The bare-bones budget

The bare-bones budget

The first state budget proposal submitted by President
Megawati Soekarnoputri to the House of Representatives on Friday
will predictably be contractionary for the economy, as the
government will take more out of the pockets of taxpayers, and
more than 38 percent of total spending will go to servicing and
installing foreign and domestic debts.

But the market, notably international creditors and investors,
will welcome the 2002 budget plan as reasonable and workable in
view of the realistic assumptions used for the most influential
variables in the budget, the conservative estimates made for the
average exchange rate and interest rate and the high targets set
for the sales of assets and state companies, as well as debt-
restructuring.

It is undoubtedly a bare-bones budget with total spending
envisaged to decline by at least 12 percent in real terms (with
the necessary adjustments made to account for inflation). The
annual budget document, which used to consist of more than 350
pages, is a boring 56-page fiscal statement devoid of any
stimulus to pump priming. But then, when almost 53 percent of
total spending will be sapped by subsidies, the servicing and
installment of foreign and domestic debts, there is not much to
say about investment to induce the self-sustaining expansion of
economic activities. Therefore, private consumption and
investment as well as exports will remain the locomotive to
generate 5 percent growth.

The strongest message of the fiscal plan urges further belt-
tightening by the public, more stringent austerity measures for
the public sector and a more vigorous tax campaign. But, given
the debt trap that caught the government after the 1997 economic
crisis, there is no other choice for the government but to focus
on fiscal consolidation, instead of stimulus, to prevent the
fiscal deficit from exploding to an unsustainable level.

Even though the budget plan has yet to undergo the healthy
rigors of democratic debates at the House and satisfy the demands
of a decentralizing government and political system, we are quite
comfortable with the way the budget has been designed.

The basic assumptions -- an average exchange rate of Rp 8,500
for the rupiah, 14 percent for the central bank's benchmark
interest rate, 8 percent for inflation, US$22 per barrel for
international oil prices and 5 percent growth for Gross Domestic
Product (GDP) -- seem to be realistic.

These assumptions are vital for determining the credibility of
the budget plan because the state budget has never been so
vulnerable to variations in interest rates, exchange rates and
inflation, as it is now, due to the public sector's mountain of
foreign and domestic debts, which now amount to 120 percent of
the GDP. This is already twice as large as the 60 percent of GDP
level, which is recognized internationally as a standard for a
prudent level of debt.

Most encouraging is the government's move to accelerate the
privatization of state companies to generate Rp 6.5 trillion and
asset recovery and debt (corporate restructuring) to raise Rp
35.5 trillion in cash and Rp 7.3 trillion in retired bonds. This
bold measure will not only attract new investors to reinvigorate
the real sector but will decrease economic bleeding and help
strengthen the banking sector.

That is because only about Rp 25.4 trillion of the cash will
be transferred to the state budget, while the remaining Rp 23.9
trillion in cash and restructured debts will go to retiring early
the government bonds issued to recapitalize banks. This, in turn,
will cut down the burden of domestic debt-servicing and allow
recapitalized banks to expand their own loan portfolios by
swapping their illiquid bonds with restructured debts.

This high target undoubtedly requires hard work and political
support from the House. But the tough homework the government has
set for itself, its bold decision to bite the bullet by further
raising fuel and electricity prices next year will certainly
create sympathy among its international creditors who are due to
meet in Paris on Monday and in Jakarta in early November.

Full support from international creditors is vital for the
budget as it still expects $4.1 billion (Rp 34.85 trillion) in
new project and program loans for next year and the rescheduling
of another $6 billion in debt principals due in 2002 and 2003.

The biggest challenge now is to get the House to agree with
the budget plan and to prepare social safety net programs to
protect the poor from fuel and electricity price rises next year.

House members, who love populist programs, would be well
advised to realize that international creditors, notably
sovereign donors, would not be willing to help a nation that is
itself not willing to make sacrifices.