Survey of recent developments 305
TABLE 3 Approved Budget 2006 and 2007 Budget
2006
a
2007 Rp trillion of GDP Rp trillion of GDP
REVENUE AND GRANTS 651.9
20.9 713.4
20.1 Tax revenue
423.5 13.6
505.9 14.3
Domestic taxes 408.8
13.1 490.2
13.8 Income tax
212.3 6.8
257.3 7.3
Value added tax 132.9
4.3 161.0
4.5 Land building tax
18.2 0.6
21.3 0.6
Duties on land building transfers 4.4
0.1 5.4
0.2 Excise
38.5 1.2
42.0 1.2
Other taxes 2.6
0.1 3.2
0.1 International trade taxes
14.6 0.5
15.6 0.4
Non-tax revenues 224.5
7.2 204.9
5.8
Natural resource revenues 161.9
5.2 151.6
4.3 Profi t transfers from SOEs
b
21.7 0.7
16.2 0.5
Other 40.9
1.3 37.1
1.0
Grants 3.9
0.1 2.7
0.1 EXPENDITURE 689.6
22.1 746.5
21.1 Central government
470.2 15.0
496.0 14.0
Personnel 79.6
2.5 98.5
2.8 Goods services
54.6 1.7
72.5 2.0
Capital 67.0
2.1 66.1
1.9 Interest payments
83.5 2.7
85.1 2.4
Subsidies 104.3
3.3 109.7
3.1 Fuel
62.7 2.0
68.6 1.9
Non-fuel 41.6
1.3 41.1
1.2 Social assistance
37.2 1.2
49.0 1.4
Other 43.9
1.4 15.1
0.4
Transfers to regional governments 219.4
7.0 250.5
7.1 DEFICIT 37.6
1.2 33.0
0.9 FINANCING
37.6 1.2
33.1 0.9
Domestic fi nancing 52.4
1.7 51.3
1.4 External fi nancing net
–14.8 –0.5
–18.2 –0.5
ASSUMPTIONS GDP growth rate p.a.
5.8 6.3
Infl ation p.a. 8.0
6.5 Average exchange rate Rp
9,300 9,300
Average SBI 90-day rate p.a.
b
12.0 8.5
Crude oil price barrel 64
65 Oil production million barrelsday
1,000 1,000
a
Revised.
b
SOE: state-owned enterprise; SBI: Bank Indonesia Certifi cate. Source:
MOF 2006b.
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306 M. Chatib Basri and Arianto A. Patunru
The budget assumes an average oil price of 65barrel which, although lower than the August 2006 price of 73barrel, is not too different from prices recorded
in October. Since current oil prices are somewhat below those assumed for 2007, this seems an ideal time for the government to shift to a policy of allowing
domestic prices to move in tandem with international prices, thus taking fuel price adjustments out of the political arena.
A key issue is the impact of the oil price on the budget defi cit. According to the Ministry of Finance MOF, a rise in the oil price of 1barrel in 2007 would
increase revenue by Rp 3.8 trillion, whereas it would also lead to an additional Rp 4.4 trillion in outlays on fuel and electricity subsidies, revenue sharing and
general allocation fund DAU transfers to the regions—thus increasing the defi cit slightly, by Rp 0.6 trillion or 0.02 of GDP. It is worth noting, however, that the
total DAU amount is fi xed upon approval of the budget by the DPR, so if the oil price increases subsequently this would in fact reduce the defi cit slightly, by Rp 0.2
trillion MOF 2006b.
Table 3 shows some key aspects of the 2007 budget: • domestic tax revenues are projected to increase from 13.1 of GDP in 2006 to
13.8 in 2007, driven mainly by increased income tax and VAT collections; • although total revenue increases from Rp 651.9 trillion to Rp 713.4 trillion, as a
proportion of GDP it declines from 20.9 in 2006 to 20.1 in 2007; • likewise, while total expenditure increases from Rp 689.6 trillion to Rp 746.5
trillion, it falls from 22.1 of GDP in 2006 to 21.1 in 2007. Expenditure on personnel increases from 2.5 to 2.8 of GDP as a result of rises
in base salaries, annual bonuses and various allowances, and salary payments to new civil servants, military and police personnel and health service providers.
Increased rates of pay are intended to improve the performance of the bureauc- racy, but this outcome is unlikely in the absence of complementary reforms Syn-
nerstrom 2006.
Capital expenditures decline from 2.1 to 1.9 of GDP, but this partly refl ects the fact that some of the amount budgeted for 2005 was not spent, and so was car-
ried over to 2006. If there is a recurrence of this problem in 2006, as seems likely, the effect would be to reduce the former fi gure and increase the latter, so capital
expenditures in both years would be about the same.
