'It is true that one has to wonder where the government can

'It is true that one has to wonder where the government can find the extra money to cover these additional expenditure requirements.'

;JP; ANPAk..r.. Indonesia-Budget 2005 Indonesian Government Budget: Are we in wonderland? JP/6/KAHLIL

2005 Indonesian Government Budget: Are we in wonderland?

Kahlil Rowter Jakarta

Like Alice, our initial reaction is astonishment at the proposed 2005 budget the government unveiled last week.

No, this is not in the same category as the Soeharto budget early in 1998 or the Habibie economic report in 1999, but distance between reality and imagination exists here too. It appears that the first thing the next government (whoever wins) must do is to both inject more reality and impose a sense of direction for the economy into the 2005 government budget.

The budget structure itself does not deviate much from the 2004. The assumptions, however, appear problematic. Take the growth figure. Moving from 4.6 percent to 5.4 percent might not seem such a huge jump, especially if we use the new gross domestic product (GDP) figures from the Central Agency of Statistics.But one must question where the source of growth will come from. Unless investment picks up significantly it is difficult to imagine this being possible. Investment in this case really depends on foreign sources in direct or portfolio flows.

Although there is hope that some diversion of funds currently absorbed by China one must bear in mind that neighboring countries are currently a lot more attractive. And with the world economy on a cooling trend exports can hardly be expected to grow substantially. Consumption, the mainstay of growth so far, is also showing signs of tapering off.

The inflation cum interest rates assumptions also raise questions. Unless Bank Indonesia raises rates more aggressively, the current inflation level of around 7.2 percent appears set to rise, mainly driven by weak and potentially weaker rupiah. More important is the wide spread expectations that inflation will rise in the near future. Mandiri Sekuritas expects inflation to reach 7.5 percent by year end and 6.5 percent next year.

But if we look at the GDP growth and inflation assumptions in combination, it might just work! Real GDP growth (5.4 percent) plus inflation (5.5 percent) becomes the nominal GDP growth (10.9 percent). So if both misses their targets, say growth remains around 4.5 percent and inflation stay at 6.5 percent, the total is still around 11 percent. And this will make the nominal GDP in 2005 at about the level assumed. The result: Tax revenues will probably be realized. As long the two totals up to around 11 percent there really is no need to worry.

A higher inflation entails higher interest rates. So if inflation is expected to still hover around 6.5 percent it is reasonable to expect that SBI (Bank Indonesia promissory notes) rates too will be at its current level of a little below 7.5 percent. Every 1 percent of SBI rate rise increases the interest burden on floating rate government bonds of about Rp 2.2 trillion (US$256 million). But this must be balanced against the increase in interest tax of Rp 1 trillion.

We come now to the most glaring difference between assumption and market reality: The oil price assumption. The current world oil price is US$48 per barrel. Ignoring the difference between oil price benchmarks, this is double that used in the budget assumption.

For every one dollar world oil price above the assumption, The Ministry of Finance calculates the impact to be between Rp 100 billion to Rp 150 billion extra expenditure requirement. This is because the central government pays all of the fuel subsidy while revenues must be shared with producing regions. Oil analyst maintain that the political premium of world oil prices currently stand at about $9-10 per barrel. Therefore the "normal" world oil price should be around $38-39 per barrel.

So what is the extra expenditure requirement should both the interest rate and the oil price assumption turn incorrect? Adding the extra interest expenditure requirement of about Rp 1.2 trillion, plus the oil price extra cost of Rp 2.25 trillion, we get Rp 4.45 trillion. Not a huge number in a Rp 380 trillion budget. Even if we increase the SBI rate to 8.5 percent and oil price to $40 per barrel, the additional cost is "only" slightly less than Rp 6.5 trillion.

Another item sensitive to the assumptions is the payment of foreign debt which stands at Rp 47.8 trillion. Taking out the disbursement of foreign loans of Rp 26.6 trillion we are left with net payment of a little over Rp 20 trillion. We have to add to this the interest on foreign loan of about Rp 25 trillion. As a simplification where we ignore the impact of currency movements on income (import-export taxes etc.) every time the rupiah depreciates Rp 100 over the assumed level of Rp 8,600, the additional loan payment burden rises by about Rp 523 billion. Should the rupiah weaken significantly, say to Rp 9,200 the government will have to come up with an extra Rp 3.2 trillion.

These simple exercises using published figures show that the additional burden from missing several targets are substantial but not alarming. It is true that one has to wonder where the government can find the extra money to cover these additional expenditure requirements.

One source would be a stronger effort in privatization, no matter the political difficulty of doing so. Another source would be to up-size issuance of government bonds, already at a record high of net issuance of around Rp 20 trillion. These are the easy steps.

More difficult, but more important in the long term, is to increase efficiency of revenue collection, especially tax ratios which by international comparison is very low. Several non-tax revenues sources should also be enhanced.

A friend recently reminded me that value added taxes revenue is too low considering that the rate is at 10 percent. Increasing just this one item to near its potential can easily solve the presently planned deficit and prepare funds should the assumptions are missed.

We are not in wonderland. That is for sure. But if one is looking for inspiration in the 2005 proposed budget, look elsewhere.

The writer is Head of Research Mandiri Sekuritas. This column was written in personal capacity to enhance public debate.