Fiscal Policy in Indonesia: State Budget in 2018 and 20191 On August 16, 2018, President Joko Widodo presented the draft 2019 State Budget (RAPBN) to Parliament for approval by the end of October. This note assesses the Government’s changes to the 2018 budget allocations as presented in the “2018 Outlook”, and highlights the key features of the proposed 2019 Budget. The “revised” 2018 budget (2018 Outlook)2 In 2018, the Government expects to meet its overall revenue target. The Ministry of Finance expects to collect IDR 1,903 trillion in total revenues and grants in 2018, 14.2 percent higher than 2017 and slightly above the 2018 Budget target. If this projection is realized, it would be the first time the revenue target has been met since 20123. Higher than expected oil prices4 drove an increase in revenues: oil and gas-related revenues exceeded the target by 69 percent, contributing 4.3 percentage points to overall growth. Value-added tax (VAT) collections are also expected to exceed the target by about 4 percent as improved compliance and higher oil prices boosted import VAT collections. Overall, tax collections are projected to increase by 15.3 percent in 2018, bringing the tax ratio to 10.5 percent of GDP from 9.7 percent in 20175 (Figure 1). The overall budget envelope has not been changed from the original 2018 budget despite higher spending on energy subsidies and interest payments. Overall, total expenditures are expected to reach IDR 2,217 trillion in 2018, with Central Government expenditure essentially the same as the approved amount of IDR 1,454 trillion. The Government’s policy of maintaining fuel and electricity prices fixed amid higher crude oil prices led to cost overruns of IDR 71.9 trillion or 0.5 percent of GDP, a 173 percent increase from the approved 2018 Budget amount. In addition, higher than expected rupiah depreciation and higher bond yields led to a heftier interest bill by IDR 10.8 trillion. The Government accommodated this additional spending within the existing envelope, as it expects to execute only 94-95 percent of the original budget for personnel, material and capital expenditures, in line with previous year’s execution rates6. The Government also used reserve funds initially allocated under ‘other expenditures’ to pay for energy subsidies7. The proposed 2019 budget: Overall revenues projected to continue double-digit growth. In 2019, total revenues and grants are projected at IDR 2,142.5 trillion, an increase of 12.6 percent (nominal terms) compared to the 2018 Outlook. This is slightly lower than the expected increase of 14.2 percent this year, but much higher than the average gain of 3.7 percent from 2014-2017. Non-oil and gas income taxes, followed by VAT collections, are expected to be the main drivers of revenue growth as efforts to improve tax compliance continue. Excises are also expected to increase by 6.4 percent in nominal terms from the 1 Prepared on August 27, 2018 by Pui Shen Yoong and Yus Medina Pakpahan under the guidance of Frederico Gil Sander and Ralph van Doorn, with contributions from other MTI, SPJ and Governance GP colleagues. 2 Although there was no official Revised Budget in 2018, the 2018 outlook published by the Ministry of Finance in the 2019 Financial Note shows reallocations of expenditures that are effectively revisions of the approved 2018 Budget. 3 Comparing actual, audited revenue collections against approved budget targets. If comparing against revised budget targets, then the target has not been met since 2010 (revenue targets were revised upwards from 2010-2012). 4 The average crude oil price is projected at USD 70 in 2018, 37 percent higher than the Budget assumption of USD 51. 5 Excluding collections from the Tax Amnesty Program. 6 The Government only disbursed 93 percent of the budget for personnel and material on average between 2014-2017, and 86 percent of the budget for capital expenditures on average over the same period. 