T

he deficit in the 2015 state budget is likely to swell far bigger than the initial target as the strong spending growth for infrastructure projects cannot be compensated by sufficient tax revenues, international financial institutions have warned.

The International Monetary Fund has estimated that the budget deficit could swell to 2.4 percent of gross domestic product (GDP) this year, while the World Bank warns it could hit 2.5 percent, far higher than the 1.9 percent of GDP targeted in the revised 2015 state budget. Indonesia has a law forbidding the budget deficit from exceeding 3 percent of GDP.

'€œWith wider budget deficits, we still think some spending cuts are necessary, given the likely material disappointment in revenue,'€ said Credit Suisse economist Santitarn Sathiratai, who predicted Indonesia'€™s budget deficit would swell to 2.4 percent of GDP.

The surging budget deficit moved in the opposite direction of the current-account deficit, which is expected to decline due to an improvement in the country'€™s trade surplus.

A budget deficit is the benchmark for fiscal policy as it indicates the gap between state revenues and spending, while a current-account deficit is the yardstick for monetary policy as it acts as the broadest measurement of international trade including exports and imports.

In the first quarter this year, the government'€™s budget deficit already reached Rp 93.7 trillion, with state revenues hitting Rp 273.4 trillion (comprising tax, non-tax and excise revenues) while state spending hit Rp 367.1 trillion, official figures showed.

To plug the additional shortfall in the larger-than-expected budget deficit, the government could access loans from international lenders, or sell more bonds, noted Handy Yunianto, a fixed income analyst with Mandiri Sekuritas.

If the government turned to the bonds market, he estimated that the Finance Ministry might have to issue an additional Rp 59 trillion of debt papers in the second half of this year.

'€œIssuing more bonds supposedly shouldn'€™t be an issue when the market is conducive, but the problem is that lately we have seen a decline in demand [during domestic bond auctions],'€ said Yunianto.

Tighter global liquidity and negative sentiment from the weakening rupiah have reduced the demand for Indonesian bonds, with the government failing to meet its issuance target in its last two bond auctions.

The latest auction on April 14 only generated Rp 10 trillion of incoming bids from investors, compared to an average of Rp 32.4 trillion in incoming bids per auction in the January-March period this year.

Issuing more bonds to plug budget deficit in a restive market environment might push up bond yields, thus making the government'€™s borrowing costs higher, analysts have said.

Trimegah Asset Management fixed-income manager Darma Yudha said the yield for 10-year benchmark government bonds might rise from the current 7.3 percent to 7.8 percent, in a worst-case scenario when the budget deficit was far larger than investors had anticipated.

If the budget deficit stays at it is, meaning the government does not have to issue additional bonds, then the benchmark bonds could rally to 7 percent by the end of this year, according to Yudha'€™s estimates.

However, Robert Pakpahan, the head of the Finance Ministry'€™s financing and risk management office (DJPR), remained upbeat about the outlook for Indonesian government bonds.