THE BIO FUEL ‘NEW DEAL’ Since January 2006 the government has been giving considerable attention to
Presidential Instruction No. 12006, strongly encouraging the production and use of bio fuels GOI 2006a. The term ‘bio fuel’ refers to fuel manufactured
from plants: for example, bio diesel can be produced from jatropha or oil palm, and bio ethanol from sugarcane molasses or cassava. As a country blessed
with fertile soil, it is easy to see Indonesia as a natural choice for producing bio fuels. This, together with the president’s concern with soaring global oil prices
and high levels of unemployment and poverty, led him to call for Indonesia to embark on a massive bio fuel production project—extending over millions
of hectares and employing millions of workers. The parallel with former US President Roosevelt’s ‘New Deal’ in the 1930s—massive government spending
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Survey of recent developments 307
to boost aggregate demand and employment—was immediately seized upon by the media Kompas, 1962006.
Others were quick to voice their support for the proposal, including the minis- ter of research and technology, Kusmayanto Kadiman, and the head of the Green
Energy Society Masyarakat Energi Hijau Indonesia, Al Hilal Hamdi. According to Hamdi, the country is capable of converting 6 million hectares of land to bio
fuel production based on oil palm within fi ve years. He claimed that this would allow the production of 22.5 million kilolitres of bio fuel over a fi ve-year period,
and the creation of 3–5 million jobs Kontan, 2472006. For his part, Minister Kadiman has suggested banning crude palm oil exports and instead using the
industry to support bio diesel production Kontan, 1552006. In similar vein, the minister of industry, Fahmi Idris, has called for a ban on sugarcane molasses
exports, so that this product can be used as an input to bio ethanol production.
7
The state-owned oil company, Pertamina, has also jumped on the bio fuel band- wagon, and was reported in June to be selling a bio diesel blend at four of its retail
outlets in Jakarta Khalik 2006. The president appears so confi dent of the desir- ability of this initiative that the government is reported to have earmarked no
less than Rp 13 trillion for bio fuel development next year Hudiono 2006, even though the 2007 budget provides for only Rp 1 trillion.
We are wary of this proposal, however. Simple technological calculations of how much land can be converted, how many trees planted, how many workers
employed and how much energy produced fall far short of the kind of careful eco- nomic analysis that should form the basis for such far-reaching policy decisions.
Broadly speaking, if the cost of producing bio fuel exceeds the price of an equivalent quantity of conventional fuel on the world market, Indonesia will lose by imple-
menting this proposal. If bio fuel production is economically viable there will be no need to ban exports of palm oil or molasses, since the bio fuel industry will be able
to purchase these inputs at world prices. Any policy that forces the diversion of a healthy export-oriented activity to a domestically oriented purpose will harm the
former, and will do nothing to increase employment or reduce poverty.
That bio fuel production is not economically viable is suggested by a joint study by researchers from Cornell University and the University of California,
Berkeley, the starting point for which is the observation that production of bio diesel and bio ethanol also requires considerable quantities of energy as an input.
The researchers found that fuels produced from various kinds of biomass in fact use signifi cantly more energy in their production than is contained in the bio etha-
nol or bio diesel produced Pimentel and Patzek 2005—a phenomenon referred to as ‘negative energy return’. In addition, the need to clear vast tracts of land to
support a bio fuel industry would lead to complicated land ownership and forest conversion issues, cause a signifi cant loss of biodiversity and exacerbate existing
severe smoke pollution problems resulting from the clearing of forests by burn- ing. In spite of such concerns, however, some countries are indeed already rapidly
moving in the direction of large-scale bio fuel production.
7 A similar campaign is also evident in Australia, where the sugar cane grower lobby is seeking to boost demand for ethanol by pushing for its compulsory inclusion in domesti-
cally consumed petrol Koch 2006.
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308 M. Chatib Basri and Arianto A. Patunru
We are aware of one study arguing that the development of bio fuels might be benefi cial to the poor Hazell and Von Braun 2006, but we are unconvinced
by this, and remain sceptical that the bio fuel initiative would have a signifi cant impact on Indonesia’s unemployment and, through this, on poverty, in the man-
ner of the ‘New Deal’. Indonesia’s stubbornly high unemployment appears more likely to be the consequence of signifi cant rigidities in the labour market Man-
ning and Roesad 2006: 167–8 than of any lack of aggregate demand, in which case the generation of jobs in a bio fuel industry would be more likely to draw work-
ers out of other sectors than to reduce the number of unemployed. We have little doubt that a far more effective approach to increasing the availability of modern
sector jobs and reducing poverty is to carry through the implementation of stalled labour market reforms. Unfortunately, however, after a process of deliberation
involving academics from fi ve of Indonesia’s top universities, the government has decided to drop its bid to reform the employment laws Kompas, 1492006.
