Budget deficit likely to increase Nurul Yuniataqwa Karunia  ;   A junior economist at PT Bank Mandiri

JAKARTA POST, 07 April 2014

                                      

                                                                                         

                                                             

In the 2014 state budget, the government expects Indonesia’s economy to grow at a maximum level of 6 percent in line with global economic conditions. Increasing world demand will support Indonesia’s economic growth, especially in terms of greater external trade, while domestic demand will also increase, driven by lower inflation and the implementation of the 2014 general election. In terms of inflation, the government expects inflationary pressure to be at a level of 5.5 percent in 2014, down from 8.4 percent in 2013. Improvements in production in various countries are expected to encourage increased supplies of food in global markets. At the same time, the increasing supply of crude oil in world markets, both by Organization of the Petroleum Exporting Countries (OPEC) members and non-OPEC states, is expected to have an impact on global oil prices. The government hopes that the increased production and national economic activities, as well as the smooth flow of goods and services, will encourage greater food security. Furthermore, the absence of a fuel-price hike this year should have a significant impact on the lower inflation figure. In 2014, the average exchange rate of the rupiah to the US dollar is also expected to be relatively more stable. Indonesia’s exports are expected to increase again in line with improved growth and global demand, and several major trading partners. These conditions will be a positive factor that will encourage exchange rate appreciation. Thus, the government has set an assumption of Rp 10,500 per US dollar in 2014, and proposed a new range of Rp 11,500-Rp 12,000 in the revised budget. Furthermore, the government predicts that interest on three-month Treasury Bills in 2014 will be slightly higher, at 5.5 percent, than the rate in 2013 of 5 percent. The assumption is based on possible volatilities that may occur in 2014 and would affect liquidity in developing countries. Meanwhile, the Indonesian Crude Price (ICP) in the global market is estimated to be lower than in 2013, declining from US$108 per barrel in 2013 to $105 per barrel in 2014. The government estimates average production of 870,000 barrels per day (bpd) for the fiscal year, but the oil regulatory body has estimated that actual oil output for the entire year may reach only 813,000 bpd. This shortfall would most likely increase fuel subsidies, and consequently the country’s budget deficit, as more oil would have to be imported to meet domestic consumption. Due to lower gross domestic product (GDP) growth and oil lifting, Bank Mandiri’s economic team expects the budget deficit to reach 1.95 to 1.98 percent of GDP this year, higher than the government’s estimate. The main challenge for the government in setting the budget is to narrow the difference between its macroeconomic assumptions and actual developments. The recent instability in domestic and global economies needs to be considered by the government in determining its macro-indicator assumptions. For example, Bank Indonesia (BI) cut Indonesia’s GDP growth in 2014 to 5.5 to 5.9 percent, down from its previous prediction of 5.8 to 6.2 percent, due to the impact of only moderate global economic growth and the short-term impact of the Coal and Minerals Mining (Minerba) Act. It seems that BI expects Indonesia’s GDP to expand by 0.1 to 0.5 percent below the government’s assumption of 6 percent overall growth, according to the 2014 state budget. According to the Finance Ministry’s sensitivity analysis, every 1 percent decrease in economic growth would increase the budget deficit by Rp 3.45 trillion ($305 million) to Rp 5.59 trillion. Thus, BI’s current economic growth prediction would lead to greater fiscal deficit in 2014, which is most likely to increase by around Rp 300 billion to Rp 2.8 trillion from the earlier government assumption of Rp 175.4 trillion, increasing to 1.72 percent of GDP from 1.69 percent. Another bearish forecast on Indonesia’s economy has come from the World Bank, which expects Indonesia’s GDP growth to be more moderate in 2014. According to its base-line scenario, the World Bank predicted that GDP growth would decline to 5.3 percent in 2014 from 5.8 percent in 2013, due to subdued investment growth and the impact of the ban on unprocessed mineral exports. These conditions would also have a negative impact on the budget’s revenue. As a consequence, the budget will face pressures from slower revenue growth, while the fiscal deficit is expected to widen by 2.6 percent of GDP in 2014. Having said that, the government has several options to keep the budget deficit at 1.69 percent of GDP, as laid out in its state budget assumptions. One option, namely to increase revenue from export tax, will be hard to achieve following the implementation of the Mining Law. Therefore, the government needs to broaden its revenue base to include other sources, such as domestic tax revenue and non-tax revenue. Another option would be to lower government spending, but this would require a limit on fuel subsidies. However, this in turn would need strong political will from both the government and the House of Representatives, which is hard to imagine this year, given the legislative and presidential elections coming up in April and July, respectively. This option may be possible in the third or fourth quarter of this year or next year, once a new administration and Cabinet have been installed. As the fiscal deficit threatens to grow, the last option for the government would be to increase financing by, for instance, issuing more government bonds, but this could cause a crowding-out effect in the domestic bond market. At this point, the ideal option would be to cut fuel subsidies. But once again, this will be hard to implement amid the political hurly-burly this year. ●