[Kabar-indonesia] Economist Intel Unit: Indonesia: The 2007 budget: Fiscal faux pas?

[Joyo at aol.com]

also: JP Correction: IMF's positive global outlook;
and Economist Intel Unit: Overstretching FTAs?

Economist Intelligence Unit 
Issue cover dated September 4, 2006

The 2007 budget: Fiscal faux pas?

Indonesia's latest budget disappoints—although at
least the government's economic assumptions are
becoming more realistic

Indonesia's draft budget for 2007 provides further
evidence of government backsliding on economic
reforms, as it proposes maintaining costly fuel and
power subsidies that will eat up almost 13% of planned
spending. With debt servicing likely to take up a
similar share of its budget, the government will have
little scope for spending programmes large enough to
reduce unemployment or stimulate GDP growth
significantly.

The Indonesian president, Susilo Bambang Yudhoyono,
presented the draft budget during his annual
state-of-the-nation address to parliament on August
16th. The draft envisages government spending of
Rp746.5trn (US$82bn at the current exchange rate), up
about 8% in nominal terms from the government's most
recent projection for this year. Revenue in the draft
budget is set to rise 9% or so to Rp713.4trn. This
leaves a projected budget deficit of Rp33.1trn,
equivalent to 0.9% of GDP according to the
government's projections.

At one level, the headline numbers are encouraging.
The proposed deficit is below the revised figure of
1.2% of GDP that the government now forecasts for 2006
as a whole. And some key assumptions appear realistic.
GDP growth of 6.3% in 2007 is not that far off the
Economist Intelligence Unit's independent forecast of
6%. Most importantly, the government appears to have
recognised the folly of underestimating oil prices in
its budget assumptions—in 2005 an initial assumption
of US$24/barrel played havoc with fiscal plans—and it
has incorporated an oil-price forecast of US$65/b. Our
forecast, in comparison, is for dated Brent crude to
average US$70/b next year.

Subsidy concerns

However, the draft budget also proposes maintaining
heavy subsidies for fuel and power. Although the
government, to its credit, has cut fuel subsidies
drastically in the past 18 months, there is still
substantial room for further cuts. Subsidies will
continue to place a heavy burden on public finances,
especially while international oil prices remain high.
Disappointingly, the draft budget envisages increasing
spending on fuel subsidies by 14% to Rp68.6trn, a sum
equivalent to 9% of total spending. The amount spent
on electricity subsidies will fall 17% in nominal
terms, but will remain high at Rp25.8trn. It is as a
consequence of this that the budget deficit will fall
to only 0.9% of GDP. Had the government lived up to
expectations that it would abolish fuel subsidies by
the end of 2006, it would have been in a position to
bring the deficit down to around 0.6% of GDP in 2007,
according to our projections (see table). However, in
his address to parliament Mr Yudhoyono was quoted as
confirming that these subsidies would remain "quite
substantial" in 2007 and that the authorities "hope"
the subsidies will be much lower in 2008. This can be
taken as meaning that not much will be done next year.

By keeping subsidies Mr Yudhoyono has, in essence,
taken the politically easy option. This is
understandable given historical precedents. The fall
of the New Order regime of Soeharto in 1998 was
hastened by public protests over fuel-price rises, and
in early 2003 similar protests forced Mr Yudhoyono's
predecessor, Megawati Soekarnoputri, into an
embarrassing partial reversal of increases in fuel
prices, electricity tariffs and telephone charges.
Given that Mr Yudhoyono was elected on a strong
popular mandate and is in office at a time when
Indonesian officials are arguably more democratically
accountable than they have ever been, there is
undeniable pressure to avoid policies that might
provoke a backlash with the electorate.

It is for this reason, however, that stronger action
is arguably all the more important now, when the next
elections are a relatively long time off. The pressure
to refrain from cutting subsidies will be even greater
when the 2008 budget is drafted, as presidential and
parliamentary elections are due in 2009.

Loss of reform momentum

The draft budget for 2007 adds to a broader picture in
which the Yudhoyono administration is struggling to
live up to its reformist promises. Mr Yudhoyono was
elected on a platform based on creating jobs,
promoting growth and fighting corruption. But
unemployment has worsened since Mr Yudhoyono took
office; the rate is in double digits according to
official figures. There have also been recent signs
that the anti-corruption campaign is running out of
steam, most notably in a recent proposal to partially
protect government officials from corruption
investigations. The move is closely related to fiscal
policy concerns, as the government is worried about
officials' growing reluctance to approve projects for
fear of being targeted in corruption probes, a trend
that is leading to underspending and that could
undermine development plans.