In short, the bio fuel proposal now being pushed by various players appears to be nothing more than a leap of faith, and is highly unlikely in the short run to be
a panacea for increasingly costly fossil fuels, high unemployment and poverty. It makes much more sense to allow the future of the bio fuel industry to be deter-
mined by the market, without distortionary intervention by the government. It should be up to fi rms in the private sector to decide whether this new industry
is commercially viable. Thus far, private sector responses have varied. PT Astra Agro Lestari and PT Perusahaan Perkebunan London Sumatra Indonesia, the two
largest agricultural companies in the country, are still reluctant to invest in palm oil bio diesel. In contrast, PT Bakrie Sumatera Plantations has stated its intention
to invest 25 million in the industry JP, 1392006.
POVERTY AND RICE IMPORTS Poverty incidence increases
In his State of the Nation address before the parliament on 16 August, the president pointed out that Indonesia’s poverty incidence had declined from 23.4 in 1999 to
16 in 2005. This statement immediately triggered strong reactions from a group of economists known as Tim Indonesia Bangkit TIB, the ‘Arise Indonesia’ Team and
some politicians, who argued that the level of poverty had risen in 2006 as a conse- quence of the large fuel price increases in 2005, and that the government was trying
to mislead the public by referring only to the now well out-of-date poverty fi gure for February 2005. The minister for national development planning, Paskah Suzetta,
asserted that there was no attempt by the government to manipulate the data: the fi
gure presented by the president, published by the central statistics agency BPS in September 2005, was the most recent available to him.
However, on 1 September 2006, just two weeks after the State of the Nation address, BPS announced that the number of people living below the poverty line
had indeed risen by 4 million, from 35.1 million in February 2005 to 39.1 million in March 2006—an increase from 16 to 17.8 of the population table 4.
8
TIB’s assertion that poverty had increased since the previous data had been released
8 The proportional increase was somewhat higher in rural than in urban areas.
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Survey of recent developments 309
was thus proven correct, although its estimate of 22 poverty in March 2006 was highly inaccurate. Its explanation of the cause of the poverty increase also seems
invalid, as we explain below. BPS pointed out that signifi cant numbers of those living above the poverty line in February 2005 had fallen into poverty by March
2006, including 30.3 of those previously categorised as ‘near poor’, 11.8 of the ‘near non-poor’ and 2.3 of the ‘non-poor’.
9
During the same period, 43.5 of those previously below the poverty line had moved above it, including 19.4
who became near poor, 17.7 near non-poor, and 6.5 non-poor. These fi gures refl ect the fact that there are many people living close to the poverty line, so that
a slight increase in prices relative to nominal earnings would cause a signifi cant number to fall below it.
The poverty line is strongly infl uenced by the prices of food items, among which rice dominates. The price of rice increased by no less than 33 from February 2005
to March 2006 Mallarangeng et al. 2006. Since more than three-quarters of the poor are net consumers of rice World Bank 2004, the rice price increase must
be expected on average to have hurt the poor Basri, Panennungi and Nurridzki 2004. A simple estimation by the World Bank forthcoming suggests that the rise
in the relative price of rice by 16.5 33 minus an average 16.5 increase in the prices of other foods could be expected to raise the number living in poverty by
about 3.1 million. On this basis it can be argued that around 77 of the rise in the number of poor during the period in question was accounted for by the increasing
price of rice as distinct from rising fuel prices, which TIB had emphasised.
This still leaves open the question of whether the rice price itself may have risen so dramatically as a result of fuel price hikes, or international rice price
increases, or other factors. The fuel price hikes presumably cannot be blamed, since the prices of other foods increased by only half as much as that of rice dur-
ing the period in question; in addition, international rice prices were more or less stable. We argue, therefore, that the surge in rice prices was mainly a consequence
of the rice import ban imposed by the government in late 2005. Contrary to its stated intent, this policy has hurt the poor signifi cantly.
9 The expenditure ranges used to defi ne near poor, near non-poor and non-poor are 100–125, 125–150 and greater than 150 of the poverty line, respectively.
TABLE 4 Poverty Incidence
Feb-05 Mar-06
Change million
million million
Urban 11.4
12.4 13.4
14.3 2.0
1.9 Rural
19.5 22.7
21.9 24.8
2.4 2.1
Total 16.0
35.1 17.8
