Haryo Kuncoro et al.
/ (IJAEBM) INTERNATIONAL JOURNAL OF ADVANCED ECONOMICS AND BUSINESS MANAGEMENT
The Cost of Public Debt Services
The Case of Indonesia
Haryo Kuncoro
Faculty of Economics,
State University of Jakarta, Indonesia
har_kun@feunj.ac.id
Abstract  This paper is designed to analyze the
cost of public debt services in the case of Indonesia
over the period of 1999-2009. First, we explore the
literature of the debt dynamic. Second, we develop
a model to capture some factors determining the
cost of public debt services. Finally, we estimate it
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empirically. Unlike the previous studies, we
concern with the real rather than nominal cost of
public debt services. Based on the quarterly data
analysis, we conclude that the cost of domestic
debt services is more expensive than that of foreign
debt. However, the usage efficiency of domestic
debt is higher than the latter. They imply that the
central government should carefully manage her
debts including re-profile, re-schedule, and re-
structure them in order to spread the excess
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burden in the future to maintain solvency. Also,
the other domestic financial resources should be
mobilized in order to get the cheaper debts.
Keywords: fiscal deficit; public debt; primary
balance; implicit interest rates
I. INTRODUCTION
Fiscal sustainability has been a subject of
intensive discussion among the macro
economists in recent years both in developed
and developing countries. The central issue of
the theory and empirics of public finance is
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whether there is a tendency for the fiscal
deficits to grow faster than the increase in
public debt so that the debtor countries become
insolvent. Or instead, are there tendencies for
the debt services to get bigger, so that the
primary balance surplus tends to tighten over
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time?
The recent sharp increase in fiscal deficits
and public debt in many countries raises a
number of important issues regarding their
impact on long-term interest rates. The
unsustainable state budget could influence the
economic stability in several ways. When the
deficit is financed by domestic resources, it
could become financial repression and
crowding out effect indicated by the low
interest rates, saving decline, and unproductive
investment [1]; [2]. Similarly, the foreign
financed budget deficit is characterized by
persistent exchange rate depreciation, balance
of payment distress, and high inflation [3].
Eventually, the debtor country experiences
unstable economic growth.
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Vol No. 1, Issue No. 1, 014 - 024
Furthermore, Easterly and Schmidt-
Hebbel [4] argued that the relationship
between fiscal deficits and interest rates is a
complex one because countries finance their
deficits in different ways. On the one hand,
under a repressed financial sector, taxes on
financial assets are a major source of revenue
for the government. On the other hand, in a
liberalized financial system, where the
government finances its deficits via domestic
borrowing, public sector will compete with the
private sector for loans. This puts upward
pressure on interest rates.
Many studies have been devoted to
analyze the unit cost of public debt services
(see for instance: [5]; [6]; [7]; [8]; [9]). In
general, they show that a stronger primary
balance is associated with a lower cost of debt
servicing. Consequently, the interest cost of
servicing the public debt is the key both to its
sustainability and to the burden it places on the
public finances and the economy. In
developing countries, the external debt has
steadily increased in recent decades, making
the analysis of the role of external debt in
financing the development process particularly
important. Therefore, the question of adequate
“exit-strategies” represents probably one of the
most important questions in public finance to
be resolved in the coming years.
Indonesia provides a unique opportunity
to examine the nature of fiscal sustainability
and debt services payment. Given the
significance of huge debt stock accumulated
by the previous regimes, whether the state
budget can finance all spending in the long
term without loosing budgetary functions is a
key political and economic issue. The main
objective of this paper is to reassess the effect
of fiscal deficits and public debt on long-term
interest rates. It complements and extends the
existing literature by exploring in particular the
effects of large fiscal deterioration and initial
fiscal conditions, the impact of countries’
institutional set up, and the likely spillovers
from global financial markets.
Although there is a significant existing
literature exploring the relationship between
deficits, public debt, and interest rates, there is
a diversity of findings, and several of the
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specific issues explored in this paper have not
been examined before. First, it explores cost of
both domestic and foreign debts. Second, it
also delivers implicit real interest rates instead
of government bond nominal yields. The
remainder of the paper is organized in six
sections. Section II analyses the impact of
fiscal variables on primary balance; Section III
examines the possible responses of the primary
balance to changes in the debt-GDP ratio;
Section IV discusses the relation between
fiscal sustainability and dynamic efficiency
and Section V briefly looks at stock flow
adjustment. Finally, some concluding remarks
and implications are drawn.