In addition, the broader push for economic reforms
seems to be losing momentum as the government
backtracks on planned policy changes. In March the
government decided not to raise electricity tariffs in
2006, as it had previously intended to do, a move
likely to cost the public purse an additional
Rp14.2trn (US$1.6bn) this year. It has also backed
down, in the face of public protests, on labour
reforms that would have given employers increased
flexibility to hire and fire workers.

Ironically, these reforms could have helped to
encourage job creation.

Proposed tax reforms that aimed to widen the tax net
are also being redrafted following strong opposition
from business. The irony is that Mr Yudhoyono's policy
reversals are making him appear indecisive and denting
his credibility, even though they have been intended
to protect his popularity.

Indonesia's key fiscal indicators*

% of GDP   2005(a) 2006(b) 2007(b) 2008(b) 2009(b)
2010(b)

Government expenditure 21.2 22.7 23.6 23.5 23.4 23.6
Interest    0.8 1.3 1.6 1.6  1.3 1.3

Non-interest   20.4 21.4 21.9 21.9  22.1 22.3

Government revenue  20.8 21.7 23.0 22.9 23.1 23.3

Budget balance  -0.3 -1.0 -0.6 -0.6  -0.3 -0.3

Primary balance  0.5 0.2 1.0 1.0  1.0 1.0

Government debt  50.0 44.7 40.4 36.5 33.0 29.8

* Calculated before the release of the draft budget
for 2007.

(a)(b)

Source: Country Forecast

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[Joyo sent the article referred to below]

The Jakarta Post 
Saturday, September 2, 2006

IMF's positive global outlook

Correction: The first three paragraphs of our story
IMF urges govt action on economy, published on this
page Friday, should not have been attributed to IMF
Senior Resident Representative Stephen Schwartz. The
paragraphs are a summary of remarks of other speakers
in the seminar. Schwartz in fact said, "The outlook
for the global economy remains positive although there
are some downside risks from high oil prices, a
disorderly adjustment to global imbalances, and the
possibility of a slowdown in U.S. economic growth."
Also, the US$150 billion figure mentioned in the story
is not the size of the 2006 budget, but it is the
estimated financing needs for infrastructure projects
in the country for the next few years.

--------------------------------------

Economist Intelligence Unit 
Issue cover dated September 4, 2006

Overstretching FTAs?

ASEAN now wants to create a common market by 2015, but
its plans may clash with Japan's even grander
ambitions for the region

A recent meeting of economic ministers in the
Malaysian capital, Kuala Lumpur, produced two notable
developments in Asia's already-busy programme of
attempted trade liberalisation. One was a plan by
members of the Association of South-East Asian Nations
(ASEAN) to bring forward the launch of an ASEAN common
market by five years, to 2015.

The other was an eye-catching proposal by Japan to
create a massive trading bloc integrating the ten
ASEAN member countries plus Australia, China, India,
Japan, New Zealand and South Korea. Both developments
provide evidence of the growing scale of Asian
governments' free-trade ambitions, but political
frictions and potential overlaps with other trading
agreements raise doubts over the achievability of
either plan.

Tough deadline for AEC

Looking first at the ASEAN-specific plan, an August
22nd joint statement by trade and economics officials
from all ten ASEAN countries announced their intention
to recommend to their respective governments a more
aggressive timetable for the establishment of the
so-called ASEAN Economic Community (AEC). Plans for
the AEC were first adopted at a meeting of ASEAN
leaders in Bali, Indonesia, in late 2003. Although
sometimes described as South-east Asia's answer to the
EU, the AEC would not have a single currency or a
parliament and would really just be a form of customs
union, albeit one that would expand the
liberalisations under way within the framework of the
older ASEAN Free Trade Area (AFTA) initiative. Whereas
AFTA is largely concerned with tariff reductions, the
AEC is envisioned as a broader arrangement that would
seek to streamline and unify product standards,
customs procedures, rules of origin, professional
qualifications, and other elements of goods and
services trade and investment across the region.

However, the fact that the original plan for the AEC
set a distant target date of 2020 underscores the
daunting complexities of implementing and policing an
ASEAN common market. Not least of these is the fact
that ASEAN's ten members include countries as diverse
as Singapore and Myanmar. These countries are at
vastly different stages of economic development and
differ greatly from each other in economic and
political structure. Singapore has virtually no
agriculture, for example, and therefore has nothing to
lose by tolerating very liberal rules for trade in
agricultural goods. But many other countries in the
region still have important agricultural sectors to
protect, making it potentially tricky for ASEAN to
negotiate trading arrangements with other countries or
regions as a bloc.

