RAPBN 2015: The baseline for the next government

As is customary before Independence Day, President SBY gave his State of the Nation address on the draft state budget (RAPBN) of 2015, which is his last. Amidst the current transition, the draft state budget does not provide clarity on key developments next year, especially in the absence of fuel subsidy cuts, a crucial issue given that ballooning fuel subsidies have weighed on the budget and dampened economic growth. All in all, we see that the draft state budget of 2015 only projects a straight line trajectory from the revised state budget of 2014, only taking into account basic needs and public services. Going forward, we expect the next government to launch several initiatives on the fiscal side to incorporate new programs into the revised state budget in January 2015 at the soonest. As such, the expected reforms of the next government to reduce fuel subsidies and undertake more value-added expenditure may serve as important catalysts to boost economic growth, which would in turn, bolster the equity market. We retain our Overweight stance with year-end index target of 5,248.  Mixed signs  The 2015 state budget is based on the assumption of GDP growth of 5.6% for 2015 and without fuel price hikes, inflation is expected to fall further to 4.4%. However, the rupiah is expected to only stabilize at its current level of Rp11,900/USD despite stronger economic growth and slower inflation, reflecting the likelihood that the Fed normalizes its monetary policy by raising interest rates in 2015. In our view, it appears that the state budget reflects a ‘business as usual’ stance, giving the next government some room to incorporate its specific programs and initiatives that it deems important in the state budget.  Expenditures mainly driven by fuel subsidies  Domestic revenues are still mainly underpinned by tax revenues which are expected to grow 10.0% to Rp1,371tn with the tax to GDP ratio remaining at 12%. Government expenditures, meanwhile, are expected to increase by 7.6% to Rp2,020tn, driven by 18.1% higher fuel subsidies, since the expenditures of government ministries looks to be fairly flat. It is apparent that the current government will leave the tough decision on fuel subsidy cuts to the next government. The budget deficit to GDP ratio is still in the range of 2.32%. In our view, it is difficult to see the 2015 budget as expansionary since subsidies still account for a large chunk of expenditures. The potential revision of the state budget by the next government could be major, especially with potential cuts in fuel subsidies which would leave the government with more funds to allocate to more productive segments.  Nearly flat Ministries’ budget  Seven ministries have been allocated budgets above Rp40tn. They are: 1) the Ministry of Defense (Rp95tn), 2) the Ministry of Public Works (Rp74tn), 3) the Ministry of Education (Rp67tn), 4) the Ministry of Religious Affairs (Rp51tn), 5) the Ministry of Healthcare (Rp47tn), 6) the National Police (Rp47tn), and 7) the Ministry of Transportation (Rp45tn). All budgets look nearly flat compared to the revised 2014 budget, with a significant increase only in the Ministry of Transportation’s budget, reflecting government plans to develop five new airports in 2015.  What can the new government do?  The first 100 days will be busy for the new government after inauguration of the new president on October 22, 2014. The new government will be responsible for the remainder of the revised 2014 budget and planning of the 2015 revised budget. Our expectation is that the new government possesses the political will to curb unproductive spending (i.e. subsidies) whilst, at the same time, boosts productive spending (such as on infrastructure or healthcare). Other goals should be to streamline the implementation of government programs and the creation of better governance, as well as broadening the tax base and improving tax administration to lift the tax ratio above the 12% level.