Cablegate: Indonesia - 2008 Draft Budget, Significant Increase In

VZCZCXRO3990
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #2777/01 2750714
ZNR UUUUU ZZH
R 020714Z OCT 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 6530
RUEATRS/DEPT OF TREASURY WASHINGTON DC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUEHKO/AMEMBASSY TOKYO 0896
RUEHBJ/AMEMBASSY BEIJING 4369
RUEHBY/AMEMBASSY CANBERRA 1294
RUEHUL/AMEMBASSY SEOUL 4226
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 06 JAKARTA 002777

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E.O. 12598: N/A
TAGS: EFIN KMCA ECON KCOR PGOV ID
SUBJECT: INDONESIA - 2008 DRAFT BUDGET, SIGNIFICANT INCREASE IN
INFRASTRUCTURE SPENDING

1. (U) Summary. On August 16, President Susilo Bambang Yudhoyono
(SBY) presented to the Parliament his FY 2008 draft budget, which
focused heavily on boosting infrastructure spending. The draft
budget targets 6.8% economic growth for 2008, up from 6.3% expected
in 2007, with 6% inflation. In order to stimulate the economy, the
Government of Indonesia (GOI) proposed a 12% increase in overall
spending for 2008 to Rp 836.4 trillion ($91.5 billion); revenue is
to increase 11.2% to Rp 761.4 trillion ($83.3 billion) from 2007.
Under the plan, the budget deficit should increase 21%, to 1.7% of
GDP from 1.6% expected this year, reflecting the GOI's attempt to
drive economic growth by boosting overall spending volume. The 2008
budget is still under Parliamentary review. End Summary.

2. (U) Note. This report uses the September 27 Rp 9140/USD market
exchange rate rather than the GOI's budget assumption exchange rate
of Rp 9,100/USD . The GOI uses a calendar year fiscal year. End
Note.

Macro Assumptions:
Deficit Expands to Stimulate Economy
------------------------------------

3. (U) The 2008 draft budget is based on a stronger economic growth
rate and results in a significantly larger deficit. It assumes 6.8%
growth in 2008, up from 6.3% expected for 2007 and generates a
deficit of 1.7% deficit-to-GDP, compared to 1.6% deficit-to-GDP in
the 2007 revised budget. The 2008 budget proposal also assumes that
inflation will ease to 6% from an expected 6.5% this year, and that
Bank Indonesia (BI) will reduce its reference rate to 7.5%. In
addition, it assumes an average dollar exchange rate of Rp 9,100, up
from Rp 9,050 in the 2007 budget.

4. (U) In his address to Parliament on August 16, SBY noted "The
rise in the budget deficit is in line with GOI's fiscal policy
orientation of providing fiscal stimulus to the economy." SBY also
indicated that the key thrusts of his 2008 budget are improving
Indonesia's infrastructure and alleviating poverty. In a speech on
September 25, Finance Minister Sri Mulyani also underscored the
government's desire to ramp up spending in the near term. She noted
that the GOI is in the process of expanding spending during the
second half of 2007, potentially increasing the 2007 deficit to 1.5%
of GDP.

-------------------------------------------
Table 1: FY 2008 State Budget Assumptions
-------------------------------------------
Macro indicators 2007 2007 2008
Budget Proposed Draft
Revision Budget
---------------------------------------------
GDP (Rp trillion) 3,779 3,804 4,306
Economic growth (%) 6.3 6.3 6.8
Inflation (%) 6.5 6.5 6.0
Exchange rate (Rp/$) 9,300 9,100 9,100
3-month SBI rate (%) 8.5 8.0 7.5
Oil price ($/barrel) 63 60 60
Oil lifting (mbd) 1.000 0.950 1.034

(Note: The oil price of $60 per barrel is the estimated real price
in 2007, so the GOI uses it for 2008 projection.)

Capital Expenditure, Infrastructure Increases
---------------------------------------------

4. (U) On September 20, Parliament's Budget Committee approved the
proposed state expenditures at Rp 836.4 trillion ($91.5 billion),
14.3% up from the 2007 budget. It consists of central expenditures
of Rp 564.6 trillion ($61.8 billion) and regional expenditures of Rp
271.8 trillion ($29.7 billion). Key spending highlights of the
final budget include:

-- Capital expenditure to increase by 49% to Rp 101.5 trillion
($11.1 billion) compared to the current budget. Social welfare
programs will also rise by 42%, to Rp 67.4 trillion ($7.4 trillion).
"The government is determined to become increasingly focused in its
fiscal policies to develop and repair infrastructure that is
strategic to the economy, and to increase programs to enhance
education, health and the prosperity of the poor," SBY stated. The

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poor condition of Indonesia's infrastructure is a growing obstacle
to much-needed foreign and domestic investment and economic growth.

