Plugging the fiscal holes

The draft 2004 state budget will immediately suffer the brunt of the government's decision to end the International Monetary Fund program in Indonesia later this year, as reflected in the 160 percent increase in foreign debt principal payments (amortization) to Rp 44.89 trillion (US$5.16 billion).

That is precisely the fiscal gap that Minister of Finance Boediono had warned of during the heated debates about the IMF role in the country before the government finally decided last week to end any special arrangement with the IMF.

Foreign debt amortization will steeply increase because the end of the IMF program will deprive the government of access to another debt rescheduling facility from the Paris Club of sovereign creditors.

Consequently, for the first time in perhaps over the last three decades, the state budget will suffer a net resource outflow of almost Rp 15 trillion. Despite this great burden, the government pledged to further cut the fiscal deficit to 1.2 percent of gross domestic product or Rp 24.9 trillion from 1.8 percent or Rp 34.4 trillion estimated for 2003.

The budget draft, which was unveiled to the House of Representatives on Friday, explains how the government will address the fiscal gap with operating (recurring) revenues from taxes, levies, fees, royalties and dividend payments from state companies and non-recurring revenues.

However, the document failed to show what the government had promised as a white paper on the reform agenda to address another gap, called the credibility gap, left behind by the termination of the IMF program. The market perceives the credibility gap as an issue of the government's will and ability to continue the economic reforms after the end of the reward-and-punishment mechanism provided by the IMF program.

The government said last week that the reform mechanism was being fine-tuned and would be announced later this week. Businesspeople have eagerly been waiting for this reform agenda as it is supposed to delineate all the structural reforms that the government intends to carry out in order to stimulate investment.

The government explanations of how it plans to address the fiscal gap are continuing to raise great concern because the bulk of the financing gap will be covered by non-recurring (non- operating) revenues, not by recurring receipts such as taxes, service fees and royalties from natural resources which are much more sustainable.

The largest portion of the non-recurring revenues next year, amounting to about Rp 26.3 trillion, will be derived from the draw down of the government reserves at the central bank.

Other major sources are asset sales by the Indonesian Bank Restructuring Agency (IBRA) which are expected to generate Rp 5 trillion and the sale of state companies which will contribute another Rp 5 trillion.

Assuming that if all these non-recurring revenue projections will fully materialize next year, there is a small chance that these sources will be able to continue their significant contributions in subsequent years when foreign and domestic debt service burdens will remain heavy. That is because the privatization of state companies has always been a sensitive political issue and IBRA has disposed of most of what the market sees as its "jewel assets".

It is almost pointless to reemphasize that this condition makes it most urgent for the government to step up its structural reforms in order to stimulate investment and smooth the way for business operations, as it is these activities that can generate sustainable sources of revenues. Hopefully, the white paper on the upcoming reform plan will strongly address this concern.

Another major development in the fiscal policy that the government will pursue to plug its budget hole is the increasing reliance on domestic borrowing through the issuance of bonds. During 2004, for example, the government plans to float Rp 28 trillion in bonds but at the same time will have to redeem Rp 18.89 trillion in mature bonds.

This once again underscores the importance of accelerating the reform program to reduce both the country and sovereign risks in order to attract both domestic and foreign portfolio investors.

The significant amount of foreign portfolio investment flows to Indonesia over the past two years, amounting to $1.2 billion in 2002, estimated at $1.4 billion this year and projected at $1.4 billion in 2004, have contributed greatly to the robust expansion of the government bond market.

However, without steady, significant progress in macroeconomic stability and in structural reforms to minimize business and sovereign risks, especially during the politically turbulent period in the 2004 election year, few investors will buy government bonds.