Revising the 2005 budget

The government and the Budget Committee of the House of Representatives have agreed on the most significant changes needed to the 2005 state budget, paving the way for the approval of a revised budget, which has been made necessary by much-higher-than-anticipated oil prices and the devastating earthquake and tsunami in Aceh last December.

Speedy enactment of the long-awaited budget revisions is crucial, especially for the disbursement of funds for poverty alleviation, special assistance funds for poor families as compensation for the inflationary impact of the March fuel-price increases, and money for the reconstruction of Aceh province.

Changes in major expenditure items for the whole year are based on new key assumptions: average international oil price of US$45/barrel (up from previous estimate of $24), economic growth of 6 percent (5.5 percent), average rupiah exchange rate of Rp 9,300 (Rp 8,600), interest rate of 8 percent (6.5 percent), and inflation at 8 percent ( 5.5 percent).

The market will be more comfortable with the new assumptions as they are more realistic, meaning that the total amount of money the government will spend will be closely aligned to what is affordable over the current year.

Predictability is important for efficient and effective implementation of policies and programs because the public sector will perform better where there is stability in macro and strategic policy and funding for existing policies.

The wild volatility of the rupiah exchange rate, which reached as high as 6.22 percent in May, as against a fluctuation of only about 3.5 percent in April, can partly be blamed on the uncertainty caused by the unrealistic budget estimates.

The amendments will increase total government spending to more than Rp 510 trillion ($54.8 billion), compared to Rp 395 trillion as originally envisaged. Encouraging, though, is the fact that the budget deficit will be maintained at the original estimate, or at 0.8 percent of gross domestic product.

This will be made possible because the government will cover the additional spending by increasing the total nominal amount of the bonds to be issued this year to Rp 47.1 trillion from Rp 43 trillion as previously planned. More than Rp 24 trillion in savings on foreign debt servicing as a result of the recent decision by the Paris Club of sovereign creditors to reschedule Indonesian debt service payments due this year will also help curb the deficit.

The revision of the budget has been imperative since early this year due mainly to persistently high oil prices and the need for huge sums of money to be spent on the reconstruction of Aceh after the earthquake and tsunami.

The government initially assumed that the average oil price would be $24/barrel for the whole year. This was revised upward to $35 when the government raised domestic fuel prices by an average 29 percent in March.

However, most analysts estimate the average oil price for the whole year will most likely hover at $50. During the first five months alone, the oil price averaged $50.75 and is predicted to remain at about the same level even during the summer due to the strong demand from China, currently the world's second largest consumer, and insecurity of supply from the Middle East.

This single change alone has created a chain of consequences that require the revision of the estimates for state receipts, the rupiah exchange rate, interest rates, and fuel subsidy and social-safety net spending programs. These are the changes that will be accommodated in the minibudget expected to be approved within the next few days.

For example, based on the new oil price assumption ($45), the government and the House Budget Committee have agreed to revise upward the fuel subsidy appropriation to Rp 76.5 trillion.

But as the high oil prices are causing stronger inflationary pressures in the economy, the rupiah is also experiencing downward pressure, forcing the central bank to tighten its money policy by upping interest rates.

The government and the House need to complete the deliberations on the revision of the budget as quickly as possible as the state budget represents a communications system that conveys signals about behavior, prices, priorities and commitments. A more realistic budget will reduce uncertainty about public sector expenditure and structural imbalances between expectations and resources.