RECENT ECONOMIC REPORTS

Table of Contents :
1. Summary
2. The Budget Presentation
3. Budget Assumptions
    - 3.1.  Inflation
    - 3.2.  Exchange rate
    - 3.3.  Oil price
    - 3.4.  The Deficit
4. The FY 01 Budget
    - 4.1.  Expenditures
    - 4.2.  Revenue
5. Financing
    - 5.1.  Budget deficit
    - 5.2.  Domestic financing
    - 5.3.  Foreign Foreign borrowing
6. Parliament's turn

1. Summary.

On October 2, Vice President Megawati Soekarnoputri unveiled the GOI's Rp 295 trillion (USD 34.7 billion) draft FY 2001 budget in a speech to parliament (the DPR). This is the first budget to implement fiscal decentralization, scheduled to begin on January 1, 2001. The proposed budget is extremely constrained, with more than two thirds of spending going toward just three items: debt service (about 60 percent of which stems from the GOI's bank recapitalization program); fiscal decentralization costs; and subsidies. Adding the central government wage bill brings these core expenditures to more than 80 percent of total outlays. Political or economic pressures will make it almost impossible to reduce spending significantly on any of the four areas. The central government's development expenditures, in contrast, are budgeted at only Rp 33 trillion or 11.3 percent of spending (donor-funded project financing accounts for more than two thirds of this figure). By proposing a deficit equivalent to 3.7 percent of GDP, smaller than FY 00's budgeted 4.8 percent figure, the FY 01 budget takes a step toward medium-term fiscal sustainability as promised in the GOI's September 7 Letter of Intent to the IMF. The deficit is to be financed by foreign loans, an ambitious Rp 27 trillion target for disposal of assets held by the Indonesian Bank Restructuring Agency (IBRA), and privatization of state-owned enterprises.The DPR will certainly challenge several controversial features of the budget, including the underlying exchange rate and oil price assumptions, domestic subsidies, fiscal decentralization provisions, the IBRA and privatization targets, and the net new foreign borrowing total. The DPR is scheduled to conclude its budget deliberations by the end of December.
End summary.

Note: The exchange rate used throughout this report is Rp 8,000/USD1, which is the high end of the exchange rate range assumed for the FY 01 budget. The FY 00 budget covered nine months (April-December 2000) as Indonesia shifted from an April-to-March fiscal year to a January-December fiscal year. Statistics are drawn from GOI public sources.

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2. The Budget Presentation

On October 2, Vice President Megawati Soekarnoputri delivered a 75-minute speech to parliament outlining the GOI's FY 01 budget proposal (President Wahid was traveling abroad). Prior to her speech, DPR Chairman Akbar Tandjung delivered remarks that touched on several issues of current interest, including the situation in West Timor, Aceh, the October 1 increase in domestic fuel prices, and the September 13 Jakarta Stock Exchange bombing (septel). DPR members made unsolicited interventions to scattered applause about West Timor and the fuel price hikes both before and after Megawati's speech, demonstrating that the issues are clearly on many legislators' minds.

 Table 1 provides the main revenue and spending levels of the GOI's FY 2001 budget:

Table 1: Summary of the GOI's FY 01 Budget Presentation to Parliament

Note: (1) Fiscal Balance includes various central government transfers to cities/regencies and provinces.

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3. Budget Assumptions

In the press release on the FY 01 budget, the GOI presented some of the assumptions as a range:

3.1. Inflation: Members of Parliament and economic observers will question several of the assumptions. The 7-percent inflation projection for 01 is in line with current trends (year-on-year CPI inflation through August stood at 6.1 percent). The October 1 increase (by a weighted average of 12 percent) of domestic fuel prices is expected to bump the 2000 inflation up. The 2001 rate depends inter alia on the exchange rate, weather conditions, and possible future administered price increases.

3.2. Exchange rate: The FY 00 exchange rate assumption of Rp 7,000/USD is proving excessively optimistic and the Rp 7,300/USD figure assumed for 2001 will surely raise eyebrows as well. (Most observers thought that the Rp 8,000/USD end of the range mentioned in the public releases would be not arouse controversy.) The average exchange rate for FY 00 through September was approximately Rp 8,190/USD, more than 17 percent above the Rp 7,000 target. During the current fiscal year, the rupiah has ranged from a strong of Rp 7,630/USD on April 3 to a weak of Rp 9,475/USD on July 17; it has remained stubbornly in the Rp 8,000-9,000/USD range since April 26. One local economist estimated that, for every 10 percent depreciation of the rupiah against the dollar, there is a negative effect on the budget equivalent to 0.25 percent of GDP.

