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INDONESIAN COMMERCIAL NEWSLETTER
July 2010

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MODERATE 2011 STATE BUDGET DRAFTED AMID HIGH GLOBAL OPTIMISM


The 2011 state budget was drafted amid high optimism that the world economy is recovering. In mid 2009, the world economy already showed sign of recovery from the global recovery. The encouraging trend continued through the first half of 2010. The World Bank in its World Economic Outlook report in July 2010, the world economy which suffered a contraction of 0.6% in 2009 would grow 4.6% in 2010. Emerging economies would be the driving motors for the growth led by China.

China's economy is forecast to grow 10.5%. Meanwhile, Indonesia is expected to maintain a fairly strong growth. The positive trend in the global economy would contribute to accelerate development of Indonesian economy.

The Indonesian economy has relatively been stable and the stability has tended to be stronger. In the first seven months of 2010, the rupiah gained 16.2% on the average against the US dollar to reach the level of Rp 9,172/US$. The stability is expected to continue through the rest of the year that in 2010, the averagely the rupiah is predicted to be 9,200 to the dollar in the whole of the year.

The rupiah strengthening will help in keeping inflation under control.  The country's inflation in the January-July period was well under control at 6.22% year-on-year or 4.02% year-to-date. Inflationary pressure is expected in the second half of 2010 with the plan to raise the electricity rate, new academic year, and religious celebrations (Idol Fire, Christmas) and New Year.  However, with stronger coordination between the government and Bank Indonesia, the country is expected to reach its inflation target by the end of this year.

With inflation kept under control, the average interest rate on 3-month Bank Indonesia promissory notes (SBI) is also expected to decline. In the first seven months of 2010, the interest rate on 3-month SBI averaged 6.58% - much lower than 8.29% in the same period last year.

Meanwhile, exports and imports rose considerably in the first quarter of 2010 respectively by 41.8% and 52.4% on-year. The expansion was attributable mainly to the revival of the manufacturing sector such as textile and garment industry, motor vehicle and chemical industries. The expansion of exports and imports brought about a surplus of US$10.9 billion in the country balance of payments in the first semester of 2010 with foreign exchange reserves scaling up to US$78.8 billion by the end of July, 2010.

In the first half of 2010, the country's economy grew 5.9% thanks to stronger economic fundamentals and favorable external condition. The economic growth was much higher than 4.3% in the same period in 2009.
Taking into account the world and domestic economic condition in the first half of 2010, the government has set macro economic targets on which the 2011 state budget was drafted.


Priority given to domestic sources of funding

There are mixed reactions to the target set in the state budget. Some analysts said the targets are quite realistic and other described the state budget as too conservative and wanted to put up higher targets. An economist said with inflation target set at 5.3% as in the 2011 state budget, the government should have the courage to cut the SBI rate to 6% to encourage cut in lending rates and boost the business sector.

The business sector also expected the government to seek to drive economic growth at a higher speed by adopting a larger deficit budget policy. The deficit in the 2011 state budget is set at Rp115.6 trillion or 1.7% of the GDP.

The Golkar Party had proposed  to widen the deficit  from 1.7% to 2.1% of GDP  and that there was no reason for the  government to be worried too much about the deficit, which it described as relatively low. What was important was the people's welfare was guaranteed, it said.

The country's second largest party pointed to figures in the draft state budget for 2011 that fund for infrastructure development was set only at Rp63.6 trillion, fund for poverty eradication around  Rp.49.3 trillion , and transfer to the regions Rp378.4 trillion .  By allowing the deficit to wide to 2.1%, there will be additional fund of Rp32 trillion for the budget that could be used for vital sectors. The budget deficit would still far below those of many other countries such as China's 2.8%, Thailand's 3.8% and Malaysia's 5.4%.

President Susilo Bambang Yudhoyono was firm in his rejection to raise the budget deficit to 2.1% saying it had no urgency. Instead the president called for tighter budget in 2011.

Yudhoyono said widening the budget deficit by 0.4 percentage point was tantamount to enlarging the state debt by Rp28 trillion. He said he wanted pruning of unnecessary spending and for which he promised to issue a presidential instruction (Inpres) and presidential regulation (Perpres) on concrete economizing in 2011.


Energy subsidy a constraint 

Among the main constraints in the 2011 State Budget are subsidies especially energy subsidies including oil fuel and electricity subsidies. When the draft state budget for 2011 was proposed, the government wanted to raise the electricity rate in January to allow it to cut electricity subsidy.

