Tax rise, subsidy cuts will weaken recovery: Report

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."