Tax rise, subsidy cuts will weaken recovery: Report
Dadan Wijaksana, The Jakarta Post, Jakarta
The tax revenue increase and sharp subsidy cuts proposed by the government in the 2003 draft state budget could weaken the pace of the country's economic recovery, a U.S. investment firm said.
Merrill Lynch said in a report that an increase in the tax collection target and reduced allocation for subsidies would hurt domestic consumption, especially the private sector, which would in turn would have a negative impact on economic growth.
"We expect private consumption, which contributes around 75 percent of GDP, to be the main driver of growth. However, the pace of consumption is likely to be moderate from here," said the report, a copy of which was made available to The Jakarta Post on Wednesday.
Delivered by President Megawati Soekarnoputri, the government proposed last week a 2003 draft budget which saw the tax revenue target jump by almost 20 percent to Rp 260.8 trillion from this year's target of Rp 219.6 trillion.
The draft also cuts subsidies on fuel, electricity and others by 39 percent from Rp 41.6 trillion to Rp 25.3 trillion.
The above measures will allow the government to reduce the state budget deficit next year to 1.3 percent of GDP from this year's estimate of 2.5 percent of GDP.
"We are encouraged by the government's focus on fiscal sustainability, especially in reducing the budget deficit. While positive in the long run, we believe this limits fiscal flexibility and is also negative for growth," Merrill Lynch said.
The subsidy cut will cause higher fuel prices and electricity rates. This will weaken the purchasing power of households, and thus lower consumer spending. The policy will create more burden on the business sector and thus limiting them to make new investments.
Merrill calculated that the fuel subsidy was expected to decline by 55 percent, which is likely to lead to a 20 percent to 25 percent hike in fuel prices.
"This alone may contribute some 2 percent to the overall inflation," it said.
The figure may get higher if coupled with increases in other sectors, such as electricity.
Commenting on other assumptions, the investment company said that, on the whole, the macro assumptions seemed realistic, although the economic growth projection and revenue target fell on the optimistic side.
The government assumes an economic growth of 5 percent, compared to this year's projected 4 percent, inflation at 8 percent, as against 9 percent this year.
Merrill that although the budget expenditure was only to increase by 3 percent to Rp 354.1 trillion, it was more a reflection of the steep decline in subsidies and interest payments, which together account for some 30 percent of expenditure.
Routine spending and allocation to local administrations ( called balance funds) are expected to increase by 24 percent and 16 percent respectively, the investment firm said.
It said that balance or decentralization funds were by far the largest chunk of expenditure, and were expected to be one of the main drivers of the economy.
"The utilization of such funds is believed to be one of the reasons behind the recent strength in private consumption locally ... strong pockets of activity in the resource-rich regions. Such spending over time can trickle down to other regions, thus providing a wider base for economic growth."