Analysis: Ministry position on 2010 revised budget

Currently, the government is proposing to revise the 2010 budget to adjust for current economic conditions. According to the Finance Ministry, the discussion in the parliament on the revised budget would be conducted around end of February or early March.

While most of the macroeconomic assumptions such as inflation rate, exchange rate and the average 3-month SBI rate would be revised, the government is likely maintain its 2010 GDP growth estimate at 5.5 percent. We believe this is partly attributed to continued volatility in advanced countries in the first two months of this year.

Concerned over rising commodity prices, the government plans to revise up its 2010 inflation rate to between 5.7 percent and 6 percent from 5 percent previously, higher than our estimate of 5.6 percent. As of today, world sugar and rice prices have climbed 97 percent and 14 percent y-y respectively. Sugar has been on a rising trend since second half, 2009 and rice since December 2009.

We note that the government has reserved around Rp 10 trillion for domestic soft commodity price stabilization. However, suffice to say that the effectiveness of this policy remains to be seen in our view. Overall, the government's revised assumptions are still in line with BI's inflation estimate of 5 percent to 6 percent.

The ministry of finance also plans to revise the average 3-month SBI rate to 7 percent, from the current 6.5 percent, suggesting that if rates were to remain flat in the first half of this year that there would be a 100-basis point increase in the second half.

It is worth noting that the average spread between the BI rate and the SBI 3 month rate is around 10 basis points under normal conditions.

With the market currently expecting flat rates in 2010 on continued manageable inflation, the government's assumption could result in negative sentiment for both the equity and bond markets in our view.

However, it is worth noting that BI currently holds the view that the current 6.5 percent level for the BI key rate is still consistent with their 2010 inflation target, although it is possible in our view that rates could increase in the second half of 2010 on higher than expected inflation.

The Finance Ministry has also unveiled a new Rp 36.3 trillion fiscal stimulus package (vis-*-vis Rp 73.3 trillion in 2009), in effect widening the budget deficit to 2.2 percent from 1.6 percent.

Thus, the deficit is expected to reach around Rp 128.7 trillion from the current Rp 98 trillion. The government plans to use the 2009 excess budget of Rp 38 trillion to finance the deficit instead of increasing its bond issuance target of Rp 175 trillion gross.

Based on the Finance Ministry exercise, the 2009 economic growth rate would only have reached 3.1 percent without the government's countercyclical policy through fiscal stimulus. Having said that, fiscal stimulus lifted the 2009 economic performance by at least 1.3 percent and should remain through the third quarter of 2010.

Hence, we remain optimistic that Indonesia is on track to meet our 2010 GDP growth forecast of 5.2 percent, helped in part by the multiplier impact from the revised budget.

We note that the government is also targeting the unemployment rate to come down to 7.5 percent - 8 percent in 2010, relatively similar to 2009's figure. Currently, around 73 percent of total employment in Indonesia is in the agriculture, manufacturing and domestic trade sectors.

Unfortunately, the growth of those sectors in 2009 only reached 4.1 percent, 4.4 percent, and 1.1 percent respectively. We expect that the same pattern would still be similar in 2010 for as long as infrastructure spending and FDI in those sectors remain obscure.

It is worth highlighting that lowering the unemployment rate would also lower Indonesia's poverty rate, targeted to reach 12 percent-13.5 percent in 2010, lower than the 14.1 percent reported in 2009.

While we believe that the government has prudently allocated the 2010 budget (i.e. to tax incentives on capital goods imports and the infrastructure guarantee fund), early disbursement continues to be a perennial challenge.

We can only hope that the coalition government can put aside political differences to work and improve Indonesia's economic prospects in 2010.