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II. INDONESIA’S STATE BUDGET:
OVERVIEW
Since the Old Order regime, Indonesia has
used foreign borrowing to finance
development. The foreign debt was utilized
during the first period of 1966 to reconstruct
economy after political turbulence. After that,
the New Order regime had a permanent
donator countries grouped in the IGGI
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(Intergovernmental Group on Indonesia).
Every year, the IGGI provided fund (from
ADB, World Bank, IMF, UNDP, and some
major developed countries) to finance
development expenditures designed in the state
budget.
During oil boom in 1970s the foreign debt
increased unevenly to foster economic growth.
The higher oil price the higher debt taken. As
one of the oil exporting countries, Indonesia
had a windfall profit as “collateral” to obtain
new soft loan form the creditor countries [10].
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The high foreign debt and the oil revenue, in
fact, had been successfully promoting
economic growth. In that period, the economic
growth rate booked the highest record, on the
average 20 percent a year.
Surprisingly, declining oil prices in the
first half of the 1980s resulted in the rapid
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accumulation of debt. World economic
recession and trade protection imposed by
most countries were the main causes.
Percentage of total external debt on GDP
increased from 26.8 percent in 1980 to 53.6
percent in 1986. In that period, Indonesia’s
government, in one hand, introduced a new tax
system to boost domestic revenues. On the
other hand, Indonesia’s government reduced
substantial central expenditures and re-
switched numerous development programs
[11].
Furthermore, in the late 1980s and mid
1990s, during Indonesia’s economic boom, the
long-term foreign debt was incurred by the
especially state-owned and private enterprises.
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Vol No. 1, Issue No. 1, 014 - 024
The government debt increased due to
PERTAMINA (oil and gas state-owned
company) was largely expanded. BULOG
(Logistic Agency) took foreign debt to realize
food self-resilience. As a result, the debt
service ratio in the 1980s, especially in 1988
and 1989 rose to an average 40 percent. In
1992, the IGGI was removed to be the CGI
(Consultative Group on Indonesia).
When the Asian financial crisis, in the mid
1997, the external debt increased significantly
from more than US$ 136 billion in 1997 to
more than US$ 151 billion in 1998, mainly due
to the depreciation of Rupiah. Since that,
Indonesia has experienced the decrease in
government revenue and the increase in
government spending to undertake the socio-
economic impacts. As a result, the
Indonesian’s government collapsed under
heavy debt burden to cover deficit the state
budget (Figure 1). The government debt
increased to three to four-fold and almost
three-quarters of those is domestic debt for
bank restructuring [12].
In the reformation era, government and
parliament made a political decision that the
most deficits should be finance by domestic
financial resources. Accordingly, the CGI was
disbanded in 2007. As a result, the amount
domestic debt stock has been ten times (100
trillion in 1998 to 1.000 trillion Rupiah in
2009). Only in one decade, the domestic debt
has been higher than the foreign debt.
Consequently, the public debt services have
been sky rocketing (Figure 2). The domestic
debt service payment was two-fold than that of
foreign debt.
Most government external debts were due
in early 2000s. In relative term, the interest
rate and amortization payments was about 40
percent of the total outlay. The other important
expenditures were subsidies for fertilizer and
energy (20 percent) and transfer to lower-layer
governments (26 percent). Those outlays
composition above, of course, severely limited
to the fiscal space. The state budget problems
then shifted from the stimulus to fiscal
sustainability [13]. Conceptually, the state
budget is said to be sustainable if it has the
ability to finance all spending in the long term
without endangering budgetary functions [14];
[15].
The issue of the sustainability is an
integral part of the discussion of the
government's long-term ability to repay debt
[16]. To maintain the fiscal solvency, the
surplus of the state budget is a must [17]. Even
though the debt ratio has been decreasing, the
new financing from both foreign and domestic
financial resources are still required in
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forthcoming years to meet the expenditure
needs. The main problem of the Indonesian
budget sustainability is the existing large
deficit. The Law No. 17/2003 Article 12 states
that deficit and the total debt is no more than 3
and 60 percent respectively. The question is
then how to keep the budget deficit at a safe
level so that the deficit can be financed.
It is well known that the change in the
debt level can be larger or smaller than the
government deficit. This difference between
the change in the outstanding debt stock and
the yearly deficit flow is known as the stock-
flow adjustment (SFA). The analysis of SFA
has become more important as the budgetary
surveillance may have provided incentives for
shifting items from the deficit to the SFA [7].
A high negative SFA shows the tendency to
improve temporarily the debt development in
some years. In this case, is there any
systematic explanation of variations in the cost
of debt servicing over time in Indonesia? The
next sections will examine the influence of
fiscal variables on borrowing costs in
Indonesia over the period of 1999-2009.