-- Fuel and power subsidies, although smaller than in the previous
year, remain high at Rp 46.7 trillion ($ 5.1 billion) and Rp 27.8
trillion ($ 2.8 billion), respectively.

-- The public works ministry's budget allocation will rise 41.1% to
Rp 35.6 trillion ($3.9 billion), for building roads, and
rehabilitating and maintaining existing ones. The transport
ministry's allocation will jump 64.1% to Rp 16.2 trillion ($1.8
billion) to expand the railway network, maritime transport and
airports.

-- Transfers to the regions decreased as percentage of GDP over the
previous year in the 2007 budget, from 6.6% to 6.3% of GDP. By
nominal terms, however, it increased slightly by 8% from Rp 252.5
trillion ($27.6 billion) to Rp 271.8 trillion ($29.7 billion). The
increase includes a 4% increase in the Revenue Sharing Fund (DBH) to
Rp 64.5 trillion ($7.1 billion), and a 7% increase in the General
Allocation Fund (DAU) to Rp 176.6 trillion ($19.3 billion).

Social Welfare Spending Rises
-----------------------------

5. (U) Personnel and social spending will increase significantly, in
line with the GOI's policy of bureaucratic reform, and poverty
reduction. The GOI will channel the bulk of the 2007 social
expenditures through line ministries for social assistance.
Spending categories include direct subsidies for education and
health programs, and a Rp 1.1 trillion ($120.4 million) conditional
cash transfer. The conditional cash transfer program represents an
extension of similar programs introduced after fuel subsidy cuts in
October 2005 to mitigate the impact of higher fuel prices on the
poorest families. The cash transfer programs distributed Rp 15.6
trillion ($1.7 billion) in 2006 and Rp 2.8 trillion ($306.3 million)
in 2007 to millions of households below a designated income level.
Social expenditures also include a Rp 3 trillion ($382.2 million)
emergency reserve and disaster mitigation fund.

Table 2 provides the spending levels of GOI'S FY 2007 proposed
budget.

--------------------------------------------- -----
Table 2: FY 2008 Expenditures
(in trillions of Rupiah)
--------------------------------------------- -----
Items 2007 2008 % Increase
Proposed Draft
Revision Budget
--------------------------------------------- -----
Expenditures 746.4 836.4 12.1
-- Central govt. 493.9 564.6 14.3
- Personnel 99.9 129.5 29.6
- Material 62.5 52.4 -16.2
- Capital 68.3 101.5 48.6
- Interest 86.3 91.5 6.1
- Subsidies 105.1 92.6 -11.9
- Social 47.5 67.4 41.8
- Others 24.1 29.6 22.5
-- Transfers to
regions 252.5 271.8 7.6

Education and Health Spending Increases
---------------------------------------

6. (U) In line with GOI's policy to increase spending on social
development, the Ministry of Education (MOE) receives the highest
budget allocation at Rp 48.3 trillion ($5.3 billion). This is more
than double its 2005 budget, or 17% of central government spending,
22.5% up from 2007 education budget realization. Nationwide
education assistance programs include school buildings, books, and
scholarships. The Ministry of Religious Affairs (MORA) budget
allocation increases by 30% mainly due to a expenditure
classification change: the amount includes part of the School
Operational Subsidy (BOS), for Islamic schools or "madrasah," which
in previous years was classified under Ministry of Education
spending.

JAKARTA 00002777 003 OF 006

-- Also in line with the President's social development agenda, the
amount of funds allocated to the Ministry of Health increased by 18%
compared to the previous year, rising to Rp 18.8 trillion ($2.1
billion). The Health Ministry's budget will have almost tripled
from 2005.

Table 3 illustrates the budget level of the ten agencies who will
receive the largest budget allocations in 2008. The allocation for
major agencies increased, with the exception of the Aceh
Rehabilitation and Reconstruction Agency (BRR).

