Abstract:
This paper investigates the potential relationship between the credibility of
fiscal policy and the cost of public debt. We analyze how a key component of fiscal
governance, the ability of governments to commit the planned budget, affects the
government borrowing cost. To test the hypothesis, we take the case in Indonesia over
the period 2001-2013. Based on the quarterly data analysis, we found that the noncredible
deficit rule tends to induce the interest rate. In contrast, the credible debt rule
policy significantly reduces the borrowing cost for about 28 basis points. More
interestingly, to reduce the interest cost burden of government debt, strengthening
commitment to the fiscal rules is as effective as decreasing the size of debt. Those
findings suggest that the credibility of fiscal policy matters to restore the fiscal burden
in order to maintain fiscal sustainability in the long-run. Accordingly, improving the
credibility of fiscal policy should be an integral part of the public sector reformation
program in the country.