DOMESTIC AND FOREIGN DEBTS

M
OF CENTRAL GOVERNMENT

1,200.00

1,000.00
TRILLION RUPIAH

800.00

600.00
EB
400.00

200.00

0.00
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
YEAR

Domestic Debt Foreign Debt

Source: Debt Management Office, Ministry of Finance
A
Figure 1
Central Government Public Debt
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Haryo Kuncoro et al. / (IJAEBM) INTERNATIONAL JOURNAL OF ADVANCED ECONOMICS AND BUSINESS MANAGEMENT
Vol No. 1, Issue No. 1, 014 - 024

CENTRAL GOVERNMENT DEBT SERVICES

1998-2009

80,000.0
70,000.0
BILLION RUPIAH

60,000.0
50,000.0
40,000.0
30,000.0
20,000.0
10,000.0

M
0.0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
YEAR

Domestic Debt Foreign Debt

Source: Financial Notes and Budget State, Ministry of Finance Republic of Indonesia
Figure 2
Central Government Debt Services
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III. EMPIRICAL EVIDENCE
A key channel through which large fiscal
deficits could be expected to have an impact
on long-term interest rates, in a broader sense,
occurs via the impact on national savings. In
the standard neoclassical model, fiscal deficits
(other things given) reduce national savings
and increase aggregate demand [18]. This
creates an excess supply of government debt,
leading to higher real interest rates. The yield
curve is also expected to become positively
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sloped in anticipation of continuing large fiscal
deficits.
Although short-term real interest rates
reflect cyclical conditions and the stance of
monetary policy, and influence real medium-
and long-term rates, the latter are likely to raise
more in response to the anticipated worsening
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to the Ricardian equivalence proposition. For
instance, [20]; [21] and [22] show no
significant effect of fiscal variables on long-
term interest rates. However, [23], [24], and
[25] pointed out some problems in their
methodology.
The second generation emphasizes that
not current but expected budget deficit or
government debt affects current long-term
interest rates. This generation of studies
consists of two groups: (1) to use published
forecasts of budget deficits as a proxy for
market expectations [23]; [26]; [27]; etc.; and
(2) to use “event analysis” of news reports or
announcements of budget projections [28];
[29]; [30]; etc. Both types of studies show
there significantly positive association between
projected budget deficits or government debts

of fiscal deficits and debt [19]. Large deficits
and debt, particularly if combined with
uncertainties relating to the pace of economic
activity, could also raise concerns about the
government’s ability to service its debts. This
would raise credit risk premium and
government bond yields. In addition, the
emergence of contingent fiscal risks
emanating, say, from the financial sector could
exacerbate sustainability concerns.
The existing literatures could be divided
for two generations in terms of their
conclusions. The first generation concludes
there is no significantly positive association
between budget deficit or government debt and
interest rates, and they attribute this discussion
and current long-term interest rates.
The fiscal variables, including the primary
fiscal balance, have had the influence on
borrowing costs in industrial countries [5]; [6].
In particular, an improvement of the primary
balance is associated with a significant
reduction in debt servicing costs, amplifying
the effects of primary adjustment on the state
of public finances. The cost of debt servicing
depends on the variables that determine the
debt dynamics: primary balance, outstanding
debt, inflation, and economic growth.
Ardagna [31] and [32] evaluated the
relative importance of the two explanations.
She provides evidence that the composition of
the stabilization policy matters for economic