7 According to the 2019 Financial Note, ‘other expenditures’ can be used for expenditures that arise from additional fiscal risks and changes in macroeconomic assumptions. They also comprise contingency funds for natural disasters, personnel spending (allowances) and price stabilization measures for food and other staples. 2018 Outlook, mostly due to tobacco excise reforms. Overall, tax revenues are expected to increase by 11.1 percent in real terms vis-à-vis the 2018 Outlook (or 15.0 percent in nominal terms, see Figure 2), bringing the tax ratio to 11.1 percent of GDP. This is an optimistic target but not unprecedented, given that real growth in tax revenues has exceeded 10 percent five times in the past 15 years. Total expenditure is proposed at IDR 2,439.7 trillion (15.2 percent of GDP) a 10.6 percent increase relative to the 2018 Outlook. This is the largest projected year-on-year increase8 since President Joko Widodo took office in 2014, highlighting the importance of boosting revenue collections to spending more while maintaining fiscal prudence. Noteworthy expenditure policies are: • A higher allocation for energy subsidies. Consistent with expectations of a weaker Rupiah and persistently high crude oil prices next year, the Government will allocate IDR 156.5 trillion for energy subsidies, about 66 percent higher than the 2018 Budget, but still a much lower amount (and share of the budget) compared to pre-reform levels (Figure 3). The proposed 2019 allocation is slightly lower than the 2018 Outlook due to the one-time payment of arrears to Pertamina and PLN in 2018 for subsidy spending in 2016 and 2017. • Infrastructure9 still a priority, but slower increase than in previous years: The Government intends to spend IDR 420.5 trillion on infrastructure in 2019 (Figure 3), a 2.5 percent increase from the 2018 Budget10. This is slower than the 12 percent average year-on- year increase between proposed budgets in 2016-2018, but still represents nearly a fifth of total expenditures, much higher than a tenth in 2013-2014 (Figure 4). Subnational governments are expected to execute 48 percent of all infrastructure spending, slightly higher than 45 percent in 2018 (Figure 5). Capital injections to state-owned enterprises, the bulk of which are infrastructure-related, increased from an allocated IDR 6.1 trillion in 2018 to IDR 17.8 trillion in 2019. • Increased benefits for families receiving Family Hope Program (Program Keluarga Harapan, or PKH) transfers. The Government intends to nearly double the amount received by each beneficiary household – currently averaging IDR 1.7 million (USD 118) per year – to IDR 3.1 million (USD 215) in 201911. Accordingly, the PKH allocation will double to IDR 34.4 trillion. The number of PKH beneficiaries has gradually increased from 2.8 million families in 2014 to 10 million families in 2018, and will be maintained at 10 million in 201912. • Larger increase in transfers to subnational governments: The Government allocated IDR 832.3 trillion for regional transfers in 2019 (Figure 6). This represents a 9.0 percent increase compared to the 2018 Outlook, larger than the average 5.5 percent increase in 2017-2018. This is mostly due to the increase in Special Allocation Funds (Dana Alokasi Khusus, or DAK) and consistent with the projected overall increase in total expenditures. The allocation for the Village Fund (Dana Desa) has been maintained at IDR 60 trillion for the 3rd consecutive year. 8 Comparing approved budget (APBN) allocations across the years. 9 Comprises economic infrastructure, social infrastructure and infrastructure support. Economic infrastructure is undertaken through line ministry spending by the Ministries of Public Works and Connectivity, non-Line Ministry spending through Viability Gap Fund and grants, transfers to villages and districts, and through financing. 10 2018 Outlook data on infrastructure spending is not available in the 2019 Financial Note. 11 Source: Kata Data news, 17 August 2018. 