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.