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Haryo Kuncoro et al. / (IJAEBM) INTERNATIONAL JOURNAL OF ADVANCED ECONOMICS AND BUSINESS MANAGEMENT
growth mainly through labor market effect
induced by moderate wage agreements. The
size of the fiscal contraction is the key when it
comes to fight rising debts. Ardagna’s
empirical findings indicate that when
governments engage in sizeable fiscal
adjustments, the probability of success in the
sense of a long-lasting debt reduction almost
doubles.
In an extension to the literature, [33],
{34], and [35] provide a non-mutually
exclusive explanation for a successful fiscal
stabilization. They show that expansionary
fiscal consolidations are more likely and
sustainable if they are relying primarily on
spending cuts. Even in the case where the
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adjustments are of the same size in terms of
reducing the primary budget deficit, cutting
back spending induces a more promising
consolidation than tax increases. In addition,
they argue that the composition of spending
cuts matters. Especially successful deficit-to-
GDP and debt-to-GDP reductions are
associated with cuts on government transfers,
welfare spending, and government wages.
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Laubach [24] explores the relationship
between long-horizon expectations of both
fiscal variables and interest rates in the United
States. Conway and Orr [36] for seven major
advanced economies also find that the impact
of public debt on long-term bond yields
depends on initial debt levels. Higher public
debt raises the perception that governments
will be less able to service their liabilities and
therefore increase credit risk. Also, countries
with large debt accumulation tend to be more
at risk of inflationary pressures raising nominal
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short-term interest rates. These factors affect
the long end of the term structure and raise
borrowing cost for long-term government
securities nonlinearly.
Baldacci and Kumar [8] reexamines the
impact of fiscal deficits and public debt on
long-term interest rates, taking into account a
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wide range of country-specific factors, for a
panel of 31 advanced and emerging market
economies. Izak [7] conducts the same study
for post-socialist countries. They find that
higher deficits and public debt lead to a
significant increase in long-term interest rates,
with the precise magnitude dependent on
initial fiscal, institutional and other structural
conditions, as well as spillovers from global
financial markets.
The association between budget deficits,
government debt, and interest rates in Japan
are analyzed by [37]. Estimating the reduced
form for the long-term interests derived from
the neo-classical frameworks finds that an
increase in projected deficit-to-GDP raises
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Vol No. 1, Issue No. 1, 014 - 024
interest rate depending on the debt maturity.
The longer maturity has the smaller effect.
Meanwhile, most of the researches conducted
in Indonesia have been devoted to assess the
economic impacts of external debt (see for
examples: [38]; [39]; and [40]). They found
that external debt has marginal impact on
economic growth regarding the inadequate
domestic revenues generated by the debt.
PPE UGM and BAF [41] conclude that
Indonesia's foreign debt has been large because
the borrowing costs are cheaper than the cost
of domestic debt. However, the state budget
has been relatively safe to be default.
Soelistijaningsih [42] obtains that the external
debt burden could be reduced by diversifying
the currency. This result is supported by the
findings of [43]. The state budget sustainability
can only be maintained if there is no heavy
depreciation.
Ulfa and Zulfadin [44] obtain ambiguous
results. Some fiscal policies (i.e. budget
reforms) reduced the sovereign debt. On the
other hand, some fiscal policies (i.e. blanket
guarantee) enlarged the contingent liabilities.
Hanni [45] concluded that some external
macroeconomic variables become the key
determinants for achieving fiscal sustainability.
Unfortunately, she did not incorporate the oil
price in her analysis. Jha [46] found that the oil
price has a significant effect to the sustainable
state budget related to the subsidies liabilities
in the case of selected Asian countries
including Indonesia.
IV. DEBT DYNAMICS
The empirical researches above provide
the same basic idea that fiscal sustainability
requires controlling interest rate, economic
growth, fiscal deficit, primary balance surplus,
and the change in current debt level. In term of
interest rate, the fiscal sustainability can be
achieved as long as the government conducts
fiscal discipline so that cost of public debt
would be reasonable to bear a particular
economic circumstance fluctuation.
In term of current debt level, the amount
of debt accumulation in particular time can be
traced to the debt dynamics. The debt
dynamics solely also explain the fiscal
sustainability. The accounting approach is
based on the rules that connect the options of
financing government spending (G). If the
domestic revenue, R, is not sufficient to cover
G, the available financing option is debt (D)
and money printing (seigniorage, S).
(Rt – Gt) = Dt + St (1)
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The debt accumulation in the next period
(t+1) will be D itself plus the interest rate (r):
Dt+1 = (1 + r) Dt + (Rt – Gt) + St (2)
The term of (R – G) is the primary balance
(PB), total government expenditures excluding
the interest rate payments. It can be rewritten
as
Dt+1 – Dt   Dt = r Dt-1 – PBt + St (3)
According to this approach, the state
budget sustainability can be achieved if there is
no debt. Even if the government takes debt, the
fiscal sustainability can be maintained as far as
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the additional debt must be proportional to the
PB surplus [47].
Equation (3) if disclosed further in the
relative form to national income (Y) will be
 [D / Y]t = r [D / Y]t-1 – [PB / Y]t + St (4a)
 RDt = r RDt-1 – RPBt + St (4b)
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In this context, the fiscal sustainability holds if
the current primary balance position increases
greater than the increase in the debt ratio [48].
The fiscal sustainability also explains the
solvency. Based on (4), dividing to Y requires
that the rate of growth of Y should be taken
into account. If the income increases
constantly (suppose at g percent overtime), the
additional debt will be
r–g
 RDt = ––––– RDt-1 – RPBt + St (5)
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1+g
When there is no new additional debt
(RDt=0), then
r–g
RPBt = ––––– RDt-1 + St (6)
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1+g
In this case, the budget surplus is required
to attain fiscal solvency if the real rate of
interest exceeds the output growth, i.e., (r–g) >