12 Source: President Joko Widodo’s address on the proposed State Budget for 2019 , 16 August 2018. A conservative fiscal stance The Government projects a fiscal deficit of 2.1 percent of GDP in 2018, slightly lower than budgeted. Given better than expected revenue performance, the Government expects to record a fiscal deficit of 2.1 percent of GDP in 2018, lower than the target of 2.2 percent of GDP and the actual 2017 deficit of 2.5 percent of GDP. The World Bank also projects a fiscal deficit of 2.1 percent of GDP in 2018, but assumes slightly less optimistic revenue outturns and lower execution of total expenditures (97 percent), given the slow disbursement of capital expenditures so far13. Fiscal consolidation ongoing into 2019. The Government targets a budget deficit of 1.8 percent of GDP in 2019. The nominal amount of planned bond issuances is projected at IDR 386.2 trillion, similar to the 2018 Outlook and significantly less than IDR 441.8 trillion in 2017. The Government has already reduced the planned issuance of domestic bonds this year by tapping additional multilateral loans, as evidenced by the shift from net issuance of securities (-IDR 26.5 trillion) to foreign loans (+IDR 14.7 trillion)14. Overall, lower borrowing requirements imply a more limited supply of IDR- denominated assets, which, along with efforts to stimulate the purchase of domestic bonds by residents,15 aims to limit the need for foreign portfolio inflows. The Government’s prudent fiscal stance and debt management supports macroeconomic and exchange rate stability, and is warranted considering tightening global conditions and emerging market volatility. Box 1: Notable reforms announced with the proposed 2019 Budget Along with the proposed budget, the Government publishes a Financial Note (Nota Keuangan), which outlines new policies that the Government aims to implement in the next fiscal year. Notable policy initiatives contained in the 2019 Nota Keuangan include: • Introduction of performance-based grants for schools (Bantuan Operasional Sekolah Kinerja) IDR 51.2 trillion has been allocated for BOS in 2019, a 12 percent increase from the 2018 Outlook. The Financial Note states that this is due to the increase in the number of beneficiaries, as well as the Government’s commitment to increase performance-based allocations. • Excise reforms: Increases in tobacco excises are expected to come from upward adjustments in excise tariffs on tobacco products, simplification of tiers, and continued efforts against illicit cigarettes trade. There is a mention of excises on plastics, although a similar mention was included last year but not implemented. • Issuing tax expenditure statements For the first time, the Government published some estimates of tax expenditures for excises, VAT and income taxes in the 2019 Financial Note. This revenue foregone is estimated to amount to IDR 154.7 trillion in 2017 (about USD11 billion). by industry and type of taxpayer in 2016-2017. • Disaster risk management In 2019-2020, the Government intends to expand the scope of financing schemes to mitigate and transfer existing disaster risks, develop new and alternative schemes for disaster risk financing, and educate all stakeholders on the importance of disaster risk management. It also intends to increase the depth of financial markets to mitigate and transfer disaster risks in the future. Source: Ministry of Finance 2019 Financial Note, World Bank staff analysis 13 As of end-July 2018, the Government has only disbursed 27 percent of the 2018 allocation for capital expenditures. 14 Ministry of Finance Mid-year fiscal report 2018. 15 For example, the plans to issue more bonds to the retail market. Source: Bloomberg, August 23, 2018; Antara News, August 15, 2018. Figure 1: The tax ratio is expected to continue to Figure 2: Tax revenues are expected to grow by improve in 2018-2019, albeit gradually double-digits for the first time since 2013 Percent of GDP Year-on-year nominal growth, percent Non-tax revenue Tax revenue Tax revenue Tax revenue, projected growth Total revenue 20 Non-tax revenue (RHS) 80 20 Tax revenue excluding tax amnesty Non-tax revenue, projected growth 15 60 15.0 14.6 15 13.0 12.9 13.3 10 40 12.5 12.2 5 20 10 9.5 9.7 0 0 5 11.3 10.9 10.7 10.4 10.5 11.1 9.9 -5 -20 0 -10 -40 2013 2014 2015 2016 2017 2018* 2019** 2013 2014 2015 2016 2017 2018* 2019** Note: 2018 refers to Outlook; 2019 refers to proposed budget. Note: Dotted lines compare proposed budget target to revised budget targets in the previous year, bold lines refer to actual yoy growth. 