Election buoys the market

The financial market predictably reacted quite positively to the peaceful and orderly presidential runoff, especially because the election was perceived to be fair. While the rupiah remained stagnant at 9,035, the stock market increased by 1 percent on Tuesday with the Jakarta stock price index closing at 824.

This market sentiment will most likely strengthen on the back of strong political stability, especially if both the president elect and the losing candidate demonstrate a high degree of statesmanship in facilitating the transition process. The immediate impact of this upbeat market sentiment will be a higher pace of portfolio capital inflows, which will fuel a higher rate of rupiah appreciation and substantial rise in stock prices.

These developments will in turn strengthen the virtuous circle within the economy. A stronger rupiah will decrease the costs of imports and consequently reduce inflationary pressures, thereby enabling the central bank to decrease its interest rates. An eased money policy will help commercial banks to cut their credit interest rates, and more businesses will be able to afford new loans to expand operations. Even more substantial will be the significant decrease in the government's domestic debt-servicing burdens, thereby releasing bigger resources for other more vital spending such as on public services and infrastructure.

The new president hardly has any time for celebration as the new government is immediately in for big challenges. First of all,the incoming government and the House of Representatives will face a very tight schedule to deliberate the 2005 state budget plan. This central government budget plan has to be approved by the House in November at the latest to allow for at least one month for local administrations to prepare their own budgets.

The government-House deliberation of the 2005 state budget plan will be quite tough as it will have to encompass painful measures to ensure fiscal sustainability. Foremost among them will be raising domestic fuel prices to cut down on fuel subsidies, which this year alone is estimated to balloon to about Rp 63 trillion ($7 billion) from the original plan of Rp 14 trillion due to the steep rise in international oil prices.

Preparing conducive political and economic preconditions for the new fuel pricing policy will be one of the most challenging and even delicate tasks for the new government. Managing the economic impact and political repercussions of higher fuel prices is never easy. In fact it was higher fuel prices that accelerated the downfall of then president Soeharto in May, 1998.

The new government has to bite the bullet because further deferring this painful measure would erode market confidence in the fiscal management and, yet more damaging, would damage the credibility of the government in continuing economic reform.

Political determination to continue the fiscal consolidation is central in the ongoing process of economic reform and is one of the bedrocks of the current macroeconomic stability. Hence, the 2005 budget plan should convey to the general public, notably the market, a strong, clear-cut message regarding the new government's fiscal policy as it will help the central bank design an appropriate monetary management to control inflationary pressures.

Better coordination of monetary and fiscal policies, as reflected in the steady easing of the credit crunch and the continued fiscal consolidation over the past two years, is vital to maintain macroeconomic stability, without which almost nothing else will work within the economy.

In this context, it is therefore imperative that the House and the government give top priority to the deliberation of the draft 2005 state budget, that was proposed in mid-August by the present government.