W

ith President Susilo Bambang Yudhoyono reaching the end of his tenure in October, he leaves behind a state budget that is grappling with the declining state of the economy. The revised budget reflects how the economy has changed so significantly just from a year ago. Growth is slowing; the rupiah exchange rate is weaker as pressures from yawning trade and current deficits mount, while oil output continues to decline.

The budget also reflects the belated and weak government responses to the deteriorating situation mid general election, and now, presidential election.

In the revised budget, the government has projected economic growth at 5.5 percent, down from the 6 percent assumed in the original budget. The rupiah exchange rate against the US dollar was projected at Rp 10,500 in the original budget but was revised to Rp 11,600.

But the rupiah has been hovering around Rp 12,000 per dollar recently. The price of oil, which was assumed at US$105 per barrel, has shot up to $114 due to mounting sectarian conflict in Iraq.

Crude oil production, which the government optimistically projected at 870,000 barrel per day last year, has to be revised down to 818,000 barrel per day.

Compared with the original 2014 state budget, the deficits in the revised budget are projected to soar by Rp 66.1 trillion or by a wobbling 38 percent. The rise in the deficits was entirely due to higher spending on fuel and electricity subsidies. At the same time, tax revenues would be Rp 34.4 trillion lower than projected in the original budget. Fearing that the deficits would cross the 3 percent gross domestic product (GDP) threshold, the government hastily decided to cut ministry spending by Rp 43 trillion to prevent a larger deficit.

However, under spending would still occur in the budget implementation just like in previous years, because the government'€™s inadequate institutional capacity to implement investment projects. In 2013, actual government spending was 95 percent of the budget, and the same thing could happen in this year'€™s budget, because of weak implementation. These two factors would keep the budget deficits under 3 percent thresholds, as mandated by the state finances law.

Tax revenue was projected at Rp 1,246 trillion, or Rp 36 trillion lower than the budget. Compared to the actual tax revenue in 2013 which was only Rp 1,072 trillion, the revised tax revenue projection would be an increase of 16 percent. Judging from the only 7 percent increase in the previous year, the 16 percent projected increase this year is unrealistic given the weakening growth.

There are several reasons for the lower projected tax revenue in 2014. One is the lower corporate income taxes due to decline in corporate earnings, because of lower economic growth and especially due to the mineral export ban, although partly offset by higher rupiah denominated revenues from dollar denominated taxes. Two, value-added tax (VAT) collection would be smaller due to lower consumption and imports. Although, in the second quarter, on account of Ramadhan, VAT receipts would likely be higher due to the increase in consumption and imports due to the Islamic Ramadhan fasting month.

On the expenditure side, fuel and electricity subsidies are projected to be 24 percent percent higher at Rp 350 trillion, the highest in the country'€™s history. The failure of the present government to address the fuel subsidy problems would mean that the burden for reigning fuel subsidies would be shifted to the new administration next year.

At the end of 2014, it was projected that a subsidy of Rp 50 trillion would be incurred but not yet paid in cash. The payment would be carried over to the 2015 budget, which would be an additional burden for the new administration. The same thing happened in 2013 when a total of Rp 40 trillion subsidies incurred had to be paid in 2014.

Meanwhile fuel subsidy spending continues to be poorly targeted, distortionary and impose high opportunity cost and fiscal risk. The new government should embark on subsidy reforms if it is serious about tackling fuel subsidy issues, and if they are serious about financing the many projects they promised during their campaign. They could draw some ideas on subsidy reforms that have been floated recently.

For instance, changing the fuel pricing from the current discretionary pricing to rule-based fuel pricing. This is important because it would reduce budget uncertainties and could ensure that the poor and the vulnerable are protected from higher prices. The new government could explore another system, namely the fixed fuel subsidy per liter system. This system would ensure subsidy expenditure and the better control of it, and at the same time could make space for price increases in line with market prices.

Another option is to set a fixed total nominal subsidy cost limit. Under this system, the government fixes the nominal amount of fuel subsidy in the budget. If the subsidy goes above the limit, then prices would adjust automatically.

This option would enhance the government'€™s ability to control spending and provide more budget certainty. The profile of the revised 2014 budget warns the new government of the need to initiate some budget reforms. There is an urgent need to broaden revenue base to prevent tax revenue growth from falling further. Subsidies also need to be reduced. If the government fails to carry out these actions, they will not have enough money to fulfill their campaign pledges.

The writer, a graduate of the School of Economics at the University of Indonesia, is a commissioner of a publicly listed oil and gas service company.