Revising the 2005 budget

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.