0. The public sector has to make debt service
payment at least equal to PB, or equivalently,
it should have a primary surplus equal to PB.
A primary fiscal surplus less than that amount
(or a primary fiscal deficit) in that case implies
perpetual public sector borrowing and debt
accumulated indefinitely. For a country whose
rate of output growth exceeds the real rate of
interest, (r–g) < 0, incurring a primary deficit
is till consistent with solvency. However, a
deficit higher than PB implies that the country
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Vol No. 1, Issue No. 1, 014 - 024
is moving away from a fiscal solvency
position.
Based on (2), one can impose discount
factor to re-examine the fiscal sustainability:
1
Dt =  –––––––– { Dt+1+k – PBt+k + St+k } (7)
(1+r)1+k
The limit value for an infinite time of the first
term in equation (7) will be asymptotically
equal to zero. The equation remains
1
Dt =  –––––––– { – PBt+k + St+k } (8)
(1+r)1+k
Equation (8) states that the amount of
government debt at a given time must equal
the present value of the primary balance deficit
in the future [49]. This means that the debt
growth should be lower than the interest
growth rate in order to be sustainable [50].
V. THE PROPOSED MODEL
FOR INDONESIA
There is no study in Indonesia so far that
integrates all of the external economic factors.
This study closes the fiscal policy empirical
gap in Indonesia by synthesizing them.
Abstracting from monetary financing that is by
the law forbidden in Indonesia the general
government budget deficit is the sum of the
primary deficit and of debt service. To finance
the deficit the government must borrow and
issue new debt ΔD:
Δ Dt = Gt – Tt + r Dt (9)
Dividing both sides of (9) by real GDP Y:
Δ(D/Y)t = (G/Y)t – (T/Y)t + r (D/Y)t (10)
Taking into account that ΔY/Y = g and
inserting for ΔD/Y into (10) we obtain:
Δ (D/Y)t + g (D/Y)t = (Gt – Tt)/Yt + r (D/Y)t
(11)
and rearranging:
Δ (D/Y)t = (Gt – Tt)/Yt + r (D/Y)t – g (D/Y)t
(12)
The change in the debt-GDP ratio (left
side) equals to the primary budget deficit-GDP
ratio (the first item on the right side) and the
debt service-GDP ratio (the second item)
adjusted for GDP growth rate (the third item).
Isolating the debt service on the left side:
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r (D/Y)t = Δ(D/Y)t + (Tt – Gt)/Yt + g (D/Y)t
(13)
From (13) is evident that to stabilize the debt-
GDP ratio, ΔD/Y = 0, the primary balance and
the growth rate times the debt-GDP ratio must
be able to finance the debt service.
Last but not least we can express the debt
service in nominal terms:
r (D/Y)t = (Tt – Gt)/Yt + g (D/Y)t + π (D/Y)t
+ Δ (D/Y)t (14)
where π is the inflation rate. In short, the
average implicit interest cost of the debt
equation is
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r = f ( RPB, g, π, ΔRD ) (15)
Inflation enters implicitly into equation
(15) in two ways: through the nominal interest
rate via the usual Fisher effect and through the
growth rate of nominal GDP. Thus, inflation
worsens the debt dynamics by necessitating
higher nominal interest rates to provide
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investors a given real return, and improves it
by raising the nominal growth rate.
Another important determinant of the debt
dynamics that appears in equation (15) is the
primary fiscal balance. In general, large
primary deficits are part of the story behind the
accumulation of public debts -- although even
once primary adjustment has taken place these
imbalances can take on a life of their own due
to large outstanding debts and high interest rate
spreads.
It is useful to express the cost of debt
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services in real term:
(r – π) = f ( RPB, g, ΔRD ) (16)
In the case of Indonesia, oil lifting (OL),
instead of oil price as suggested by [46], is
quite important determining factor to
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government budget either through non tax
revenue or oil subsidies. For Indonesia’s
government, oil lifting is rather under-
controlled than oil price which is exogenous
variable to determine overall fiscal deficits.
As explained previously, the change in the
debt level can be larger or smaller than the
government deficit. Therefore, it is reasonable
to incorporate them into the proposed model:
(r – π) = f ( RPB, g, ΔRD, OL, RDEF) (17)
Regarding to the types of debt, equation (17) is
estimated for domestic debt, foreign debt, and
total debt.
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Unlike the previous studies in Indonesia
(which generally used annual data), the model
are estimated with quarterly data during the
post-crisis period (1999-2009). The data for
this study have already been available on a
quarterly basis except the primary balance as
well as deficits. The data is then interpolated
linearly from annual basis to fit the other data
on the model. In general, the data obtained
from IMF, World Bank, Central Bank of
Indonesia, Ministry of Finance (i.e. Debt
Management Office), and Central Board of
Statistics.
Variables that will be used are specified as
follows. Debt that is analyzed here is the
central government debt only (excluding
Central Bank of Indonesia, state-owned
enterprises, local government-owned
enterprises, or local government debts).
Foreign debt is denominated in US dollar and
then transformed into Rupiah using official
exchange rate. Depreciation is calculated as a
percentage change of the Rupiah against the
US Dollar. Similarly, economic growth is
calculated as the percentage change in GDP at
constant prices in 2000. Inflation rate is
derived from the relative change in GDP
deflator. The latest is also used to convert all
variables into the real values.
VI. DISCUSSION
Table 1 presents that the elementary
statistics covering mean, median, and extreme
values. The mean and median values of
nominal interest rate for total debt (IRTOT),
depreciation rate (DEP), primary balance ratio
(RPB), overall deficit ratio (RDEF), and total
debt ratio (RDTOT) are almost the same
respectively. Those preliminary indicate
normal distribution. Except inflation rate (INF)
and economic growth rate (EG), the null
hypotheses that the series data is normally
distributed can be accepted in 95 percent
confidence level using the JB (Jarque-Bera)
test.
The lower tail of the economic growth rate
distribution is thicker than the upper tail
(indicated by the negative value of skewness)
and the tails of the inflation rate distribution
are thicker than the normal (indicated by the
kurtosis coefficient greater than 3). The table
also delivers standard deviation. Statistically, a
set data is said to be volatile if its CV
(coefficient of variation, e.g. ratio of standard
deviation to mean) is more than 50 percent.
Based on the empirical rule, inflation,
depreciation, and economic growth rates are
the most volatile indicated by the highest CV.
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Table 1 Descriptive Statistics

