I

ndonesia is considered one of the most stable emerging economies in the world as several indicators, such as inflation and current account deficit have improved remarkably over the past two years, as a result of higher interest rates and a weakening rupiah over the period of 2013 to 2015.

Both the government and Bank Indonesia (BI) have shifted the policy focus from maintaining stability to policies that stimulate economic growth since the end of last year. Government spending has been an important factor to the improvement of the domestic economy, as gross domestic product (GDP) growth rebounded to 5.18 percent in the second quarter this year, the highest growth since 2013.

Growth of government spending soared to 6.3 percent year-on-year (yoy) from 2.9 percent the previous quarter, while private investment growth fell from 5.6 percent to 5.1 percent. However, the ongoing momentum of domestic economic growth is feared to fade because its success also caused pressure on the budget.

Fiscal conditions have gotten tighter as the growth in government spending realization was significantly higher than tax revenue growth. Latest data in August showed that total revenue in August only reached Rp 870 trillion (US$67 billion), only growing 1.1 percent compared to the last year, and the tax revenue only grew 2.4 percent. At the same time, total spending grew 7.6 percent yoy from Rp 1,054 trillion to Rp 1,134 trillion.

As a result, the fiscal deficit as of August reached Rp 263.8 trillion, or equal to 2.1 percent of the country’s GDP, getting closer to the limit allowed by the regulation of 3 percent of GDP. The finance minister has expected that there will be a shortfall in tax revenue this year of Rp 219 trillion and the public spending has been cut by Rp 137.5 trillion for the remainder of the year.

The government is also preparing for a wider deficit of 2.7 percent of GDP to address the shortfall, up 0.2 points from the previously set target. The spending cut will undermine the acceleration of overall economic growth.

Fortunately, now the tax amnesty program has gathered steam. Since July to September, the most generous period, total revenue generated by the government reached Rp 97.2 trillion, already above BI’s forecast of Rp 60 trillion revenue and getting close to the government’s target of Rp 165 trillion.

Moreover, people declaring assets unexpectedly reached Rp 3,484.1 trillion, or 90.1 percent of government’s target of Rp 4,000 trillion. With this achievement, the Indonesian Tax Amnesty program is considered to be the world’s most successful tax amnesty program ever.

The current development of the tax amnesty program is hopefully will be able to limit tax revenue shortfall this year. With the latest development, we estimate total revenues generated by the tax amnesty program will be around Rp 120 trillion by the end of this year, still falling short of the government’s target because most of the asset declaration has been done in the first three months of the program. We expect, with the assumption of tax revenue growth of 3 percent this year plus the additional tax revenue from the tax amnesty program, total tax revenue will be around Rp 1,350 trillion, meaning there will still be a shortfall of around Rp 190 trillion.

Overall, it will still take time for the tax amnesty to have an impact on the economy. Last week, the Finance Ministry and the House of Representatives agreed on the draft 2017 state budget. The economy is poised to grow by 5.1 percent, the target of government’s revenue lowered by 2 percent, and the spending allocation lowered by 0.1 percent to Rp 2,080 trillion compared to the revised budget of 2016.

The growth target is lower than previously articulated in the 2017’s budget draft of 5.3 percent. It seems that the government is being more cautious and more realistic. A more realistic tax revenue target will enhance Indonesia’s fiscal credibility. What’s very important is how the government convinces the private sector that the economy is on the right track.

The capital and currency markets have been quite bullish on the economy since the House approved the tax amnesty program. The rupiah appreciated from the 13,600 level to 13,220 in June, the Jakarta Composite Index (JCI) surpassed the 5,000 level for the first time since June of 2015, while the foreign capital flows to the domestic stock market reached as much as Rp 20.7 trillion in June and July.

The market has also reacted positively to the monetary policy stance. BI has loosened monetary policy by cutting the policy rate — now the 7-day reverse repo rate — by 125 bps this year to 5 percent at present to boost economic growth as inflation remains stable. The level of the policy rate has dropped to a multi-year low.

Even though theory suggested that lower interest rates would drive capital outflows as the spread between domestic and global market yield was narrowing, luckily this did not happen as the rupiah kept appreciating to below Rp 13,000 per US dollar for the first time since May 2015.

Interest rates are not the only tool available to BI to undertake stimulus policy. BI is considering other policy measures, which is lowering the reserve requirement ratio for banks that currently stands at 6.5 percent. This step hopefully can also boost the economy by giving room for banks to increase the loan growth. This monetary and macro prudential stimulus, combined with the implementation of 13 economic policy packages, will hopefully have more impact on domestic growth next year.

Everybody agrees that risks to limiting economic growth this year and next year is still high. There remains uncertainty in global economic conditions, while improvement in domestic economic conditions are still slow.

One thing that has not been working as good as expected is the repatriation from the tax amnesty program. The amount of money stashed overseas that rich Indonesians brought back only reached Rp 137 trillion, or slightly above 10 percent of the government’s target. The government should focus on this in the second and the third period of the program. Repatriated funds will have a very positive impact on portfolio and real investment. Moreover, it will also have strong impact to the balance of payment. The government and the financial authorities need to prepare more attractive investment instruments where the funds need to stay for three years.