The unexpected decision by President Prabowo Subianto to reduce a tax hike caused the Indonesian rupiah to fall by almost 1%, and the finance minister had to downplay worries about the nation’s financial stability.
Finance Minister Sri Mulyani Indrawati stated Thursday at a ceremony commemorating the first day of stock trading in 2025 that the 2024 budget deficit will probably be far lower than the official forecast once second-half revenues have recovered. Even though the state spent more last year, it is still the case.
“This is an extraordinary result — smaller, much smaller, than the first-half report in which we predicted the deficit would close at 2.7%” of gross domestic product, she said. “This means that our state budget will close in 2024 relatively healthy and safe, which will be a strong position for 2025.”
Her remarks were the first since Prabowo surprised investors on New Year’s Eve by reducing a value-added tax hike from 11% to 12%, with the higher tax now solely being applied to luxury goods like yachts and private planes. At 10:37 a.m. Jakarta time, the rupiah was trading at 16,225 after dropping as much as 1% to 16,259 against the dollar.
Among the most heavily traded Asian currencies on Thursday, the rupiah was by far the greatest drop. Indonesia’s 5- and 10-year paper yields remained largely unchanged.
“While the government’s decision to cancel the VAT hike is positive for GDP growth and inflation, it makes the government look inconsistent and imprudent to investors,” said Lionel Priyadi, a macro strategist at PT Mega Capital Indonesia. “Investors are now pricing in regulatory uncertainty and greater fiscal risks.”
Mukhamad Misbakhun, who chairs the parliamentary commission in charge of financial affairs, said in a statement on Wednesday that the watered-down VAT hike is expected to generate only 3.2 trillion rupiahs in state revenues, whereas an all-out VAT hike was anticipated to generate approximately 75 trillion rupiahs ($4.6 billion).
“This is a difficult choice that President Prabowo’s government must make for the sake of supporting purchasing power,” Misbakhun said.
Prabowo made his choice after Indonesia’s economy shrank to its lowest level in a year during the third quarter due to a wave of manufacturing job losses and poor consumer spending. Labour and business organizations had cautioned that a VAT increase might further depress the largest economy in Southeast Asia.
However, since VAT makes up around 25% of total tax revenues, the government will have to strike a careful balance. Prabowo intends to increase expenditures this year in order to carry out his campaign promises, which include a $30 billion free meal program, free medical examinations, school upgrades, and other significant initiatives.
According to Indrawati, the government would continue to work to boost growth, including plans to lessen the effects of the VAT hike if it is completely implemented.
“The stimulus won’t be retracted,” she said. “We will still give the stimulus.”
Additionally, the 2025 budget deficit is projected to be 2.53% of GDP, significantly less than the 3% legal cap.
“While the news looks less favourable at the outset,” it should be noted that the VAT hike was not factored into the 2025 state budget projections, said Alan Lau, an FX strategist at Malayan Banking Bhd in Singapore. The rupiah’s weakening “could also be due to the lower liquidity as markets gradually return from the festive season.”
