Bill Guerin, Jakarta – A week after investors were promised a better deal, including lower taxes, surging world oil prices are dealing Indonesia's economy a double whammy, battering the currency and blowing out the domestic budget.
A week ago, the rupiah closed at 9,985/9,995 to the dollar after briefly hitting the psychologically important level of 10,000. This week, despite intervention from Bank Indonesia, the central bank, the beleaguered currency dropped to fresh lows. Traders sold off the currency amid thin dollar supplies and fears the central bank would not keep up its earlier aggressive defense of the rupiah. So far it has lost 9.7% of its value this year and efforts to support it have cost at least US$5 billion since April.
Panic buying of dollars by local businesses to pay for imports, and, in many cases, service dollar-denominated debts, extended the rupiah's two-week slide to 10,300 per dollar, the currency's lowest point since February 2002. At least one local analyst was prompted to say the situation could prove to be "very dangerous". Arguing that the current scenario is similar to that during the run-up to the 1997-1998 financial crisis, Kahlil Rowter, head of research at Mandiri Securities, said any further slide of the rupiah would no longer depend on technical factors.
Economists warn that the central bank needs to take drastic moves to signal a full-blooded commitment to defend the rupiah. On Wednesday, it raised a key interest rate by a quarter of a point, to 7.5%, to encourage rupiah buyers, but further rate increases could push up government borrowing costs and impact on economic growth. Overall, the economy grew 5.54% in the second quarter, down from 6.19% in the first. The government forecasts GDP growth of 6% in 2005 and 6.2% in 2006, the fastest pace since 1996.
However, Burhanuddin Abdullah, the central bank governor, says that although the bank will continue to try "to reduce volatility", what is important is not the level of the rupiah but stability, so that businesses can "make their plans". These sentiments are at odds with the perception of the business community.
Mohamad Hidayat, chairman of the Indonesian Chamber of Commerce and Industry (KADIN), was quoted as saying: "It is true that businessmen are panicky. It happened after they realized that the rupiah is moving out of control." Industry is now facing a serious risk of foreign exchange losses and rising costs for raw material imports, he said.
The Coordinating Minister for the Economy, Aburizal Bakrie, who was KADIN chairman for 10 years before being appointed to the cabinet, has warned the central bank's intervention would only be "temporarily" effective in curbing the rupiah's fall and what is needed to ease pressure on the currency is a change in the fuel subsidy policy.
Bakrie said one factor that has caused the rupiah's depreciation is the public perception that the country is facing a huge budget deficit, even though the current account and capital account are expected to post a surplus of $4.7 billion this year. He blamed poor market sentiment over the potential impact of subsidies on the budget deficit, though conceding that the main pressure on the currency was due to the need to spend dollars for oil imports and then subsidize fuel at the same time.
The central bank has bought around Rp13 trillion in the last four months while, conversely, the government has been buying dollars to finance subsidies. Indonesia is the only OPEC member that is a net importer of oil. State oil giant Pertamina needs on average $1 billion every month to import crude oil and refined petroleum to meet a rapidly growing domestic demand. The 2005 budget assumes Rp76.5 trillion will be spent on selling fuel at below-market prices. Yet at current fuel-consumption levels, and with oil prices above $60 dollars a barrel, subsidies would need to be almost doubled to Rp150 trillion ($15.3 billion).
Rolling back the costly subsidies, however, and forcing consumers to bear more of the brunt of record-high costs, could lead to a social and economic backlash. Bakrie said the government needed to shift to a more targeted subsidy system as the current policy has often led to illegal sales of subsidized fuels to industrial customers. By Wednesday, President Susilo Bambang Yudhyono had entered the fray, promising the government and the central bank would act quickly to bolster the rupiah, and urging currency speculators to stop selling the rupiah.
"We have agreed that we'll take concerted efforts to overcome the rupiah's weakness," Yudhoyono told journalists after an unprecedented late-night meeting with senior officials of Bank Indonesia. "We will continue to reduce the deficit and [fuel] subsidies, without sacrificing the lower-income people whom we have to protect," he said.
Plugging the gap
The state budget has been a constantly moving target for months. The Megawati administration had set a 2005 budget deficit target of 0.8% of GDP but in March the new government revised this to 1.07% to reflect the impact of higher oil prices. The draft 2006 budget outlined in the president's first "state of the nation" speech to the House of Representatives assumes a reduced deficit of 0.7% of GDP. Yudhoyono warned that the financing challenge of the budget "is not less menacing" given the need to repay maturing foreign debts of Rp60.4 trillion and domestic debts of Rp30.4 trillion. Interest payments of Rp73.5 trillion are also due this year.
There are limited options to increase revenues. The government plans to increase the sale of bank assets to help achieve the budget deficit target. Funds are expected from privatization and disposal of banking assets held by state asset management firm PT Perusahaan Pengelola Aset (PPA). The full-year asset sales target for these assets, taken over by the government during the financial crisis, has been raised to Rp5 trillion from Rp4 trillion.
Overall, state revenue is estimated at Rp539.4 trillion in 2006, up from Rp491.59 trillion for this year. This will come from tax revenues of Rp402.1 trillion, non-tax revenues ofRp132.6 trillion and grants of Rp4.7 trillion. Another Rp19.6 trillion will come from government investment account and treasury bonds sales and Rp29.9 trillion in foreign loans.
The show must go on
Despite the growing uncertainty, the government is moving on with its commitment to create a business-friendly regulatory environment and push for more inward investment. Draft revisions of the tax legislation based on Ministry of Finance proposals have been hailed as they offer relatively low tax rates while encouraging better compliance among taxpayers. The president has promised to cut taxes for listed companies and said he would triple the minimum threshold for personal taxation in a bid to attract support from lower-paid workers.
The drafts propose a reduction in the corporate income tax rate to 28% in 2007 and 25% in 2010, down from the current 30%. Personal income tax rates would be reduced to 33% in 2007 and 30% in 2010 from a current rate of 35%. The ceiling on luxury taxes, targeted in particular at luxury cars, is to be raised to 200% from 75%. However, the draft laws have still to be debated and approved by parliament. Hidayat said the draft laws offered incentives that would not only stimulate the economy but also help expand the tax base through the introduction of a simpler taxation regime.
Approved foreign direct investment jumped 79% to $6.64 billion from $3.71 billion in the same period last year. The Investment Coordinating Board (BKPM) and the Coordinating Ministry for the Economic Affairs will co-host the Indonesian Global Investment Forum in September. This will promote investment opportunities in SE Asia's largest economy to exclusively invited audiences of institutional and foreign direct investors in London and New York. Bakrie will head up the forum in London and the president will join key government ministers and corporate leaders in New York.
Some comfort came from the IMF whose managing director Rodrigo Rato emphasized that despite the "inflationary problem", Indonesia's economy was on a "strong footing". The sting in the tail was his reminder that though subsidies may be politically very popular, they are not efficient. The Indonesian government must accept that "masquerading the reality of oil prices is not a sustainable policy".
[Bill Guerin, a Jakarta correspondent for Asia Times Online since 2000, has worked in Indonesia for 20 years as a journalist. He has been published by the BBC on East Timor and specializes in business/economic and political analysis in Indonesia.]