ITHE GOVERNMENT NEEDS TO EXPAND FISCAL SPACE -- May 2011

INDONESIAN COMMERCIAL NEWSLETTER

May 2011

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THE GOVERNMENT NEEDS TO EXPAND FISCAL SPACE

Indonesia has recorded quite impressive performance in the past three years with economic growth averaging 6% placing itself safe from the impact of the global crisis in 2008-2009. However, the economic growth, for some analysts and observers, was still too low compared with a leapfrogging rise of more than 8% recorded by China and India. A 6% growth is not enough to help reduce poverty and unemployment problem, they said.

There are a host of difficulties coming in the way of efforts to boost the country's economic growth faster after the 2009 financial crisis although the country's economy has strong fundamentals. The country has succeeded in keeping its inflation low. The rupiah is gaining and the country's foreign exchange reserve has continued to scale up. The benchmark interest rate of Bank Indonesia was kept at no more than 6.75% despite the threat of European and US debt crisis.

Analysts said other than its role in keeping monetary stability the government has little to contribute to good records in macro economic indicators. The success is attributable more to role played by the business sector and the general consumers it was apparent in the little fiscal stimulus the government could provide to push growth. In fact the government has almost no fiscal space to allow it to provide stimulus for priority projects in the state budget . Fiscal space will give the government greater flexibility in allocating larger funds for priority sectors in the national economic development plan such as infrastructure projects. Fiscal space could be created by reducing non-discretionary allocations such as civil servants spending, interest payments, subsidies and expenditures allocated for the regions.

After the fall of the regime of the New Order, the government has maintained low budget deficit and cut reliance on foreign loans. As a result the government could provide fewer funds for development despite growing state budget from year to year while the portion for routine expenditure continued to increase.

Every year since 2006, the state budget has increased in value from Rp 985 trillion to Rp 1,418 trillion in the draft state budget for 2012.

Routine expenditures and subsidies dominate state budget (APBN)

The portion of non discretionary spending such as employees' spending, interest payments, subsidies and expenditures allocated for the regions dominate APBN, by more than 76 %. For example, in the revised APBN of 2011, of the state budget of Rp 1,320 trillion, Rp 182 trillion are for employees' spending, Rp 106 trillion for interest on debts and Rp 273 trillion for subsidies. Funds transferred to the regions reached Rp 412 trillion. With discretionary funds from other posts, non discretionary funds in the APBN are less than Rp320 trillion.

As shown in the following table, the fiscal space of Indonesia fluctuated in the period of 2006 - 2001. Fiscal space declined in 2010 to 19.8% from 23.3 % in 2009. The decline was a result of an increase in subsidies to follow he oil price hike after a dip in 2009. In 2011, fiscal space expanded again to 23.8% after the government's fiscal policy to boost state income and capital and goods spending.

Dilemma faced by the government in increasing fiscal space

In order to accelerate economic growth, it is necessary to allocate fund for stimulus in the state budget to boost the business sector for that purpose, adequate fiscal space will be needed.

Wider fiscal space could be created such as efficiency in the use of state budget, a cut in subsidies and payments of debt interest.

In 2012 draft state budget (RAPBN), subsidies are smaller compared to ones provided in the revised state budget (APBN-P) for 2011, but subsidies remain a huge allocation of spending reaching Rp 208 trillion. If the subsidy fund could be reduced further, it will give the government a greater flexibility to boost economic development by providing larger fund for more productive projects such as infrastructure projects.

The pressure on the state budget is heavier with the rising oil prices back again at the level of more than US$ 100 per barrel. Aware of the difficulties faced by the government in its attempts to boost economic growth, some politicians and economic observers began to suggest immediate increase in the BBM prices to reduce subsidies.

However, as new waves of global financial crisis began to hit Europe and the United States again, a cut in BBM subsidies needs to be reconsidered.

Among factors sparing the Indonesian economy from the devastating impact of the 2008 financial crisis was its huge domestic market. Large consumers spending propped up the economy and sustain growth. The purchasing power of the people remained strong thanks to subsidies that kept the BBM prices fairly low. The government, therefore, was able to control the inflation at around 5% per year.

Absorption of APBN needs to be increased to wide fiscal space

If the BBM subsidies are reduced while the oil prices in the world market are high, inflation is feared to surge Investors will likely buy US dollar resulting in weaker rupiah. Uncontrolled inflation will lead to worse condition that could shake the country's economy despite the strong fundamentals and healthy banking sector.

The government, therefore, needs to remain cautious in picking the right time when to increase the BBM prices. Amid the potential external threat, a slight mistake could trigger wide spread panic and big disaster. For example, early 2011, there was pessimism and many observers predicted that the economy would suffer a setback as the prices of food products rose and inflation surged. However, the food price hike did not last long. It was seasonal ahead of grand harvest the condition was normal again after harvest.

Currently the greater concern of the world as well as Indonesia is the debt crisis in Europe and the United States. However, analysts are not all in agreement on the extent of the damage caused by the present condition Some said the present problem, which began with default involving a country, Greek, is worse than the 2008 crisis which was triggered by defaults involving a number of giant companies.

Taking a lesson from the crisis in 2008, Indonesia should be able to forestall and ward off serious impact. The government needs to remain cautious but should not be overcautious in seeking to expand the fiscal space hat would further strengthen the economic fundamentals. There should be n more delay in the development of infrastructure which is needed to drive the economic growth.

The government should not too hesitate to cut subsidy to widen the fiscal space. In addition the government needs to accelerate implementation of APBN projects.

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