Bill Guerin – Indonesia's economy, the biggest in Southeast Asia, may not be badly hit by the devastating tsunami disaster. "Given that the energy [mainly oil and natural gas] production facilities in Aceh or Northern Sumatra have survived the tsunami, the overall damage to Indonesia's economy appears to be minimal," United States investment bank Morgan Stanley said last week. Aceh contributes only a little over 2% to the country's gross domestic product (GDP).

Yet, saddled with government debt equal to more than a third of its GDP, the new government has found it will need to allocate a sum equivalent to a quarter of its domestic tax revenues just to service the national debt for 2005.

Total external debts are around $136 billion, with some $78.81 billion of that government debt penciled in for debt repayments. Some $47.78 billion is owed to the Paris Club, a group of 19 creditor nations. This debt alone needs payment of $3.15 billion in principal and $1.36 billion in interest for 2005.

Almost all Paris Club donors are also affiliated with the World Bank-led Consultative Group on Indonesia, or CGI, which meets each year to discuss Indonesia's external financing needs from the international donor community. The Asian Development Bank and Japanese government are also included in the group.

During the presidential election, campaign promises were made that new borrowing would be reduced this year, though a draft government proposal shows plans to borrow another $3.09 billion from international lenders to help finance the budget. According to the draft, the government will ask the CGI for $2.77 billion, leaving other lenders to top up with $320 million. Last year, the CGI pledged $3.4 billion. The request will be discussed at the next CGI meeting, scheduled in Jakarta for January 19-20.

The country may be offered debt relief to ease pressure on the budget and give the economy some breathing space though some economists fear that such a move could downgrade the country's sovereign rating and create new pressure on the rupiah, thus raising the cost of servicing its debt. Debt rescheduling is little more than a temporary relief measure in coping with short-term cash flow problems. The impact on the net cash available to the government will be marginal. Economists point out that sustainable, robust economic growth that can generate larger tax revenues for the government is the best option for reducing the national debt. Much of this debt resulted from the misuse and squandering of loans by former authoritarian leader Suharto and his cronies.

Extending debt repayments by several years would pass the burden onto the next generation.

Several members, including the United Kingdom, Germany, France and Japan, have proposed a moratorium for Indonesia. The proposal will be discussed at a meeting of the Paris Club this Wednesday. Jakarta has said it wants to be certain

that any arrangement would not be tied to a new International Monetary Fund (IMF) program and conditions.

Growth

Morgan Stanley stands by its 4.5% growth forecast for this year, though in a year-end economic assessment, Coordinating Minister for the Economy Aburizal Bakrie said the government was confident that growth would reach 5% this year.

The IMF is making no predictions on the level of growth, but it upbeat on the prospects. "While GDP growth is still below Indonesia's potential and unemployment remains high, economic performance has continued to improve in recent months and financial markets have rallied," the agency said in a statement late last month.

Tax breaks

The government is targeting tax revenue of Rp297.51 trillion ($32.7 billion) in the 2005 state budget. Last year, it raked in Rp238.9 trillion – Rp300 billion above its own target – but only 2 million or so individual income taxpayers are on the books, not count ing civil servants and private sector employees whose income taxes are deducted from their salaries by their employers.

The unfavorable taxation regime in the country has long been seen as one of the main obstacles to attracting new investors. This looks likely to change with the Ministry of Finance finalizing a whole range of new tax break facilities to help improve the business climate and attract new investment, as well help reduce unemployment rates by encouraging further expansion by existing businesses. These are likely to come into force this month.

Director General of Taxation Hadi Purnomo said the incentives would include a reduction in the 30% withholding tax on dividends to 10%, and extensions on untaxable income due to operational losses would be extended from the current five years to 10 years. Another ruling would also allow companies to claim tax refunds on asset depreciation within two years, instead of the current five.

Businesses in underdeveloped regions, mainly in the east of the country, will be allowed to set aside a minimum of 30% of profits for investment and expansion, without having to pay for the expenditure tax at the end of their annual fiscal year. The government is also considering a tax amnesty, which could see the return of up to $60 billion in funds to help implement its major infrastructure plans.

A tax amnesty could encourage rich Indonesians who had moved their money out of the country or into foreign banks in Indonesia during and following the financial crisis in 1998, to reinvest their funds in domestic banks without fear of being questioned and slapped with tax demands.

Investment

Election promises to push growth to 7% by 2009 spurred an ambitious five-year plan for major investments in infrastructure. Roads, railways, ports, airports, power plants, telecommunication facilities, gas distribution, water plants, irrigation facilities and housing projects planned over the period will need between Rp700 trillion and Rp1quadrillion, expected to come from the private sector.

Around Rp200 trillion will be funded from the state budget and an equal amount by local banks but the rest needs to come from local and foreign

institutional investors, and the World Bank and the Asian Development Bank. An Indonesian Infrastructure Summit set up by the Coordinating Ministry for the Economy and the National Development Planning Agency (Bappenas) has been oversubscribed.