Moreover, just as tariff reductions under AFTA have
faced delays and complexities—such as special
treatment for certain sectors in certain
countries—there is little to suggest much has changed
to suddenly make an earlier AEC deadline more
feasible. Integrating goods and services trade for ten
roughly comparable economies would be difficult
enough, but implementing the accompanying structural
and regulatory changes in the less developed
economies—Laos, Myanmar, Cambodia and, to a much
lesser extent, Vietnam—is widely seen as a major
obstacle.

Politics also poses a problem, most notably because of
Myanmar. Its international pariah status raises the
awkward question of how countries that have economic
sanctions against Myanmar, such as the US, would treat
certain exports from the AEC bloc. Myanmar's
international critics will also continue to be
troubled by ASEAN's tradition of non-interference in
the affairs of other member states—although there are
signs that ASEAN's patience with Myanmar is wearing
thin and that members are more prepared to criticise
the military regime there, albeit still cautiously.
But ASEAN's lack of institutional mechanisms to oblige
members to behave in certain ways remains a
fundamental shortcoming of the organisation. This not
only has implications for politics but also raises
questions about ASEAN's ability to administer a trade
bloc.

Japan's grand plan: ASEAN + 6

If the AEC looks overambitious, it is nothing compared
to the grandiose proposal from Japan to create an East
Asia Free Trade Agreement (EAFTA). The idea surfaced
in mid-April, but it made headlines at the latest
ASEAN economic ministers' meeting in Kuala Lumpur when
it was raised by Japan's minister for economy, trade
and industry, Toshihiro Nikai, who was in the
Malaysian capital for meetings with the same ASEAN
officials.

EAFTA is the latest variation on the "ASEAN Plus"
theme of trade integration, which refers to a number
of planned or approved FTAs that connect ASEAN with
one or more of China, India, Japan and South Korea.

ASEAN and China have already signed an FTA, and a
similar "ASEAN + 1" arrangement was signed with South
Korea in May (albeit with Thailand's dissent). Japan
is also seeking its own bilateral FTA with ASEAN, a
fact not lost on critics of the new EAFTA proposal,
who have pointedly remarked that Japan would do better
to complete what it has started before embarking on an
even more ambitious project.

That Japan is not doing so betrays aspects of its
strategic agenda, both in terms of economic diplomacy
and its political clout in the region. EAFTA would
effectively constitute "ASEAN + 6". According to
Japan's Ministry of Economy, Trade and Industry, such
a common market would include one-half of the world's
population and raise its members' total GDP by about
one-quarter over the level that they would otherwise
attain. Such a common market would also ensconce Japan
in a stronger network of diplomatic relationships and
reduce the chances that political quarrels might
jeopardise its diplomatic and security interests. This
is of increasing concern given Japan's deteriorating
relations with its neighbours.

EAFTA also probably represents an attempt by Japan to
counter the economic emergence of China, by ensuring
that free-trade networks are developed on Japan's
terms. Japan, in essence, wants to trump China's FTA
with ASEAN by creating something even grander. This,
of course, suggests Japan is worried by the fact that
China has beaten it to the mark in signing an ASEAN +
1 deal.

Whatever Japan's motives, there are numerous potential
problems with EAFTA. The US—which also signed a Trade
and Investment Framework Arrangement with ASEAN on
August 25th—is likely to be unhappy at its own
exclusion from such a pact. China is likely to have
reservations over joining India in such a pact, partly
out of suspicion that Japan would like to use India as
a counterweight to China's burgeoning influence. China
is also likely to oppose the inclusion of Australia
and New Zealand, on the grounds that those countries
might function as informal agents of the US.
Meanwhile, Japan's badly strained relations with China
and South Korea might well prevent constructive
discussions from getting off the ground at all.

FTA overload

Perhaps the biggest problem of all, however, is that
Japan's plans are yet another addition to an already
crowded picture, in which proposed and actual FTAs of
all stripes are expected to function. Many fear that
Asia's current obsession with FTAs—including bilateral
pacts between individual countries as well as the
broader regional agreements discussed above—is
creating a spider's web of criss-crossing commitments
that overlap or conflict. This has the potential to
undermine multilateral trade liberalisation and, at
least in part, to defeat the purpose of FTAs by
raising compliance costs for business and negating
some of the supposed economies of scale such
agreements promote. In this respect it is notable that
some ASEAN members appear worried that Japan may
expect to establish EAFTA by knitting together
disparate bilateral FTAs with individual countries
rather than by attempting to create a genuine unified
trade regime.

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Joyo Indonesia News Service
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