The Optimal Coordination Between Monetary and Fiscal Policy in Indonesia: Central Bank of Indonesia and Ministry of Finance Role

Based on the legal perspective, there have been varying levels of monetary and fiscal policy coordination in Indonesia which depending on the applicable legal framework. Under act Number 13 of 1968, Bank Indonesia was a member of monetary board chaired by the Finance Minister and including a government representative. This policy is directly coordinated to policy coordination in order to prevent problems since BI stands as a working partner in the monetary board. Because BI as part of the government, there was no internal control system to prevent the government from funding its deficit at BI expense. During that period, BI provides massive loans to the government, government institutions and banks. In 2004 Act number 23 of 1993 was amended in order to give the independent status of Bank Indonesia. But still, the coordination between monetary and fiscal policy coordination is still there. We can see in terms of monetary policy, we still need to requires fiscal deficit funding to take into account the monetary policy objective of Rupiah stability.

The law of Bank Indonesia exists to have adequate provision for the monetary and fiscal policy coordination, as it restricts the possibility of fiscal deficit funding from Bank Indonesia. Like in other countries, fiscal policy in Indonesia gives greater emphasis on promoting economic growth and equity through job creation which has applied since the First Five-Year Development Period (PELITA 1. On the other hand, monetary policy aims to regulate and maintain stability in the Rupiah which based on inflation and exchange rate. BI’s policy objectives to maintain Rupiah stability, facilitate production and development as well as promote job creation in order to improve the welfare of the population.

Since 1999, Indonesia has implemented a new law for the central bank. The law stated that the Central Bank of Indonesian must be independent from interventions of political pressure and the central government in conducting its monetary policy. Moreover, the central bank is only responsible for price stabilization as a one-goal policy rather than multiple objectives which are stated in the previous law. Furthermore, since June 2005 Indonesia has implemented inflation targeting in the monetary policy frameworks. We acknowledge that macroeconomic policy is the monetary and fiscal policy. Monetary policy covers all government actions aimed at influencing the course of the economy through the addition or reduction of the amount of money in circulation (money supply), it is said that the instrument is a variable M, which is the amount of money in circulation is called also offer money supply. Fiscal policy is all the actions taken by the government, aiming to influence the course of the economy through the addition or government subtraction and or tax expenditures, have tax or Tx, or the payment or transfer of Tr, and government spending, or G.

In Indonesia, the monetary authority coordinates with the fiscal authority in conducting macro policy or to control macroeconomic balance. Since Bank Indonesia has operational independence in determining monetary policy, to improve the effectiveness of monetary policy and fiscal policy is by pursuing close cooperation between the central bank and fiscal authority. Even though Bank Indonesia is prohibited to buy government securities for its own account, but in the primary market short term government securities Bank Indonesia acts as non-competitor in purchasing short term government securities and at the same time Bank Indonesia becomes an administrative agent for government security. In the end the connection is clear on how the government is required to consult with Bank Indonesia before issuing government securities.

The Indonesian economy has been trying to grow up under macroeconomic and financial stability well maintained. Asia crisis in 1998 has taught the lesson to strengthen the domestic economic fundamentals that made Indonesia really fine in facing the 2008 global crisis. In fact, in the period of 2009 to 2011, Indonesia benefited from high global commodity prices and huge capital inflows that result in high growth, low inflation, current account surplus, and exchange rate appreciation (Indonesia: Global Spillover and Policy Response, Perry Warjiyo – Deputy Governor, Bank Indonesia, Asia Economic Policy Conference (AEPC), Federal Reserve Bank of San Francisco (FRBSF), 19-20 November 2015). Indonesia more concern about strong financial system, that is why monetary and fiscal policy coordination is really mattered in order to induce economic growth.

Indonesia’s new monetary policy 2016 has been released on March buy cutting the policy rate of Bank Indonesia from 7.00% to 6.75% based on the majority of market analyst expectation. This policy tries to support economic growth by cutting the policy rate for a third consecutive time. The Bank also cut deposit facility rate to 4.75% and the lending facility rate to 7.25% by 25 basis points each. Bank Indonesia stated that this policy finally applied by lowering the policy rate to boost domestic demand and the economy’s momentum. The Bank will keep coordinating with the government to stimulate the economy as well as to conduct future monetary policy easing. Even though Indonesia is not so sure about the growth of this year and for the next year as well, the Bank believes fiscal stimulus may boost growth in the first quarter by concerning more toward export revenues. It also will affect price development based on oil price which creates price pressure. Responding to this situation, Bank and Government will coordinate the policy regarding price pressure.

Besides monetary policy, Indonesia also released a new fiscal policy for financial stability in August 2013. Indonesia’s current account deficit can be seen in the form of the rupiah exchange rate, high inflation and slowing economic growth. That is why the Indonesian government and the central bank had released policy packaged in August 2013 that aimed to restore the country’s financial stability. The additional policy package is by controlling the import and increasing export as well as boosting the foreign investment in Indonesia. In order to get it, government is busy to prepare various tax incentives and tax holidays. Indonesia’s current account deficit reaches a record of USD $9.8 billion in the second quarter of 2013 which equal to 4.4% of GDP. But in the third quarter of 2013, the deficit was decreased to USD $8.4 billion which equivalent to 3.8% of GDP. This positive development was supported by Bank Indonesia on 1.75% rate hike from June to November 2013. Indonesia’s benchmark rate was raised from 5.75% to 7.50% which shows the development of finance is connected to higher economic growth.

In order to boost economic growth, the coordination between monetary policy and fiscal policy is really needed to make Indonesia’s economy keeps stable and under control. Since Indonesia is adopting open economy system which means Indonesia has opened its economy overtime to the outside world by opening the capital account for decades such as allowing substantial flows of capital portfolio and boosting the development of capital markets as well as allowing foreign investors to take a part in economic growth of Indonesia, the context of coordination in making policy is needed to be implemented well. If we talk about the analytical model framework of the economy in the typical open market country, we can use a curve that can explain the international transmission of the global economy by using Mundell – Fleming Model. But if we assume that Indonesia as a country with a closed economy, we can analyze by using the IS-LM curve because these models emphasize the interaction between the goods market and the money market.

Acknowledging the uncertainty economy situation from time to time, make Indonesia need to ready for every single possibility like what happened in 2008 when the financial crisis broke out in the West implied serious consequences for Indonesia especially for the rupiah rate. Indonesia was one of the worst affected emerging market economies which make investors concern more because of the current account deficit. Luckily after the Brexit case, the rupiah rebounded in the weeks after the government applied for the tax amnesty program. This situation made Bank Indonesia decided to leave the interest rates unchanged at the July policy meeting because of the tax amnesty program prospect in the future whether the program will be able to offset the capital outflows in the post-Brexit case. The central government of Indonesia and Bank Indonesia had different expectations on the tax amnesty program which became a challenge in determining upcoming policy under the name of coordination among both of party. Meaning that monetary policy and fiscal policy should be in harmony in order to make mutually supportive policies in the future.


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