T

he market concern about the likelihood of Indonesia'€™s larger fiscal deficit in the current fiscal year that could increase sovereign risks seems to support the recent estimates of the World Bank and International Monetary Fund (IMF), which projected a budget deficit of 2.5 percent of gross domestic product (GDP), much higher than the government target of 1.9 percent.

The pessimistic fiscal-deficit projection is still below the maximum 3 percent set by the State Finances Law. Nonetheless, a projection of a bigger budget deficit could still increase the sovereign risks, as perceived by the market, and this in turn would raise the costs of government borrowing (increasing state bond yields).

The worry about the likely larger budget deficit was caused mainly by the high probability that the ambitious target of Rp 1.4 quadrillion (US$108 billion) in tax revenues, which is 30 percent more than last year, would not be achieved due to lower-than-estimated economic growth and the persistently weak commodity market.

Even the World Bank estimated in its latest quarterly report on the Indonesian economy that there would be a shortfall of about Rp 282 trillion in total state revenue this year, which is projected to reach Rp 1.7 quadrillion, due to an unrealistic tax revenue target set by President Joko '€œJokowi'€ Widodo.

True, tax receipts could indeed be lower than the ambitious target, but we do not think this could raise the fiscal deficit by as much as 60 basis points (0.6 percentage points), as predicted by the multilateral development bank because the pace of budget execution under the new government could even be slower than last year.

We learned that the implementation of development (investment) budget at more than 10 ministries has been slowed down by the changes in their administrative mandates (jurisdiction) and portfolio composition of Jokowi'€™s Cabinet. Even now, already almost four months into the fiscal year, most ministries have only started the tendering of projects.

Many analysts are understandably pessimistic that Jokowi will be able to fully execute his growth-focused economic agenda that includes a 50 percent increase in the infrastructure-development budget to a total of Rp 290 trillion.

We reckon the government would not allow the fiscal deficit to increase much above the 1.9 percent target, given the tight liquidity in emerging markets, in view of the upcoming fund rate rise by the US Federal Reserve in the second half.

We share the views of analysts that tighter global liquidity and negative sentiment from the weakening rupiah could dampen investor interests in Indonesian bonds. In fact, the government failed to meet its issuance target in its last two bond auctions. Moreover, issuing more bonds to plug budget deficit in a tight market environment might push up bond yields.

We reckon the government would simply adjust (tighten) its development spending whenever tax receipts would be significantly short of the target because of the high import content of infrastructure projects and the risks to the current accounts.