3.3. Oil price: In view of current high world prices, another potential point of controversy is the oil price, conservatively tagged at USD 22/barrel. The GOI enjoyed windfall revenues in FY 00 as oil prices far exceeded the USD 20 assumption. Although higher prices also meant that the bill for the domestic fuel subsidy doubled, the higher prices under prevailing consumption levels and exchange rates provided a large net positive boost to the budget that helped offset shortfalls in other receipts. The domestic fuel price increase belatedly introduced on October 1 did not even cover the increment to the subsidy bill caused by the weaker-than-assumed rupiah. The GOI announced that it would use the estimated Rp 800 billion in October-December 2000 savings on the subsidy bill to finance programs that would directly (cash payments) and indirectly (micro enterprise finance schemes and infrastructure projects) benefit the poor. If the average oil price for FY 01 remains above the assumed USD 22/barrel level, the subsidy bill will also be higher than in the draft budget. In view of the optimistic exchange rate assumption, one commentator characterized the conservative oil price assumption as a blessing.

3.4. The deficit: The GOI has posited an expansionary fiscal stance in its last two budgets. The deficit has, however, been smaller than budgeted as the GOI has maintained its traditionally conservative fiscal behavior. In FY 00, higher oil prices have partially offset difficulties meeting requirements for disbursement of program (budget support) loans. The deficit is nonetheless likely to be smaller than budgeted. Historically allergic to domestic borrowing to finance budget deficits, the GOI faces new challenges managing the large domestic debt associated with the bank recapitalization program. The carrying costs of domestic debt are forecast at Rp 55.8 trillion (USD 6.97 billion) in FY 01, of which IBRA asset disposals are to contribute Rp 27 trillion (USD 3.37 billion). In the FY 00 budget debate, the DPR insisted on raising the target for IBRA cash contributions to the budget.

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4. The FY 01 Budget

4.1. Expenditures: Indonesia's major budget concern is fiscal sustainability, which the Government defines as both reducing the debt/GDP ratio and eliminating the Government's budget deficit. The strategic target outlined in various Letters of Intent and by Vice President Megawati is to reduce the debt/GDP ratio from its current 100-percent level to 80 percent by 2002 and 60 percent by 2004. The principal threats to fiscal sustainability are debt service, especially the costs of carrying Indonesia's large domestic debt (Rp 55.8 trillion in FY 01); fiscal decentralization to be introduced on January 1, 2001 (Rp 74.9 trillion); and subsidies (Rp 48.3 trillion). On decentralization, the incremental amount being shifted from the central government to regional governments is equivalent to 1.6 percent of GDP. The principal difference between FY 01 and previous years is that regional governments rather than central authorities are to allocate resources received in line with transferred responsibilities. When relatively fixed government personnel costs are added to the three expenditure categories above, more than 80 percent of government spending has been accounted for. Political and/or economic considerations make it difficult to significantly reduce spending on any of the four. Other issues on the expenditure side include the following:

--Government wage bill: Civil servants received a 15-percent increase in their base wages in April and may receive another increase in October. The size of the government's wage bill in FY 01 will depend on how the fiscal decentralization program is implemented. The costs of some public employees may be shifted to local authorities, but it is not clear whether local authorities are willing to accept a full complement of transferees. This could create a requirement to finance a larger-than-needed central bureaucracy as well as local government staffs.

--Subsidies: While the net effect of higher-than-assumed oil prices on the budget is positive, they also lead to increased domestic subsidies. Domestic fuel subsidies are projected to reach Rp 43.2 trillion for FY 00, almost double the budgeted amount. If world oil prices remain high, the proposed FY 01 expenditures for domestic fuel subsidies are also understated. In its September 7, 2000 Letter of Intent to the IMF, the Government commits to developing a medium-term program for energy prices. Reactions to the October 1 domestic fuel price hike, so far muted, will influence the government's desire and ability to press forward with this program.

--Education and health spending: At a combined total of approximately Rp 5 trillion for routine expenditures and Rp 10 trillion for development expenditures, central government outlays on education and health represent less than 7 percent of central government outlays (excluding fiscal balance funds). Some education and health expenditures will be transferred to regional governments and are likely contained in the fiscal balance portion of the budget. DPR Chairman Tandjung and others have called for increases in education spending as a means of improving Indonesia's economic competitiveness.