2016 and 2017 exclude tax amnesty. 2018 is Outlook vs. 2017 actual; 2019 is proposed budget vs. 2018 Outlook. Figure 3: Energy subsidies increase but still lower Figure 4: Allocations for health, social assistance and than pre-reform levels; infrastructure maintained infrastructure continue to increase in 2019 IDR trillions Expenditure by functional classification, percent of total expenditure 450 Health Infrastructure Social assistance Infrastructure Spending 400 25.0% 350 300 20.0% 17.2% 250 15.0% 200 Energy Subsidy 10.0% 9.4% 150 7.6% 100 5.0% 7.3% 50 2.6% 2.3% 0.0% 0 2013 2014 2015 2016 2017 2018* 2019** 2013 2014 2015 2016 2017 2018* 2019** Note: 2018 Budget for infrastructure; 2018 Outlook for subsidies. Note: Government definition of infrastructure spending (see For infrastructure spending definition, see footnote 9. footnote 9). Figure 5: Subnational governments are expected to Figure 6: Larger increase in transfers to subnational execute almost half of infrastructure spending in 2019 governments in 2019 Spending on infrastructure, IDR trillions IDR trillions Central Government Subnational governments 3,000 Central Government FLPP Capital injections Village fund State Assets Management Special Autonomy & district incentive funds 450 Balancing Funds (DBH, DAU, DAK) 400 350 2,000 300 250 200 1,000 150 100 50 0 0 2017 Revised 2018 Budget 2019 Proposed 2017 Actual 2018 Outlook 2019 Proposed Budget Budget Budget Note: State Assets Management (LMAN) is for land acquisition; FLPP is housing subsidy program. For infrastructure spending definition, see footnote 9. Source for all charts and table below: Ministry of Finance, World Bank staff calculations. MoF Outlook 2018 RAPBN 2019 APBN RAPBN Outlook vs APBN vs APBN IDR trillions unless otherwise stated 2018 (% 2018 (% 2018 2018 2019 difference) difference) A. Revenue & Grants 1,894.7 1,903.0 2,142.5 100 13.1 1. Tax revenues 1,618.1 1,548.5 1,781.0 96 10.1 a. Oil & gas income tax 38.1 55.4 62.3 145 63.5 b. Non-oil & gas income tax 1,385.9 1,295.5 1,510.0 93 9.0 c. Excises & international trade taxes 194.1 197.6 208.7 102 7.5 2. Non-Tax revenues 275.4 349.2 361.1 127 31.1 3. Grants 1.2 5.4 0.4 449 -63.7 Memo item: commodity-related revenues 141.7 224.6 240.4 159 69.7 B. Expenditure 2,220.7 2,217.3 2,439.7 100 9.9 1. Central Government 1,454.5 1,453.6 1,607.3 100 10.5 a. Personnel 365.7 342.5 368.6 94 0.8 b. Material 340.1 319.6 319.3 94 -6.1 c. Capital 203.9 193.7 211.9 95 3.9 d. Interest payments 238.6 249.4 275.4 105 15.4 e. Subsidies 156.2 228.1 220.9 146 41.4 i. Energy Subsidy 94.6 163.5 156.5 173 65.5 - Fuels 46.9 103.5 100.1 221 113.4 - Electricity 47.7 60.0 56.5 126 18.4 ii. Non-Energy Subsidy 61.7 64.7 64.3 105 4.3 f. Grants 1.5 1.5 1.9 100 32.9 g. Social 81.3 80.3 103.2 99 27.0 h. Others 67.2 38.6 106.1 57 57.8 2. Transfers to subnational governments 766.2 763.6 832 100 8.6 a. Transfers to regions 706.2 703.6 759.3 100 7.5 b. Village Fund 60.0 60.0 73.0 100 21.7 Overall balance -326.0 -314.2 -297.2 -4 -0.1 percent of GDP -2.2 -2.1 -1.8 C. Financing 341.6 314.2 297.2 1. Debt financing 399.2 387.4 359.3 SBN 414.5 388.0 386.2 Foreign loans (18.4) (3.8) (27.4) Other 3.1 3.1 0.5 2. Investment financing (65.7) (65.7) (74.8) 3. Lending 6.7 (6.5) (2.3) 4. Guarantee Obligation 1.1 (1.1) - 5. Other financing 0.2 0.2 15.0 Macroeconomic assumptions Real GDP growth, year-on-year, percent 5.1 5.2 5.3 Inflation, percent 3.6 3.5 3.5 Exchange Rate, IDR per USD 13,384 13,973 14,400 Interest rate 4.3 5.2 5.3 Crude oil price (USD/barrel) 51 70 70 Oil Lifting ('000s of barrels/day) 804 775 750 Gas Lifting ('000s of oil-equivalent barrels/day) 1,142 1,116 1,250 Note: Commodity-linked revenues are the sum of oil and gas income taxes and natural resource non-tax revenues.