--------------------------------------------- -----
Table 3: FY 08 Budget Allocation By Ministries/
Agencies(in trillions of Rupiah)
--------------------------------------------- -----
Ministries/ 2007 2008 % Increase
Agencies Budget Proposed
Revision Budget
--------------------------------------------- -----
Education 39.4 48.3 22.5
Public Works 25.3 35.6 41.1
Defense 29.6 33.7 13.9
National Police 17.8 20.9 17.3
Health 15.9 18.8 18.0
Transportation 9.9 16.2 64.1
Religious Affairs 12.4 16.1 30.0
Finance 8.6 10.3 19.7
Agriculture 7.9 8.9 12.7
BRR (1) 9.9 7.0 -29.7

(1) Aceh Rehabilitation and Reconstruction Agency

Civil Service Salary Increases
------------------------------

7. (U) The GOI significantly increased personnel expenditures, by
30% in nominal terms over 2007, reflecting the GOI's civil service
reform effort. The civil service reform package includes a 20%
increase in base salaries and retirement benefits for the civil
service, the military, the police; an increase in teacher
allowances; and an increase in official per diem for the police and
the army (from Rp 30,000/day to Rp 35,000/day, or $3.3/day to
$3.8/day) as well as the civil service (from Rp 10,000/day to Rp
15,000/day, or $1.1/day to $1.6/day).

8. (U) The draft 2008 budget allocated increases to prioritized four
government institutions that will implement civil service
remuneration reforms; the National Police, the National Land Agency
(BPN), the Attorney General Office (AGO), and the Investment
Coordinating Board (BKPM). This follows four other institutions
that initiated the project in 2007 (the Ministry of Finance, the
State Audit Agency, the Supreme Court, and the State Ministry for
the Administration).

Increased Anti-Corruption Spending
----------------------------------

9. (U) All but one the major anti-corruption agencies received
spending increases. The Supreme Audit Board (BPK) the Supreme
Court, and the Ministry of Law and Human Rights (MOLHR) continue a
multi-year trend of budget increases. Only the Corruption
Eradication Commission (KPK), which has recently moved into its
newly-renovated building and had large budget support in the past,
has slowed down. The KPK also continues to receive robust donor
assistance.

--------------------------------------------- ------
Table 4: FY 08 Budget Allocation for Civil Services
Reform and Fighting Corruption
(in trillions of Rupiah)
--------------------------------------------- ------
Ministries/ 2007 2008 % Increase
Agencies Budget Proposed
Revision Budget
--------------------------------------------- ------
National Police 17.8 20.9 17.3
BPN 2.3 2.4 6.3

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Attorney General 1.5 1.8 19.9
Investment Board 0.31 0.35 10.8
BPK 1.1 1.3 21.3
Supreme Court 2.8 3.2 16.3
MOLHR 3.8 4.3 13.6
KPK 0.32 0.26 -18.7

Key Revenue and Financing Highlights
------------------------------------

10. (U) The GOI projected an 11% nominal increase in revenue in 2008
over 2007 to Rp 761.4 trillion ($83.3 billion). The increase is
predicated on higher tax receipts, which are expected to increase by
19% in nominal terms to Rp 583.7 trillion ($63.9 billion) or 14% of
2008 GDP. Tax revenue accounts for approximately 77% of government
income in the 2008 budget. Table 5 provides summarized revenues for
FY 2008.

--------------------------------------------- ---
Table 5: FY 2008 Revenue (in trillions of Rupiah)
--------------------------------------------- ---
Items 2007 Revised 2008 Draft
Budget Budget
--------------------------------------------- ---
Domestic Revenue 681.8 759.3
- Oil and gas 142.9 153.3
- Non-oil and gas 538.9 606.0
Foreign Grants 2.7 2.1
Tot. Revenue/Grants 684.5 761.4

11. (U) The projected 2008 budget deficit is Rp 75 trillion ($8.2
billion), equivalent to 1.7% of GDP. In nominal amount, the 2008
projected deficit-to-GDP ratio rises by 21% on calls for increased
government spending to spur growth. The GOI will mainly finance the
deficit through bond issuances. The GOI continues to rely more
heavily on domestic financing at around 85-15% proportion as in
2007. The GOI projected net privatization proceeds of Rp 1.5
trillion ($164.1 million) for 2008. Table 6 provides the breakdown
of the budget's source of financing.

