Budget gives wrong signals

The financial market has reason to be uneasy about the 2006 state budget proposal President Susilo Bambang Yudhoyono unveiled to the House of Representatives on Tuesday.

It seems the key assumptions used for revenue and spending estimates deviate far from what most market players expected.

While most analysts anticipate that oil prices will fluctuate at a range of US$55-60/barrel within the foreseeable future, as against the actual average of $50.50 in the first seven months of this year, the draft budget assumes an average price of $40 for the whole of next year.

It is completely unreasonable to expect such a steep fall in oil prices from the current assumption of more than $63 within the next four months to bring them down to an average $40 next year even though, as the government supposes, the world demand for oil will decline and supplies from OPEC will increase.

The government seems unwilling to learn from its current fiscal debacle, which was caused by its gross mistakes in underestimating the oil price cycle.

As the government stubbornly deluded itself into believing that the era of cheap oil would soon return, it initially predicted for the 2005 state budget that oil prices would average $24 for the whole of the current fiscal year. But the government was forced to revise the price estimate to $35 in March. This was the price used as the basis for setting the 29 percent increase in domestic fuel prices in that month. But the estimate was again revised in June to $45 before the government finally accepted, in its latest estimate for the current budget, that the average price for this year would hover at least at $50.60.

The government also seems overly optimistic of economic growth for next year, as if denying that the skyrocketing oil prices are likely to damage growth prospects and affect macroeconomic stability.

While the International Monetary Fund has predicted a decline in the world economic growth to 4.3 percent this year from 5.1 percent last year, and the Central Statistics Agency announced on Monday that the rate of Indonesia's economic growth fell from 6.2 percent -- year-on-year basis -- in the first quarter to 5.54 percent in the second quarter, the government still expects a robust growth of 6.2 percent next year.

As the country is already a net oil importer with a daily import need of around 350,000 barrels, grossly underestimating the oil price average could result in misguided fiscal policies and threaten macroeconomic stability as fuel subsidies and the budget deficit would reach unsustainable levels, thereby causing inflation to spiral and pushing down the rupiah and forcing interest rates to skyrocket.

Higher-than-estimated oil prices would also severely hurt the country's balance of payments, cut into foreign reserves and consequently trigger stronger speculative attacks on the rupiah. To defend the rupiah, the central bank would have to raise interest rates and this credit crunch would choke the business sector.

Likewise, the overly optimistic economic growth estimate could upset the targets of a 26.4 percent increase in income tax receipts and 27.5 percent rise in value added tax and luxury sales tax revenues set for next year, which together are responsible for about 61 percent of total domestic revenues.

This potential vicious circle should be among the apprehensions of market players in reading the budget proposal, and this negative perception is quite worrisome because a budget plan is supposed to communicate the right signals about bureaucratic behavior, prices, priorities, intentions and commitments.

Further down the road, uncertainty caused by the unrealistic budget estimates would prompt most investors to further wait on the sidelines and this in turn could abort the target of a 15.2 percent expansion in investment set for next year.

It would have been much better, in terms of policy adjustments, if the government was more conservative in regard to an oil price estimate, gearing up for the worst situation with oil prices foreseen above $50. After all, it would be much easier to reallocate a budget surplus in case oil prices turned out lower than the estimate, rather than having to take painful measures to cover a bigger budget deficit in case oil prices are much higher.

Predictability is important for the efficient and effective implementation of policies and programs because the public sector will perform better where there is stability in macro and strategic policy and the funding of the prevailing policy. However, this draft budget is instead causing uncertainty.

It is, therefore, imperative for the House of Representatives and the government to revise the key assumptions for the draft 2006 budget and consequently estimates for revenues and expenditure closer to market realities.