At least 700 potential investors, foreign and domestic, have asked for one of the 500 seats available at next week's event. Both President Susilo Bambang Yudhoyono and Vice President Jusuf Kalla will address the visitors, who include executives from General Electric, Siemens, Paiton Energy, Sumitomo Corp, Alcatel and Motorola.

The target is to increase investment from the current 20.5% to 28.4% of GDP by 2009. If the five-year plan succeeds, it should be sufficient to reduce the unemployment rate to 6.7% from the current 9.5%. About 40 million of Indonesia's 235 million people are either jobless or work fewer than 35 hours a week.

Almost 70% of the current workforce is comprised of elementary and high school graduates, or school dropouts. More than $4.2 billion worth of new oil and gas contracts were signed last month though these are unlikely to create many new jobs, unlike investments in the labor-intensive manufacturing and infrastructure sectors.

Cost of living

Retail spending represents more than two-thirds of the economy and consumers are likely to pay more for goods and services this year. Petrol prices will be raised early this year while tariffs for kerosene – widely used for cooking – and diesel – used in the farming sector and in public transport – will be kept low. Higher transport costs will also affect food prices, which account for 38% of inflation calculations. A 1.51% increase in the price of basic foods as well as a 0.31% rise in clothing costs contributed to 6.4% inflation in 2004.

The government expects to peg inflation to 7% for 2005, an upward revision of its earlier target of 5.5%.

The fuel price hike may also trigger increases in other prices such as electricity, water and telephone charges. The price of several goods and services have already risen slightly on news that the government would go ahead with fuel price increases in line with its commitment to bringing domestic energy prices closer to world prices. Andrew Steer, the World Bank's Indonesia representative, pointed out that the subsidies are not "sound policies" and their reduction and eventual elimination should boost competitiveness.

Budget balancing

The total cost for reconstructing Aceh is expected to be at least $1.07 billion over the next five years but with major assistance pledged by the international community, the effect on the budget may be minimal.

Though the state budget has run deficits since 1998, the new administration plans to balance the budget by 2007. It wants to narrow the deficit to 0.8% of GDP in 2005 and is likely to push ahead with a sale of a $1.5 billion worth of bonds to help achieve this.

The deficit last year amounted to Rp27.8 trillion, or 1.4% of GDP, higher than the initial projection of Rp26.3 trillion, or 1.3% of GDP. The higher deficit was caused by a rise in fuel subsidies following soaring global oil prices.

The government paid out Rp70 trillion in fuel subsidies in 2004, though early in the year the cost was forecast at only Rp31.82 trillion. The 2005 subsidy bill is to be cut to Rp25 trillion and the 2005 budget deficit is estimated at Rp7.4 trillion.

Overall, promising

Improving macro-economic stability inherited from the previous administration has also encouraged Bank Indonesia to continue cutting interest rates, which stood at a record low of 7.41% in December. A stronger rupiah and a lower interest rate environment should continue to enhance the economy. Conversely, any pressure on inflation and the exchange rate could see the central bank increasing rates. The rupiah is forecast to average 8,900 to the dollar this year, hardly changed from its average strength of 8,925 last year.

Cheaper consumer loans has fuelled private consumption. Sales of electronic appliances, cell phones, motorcycles, and, particularly, cars, soared throughout last year. Indonesia is now the second-fastest growing automotive market after China. The Association of Indonesian Automotive Industries (Gaikindo) raised its 2004 vehicle sales forecast by over 7% to 420,000 units and predicts total sales of well over 465,000 vehicles for the year once the figures are in, an increase of around 30% on last year.

Though private consumption has been the main engine of growth, most sectors saw higher growth last year with the exception of the mining and extractive industries sector, which declined by 5.96%, bedeviled by various uncertainties, which stalled investment.

Ready to go

"In the midst of this grief, no matter how difficult, the government will complete the (100-day) program," Yudhoyono said last week prior to ringing the opening bell at the Jakarta Stock Exchange to mark the first trading day of 2005. His 100-day program outlines his priority reforms agenda and aims to improve public confidence in the new government.

Voters chose Yudhoyono for his pledges to fight corruption, reduce poverty and attract investors to create jobs. "The time for competition is over. The time is now for unity. If God wills it, and we can work hard and together, we will be able to build a better Indonesia, a safer, more just and wealthier Indonesia," Yudhoyono said when being sworn in as president. He has a lot of political capital, and, with his deputy now heading Golkar, one of the two leading opposition parties, is well positioned to push reforms through parliament to deliver on his promises.

[Bill Guerin, a Jakarta correspondent for Asia Times Online since 2000, has worked in Indonesia for 19 years in journalism and editorial positions. He has been published by the BBC on East Timor and specializes in business/economic and political analysis in Indonesia.]