---------------------------------------------
Table 6: FY 08 Financing
(in trillions of Rupiah)
---------------------------------------------
Items 2007 Revised 2008 Draft
Budget Budget
---------------------------------------------
Primary balance 24.3 16.5
---------------------------------------------
Deficit (61.9) (75.0)
Financing 61.9 75.0
-- Domestic (net) 74.6 91.7
- Bank financing 10.6 0.3
- Privatization 2.0 1.5
- Assets restructuring 1.7 0.3
- Govt bonds (net) 62.3 91.6
- Infrastructure
Supporting (2.0) (2.0)
-- Foreign loans (net) (12.6) (16.7)

Finance Minister Describes Direction,
Highlights Risk to Fiscal Stability
-----------------------------------

12. (U) In a September 25 briefing for the international community
in Jakarta, Finance Minister Mulyani detailed her Ministry's ongoing
plans for fiscal reform. The plans include streamlining
administrative procedures, modernizing customs processes, improving
debt management, deepening debt market, developing sound risk
sharing schemes for public private partnerships, and reforming the
bureaucracy. Efforts to improve the quality of the bureaucracy
range from better job evaluation and remuneration to improving
policy credibility.

13. (SBU) Minister Mulyani also detailed the risks to fiscal
stability in Indonesia. Her largest concerns were global
macroeconomic instability, a rise in government debt burden, the
need to fund massive infrastructure projects, and a decline in the

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performance of state-owned enterprises. She also raised concerns
about decentralization, both in terms of local governments' ability
to spend funds to stimulate local economic activity and in terms of
local governments' ability to build fiscal capacity. She conceded
that local governments still face difficulties in effectively
managing and implementing budgets. She listed the prevalence of
natural disasters in Indonesia as a significant ongoing contingent
liability for the national budget.

Comment
-------

14. (SBU) The draft budget reflects the GOI's attempts to stimulate
economic growth by upgrading infrastructure, after leaving economic
growth mainly to private consumption in recent years. It has
significantly increased spending volume to help drive economic
growth, however analysts view that the key to stimulating higher GDP
output is the timely disbursement of funds rather than the absolute
amount of resources. Recently, some government project managers
have been reluctant to spend for fear of being charged with abuse of
public funds without clear procurement guidelines. The budget
clearly tries to address years of low education and social welfare
spending with large increases. Although the 2008 budget is
conceptually good, some observers have criticized it as overly
ambitious. According to the critics, the GOI has focused more on
monetary goals (macroeconomic stability, lower inflation, stable
exchange rate) and neglected priorities such as investment in the
real sector, job creation, and poverty reduction.

--------------------------------------------- ------
Table 7: FY 2007 Revised Budget and FY 2008 Draft
Budget
--------------------------------------------- ------
FY 2007 FY 2008
Items (1) Rp % of Rp % of
Trill GDP Trill GDP
--------------------------------------------- ------
A. Total revenue 684.5 18.0 761.4 17.7
I. Domestic revenues 681.8 17.9 759.3 17.6
Tax revenues 489.9 12.9 583.7 13.6
Domestic taxes 472.8 12.4 568.3 13.2

Int. trade tax 17.1 0.5 15.4 0.4

Non-tax revenues 191.9 5.0 175.6 4.1
Natural resources 112.2 2.9 119.8 2.8
SOE profits 21.6 0.6 20.4 0.5
Other 58.2 1.6 35.5 0.8

II. Grants 2.7 0.1 2.1 0.0

B. Expenditures 746.4 19.6 836.4 19.4
Central govt. exp. 493.9 13.0 564.6 13.1
Routine 162.4 4.2 181.9 4.2
-Personnel 99.9 2.6 129.5 3.0
-Material exp. 62.5 1.6 52.4 1.2
Capital exp. 68.3 1.8 101.5 2.4
Interest payments 86.3 2.3 91.5 2.1
Subsidies 105.1 2.8 92.6 2.2
Social assistance 47.5 1.2 67.4 1.6
Other expenditure 24.1 0.6 29.6 0.7

Transfer to regions 252.5 6.6 271.8 6.3

--------------------------------------------- ------
Primary balance 24.3 0.6 16.5 0.4
--------------------------------------------- ------
Overall balance (61.9) (1.6) (75.0) (1.7)
--------------------------------------------- ------
Financing 61.9 1.6 75.0 1.7
Domestic financing 74.6 2.0 91.7 2.1
Domestic banks 10.6 0.3 0.3 0.0
Privatization 2.0 0.1 1.5 0.0
Assets restructuring 1.7 0.0 0.3 0.0
Govt debt 62.3 1.6 91.6 2.1
Capital participation (2.0) (0.1) (2.0) (0.0)
Foreign financing (net) (12.6) (0.3) (16.7) (0.4)
Gross drawing 42.4 1.1 43.0 1.0

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Program loan 19.1 0.5 19.1 0.4
Project loan 23.3 0.6 23.9 0.6
Amortization of
foreign debt (net) (55.0) (1.4) (59.7) (1.4)

(1) Column totals may not add perfectly due to rounding.

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