For policymakers, burden sharing looks like a practical solution. Yet, economists view it more cautiously. — The Jakarta Post
BANK INDONESIA (BI) recently announced the continuation of its burden sharing scheme with the government and has purchased 200 trillion rupiah (US$12bil) worth of government bonds on the primary market as of early September.
The burden sharing scheme was partly intended to help finance president Prabowo Subianto’s priority programmes that focus on the so-called community economy agenda, such as public housing, food security, small enterprise support and rural cooperatives.
At first glance, the BI policy seems straightforward. By stepping in as a large buyer, the central bank helps push bond yields lower, which in turn reduces borrowing costs and gives the government more fiscal space to fund its populist programs.
Cautious stance
For policymakers, this looks like a practical solution. Yet, economists view it more cautiously. That is because burden sharing is essentially debt monetisation, or what textbooks call “seigniorage”. Here is how seigniorage works.
When the central bank buys government bonds on the primary market, it credits the government’s account with newly created money.
This expands both government debt and the central bank’s balance sheet. Bajaj and Datt (2020) describe three types of monetisation: direct (buying bonds directly on the primary market), indirect (buying them on the secondary market) and debt write-off.
Although the mechanisms vary, the core idea remains the same: money is created to finance government expenditure.
In practice, debt monetisation is similar to quantitative easing. The crucial difference between the two is that the central bank is allowed to buy only seasoned bonds under quantitative easing, whereas under debt monetisation, it is allowed to buy new government securities as a direct source of financing (Cukierman, 2021).
This distinction explains why monetisation is often considered taboo.
Many concerns exist on the risks monetisation will pose to macroeconomic stability, notably related to inflation and the exchange rate.
The practice undermines central bank independence and opens the door to fiscal dominance.
Blurred lines
With BI now holding around a quarter of all outstanding government bonds, the line between fiscal and monetary policy is blurring.
This is what economists call fiscal dominance. Under normal circumstances, BI should focus narrowly on its mandate: ensuring price stability, which in practice means maintaining low inflation and a stable rupiah.
Unlike the United States Federal Reserve, which carries the dual mandate of price stability and maximum employment, BI holds no such balancing role.
There is no urgency for BI to sacrifice its independence for the cost of higher inflation and depreciation.
With the current high government debt ratio, at around 39% of gross domestic product, the burden sharing scheme merely creates public and investor concerns about Indonesia’s macroeconomic stability and fiscal sustainability.
The consequences of this fiscal dominance are already visible. Large-scale liquidity injections put downward pressure on the rupiah, raising the risk of imported inflation and a weaker trade balance.
This is especially dangerous in Indonesia, where more than 90% of raw materials are imported for the manufacturing industry and capital goods.
Any depreciation of the rupiah translates almost directly into higher domestic prices, hitting low-income households the hardest. At the same time, rising debt ratios leave the economy more vulnerable to shocks and narrow fiscal space in the future.
Lost credibility
The most worrying is the loss of some degree of central bank independence. Credibility will be lost once markets perceive that BI’s policy choices are driven by fiscal needs rather than its legal mandate, and rebuilding credibility is far harder than defending it in the first place.
To avoid falling into this trap, BI must first and foremost draw clear boundaries around its burden sharing role. Transparency should be the first step.
The central bank needs to tell markets how much it intends to purchase, over what maturities and for how long, as well as under what conditions it will exit. During the Covid-19 pandemic, policymakers stressed that burden sharing was only a one-off emergency measure. That clear communication reassured investors who feared permanent monetization.
A similar level of clarity is even more necessary today. A single example of an exit strategy, such as tightening banks’ reserve requirements, can also anchor expectations and help reassure markets.
Second, the central bank must maintain monetary discipline. Bond purchases tend to weaken the rupiah. To anchor market expectations, BI should deploy foreign exchange interventions in a consistent and predictable manner.
Without careful calibration, burden sharing could accelerate depreciation and drive up imported inflation.
Finally, the central bank must maintain its independence by implementing sound fiscal-monetary coordination. The government must maintain fiscal discipline while BI upholds its mandate for rupiah stability.
As Alesina and Summers (1993) demonstrated, independent central banks are consistently associated with lower inflation and stronger macroeconomic performance.
The burden sharing policy should be an instrument to be used only in times of extraordinary crisis or force majeure, such as the pandemic. Indonesia must avoid turning burden sharing into fiscal dependence.
Outside a crisis situation, such a fiscal dominance policy would erode market trust and central bank independence. — The Jakarta Post/ANN
Nauli Desdiani is a researcher at the University of Indonesia Institute for Economic and Social Research and a doctoral candidate at the University of Groningen. The views expressed here are the writer’s own.
