RECENT ECONOMIC REPORTS

The GOI's FY 2000 Budget: Debt Services Hikes, Development Cuts, Regional Focus

February 14, 2000

Summary:

1. The Government of Indonesia's FY 2000 budget (April-December, as Indonesia transitions to a calendar year budget) amounts to a prudent effort to make ends meet and keep the wheels of government turning while Indonesia works its way out its deep economic slump. The GOI submitted the draft budget to Parliament on January 20. Parliament is now debating the budget and is expected to pass it into law before the end of March, but the line item amounts remain subject to change. Not coincidentally, the GOI signed its new 98-paragraph Memorandum of Economic and Financial Policies -- its IMF-supported gameplan for restructuring -- on the same day President Abdurrahman Wahid and Vice President Megawati Soekarnoputri presented the budget to Parliament.

Expenditures: The budget calls for a 15 percent increase in expenditures (in annualized terms) over the belt-tightening FY 1999/00 budget (Table 1).

Revenues: The expenditure increase, unavoidable because of mounting debt servicing costs for bank recapitalization bonds (interest on the bank recapitalization bonds accounts for almost one quarter of expenditures), is to be funded by an aggressive 42 percent increase in domestic revenues, (Tables 1 and 7).

Financing: The foreign financing component of the budget, no longer listed as part of revenues as Indonesia moves to more conventional budget presentation, is being reduced as the GOI seeks to begin easing its foreign debt burden (Tables 1 and 2).

Deficit: The budget still calls for a 5-percent-of-GDP deficit, versus the planned 6.8 percent (in the event estimated at 3.75 percent of GDP) deficit for FY 1999/00. But the deficit is not seen as stimulating economic activity significantly because investment-oriented development spending will decline (Tables 3a and 3b).

Regionalization: In acknowledgment of the government-wide move toward decentralization, the budget foresees transfer of more resources to the regional level (Tables 4-6), but does not yet implement the Fiscal Decentralization law.

Expenditures for Ailing Banks

2. The most unwelcome expenditure line on the GOI's FY 2000 (April-December) draft budget, not yet passed by Parliament, is the Rp 42 trillion bank recapitalization bill, which is the carrying cost for the Rp 400 trillion in bank recapitalization bonds issued in 1999 (Rp 280 trillion), or expected to be issued this year (Rp 120 trillion), to keep afloat troubled state-owned and private banks (Table 1). This expenditure alone accounts for almost one fourth of total expenditures (Table 2). As expensive as it is, Ministry of Finance officials said they were worried the interest cost could be higher still if inflation exceeds expectations, pushing interest rates up. The GOI will be coping with this carrying cost for a decade, since some of the bonds have maturities of 10 years, unless economic conditions improve enough for the GOI to buy back bonds. The sizable domestic debt marks a sharp change for the GOI, which historically considered avoidance of domestic debt a cornerstone of its fiscal policy.

3. On the expenditure side, the GOI made room for this crisis hangover bill mainly by cutting development spending, which has declined from 39 percent of expenditures in the pre-crisis FY 1997/98 budget, and 29 percent in FY 1999/00, to 22 percent of expenditures in FY 2000 (Table 2). Consequently, the largest funding areas in the development budget were cut significantly in the FY 2000 budget (Table 3a); in only a few cases are the cuts offset by increases on the routine side of the budget (Table 3b). Other major changes on the expenditure side include a salary increase for civil servants, budgeted at 15 percent but still under discussion in Parliament; and fuel and electricity price hikes, both expected to increase by an average of 30 percent, with coupon schemes under discussion to protect the poor. (The subsidy expenditure shows an increase despite electricity and fuel price increases because the higher oil price assumption in turn increases the cost of the subsidy.)

Table 1. GOI Budget Summary: FY 2000 vs FY 1999/00

* In this and subsequent tables, FY 2000 figures are converted to a 12-month basis in the columns making comparisons with FY 1999/00 figures.

Source: data from GOI Budget document ("Nota Keuangan 2000")

Table 2. GOI Budget Items by Percent Shares

* Large decrease
** Large increase

Source: data from GOI Budget document ("Nota Keuangan 2000")

Table 3a. Changes in Largest Funding Areas in Development Budget, FY 1999/00 versus

FY 2000

Table 3b. Changes in Same Funding Areas as Table 3a, Taking into Account Both

Development and Routine Expenditures

*Percent changes in this column calculated after converting the FY 2000 budget to a 12-month basis.

Source: data from GOI Budget document ("Nota Keuangan 2000")

Regional Control of Funds

4. The FY 2000 budget cuts the development budget, as noted above, but shifts the remainder in large part to the regions (Table 4). The GOI's budget documents said this adjustment was in keeping with laws number 22 on Regional Autonomy and number 25 on Fiscal Decentralization, though Finance Ministry officials made clear that the laws are not yet being implemented (nor have the necessary regulations been drafted). The regional funds in the FY 2000 budget are to be directed at the village (desa), regency/city (kabupaten/kota), and provincial (propinsi) levels:

Villages: Rp 0.67 trillion (US$ 95 million); a 10-percent increase over FY 1999/00 (adjusted for twelve months). 68,988 villages will each receive an allocation of Rp 9 million (US$ 1,285) for community services and family support, with least-developed villages receiving more.