IRTOT INF DEP EG OL RPB RDEF RDTOT
Mean 13.6870 4.1795 0.7252 1.0514 1.1459 1.7726 -1.3420 23.0818
Median 13.7024 2.6050 1.0050 2.0500 1.0800 1.6607 -1.3141 22.5210
Maximum 25.0292 111.0000 24.6800 16.2900 1.5200 4.6150 1.2482 38.7533
Minimum 5.3663 -13.3300 -22.5600 -38.9600 0.9400 -0.0116 -4.6197 11.7140
Std. Dev. 3.6403 16.9809 8.5993 7.4822 0.1834 1.0594 1.1633 8.6543
CV 26.60% 406.29% 1185.74% 711.67% 16.00% 59.76% -86.68% 37.49%
J-B 2.6217 2405.8340 2.3284 621.7590 4.3795 0.7036 2.0566 3.4430
Prob. 0.2696 0.0000 0.3122 0.0000 0.1119 0.7034 0.3576 0.1788
Skewness 0.3325 5.7944 -0.0496 -3.2346 0.5918 0.3088 -0.4384 0.3286
Kurtosis 3.9939 37.3216 4.1226 20.2421 2.0060 2.9503 3.5942 1.7974

Table 2 shows the results of Augmented hypothesis is rejected even at the 1 percent

M
Dickey-Fuller (ADF) and Phillips-Perron (PP)
unit roots tests for the underlying data series in
levels and first differences. The null hypothesis
of existence of unit root cannot be rejected for
each of the variables (except the three types of
debt) in the level and thus it is concluded that
the series are non stationary. However, the null
level of significance for all of them in their
first differences. This indicates that stationary
is achieved for them after the first differencing
i.e. all the series are I(1). The non-rejection of
the null hypotheses of unit root may be the
result of shifting deterministic trend.

