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Can Indonesia’s Fiscal Policy be Sustained, with Exploding Debt?

The debate over debt issues always becomes hot potatoes to be discussed. Recent data in debt position which accounted for 1.977,71 trillion IDR on December 31st 2012 has made a thousand eyes looking at The Central Government and questioning whether Indonesia should continue to rely on debt for development financing, and whether its debt level is dangerous for fiscal sustainability or not. This paper analyzes debt sustainability by using Natural Debt Limit (NDL) approach introduced by Mendoza-Oveido. In order to examine how the Indonesian government reacts to changes in its debt position, this paper estimates fiscal reaction functions using an econometric approach, namely Vector Error Correction Model (VECM). The result shows that: (i) natural debt limit for Indonesia is 32,3% over GDP; (ii) since 1992 the central government has run a sustainable fiscal policy, by reducing the primary deficit or increasing the surplus in response towards rising debt. Indonesia has a space to utilize more debt, but in a good manner (well-managed) especially aimed for productive and priority spending such as for infrastructure and education.

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Center for Economics and Development Studies is a research center under the Department of Economics, Padjadjaran University, Indonesia. A leading research institute in Indonesia in the area of economics and development studies.
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