The government did not change its 5.3 percent growth assumption. This is despite mid-2016 growth being only about 5.04 percent. The first half usually contributes 49 percent to annual gross domestic product (GDP). 

Hence we can expect full-year growth to register at around 5.1 percent. Next year, there is no particular reason for rosy growth unless commodity prices pickup. 

The latest evidence suggests that only the US economy is picking up steam. The Chinese economy is stabilizing. Japan is showing signs of sluggishness. And Europe would be lucky to avoid a recession.

Meanwhile, the exchange rate and inflation assumptions appear reasonable. Currently, emerging-market countries are receiving inflows from excess liquidity in developed nations. 

Once the US starts raising rates, the inflow can reverse, but when the rate will be raised remains unknown. Still, liquidity from Japan, Europe and the UK will remain ample in the short term.

Inflation is quite tame this year and is likely to be the same next year, given stable energy and food prices. It bears attention that the headline (CPI) inflation assumed is no longer relevant. 

A more appropriate indicator would be the GDP deflator. Adding up real growth and inflation results in nominal growth. This forms the basis of revenue forecasts.

However, this is misleading for two reasons. First, CPI inflation only includes a subset of all goods produced in the economy. 

Second, in recent years the deflator has grown slower than CPI inflation. In the second quarter of 2016, real GDP growth reached 5.18 percent. But it does not translate to transactions on the ground. Why? Because it is nominal growth that drives transactions.

In the second quarter, nominal growth was only 7.6 percent, compared to 7.8 percent in the first quarter. Compare this to 9.2 percent in 2015 and we can explain why there is such a gloomy feeling. 

Thus, real growth rose because of the fall in inflation rather than pickup in economic activity. Hence it is more useful to start using GDP deflator as a budget assumption.

The oil price assumption is higher than market expectations. With China stabilizing, but in Europe and Japan cooling demand is set to weaken. 

Meanwhile, US oil production is on an upward trajectory. Hence rising growth in the US will not be enough to pull up energy prices in the short term. One bright light in the future of oil prices is that Saudi Arabia is not flooding the market with its crude. But even this is a temporary move that may not outlive Aramco share IPO.

The government has slashed revenue and expenditures to more realistic levels. Reduction in revenues will be 2.7 percent, but only 0.6 percent in expenditure. Central government expenditure will remain almost flat. Regional transfers will see a cut by about Rp 29 trillion (US$2.21 billion). Yet transfers to villages will rise by about Rp 13 trillion. A big cut takes place in state- owned enterprises equity injection, from around Rp 50.5 trillion this year to only Rp 4 trillion next year.

Despite the hefty cut in tax revenues, tax to GDP ratio is still high at 11.5 percent. It is comparable to the 2016 figure at 11.9 percent, which was itself a significant rise from only 9.8 percent in 2015. 

That means the Directorate General of Taxation will have to work all full speed to gather the required income.

It is good to see that the budgets of key infrastructure ministries have been  not put under the knife. The Public Works and Public Housing Ministry will see an increase of about Rp 8.5 trillion. And the Transportation Ministry’s budget goes up by about Rp 5.8 trillion. 

In public works, there is more money in the water sector, road and housing development. 

In transportation, more funds are available for railways to the tune of Rp 7.6 trillion. 

The government also aims to lower poverty levels and improve income distribution. To that end, it is enlarging access to the smart card program and enlarging welfare programs. The rise in social ministry budget for these is about Rp 5.3 trillion. 

Meanwhile, the larger village transfer funds should also help to reduce inter-regional income disparity.

The burden of financing falls on bond issuance, again. Next year we will see an increase in issuance of close to Rp 40 trillion, about an 11 percent rise from 2016. This can become a concern as government fund absorption affects the banking sector. Competition from government instruments affects deposit rates and volumes as well. 

It is good to note that revenue targets next year are not pinned on one-off inflows, such as that from the tax amnesty. We have yet to see a large amount of tax amnesty related revenues. 

In fact, anecdotal evidence suggests most of the recently declared assets are domestic properties. 

Hence, there is minimal impact on future revenues as property taxes on them are paid on a regular basis. Enlarging the tax revenue base is not easy, especially given a slowing economy. A better database resulting from the tax amnesty exercise is a big help.

Yet there are bigger issues outside the tax administration itself. 

First is the still large informal sector. This sector neither participates in the modern financial sector nor does it pay taxes. 

Second is finding a fast growing sector that contributes to tax revenues. Before the Asian financial crisis in the late 1990s that sector was manufacturing. For a decade until 2013 it was the natural resources sector. The question now is, what is the next growth engine? The government must find it to jump start economic growth and to ensure medium-term revenue sustainability. The Finance Ministry can play a pivotal role in this endeavor.

***

The writer is chief economist at PT Danareksa. The views expressed are his own.

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