Formidable fiscal challenges

Minister of Finance Sri Mulyani Indrawati has charted out the biggest challenges in fiscal management during the 2006 fiscal year beginning next month: Government revenues will most likely fall short of their targets while expenditures will be much more than estimated.

This is not a pessimist's view, but a rational analysis that can serve as an early warning to the whole government that fiscal management next year would be quite formidable challenge and all government agencies should exercise high budget discipline with a high spirit of austerity.

Tax receipts, which account for more than 75 percent of government revenues, will most likely fall short of the 2006 budget forecast because economic growth will be lower than the 6.2 percent target. She predicted gross domestic product growth next year would be between 5.3 percent and 5.7 percent because new investment is expected to pick up in a robust manner not until the second semester.

Since most companies are still struggling with the cost-push inflation caused by the average 126-percent increases in fuel prices in October and their multiplier impact, including high interest rates and tremendous pressures for higher labor wages, most businesses will book smaller taxable income. Many may even operate in the red.

The dilemma though is that the public sector's expenditures next year will have to increase significantly because of the budgeted rise in the civil service pay and greater-than-estimated debt service burdens.

Debt service and repayment burdens will be much larger than the Rp 91.6 trillion ($9.2 billion) estimated in the budget because the interest cost of the government domestic debts (bonds) will increase sharply due to the steep rise in the interest rate from an average of 9.5 percent envisaged in the budget to as high as 12.75 percent today. The Rp 46.2 trillion in interest payments on government bonds was estimated on the assumption of an average interest rate of 9.5 percent.

Even though the interest rate is expected to begin declining in the second semester, the average interest rate for the whole of 2006 would most likely still be hovering above 11 percent, while officials have estimated that every one percentage point increase in interest rates will add Rp 3 trillion to the interest charges of the government bonds.

The big question now is what would happen to the government plan to conduct economic pump priming next year. The state budget itself, which was approved by the House of Representatives at the end of October, provides a 20-percent expansion in spending to a total of Rp 647 trillion. On top of that, another stimulus of Rp 10 trillion to Rp 15 trillion in public sector investment, carried over from the 2005 budget, will be pumped into the economy.

The tight fiscal condition certainly requires tough fiscal discipline. This not only calls for a high spirit of austerity, but also effective and efficient spending of every single rupiah of the taxpayers' money. That also requires a more vigorous tax collection effort.

We are still optimistic, though, that tax receipts can still be increased significantly, despite the bleak business outlook. The tax directorate general had, as of October, increased the number of registered personal income taxpayers to over 10 million from a mere 3.5 million.

Certainly, many of the registered taxpayers may later turn out to be ineligible because their income is still below the taxable income level, or because they are employees whose income tax is withheld by their employers. It is nevertheless reasonable to expect that at least 30 percent of the 6.5 million newly registered taxpayers would add to tax receipts.

The biggest challenge for the new finance minister is to ensure that the tax directorate general is well geared up to meet the big task of administering and managing the much larger taxpayer base.

The market, we think, will remain comfortable despite Minister Sri Mulyani's message of fiscal caution because that early warning demonstrates her competence in budget analysis and fiscal management.

After all, it is much better to err on conservative estimates than on overly optimistic predictions. She simply demonstrates the basic principle of prudent fiscal management that the total amount of money the government will spend will be closely aligned to what is affordable over the current year.

This is a factor of predictability the market wants to live with because businesspeople can rest assured that there would not likely be any painful surprises within the next fiscal year.

Moreover, the market confidence in the overall economic management and consequently in the economic outlook will get stronger under the effective coordination of the new chief economics minister Boediono, himself with an internationally- respected record of prudent fiscal management.