Indonesia's subdued outlook awaits fiscal response; on a tightening budget

AS Indonesia emerges from its first annual gross domestic product (GDP) contraction since 1998's Asian financial crisis, analysts are hopeful for fiscal policies to support the recovery in 2021 and beyond. But the government is working on a tightening budget, and benign tax revenues that may not be living up to the economy's potential.

The official growth target for 2021 is between 4.5 and 5.5 per cent, but much is up in the air. On Friday, a BofA Global Research report lowered BofA's expectations for Q1 2021, due to public mobility taking a hit from new public activity restriction measures in place since Jan 11. BofA economists also noted that Indonesia's plans to vaccinate over 180 million people by end-2021 appear scant on details, with "no clear and straight path" to herd immunity.

Now, analysts await the government's further policy response to support recovery. On the fiscal end, Indonesia raised its Covid-19 recovery budget earlier this month - for the second time this year - to 619 trillion rupiah (S$58.66 billion), up from the 372 trillion rupiah initially set aside. But these increases are likely to be funded through budget reallocations, as the government seeks to maintain spending discipline.

"(The) onset of the pandemic and a sharp increase in public expenditure to defend against its economic impact have placed significant fiscal strain (on Indonesia)," said DBS economists Radhika Rao and Chang Wei Liang in a note on Tuesday. "Indonesia's fiscal deficit and debt levels widened in 2020 and a gradual consolidation, under the cover of growth, is likely this year."

Indonesia's fiscal rules were temporarily relaxed for 2020-22, to offer greater flexibility in responding to the health crisis. Normally, Indonesia's budget deficit is capped at 3 per cent of GDP, and maximum government outstanding debt is capped at 60 per cent of GDP.

These efforts have improved Indonesia's public finances over the past two decades, as evidenced by rating upgrades from S&P, Fitch and Moody's. S&P, however, lowered its rating outlook from stable to negative in April last year, citing increasing financial risks from ramped-up government spending.

Presently, the budget deficit for 2021 is set at 5.7 per cent of GDP. Ms Rao and Mr Chang foresee higher deficits pushing borrowings, likely taking public debt levels to up to 40 per cent of GDP, compared to 30 per cent in end-2019.

"Concurrently, this is likely to sharply lift debt/revenues ratio from 203.0 in 2019 to 236.0 in 2020 before moderating, which underscores not only a rising debt load but also benign underlying revenues," said the economists.

Tax revenues dominate Indonesia's receipts mix, and these are still reliant on natural resources, they pointed out. While tax revenues were robust in the years of the commodity boom, they have moderated from over 11 per cent of GDP in 2012, to less than 10 per cent in 2019.

In the preceding decade (2003 to 2012), non-tax oil and gas revenues grew 17 per cent year on year, before slowing to 6 per cent in the seven years till 2019. Concurrently, these revenues accounted for 20 per cent of total tax revenues on average, and have since narrowed to a tenth.

Meanwhile, tax buoyancy - namely, the responsiveness of revenues to shifts in growth or national income - has been "sub-par", said the economists. Indonesia's tax to GDP ratio lags regional peers, and is among the lowest compared to its peers with BBB ratings.

This is attributed to the country's sizeable informal sector, lower tax compliance, and weak monitoring, resulting in a narrower tax base and more leakages. The government's recent efforts to address these vulnerabilities include new levies on sectors like e-commerce, and tax reforms to simplify processes.

Nonetheless, Ms Rao and Mr Chang noted Indonesia's fiscal dynamics remain sound compared to regional peers like India, the Philippines, Thailand and Malaysia, which consistently run budget deficits.

"Compared to these countries, Indonesia has fared well on the level of fiscal deficits as a percentage of GDP, as well as government debt levels," they said. "In the past decade, deficits have remained below 2.5 per cent, compared to 7 per cent in India and 4 per cent in Malaysia."

The economists also expect the government to reinstate fiscal rules as pledged, by 2023.