'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.'

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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.