2010 budget on the right track, but challenges remain

Andry Asmoro ,  Analyst   |  Thu, 09/17/2009 2:32 PM  |  Business

Taking a closer look at the 2010 state budget could shed some light on the short-run economic direction of Indonesia.

But before we do that, let's look at examples of how three other countries' budget policies have impacted on curbing the financial crisis.

The Japanese government under Prime Minister Taro Aso's administration designed a 2010 budget to boost the country out of the global economic crisis and strengthen social security. Thus, they are focusing on creating job opportunities for young people and improving the conditions for private investments in Japan.

Similar policies were taken by US President Barack Obama, who made health care, clean energy, education and infrastructure the focal points of the 2010 budget. Together with the recovery plan, this will increase the national debt by more than US$900 billion each year from 2010-2019.

Last but not least, Germany's chancellor, Angela Merkel, plans to disburse around 50 billion euro ($73 billion) for a stimulus package that will include funds for road construction and tax cuts for both corporations and individuals. The stimulus package will contribute to ballooning 2010 budget deficit that will exceed 4 percent, higher than the maximum 3 percent limit set by the European Union.

Now in Indonesia, President Susilo Bambang Yudhoyono has clearly stated that economic recovery will be the main focus in 2010 in six specific ways: Lowering unemployment with, among other strategies, infrastructure projects; maintaining price stability; giving fiscal incentives to the real sector; raising consumer purchasing power by lowering income tax and increasing salaries for civil servants; combating poverty with educational aid, subsidized rice, and targeted direct cash transfers; and finally, maintaining food stability by ensuring minimum rice reserves of 1.5 million tons are kept.

As a consequence, the government has set a budget deficit of 1.6 percent, with expected economic growth of 5 percent.

While we applaud the direction that the government is taking in 2010, we believe that next year will be a challenging period for the domestic economy, particularly if economies around the globe progress as expected.

The prospect of improved global economies is likely to raise oil and commodity prices to normalized levels. And this is prior to any speculative move by hedge funds, which may further apply upward pressure on commodity prices.

It is worth noting that the average oil price for the last five years was $69.9 per barrel, while the year-to-date average price in 2009 has only reached $56.8 per barrel.

The government is currently using $65 per barrel for the 2010 budget and based on that calculation has arrived at Rp 58.9 trillion ($6 billion) in oil subsidies, a slight increase on the Rp 54 trillion in oil subsidies allocated for in the 2009 budget.

If we account for an average oil price of between $65 and $70 per barrel in 2010, the budget would still be safe. However, if the oil price were to exceed beyond the $70 per barrel level, the government may have to increase the price of subsidized oil.

Moreover, it is reported that the government and the parliament have agreed to cut the electricity subsidy in the 2010 budget to Rp 37.8 trillion, down from Rp 40.4 trillion, given state-owned electricity company PLN's plan to raise electricity tariffs for industry and services to a maximum of 30 percent.

Any of the above mentioned price hikes, if indeed they do occur, would undoubtedly weaken consumer purchasing power. Our sensitivity analysis suggests that for every 10 percent hike in the price of subsidized oil, inflation would rise by 0.75 percent. It should however be noted that our 5.5 percent inflation rate in 2010 does not include the possible electricity and fuel price hikes.

If inflation were to spike, the central bank may be forced to raise its benchmark interest rate by as early as end first quarter of 2010. While we currently expect an increase of just 50 basis points, it is possible that we could see a BI rate of as much as 100 basis points higher towards the end of 2010 if inflation is higher than expected.

This could curb the much needed GDP growth. According to the Central Statistics Agency (BPS), in normal conditions, every 1 percent of economic growth translates into the creation of 700,000 jobs. Thus, challenges remain for the government in its bid to lower the unemployment rate from 8.3-8.6 percent in 2009 to 8 percent in 2010.

Thus, steps to economic stability and growth in 2010 are certainly in the cards. However, greater effort is required by the government to ensure that this plan is kept on track.

The writer is an economist at Bahana Securities.

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