Budget gives wrong signals

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.