Indonesia’s bold 2015 budget strategy

Author: David Nellor, NUS

No more ‘business-as-usual’ is the Jokowi government’s message in the 2015 budget. Fuel subsidies have been cut, infrastructure spending is to be ramped up, and revenues are projected to rise dramatically. These three steps deliver a 1.9 per cent fiscal deficit, down from 2.2 per cent in 2014. This leaves space for a fiscal response in case the global economy turns less friendly. The success of this bold strategy depends on whether the dash for immediate results risks delaying or possibly even sacrificing medium-term gains.

The first step, eliminating fuel subsidies and adopting a floating price for energy products, was implemented in 2014 and has been the government’s major economic policy success. Low global oil prices have helped public acceptance and provide an opportunity for non-contentious and formula-driven adjustments to retail prices, which could serve to create a credible and sustainable system of floating prices.

The second step is to use the fiscal space created by reduced subsidies to tackle the infrastructure gap that is standing in the way of higher growth. The budget envisages a large and multi-pronged attack on the infrastructure deficit; national, regional and local governments as well as state-owned enterprises will be investing. At the national level, direct infrastructure spending is targeted to almost double, reaching 2.2 per cent of GDP. Transfers to the regions and villages are increased by 16 per cent. And state-owned enterprises balance sheets will be strengthened by reducing dividend payments to government as well as a significant equity injection amounting to about 0.5 per cent of GDP.

The third step is to increase revenue collection to ensure sustainable public finances and to finance the medium-term investment agenda. The subsidy reduction was essential and created immediate fiscal space but it alone is not enough. Low oil prices increase the revenue challenge because they mean that oil and gas sector revenues will be much lower than anticipated late last year.

An almost one-third increase in domestic tax receipts is the budget assignment. Additional administrative ‘effort’ rather than defined policy measures is to drive the revenue growth. A tax revenue increase of this magnitude from additional effort in a single year is unprecedented. This ambitious revenue target is made even more difficult due to low oil prices, weak commodity prices, and a slowing economy.

This budget strategy is high risk.

The success of the government’s growth strategy will ultimately be built on the foundation of a more attractive investment environment. Quality infrastructure and the tax system are both important factors shaping the investment environment.

The infrastructure-spending ramp up needs to meet national priorities and standards. At the national level, meeting the target spending levels and doing so in priority areas will be a challenge considering the capacity for delivering spending over the last few years. It is unclear by how much transfers to other levels of government will translate into meeting high priority infrastructure needs. Moreover, the selective capital injections into SOEs will need to be integrated with national priorities.

Trying to meet the ambitious 2015 revenue target within the year is likely to mean drawing largely on the existing narrow tax base. This effort could hurt the investment environment because it risks imposing a greater burden on compliant taxpayers rather than looking to meaningfully broaden the base. The government could lose its first year chasing ‘revenue quick wins’ to reach the budget target, while sacrificing the opportunity to build the foundation for a systematic and sustainable revenue increase that is essential for meeting medium term infrastructure plans.

The way forward is twofold. First, for the 2015 budget, the Indonesian government should implement spending plans in a phased manner that targets spending priorities. The government should proceed with each phase of spending as revenue realisation becomes clearer. This approach will minimise the cost to government priorities in the event that there are late-year revenue shortfalls.

Second, the long-term success of the administration will depend much on its ability to mobilise public revenue. For 2015, with a plausible and prioritised spending plan, a dramatically higher revenue ratio is neither necessary nor appropriate especially in a slowing economy. But, time is of the essence. The challenge of transforming the tax system and generating revenues is large. Focus needs to turn to adopting a systematic plan that builds revenue steadily over time, strengthens the investment climate, and builds the public’s trust and confidence in the tax system.

The budget is a bold strategy to change the direction of the economy. But, the rush for results is a risky strategy because it could delay essential reform and harm the government’s credibility if the budget’s ambitious targets are not met.

David Nellor is an Adjunct Professor in the Lee Kuan Yew School of Public Policy, National University of Singapore.