STATEMENT OF THE INDONESIAN BUDGETARY SITUATIONby Prijadi Praptosuhardjo Minister of Finance Republic of Indonesiato the Interim-Meeting of the Consultative Group on Indonesia (CGI) Jakarta, Indonesia 23 April 2001 Mr. Chairman, Excellencies, colleagues, ladies and gentlemen, Those of you that visit from abroad, welcome to Indonesia. It is a great pleasure to have this first interim CGI in Jakarta. The venue brings us closer to the issues we all face, and maybe it brings us closer to the solutions for those issues as well. As our Co-ordinating Minister stressed in his speech, first and foremost, 1 would like to review the budgetary situation. It will come as no surprise to you that this situation has been worsening over the last few months. The political uncertainty that Indonesia's nascent democracy brings along with it has increased the perception of the country's risk. This has driven the Rupiah down and interest rates up. Both play havoc with the budget: foreign debt service and fuel subsidies have shot up, while servicing the bank recapitalization bonds issued by Government in the course of bank restructuring has become more expensive as well. These expenditures now loom large on the nation's budget only four months after Parliament has approved it. Another major challenge facing the budget is the need for fiscal decentralization. The goal is to transfer authority to the local government in a fiscally responsible way and preserve the territorial integrity of the Republic while preserving economic stability and the quality of public service. We intend to link the transfer of resources to the transfer of responsibilities to guarantee a smooth implementation while maintaining the sustainable fiscal decentralization. This seems to be rather difficult to fully achieve it in the first year of implementation. Beyond decentralization, several other factors play a role as well, including our failure to implement some of the measures the Government proposed to Parliament to strengthen state finances such as an extension of the tax base and a reduction in fuel subsidies. On the latter, when it was time to decide on the April 1 increases, the social tensions in the country simply ran too high. We decided therefore to postpone the price increase for consumers, while compensating for this by increasing prices for industry by more than planned. Over the last few weeks, I and my colleagues have been working closely with the IMF to do three things: (i) assess the size of the problem; (ii) agree on the direction that a solution should take us; and (iii) identify potential solutions. I am pleased to be able to tell you that the cooperation between us and the IMF has been excellent, and that there are no mayor differences between us on either of the three issues. We and the IMF will finalizing this budget adjustment and soon afterward submitted to parliament for approval. We agree with the IMF that the current economic environment would balloon the budget deficit to 6 percent of GDP up from 3.7 percent in the budget approved by Parliament. This is clearly an unsustainable situation, and the size of the deficit clearly conflicts with the Government's goal to regain fiscal sustainability, and reduce debt. Moreover, this size of deficit cannot be financed in any non inflationary way. We therefore also agree on the direction that the solution should take us: Government try every effort to bring back the deficit in the direction of the 3.7 percent of GDP as was originally planned. It is by no means easy to balance the budget in the short run, given the swelling magnitude of deficits resulting from increased expenditures and the outstanding of large official debts. It is our challenge to improve the pessimistic consumer sentiments and to eliminate the fear of rising interest rates by the market. Against this backdrop, we have already designed several important measures for reshaping our current fiscal stance. We call these measures as part of Fiscal Adjustment Package. The package that we propose to overcome this problem will focus on the revenue effort and expenditures streamlining, while keeping the risk of their adverse effect on the economy as minimal level as possible. In brief, basically there will be five measures within the fiscal adjustment package that we are considering to be taken are as follows; First, broadening tax base on certain taxes while keeping the tax collection and tax compliance effort at its optimal level. Second, reducing of oil subsidies on petroleum products and electricity. Fuel prices are now only some 40 percent of international market prices, and as low as 16 percent for kerosene. This year, we propose of price increase to be accompanied by the compensation measures for the low income group. Last year implementation was partially successful and we will improve the compensation mechanism for this year. Third, using the contigency funds for decentralization efficiently. We plan to alocate the transfer of contigency funds to local governments as efficient as we can, and only provided for regions that experience any fiscal gap to make sure the quality of public service delivery to be maintained responsibly. Four, streamlining the development spending. The government will optimize the development budget priorities by streamlining the development projects. In the implementation of this policy, government will still give priorities to finance the basic need services of the people, such as : education. Health, social welfare, and infrastructure. On the detail mechanism, we will have to further discuss with our colleagues from multilateral agencies and other donor agencies. Five, adopting fiscal austerity measures within the fiscal decentralization framework. This year budget, the government will be transferring 31 % of domestic revenues to the regions and it is predicted, some regions will enjoy the surpluses of the funds. We will be, therefore, introducing some policy measures to correct the fiscal non-neutralt'ty. To further ensure all of these measures can be implemented, government will have to consult with RAAC, a Regional Autonomy Advisory Council (RAAC), which including regional government representatives. Mr. Chairman, Excellencies, colleagues, ladies and gentlemen, Even if we manage to reduce the deficit to 3.7 percent of GDP, we realize we will have to work hard to obtain the necessary financing. On the domestic front, we will take measures to ensure that the privatization target and the target for IBRA asset sales are met. We are already in the process of sequencing a number of IPOs. With the sale of government stakes in companies such as BCA and Bank Niaga to strategic investors in the pipeline. Given the market conditions, IBRA has been assigned to provide a second line of defense to cover any potential of short fall and we are confident we can achieve these targets. On the external front, we are fully aware that maintaining our obligations to the Paris Club is key to our external financing this year. The generous rescheduling offered by the Paris Club of which many of you are member has helped us greatly in maintaining a manageable financial situation for Indonesia. We are fully aware that we will have to live up to our side of the agreement, and therefore we are keen to keep our program with the IMF on track. I realize that this is a difficult and uncertain time for the Paris Club members, but I wish to reassure you that we do everything we can to continue our cooperation, and we are in constant dialogue with the Paris Club representatives, and I am confident that we can continue to fulfill our obligations under the agreement. On CGI financing, I would like to reiterate the importance of your support in these difficult times. I realize that some of the financing pledged in Tokyo has not materialized, and other is yet to materialize because of delays in reforms. We will make sure that our Government is taking the steps necessary to trigger the budgetary support for this year. And some of the measures that we will take to remedy our budget problem including energy price increases already go a long way in the direction of meeting some of the conditions on key loans. Nevertheless, foreign financing may still fall short of the amount to cover even a deficit of 3.7 percent. I would therefore like to ask you to support us as much as you can once we take the appropriate measures to address the budgetary problems ourselves. Mr. Chairman, Ladies and Gentlemen, I have outline the challenges we are facing with respect to our fiscal position. The measures we are putting in place require cooperation from the entire government, at center and the regions. It calls for sacrifices from all of us to conduct ourselves with prudence and fiscal austerity. Some of the proposed measures would impact on the poor but we are putting in place the compensating mechanism. It is a national sacrifice and we seek cooperation from all to face the challenges and will succeed. Once again, On behalf of the Government of Indonesia, I would like to thank you for all the support you have shown. Thank you.