Regencies/Cities: Rp 5.94 trillion (US$ 843 million); a 37-percent increase over FY 1999/00 (adjusted for twelve months). These funds are intended for roads, housing, education, health, agriculture, and the environment. A formula will give each regency/city Rp 8,850 (US$ 1.25) per capita and Rp 45,000 (US$ 6.40) per square kilometer of area. Regencies/cities with populations smaller than 226,000 persons will receive a minimum of Rp 2 billion (which is Rp 8,850 times 226,000). Small island areas will receive an additional Rp 7.5 million (US$ 1000) per island. Of the Rp 5.94 trillion for regencies/cities, Rp 0.32 trillion (US$ 45 million) is to be allocated based on regional income and regional potential, not defined further.

Provinces: Rp 3.11 trillion (US$ 440 million), a 30-percent increase over FY 1999/00 (adjusted). Each province will get a flat Rp 30 billion (US$ 4.3 million) plus Rp 75,000 (US$ 10) per square kilometer.

Revenue sharing? Not Yet

5. Included in the regency/city figures and in Table 6 are "special supplements" to be given to four provinces, Aceh (Rp 273 billion), Riau (Rp 367 billion), East Kalimantan (Rp 244 billion), and Papua (the new name for Irian Jaya, Rp 315 billion). These are resource-rich provinces that are slated to receive extra revenues in FY 2001, when the Fiscal Decentralization law (Law Number 25 of 1999) takes effect. Finance Ministry officials said the supplements are not meant as predictions of how much extra revenue the provinces will get under the new law, but are intended as a step in that direction. As for estimates of how much resource revenue the various areas would get, Finance Ministry officials said that even preliminary figures remain unavailable because surveys are still under way, complicated by the fact that many oil and gas fields cross provincial and/or regency boundaries.

6. How were provincial and regency governments reacting to the prospect of revenue sharing in FY 2001? Positions had not hardened, Finance Ministry officials said, because the regulations that would govern the resource transfers had yet to be drafted. The GOI's approach was first to draft regulations connected with the Regional Autonomy law (Law Number 22, 1999), expected to be finished by the end of February, to be followed by regulations on fiscal decentralization. In the meantime, some provincial officials resented the fact that the laws in large part bypassed provincial authority, but there was little expectation that the basic structure of the laws (emphasizing devolution of authority and resources to district levels) would be revisited.

7. Another persistent problem was that local representatives lacked a basic understanding of how oil and gas revenues worked. They continued to estimate their regions' shares by multiplying the oil or gas price times production, neglecting production costs, taxes and other factors that decreased their potential net. The overall tone of the discussion on this subject was that there is much more ground to be covered in deciding how much revenue each region will receive, and in convincing regions that their shares are just. Not mentioned at all was the likely resentment on the part of regions that may get reduced revenues, as foreshadowed in table 6.

Table 4. Development Budget -- Regionally vs. Centrally Controlled Funds, FY 1999-2000 and FY 2000

Source: data from GOI Budget document ("Nota Keuangan 2000").

Table 5. Breakdown of Development Funds to Regions

Source: data from GOI Budget document ("Nota Keuangan 2000").

Table 6. Development Funds, by Province

*Percent changes in this column calculated after converting the FY 2000 budget to a 12-month basis.

Note: Each province's figure is the sum of village, regency/city, provincial, land/building tax, and social safety net shares.

Source: National Development Planning Agency, Development Budget Notes, January 2000.

Aggressive Revenue Targets

8. The FY 2000 budget includes aggressive tax revenue targets. That is because of bank recapitalization costs, and because the GOI hopes to reduce external financing. Table 7 indicates how aggressive the tax targets are, but also indicates that the GOI is being conservative on the non-tax side; perhaps the two will balance out. The Finance Ministry estimates that each one dollar increase in the price of oil (currently selling at US$ 24/barrel versus the FY 2000 budget assumption of US$ 18/barrel) translates into a net revenue increase of about Rp 1 trillion (US$ 143 million) after subsidy costs are subtracted; the revenue impact is subject to change based on export levels and price levels. The potential net revenue increase will be larger once subsidies are cut.

9. As Table 7 indicates, based on realizations through November 1999, the GOI expects to collect more income tax for FY 99/00 than budgeted. But the FY 2000 target (converted to a 12-month basis) is 10 percent higher still and other tax categories are slated to increase even more. To meet these tax targets, the GOI plans to broaden the tax base, starting with a public relations campaign aimed at making sure every individual has a taxpayer number. (Finance Minister Bambang Sudibyo is said to be sending such ID cards to his former university colleagues, not entirely in jest.) Another part of the strategy is to remove most VAT tax exemptions (essential if the targets are to be met, officials said), including the exemption for Batam Island near Singapore. Tax holidays are being reviewed. U.S. and other foreign companies are concerned that tax officials will "hunt in the zoo" by going after large foreign corporate taxpayers for increased revenue.

Table 7. GOI Revenue Targets and Realizations, FY 99/00 and FY 2000

Key:

Column A - FY 99/00 Budget figure
Column B - Realization, Apr 1-Nov 30, 1999 (8 months)
Column C - GOI estimate for FY 99/00 Realization
Column D - FY 2000 Budget figure (nine-month fiscal year)
Column E - FY 2000 Budget figure compared to GOI estimated realizations for FY 99/00 (FY 2000 converted to twelve-month basis)

* Income tax on oil/gas is listed separately for the FY 200 budget but is combined with other oil/gas revenues here to allow comparison the FY 1999/00.

** Privatization is listed under Financing in the FY 2000 budget but included here for comparison. Thus, Rp 143.6 trillion minus Rp 5.9 trillion equals the Rp 137.7 trillion domestic revenue figure in the FY 2000 budget.

Source: data from GOI Budget document ("Nota Keuangan 2000")

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