Table 2 Unit Roots Tests

Variable to be
tested
EB Level
ADF
First Difference Level
PP
First Difference
RDD -2.16695 -5.98128 -1.93178 -3.16913
RDF -1.01394 -9.30373 -1.54154 -9.56435
RDTOT -1.68839 -3.83114 -0.42020 -6.61045
EG -4.65644 -4.32276 -34.00936 -34.57056
OL -2.04747 -6.35022 -3.24531 -6.35159
(IRD-INF) -18.18338 -9.23583 -14.43330 -54.98620
(IRF-INF) -28.05540 -37.65963 -20.71344 -40.15417
(IRTOT-INF) -22.67623 -26.61991 -16.78454 -52.62805
DEP -10.36004 -2.90595 -10.19797 -23.61606
RPB -2.90723 -5.84746 -2.28904 -7.97459
RDEF -3.89751 -4.63906 -2.68776 -4.71217

Table 3 displays the results of Johansen’s
A
co-integration test. Rank order for 5 variables
in the implicit real interest rate for domestic
debt service model has at least 4 co-integrated
variables in 95 percent confidence level. The
implicit real interest rate for foreign debt has
co-integrated for all variables rank. The total
debts service models has at least 5 co-
integrated variables. They imply that the all
variables have a long-run relationship. As a
consequence, they can be modeled to find out
the parameter estimate using empirical data.

Table 3 Multiple Co-integration Tests

IJ

Domestic Debt Foreign Debt Total Debt

Hypothesized Trace Hypothesized Trace Hypothesized Trace
No. of CE(s) Statistic No. of CE(s) Statistic No. of CE(s) Statistic
None ** 171.0007 None ** 217.8390 None ** 221.7210
At most 1 ** 121.0231 At most 1 ** 162.0633 At most 1 ** 160.1709
At most 2 ** 78.6000 At most 2 ** 117.6211 At most 2 ** 114.3329
At most 3 ** 46.4100 At most 3 ** 81.5476 At most 3 ** 74.2765
At most 4 * 19.3816 At most 4 ** 51.3750 At most 4 ** 43.7738
At most 5 3.2657 At most 5 ** 21.5117 At most 5 * 19.9295
At most 6 ** 6.8133 At most 6 3.5802
*(**) denotes rejection of the hypothesis at the 5% (1%) level

The following section presents empirical
results for a quarterly time series data for 1999
to 2009 to avoid uneven depreciation rates.
Table 4 highlights estimates of equation (17)
for the three models specification, namely
domestic debt, foreign debt, and total debt.
Regression (17) is individually estimated with
ordinary least squares (OLS) because there is
no simultaneous relationship among variables
in the model.

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Haryo Kuncoro et al. / (IJAEBM) INTERNATIONAL JOURNAL OF ADVANCED ECONOMICS AND BUSINESS MANAGEMENT
Vol No. 1, Issue No. 1, 014 - 024

The estimation results show that the unit
cost of domestic public debt is more expensive
than foreign debt service. This is indicated by
constant term. On the average the unit cost of
domestic debt is about 53 percent compared to
foreign debt (about 16 percent). Totally, the
average of public debt is about 41 percent.
This finding is in line with the result of [41].
The cheaper cost of foreign debt is a source of
explanation why the Indonesia’s government
foreign debt becomes massively accumulated.
The rate of growth of the economy tends,
as predicted, to induce the cost of debt and the
effect is statistically significant (even greater
than unity) in the three model specifications. In
addition, the economic magnitude of the
currency diversification can help the
government to decrease the sovereign burden.
Both flow and stock variables have an
impact: using the change in public debt as an
explanatory variable suggests that an increase
in the debt ratio of 1 percentage point of GDP
leads to an increase in bond yields of around
25-63 basis points. The initial level of fiscal
deficit ratio (RDEF) also has a similar and
statistically significant impact, although its
size varies over time (2.5-6.9 percent). It
seems that the Indonesia’s government
conducts prudent fiscal policy, i.e. the change
in debt is proportional to meet the fiscal deficit
so that the impact on real interest rates almost
equals.

