Economy of Indonesia - Public Expenditure

Public Expenditure

Since the Asian financial crisis in the late 1990s which contributed to the end of the Suharto regime in May 1998, Indonesia’s public finances have undergone a major transformation. The financial crisis caused a huge economic contraction and a commensurate decline in public spending. Debt and public subsidies increased dramatically while development spending was sharply curtailed.

Now, one decade later, Indonesia has moved out of crisis and into a situation in which the country once again has sufficient financial resources to address its development needs. This change has come about as a result of prudent macroeconomic policies, the most important of which has been very low budget deficits. Also, the way in which the government spends money has been transformed by the 2001 "big bang" decentralization, which has resulted in over one-third of all government spending being transferred to sub-national governments by 2006. Equally important, in 2005, spiraling international oil prices caused Indonesia’s domestic fuel subsidies to run out of control, threatening the country’s hard won macroeconomic stability. Despite the political risks of major price hikes in fuel driving more general inflation, the government took the brave decision to slash fuel subsidies.

This decision freed up an extra US$10 billion for government spending on development programs. Meanwhile, by 2006 an additional US$5 billion had become available thanks to a combination of increased revenues boosted by steady growth of the overall economy, and declining debt service payments, a hangover from the economic crisis. This meant that in 2006 the government had an extra US$15 billion to spend on development programs. The country has not seen “fiscal space” of such magnitude since the revenue windfall experienced during the oil boom of the mid-1970s. However, an important difference is that the 1970s oil revenue windfall was just that: a lucky and unforeseen financial boon. In contrast, the current fiscal space has been achieved as a direct result of sound and carefully thought through government policy decisions.

However, while Indonesia has made significant progress in freeing up financial resources for its development needs, and this situation is set to continue in the newt few years, subsidies continue to place a heavy burden on the government’s budget. The 2005 reductions on subsidies notwithstanding, total subsidies still accounted for close to US$ 30 billion in government spending in 2012, or over 15% of the total budget.

One of the results of the Habibie government (May 1998 to August 2001) to decentralize power across the country in 2001 was that increasingly high shares of government spending have been channeled through sub-national governments. As a result, provincial and district governments in Indonesia now spend around 40% of total public funds, which represents a level of fiscal decentralization that is even higher than the OECD average.

Given the level of decentralization that has occurred in Indonesia and the fiscal space now available, the Indonesian government has a unique opportunity to revamp the country’s neglected public services. If carefully managed, this could allow the lagging regions of eastern Indonesian to catch up with other more affluent areas of the country in terms of social indicators. It could also enable Indonesian to focus on the next generation of reforms, namely improving quality of public services and targeted infrastructure provision. In effect, the correct allocation of public funds and the careful management of those funds once they have been allocated have become the main issues for public spending in Indonesia going forward.

For example, while education spending has now reached 17.2% of total public spending ─ the highest share of any sector and a share of 3.9% of GDP in 2006, compared with only 2.0% of GDP in 2001 ─ in contrast total public health spending remains below 1.0% of GDP. Meanwhile, public infrastructure investment has still not fully recovered from its post-crisis lows and remains at only 3.4% of GDP. One other area of concern is that the current level of expenditure on administration is excessively high. Standing at 15% in 2006, this suggests a significant waste of public resources.