However, later in deliberation with the House of Representatives, the government agreed not to raise the electricity rate in 2011. The decision could mean an increase in electricity subsidy but the government and the House agreed to keep the electricity subsidy the same at Rp41 trillion as proposed in the draft state budget.  The government, however, proposed delay in the payment of carry over of subsidy of Rp4.6 trillion from 2009. In line with the financial note of the draft state budget of 2011, electricity subsidy was set at Rp41.02 trillion  on assumption that electricity subsidy in current year of 2011 would  reach Rp36.4 trillion , carry-over from 2009 at Rp4.6 trillion  and increase of 15%  in electricity rate per January 2011.   

With no hike in the electricity tariff in 2011, the government chose to defer payment of electricity subsidy of Rp4.6 trillion carried over from 2009.  Therefore, there would be no hike in electricity tariff and subsidy in 2011.

In the past four years, the government has cut budget for subsidies. In 2008, subsidies totaled Rp275 trillion. In 2009, it was slashed to Rp158 trillion to prevent a swell in state budget deficit amid shrinking domestic income as a result of the global financial crisis. In 2010, subsidies shot up as a result of a resurge in oil prices.

In 2011, subsidies are to be cut again despite an increase in oil fuel subsidy. Oil fuel subsidy rises with the domestic prices maintained amid rising oil prices in the world market. 

Relying More on Domestic Sources of Funding

The government plans to look for domestic sources of funding to be in line with its policy of reducing foreign debts. Foreign financing would be used mainly in the form of grants or debt write-off. Chief economic Minister Hatta Rajasa said if it is urgent the government could use low interest foreign loans such as Samurai Bond which is guaranteed by the Japanese government. With the improved rating that has placed the country in the investment grade debt burden could be lighter.

Among the domestic sources of funds to cover the deficit in 2011, the government could issue bonds and privatize 10 state companies (BUMN) especially state plantation companies. Currently is the right time to issue bonds and divest stake in state companies. As a country that has succeeded in weathering the impact of the global crisis, Indonesia has been seen as a favorable investment destination. With the improved rating of Indonesia, investment cost will be lower in the country.  In addition, the rise in the prices of plantation commodities is expected to push up the prices of the shares of the state plantation companies when they launch IPO.

The cost of fund in the country is relatively high. The 6.5% rate of SBI is a record low in the past decade but it is still far higher compared to those of other countries.  Similarly, the Indonesian bonds still carry a higher rate compared with other countries.

Table - 4
Budget financing, 2008 - 2011
       (Billion Rp)

Taxes become main sources of income

Taxes have become the main source of state revenues since state revenues from the oil and gas sector fell sharply.  Revenues from other sectors could not yet make up for the fall in oil and gas revenues.

Table - 5
State income, 2008 - 2011

Conclusion

After going through the global financial crisis in 2008 and 2009, the country's economic condition in 2010 improved and the trend is expected to continue through 2011.  The government is quite optimistic that the country's economy would grow   by 6.3% or faster than in 2010.

The government tends to be conservative and chose to set a moderate growth target in 2011. The country's neighboring countries, which are badly hit by the crisis, are set to take a big leap forward.  Singapore, Thailand, and the Philippines are eyeing a higher growth than Indonesia dares to think for 2011.

The moderateness of the government is shown by its sensitivity to deficit, decision to maintain the SBI rate at 6.5% and attempt to cut foreign financing. 

Apparently the government still feels the trauma of the monetary crisis in 1998 the impact of which has not entirely been removed.  The government, however, should not allow itself to be controlled by the trauma as it may allow good opportunities to pass by. Being in a better position in the wake of the 2009 global crisis, the country should be ahead in making preparation for a big leap forward.

Finance is among the main constraints for the country to move faster forward.  The lending rates remain high. The SBI rate of 6.5% is still among the highest compared to the benchmark interest rates of the central banks of many other countries.   The government bonds have higher yields even compared with the bonds of the Philippines government. The Philippines suffered badly under the impact of the global financial crisis, but the Philippine government succeeded in selling bonds with lower yield that Indonesia.

The condition actually gives the country good opportunities to move faster to narrow the gap that puts it behinds its neighboring economies like Malaysia and Singapore. Conservativeness is good to maintain stability but it would keep the economy behind in competition against other economies.

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