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“Indonesia needs to reduce subsidies and to encourage more income tax payments”, says deputy finance minister

Interview - July 1, 2014
Budget, subsidies and taxation are discussed by Bambang Brodjonegoro, Deputy Minister of Finance, as the government works towards improving fiscal policy.

What is the impact of subsidies on the Indonesian economy?

Indonesia spends a significant amount of money on subsidies. If you look at our subsidy structure, it is dominated by the energy subsidy. The way we implement that is through a price subsidy scheme, where the government pays the difference between the international energy price and domestic energy price. The government sets the domestic price, taking into account the purchasing power of the Indonesian people, and fills the gap between that and the international price. One of the challenges with filling this gap is that the international energy price is quite volatile. It relies on the international oil price and in the past we have had problems with spikes whenever there is trouble in the Middle East. Indonesia is no longer a major oil producer or exporter. We are a minority producer and need to import large volumes of oil to cover domestic consumption. To import, we have to pay in US dollars so if we have a problem with currency, which we did in May 2013, then the subsidy gap widens further.

With a large subsidy, the budget becomes less sustainable. We cannot predict the volatility of the international energy price and the cost of the subsidy. As a result our fiscal space, or budget space, has become smaller. Once you account for our revenue and mandatory spending, our fiscal space becomes extremely limited. We need to reduce the amount of the subsidy to increase our fiscal space. With a bigger fiscal space we can spend more on infrastructure.

Biofuels are being developed as an alternative to crude oil and other renewable energy shows promise in the country. Could such technology provide a solution to addressing the energy subsidy issue?

One way or the other, Indonesia needs to use more renewable energy. We have many types of renewable energy available for use in this country. Currently, our main drivers of energy use are power and transportation. As an alternative for Indonesia’s power, I think geothermal energy has potential. However, we do not have an equally viable alternative for transportation yet. We rely heavily on fossil fuels at the moment and I believe biofuels will be helpful the future.

We are the world’s largest producer and exporter of crude palm oil (CPO). CPO will be attractive for food supply in the Pacific and for other derivative industries, such as the cosmetics business. CPO also has the potential to be liquid energy. Our challenge now is that we can only mix 10% biofuel in diesel. We need to increase the amount of biofuel we can mix with fossil fuel. Brazil, with ethanol, has been able to achieve mixtures of 30-40%. I think Indonesia needs to move in that direction. It will be a useful step for government to invest more in these fuel alternatives because it will help reduce our reliance on oil. You can create biofuels or you can buy fossil fuels; the calculation is simple in theory.

What would you say are the main challenges associated with tax collection?

So far, our tax ratio is still 12% and it has been stuck for some time. We’ve been trying to change it but we need a breakthrough. Indonesia’s three biggest tax contributors are income tax, value-added tax (VAT) and excise tax. Because excise tax has limited application we need to focus on changes to the other two forms of taxation.

Income tax is very low in Indonesia. Having lived in the US, I know from experience that their tax revenue depends on personal income tax. That’s why it’s an important political issue. In Indonesia the contribution of personal income tax is 3 trillion IDR. Compare this to our total tax revenue of 1000 trillion IDR. Only 3 trillion IDR comes from personal income tax. The difference comes from corporate income tax and VAT. We need to tackle this disparity, especially as Indonesia has been growing from a low-income country into a low-middle income country.

Is it part of the challenge engaging Indonesia’s growing middle-class population and making them aware of the tax system requirements?

Yes. Given that Indonesia has been implementing democratization since 1998, I believe the personal income tax principles should have been developed alongside this change. As people pay more tax they should be able to expect a greater return from the government, such as more services and new infrastructure. Still, many Indonesians do not clearly understand the link between taxation and public services. Our office has focused on corporate income tax because that’s where we can meet our targets. Corporations are good taxpayers and they wind up shouldering most of Indonesia’s tax burdens. That is not good for investment. We need a change in Indonesia’s mindset. Like in the US, personal income tax should be more important than corporate income tax. We need companies to open in Indonesia, for investment, growth and job creation, not taxation. Most people file tax reports and simply claim that they have already paid their tax, or that their employer did.

What are the main issues facing customs authorities in Indonesia?

The main duty of customs is to protect domestic trade in Indonesia. We are trying to protect Indonesia from smuggling, dumping and other threats. Smuggling is our biggest problem. Indonesia has a large area and huge lengths of coastline movements of goods, particularly in seaports. To combat smuggling we need strong monitoring in our seaports. Given the size and growth of seaport operations in Indonesia, surveillance is problematic and can impede the movement of goods. If customs inspected every ship or container there would be a huge bottleneck. The trick is having good risk management. Not long ago premium rice shipments were all green-lit and approved without inspection but we eventually found imported medium rice on the market. We realized that rice was being smuggled through existing channels and customs had to reassess its inspection protocols.

Will the creation of the ASEAN Economic Community affect customs?

We have an ASEAN Customs Forum and they have come to an agreement on standardizing inspection among ASEAN states. They do this with country of origin (COO) checks. Whenever a container arrives in an Indonesian port we perform a COO check. A new Toyota car could come from production facilities in Japan or Thailand. We found that some cars would come from Japan and be marked from Thailand in order to gain access to customs priority privileges. The new agreements will hopefully curtail these problems. Indonesia has a lot to gain or lose because we are the biggest market in the region.

Among state-owned enterprises (SOEs) in Indonesia there has been a marked move towards restructuring in order to improve efficiency. Do you believe this will increase competitiveness in the region?

In general we are very happy with how the SOEs are operating. Garuda Indonesia is now considered one of the region’s best airlines. We are happy with their internal efficiency and management, but we are still worried that our market size and profitability is actually hampering expansion. People often ask why Garuda does not fly to the US. It does not fly to the US because it is not profitable. Our SOEs are not necessarily internationally competitive because our domestic market is so attractive. Most SOEs are unprepared for expansion into other markets. Our worry is that with the implementation of the ASEAN Economic Community our domestic SOEs might not be able to compete with international competitors in the Indonesian market.

Indonesia is very receptive to inflows and outflows of capital, how will that be affected by the formation of the ASEAN Economic Community?

In terms of inflow, being part of the ASEAN market is expected to be largely beneficial. However we have some slight concerns about the volatility of capital inflow. With or without the ASEAN Economic Community, our job in the Ministry of Finance is to make sure that Indonesia maintains macroeconomic stability. We need to make sure that our macroeconomic foundations are strong enough to deal with the volatility of inflows because they can happen anytime.

How do you maintain stability given the country’s vulnerability to international fluctuations?

What we have done so far will be continuing. Macroeconomic stability is necessary for weathering uncertainty and we will continue to maintain current stability.

Still, we don’t have enough domestic investors for both the stock market and bond market at the moment so we are looking to broaden our domestic investor base. Japan is okay with a 200% debt-to-GDP ratio because their investors are domestic investors. In our case, it’s the other way around. Our stock market is filled with totally foreign players. In our bond market, foreign buyers hold 30% of IDR bonds. We have to be careful of the sudden reversal of this environment because it could happen anytime and would destroy our market. So the only way to make sure that doesn’t happen is to ensure we have sound macroeconomic fundamentals. We maintain our current account deficit below 3% of GDP, if we have more than 3%, like we did in the second quarter of 2013 it damages our currency. We still had 5.8% growth last year, even though we were balancing the current account deficit. We’d like our current account deficit and budget deficit to sit around 2.5%. This puts Indonesia in the best possible position to deal with international volatility.