accurate (although the peak in tax declarations and inflows is expected to occur in the next couple of months). For the moment, based on data from Indonesia's Tax Office, only 0.1 percent (or IDR 84.5 billion) of the additional tax income target (IDR 165 trillion) was achieved per 3 August 2016.

The problem that emerges at this point is that a country's monetary policy and fiscal policy should be in harmony and mutually supportive. If not, it can be counterproductive, implying that the wheels of the economy cannot be in motion optimally. An example is the relatively high yields on Indonesia's government bonds, while Bank Indonesia has cut its BI rate four times so far this year - each time by 25 basis points - from 7.50 percent to 6.50 percent: while Bank Indonesia's monetary policy aims at increasing liquidity within the economy, the government in fact absorbs liquidity with its relatively high bonds yields.

However, for the government it is difficult to cut yields now it needs to deal with a potentially large shortfall amid weaker-than-expected tax revenue and the low commodity prices. Therefore, the government needs to close gaps (using bonds and the tax amnesty program) by making new gaps. However, a lesson that should be learned by the government is that it should start to make realistic state budgets, especially in terms of tax revenue. For the past two years, the government has been overly ambitious when setting targets, while neglecting the negative impact of low commodity prices and sluggish economic growth on tax revenue. The table below shows that Indonesia is plagued by a widening shortfall in tax money.

Indonesia's Tax Collection Target and Realization 2008 - 2015:

	2008	2009	2010	2011	2012	2013	2014	2015
Target (in IDR trillion)	534.5	597.5	661.4	878.7	885.0	995.2	1,072.4	1,294.3
Realization (in IDR trillion)	607.4	563.2	650.0	872.6	835.3	916.3	985.1	1,055.6
Balance (in IDR trillion)	72.9	34.3	11.4	6.1	49.7	78.9	87.2	238.6

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