M
effects is rather small. For example, increasing
the real growth rate by 1 percentage point
increases the unit cost of debt by about 16-21
basis points. This may reflect the errors-in-
variables bias associated with the including
quarter growth rates when long-run growth
rates are relevant to the debt dynamics.
The increase in oil production lightens the
cost of debt payment for about 5-44 percent.
EB
As a net oil importer country, Indonesia faces
the dilemma when the world crude oil price
increases. In one hand, the central government
revenue increases substantially. On the other
hand, the central government has to spend
more subsidies to avoid the increase of
domestic fuel prices. When Indonesian oil
lifting could be promoted, the state budget can
save 4-5 trillion Rupiah which can be used to
pay debt services.
Depreciation also makes the burden of
debt service payment slightly reduces. Even
A
though the impact of monetary crisis 1997 has
been getting lower, the effect of depreciation
rate is still material. The magnitude of its
effect is about 35-91 basis point. It is notable
that most of outstanding foreign debt is
denominated in US dollar. This finding is
supported to the studies of [42] and [43] that
IJ
The results confirm the relevance of fiscal
variables to borrowing costs. For all three
specifications, a government running a primary
surplus faces significantly higher interest costs.
The magnitude of the coefficients is also large:
a one-percentage-point increase in the primary
surplus-to-GDP ratio associated with a
reduction in the unit cost of debt servicing of
roughly 34-76 basis points. For a government
with a large debt, like Indonesia, this would
provide an important additional reason for
fiscal adjustment.
To sum up, the primary balance is
regarded as a target for fiscal adjustment to
secure fiscal sustainability. The government
should run a sufficiently large primary surplus
to ensure that it has a positive or zero net
wealth. The differential interest rate-economic
growth together with the debt-GDP ratio
determines the primary surplus government
needs to run to prevent a change in the ratio.
As the economic growth greater than real
interest rates, the Indonesia’s government
cannot run a primary deficit to avoid high
inflation (and in turn depreciation) with putting
upward pressure on the debt-GDP ratio. As a
result, the government has a sustainability
constraint.

Table 4 OLS Estimates for Cost of Public Debt (1999-2009)

Dependent Variable: Implicit Real Interest Rates
Independent Variables Domestic Debt Foreign Debt Total Debt
Coeff. t-stat Coeff. t-stat Coeff. t-stat
C 53.04326 6.16641 16.40625 2.92272 41.88074 6.91481
EG 2.10419 14.85388 1.59753 12.44417 1.83415 14.41444
OL -0.05579 -6.32717 -0.17059 -2.96963 -0.44066 -7.40830
DEP - - -0.91611 -4.04053 -0.34611 -2.09631
RPB 7.63372 6.33212 3.42383 4.28119 6.05700 6.41246
RDEF -6.88138 -6.46367 -2.52914 -2.88914 -4.95034 -5.44371
 Debt Ratio 2.51588 1.73001 6.34219 5.04412 2.92267 3.69862
R-sq 0.90336 0.91920 0.91760
Adj R-sq 0.89064 0.90610 0.90424
F 71.04137 70.15609 68.67557
DW 1.60143 2.02517 1.73181
SEE 6.72640 5.18917 5.61905
N 44 44 44
The complete diagnostic tests can be found from the author on request

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Haryo Kuncoro et al. / (IJAEBM) INTERNATIONAL JOURNAL OF ADVANCED ECONOMICS AND BUSINESS MANAGEMENT
VII. CONCLUDING REMARKS
This paper focuses on periods of fiscal
adjustments in the case of Indonesia. It shows
that historically, the governments have
employed different fiscal adjustment strategies
when confronted with high deficits and rising
debt. Accordingly, these measures not only
differ in duration, size, and composition, but
also in their success. Controlling for various
economic, fiscal, and political factors, we find
that the size and the composition of a fiscal
adjustment significantly affect real interest
rates. Large adjustments and those that mainly
depend on expenditure cuts lead to
substantially lower interest rates.
The factors influencing the debt service in
M
real terms and analyzed from quarterly data
during 1999 to 2009 in this paper are primary
balance, overall deficit, growth rate of real
GDP, economic growth, depreciation rate, oil
lifting, and the change in debt level. The
negative overall balance and cheap cost of
foreign debt have been contributing to the
increase of huge debt. Meanwhile, oil lifting
has a marginal significant contribution to
EB
lighten cost of public debt services.
The evidence shows that large deficits and
debt can have a marked adverse impact on
implicit real interest rates, but that a variety of
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