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Indonesia's Tax Reform Plan Raises Concerns Over Revenue Collection

Fitch warns Indonesia's tax reform may disrupt revenue, impacting its 'BBB' credit rating and ambitious spending plans.

By Barry Stearns

5/15, 00:11 EDT

Key Takeaway

  • Fitch warns Indonesia's tax reform plan to separate revenue agency from finance ministry could disrupt long-term revenue collection.
  • Indonesia's state revenue forecasted to decline to 14.6% of GDP, the lowest among peers, challenging credit rating improvement.
  • President-elect Prabowo's spending plans risk fiscal deficit limits without raising tax rates, aiming for a higher tax-to-GDP ratio.

Tax Reform Concerns

Fitch Ratings has expressed concerns over Prabowo Subianto's proposal to establish a new state revenue agency separate from Indonesia's finance ministry. According to Thomas Rookmaaker, Fitch Ratings’ head of Asia-Pacific Sovereigns, the implications of this move on Indonesia's long-term revenue collection remain uncertain. He highlighted potential issues such as increased uncertainty and operational disruptions that could arise from detaching the tax and customs office from the ministry. Rookmaaker suggested that to enhance revenue, the government should focus on eliminating tax exemptions and improving compliance.

Economic Implications

Indonesia's struggle to increase its state revenue relative to the size of its economy has been a longstanding issue. Fitch forecasts a decline in state revenue to 14.6% of the gross domestic product (GDP) for the current year, marking the lowest ratio among its peers with similar credit ratings. This low revenue ratio is a significant factor preventing Indonesia from achieving a credit rating upgrade, despite its robust growth and improving external balance. The country's credit rating currently stands at ‘BBB’, which is the second-lowest investment grade.

Fiscal Challenges and Promises

The president-elect's ambitious spending plans, including providing free lunch and milk for school children—a program estimated to cost up to 460 trillion rupiah ($29 billion)—could be jeopardized by any disruptions in tax collection. These initiatives are expected to push the fiscal deficit close to the 3% of GDP legal limit. Despite these challenges, Prabowo has committed to not increasing tax rates while aiming to raise the tax-to-GDP ratio from approximately 10% to up to 16% during his tenure, in an effort to maintain the deficit within the legal cap.

External Financial Outlook

Rookmaaker also touched upon the importance of monitoring Indonesia's external finances, especially given the likelihood of a deteriorating current-account deficit as commodity prices normalize. He noted that foreign direct investments (FDIs) have not increased significantly despite governmental efforts to attract companies to establish nickel smelters and battery assembly plants within the country. The level of FDI remains roughly the same as before the pandemic, indicating that the anticipated benefits of shifting supply chains have yet to materialize.

Street Views

  • Thomas Rookmaaker, Fitch Ratings (Neutral on Indonesia's tax collection strategy):

    "It remains unclear how the president-elect’s plan would bolster long-term revenue collection... Removing the tax and customs office from the ministry may worsen uncertainty and lead to operational hiccups. In the short term, it could even cause some disruptions."