--Military and police budget: The FY 01 budget proposes Rp 9.8 trillion in routine and development spending for the military. This represents 3.3 percent of total government expenditures or 0.7 percent of projected GDP. The equivalent figure for the police is Rp 5.4 trillion, or 1.8 percent of total government expenditures.

Table 2: Expenditures :

4.2. Revenue: With so little flexibility on the expenditure side, increasing the amount of government revenue is critically important and a major issue in Indonesia's IMF-supported economic program. FY 00 tax revenues have largely kept up with their targets. The FY 01 budget proposes to raise domestic tax receipts by an ambitious 1.1 percent of GDP, almost half of which is slated to come from an increase in non-oil and gas income tax receipts. Of total government revenues, the oil and sector was budgeted to contribute 28.3 percent in FY 00 and is projected to contribute 27.6 percent in FY 01. Under FY 01 projections, Indonesia's domestic tax/GDP ratio will rise significantly from 11.1 percent to 12.3 percent. (Note: Even at 12.3 percent, Indonesia will still trail behind its ASEAN neighbors Singapore, Thailand, Malaysia, and the Philippines.)

Table 3: Revenues

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5. Financing

5.1.Budget deficit: The primary surplus (the fiscal balance before payments on government debt are deducted) increases from 1.2 percent of GDP in the FY 00 budget to 1.8 percent in the FY 01 proposed budget.

Table 4: Financing

5.2. Domestic financing: The FY 01 budget reduces the amount to be raised from privatization of state-owned enterprises (SOE) from Rp 6.5 trillion to Rp 5.0 trillion. Judging from the GOI's performance on privatization in FY 00 (zero privatization receipts to date), however, even the reduced Rp 5 trillion figure may not be met. In June, the GOI issued a revised master plan for SOE restructuring and privatization and a primary and a stand-by list of enterprises to be privatized. Coordinating Economic Minister Rizal Ramli's attitudes toward privatization are unclear. He has spoken publicly of privatizing state-owned telecommunications firms (which are on the stand-by list), but has also repeatedly stressed the need to restructure SOEs before they are sold.

The major source of domestic financing is disposal of IBRA-held assets, targeted to contribute Rp 27 trillion (USD 3.37 billion) to the budget. The funds would be generated primarily by selling taken-over banks and their assets, non-performing loans transferred to IBRA from recapitalized banks, and shares in companies pledged to IBRA to cover obligations of former bank owners. IBRA claimed to be on-target for its FY 00 collections. Maintaining that record will require accelerating disposals.

5.3. Foreign borrowing: When projected interest payments on foreign debt (Rp 21.6 trillion) are added to the Rp 15.9 trillion in principal payments on official loans scheduled for FY 01, the Government's actual net foreign financing flow is negative Rp 1.5 trillion (USD 186 million). These figures take the Paris Club rescheduling of principal owed by the GOI to official bilateral creditors into account. In the government's budget presentation, a projected Rp 36 trillion in foreign loans are listed as a source of funding for the budget deficit. These loans are divided between program loans (Rp 13.7 trillion) and project loans (Rp 22.3 trillion). After Rp 15.8 trillion in principal repayments are deducted, the net amount of new foreign borrowing is Rp 20.1 trillion (USD 2.5 billion). As Indonesia's financial crisis recedes, donors hope to shift from program to project financing, a trend reflected in the FY 01 budget proposal. The government's reliance on new foreign borrowing, to which some Indonesian parliamentarians and NGOs are opposed, may emerge as a political issue during budget deliberations.

6. Parliament's turn

The DPR's consideration of the FY 01 budget promises to be intensive and critical. The GOI and the DPR have already held several hearings on the anticipated assumptions for and outlines of the FY 01 budget. A more intense round of meetings will begin this week. During the deliberation of the Government's FY 00 budget proposal, the DPR made several changes. This year, with its greater experience as an independent parliament, the DPR could insist on additional information and make important changes to the budget document. Areas likely to draw particular attention are the assumptions and issues with the strongest domestic political appeal or public resonance, including subsidies, education spending, foreign borrowing, and privatization.

Future reports will cover decentralization and sectoral allocations in the FY 01 budget.

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