(Bloomberg) -- Bank Indonesia intervened to stabilize the rupiah after President Prabowo Subianto’s surprise decision to scale back a tax hike sent the currency weakening by nearly 1%.
The central bank was in the market on Thursday to maintain the balance of foreign exchange supply and demand, according to director for monetary and asset securities management Edi Susianto.
The rupiah pared its losses to 0.7% against the dollar at 2:27 p.m. local time after falling as much as 1% in morning trading in Jakarta. Still, it was the biggest loser on Thursday among the most-actively traded Asian currencies. Yields on Indonesia’s 5- and 10-year papers were mostly unchanged.
Prabowo shocked markets with his New Year’s Eve decision to pare back a value-added tax hike from 11% to 12%, with the higher levy now only applying to luxury items like private jets and yachts. On Thursday, the government said certain vehicles and motorbikes will be subject to VAT.
The move to limit the scope of the levy is aimed at boosting Indonesians’ spending power, but it also stoked concerns about the country’s fiscal health, with VAT accounting for a quarter of total tax receipts.
“The decision to keep the VAT broadly unchanged could reduce planned fiscal revenues for this year,” said Lloyd Chan, an FX strategist at MUFG Bank Ltd. in Singapore. “This may be having a negative effect on the rupiah today, which has weakened the most among major Asian currencies despite a modest decline seen in the US dollar index.”
Earlier on Thursday, Indonesian Finance Minister Sri Mulyani Indrawati downplayed the concerns, saying the 2024 budget deficit will likely come in “much smaller” than the official estimate of 2.7% of gross domestic product. State revenues recovered in the second half of last year to help offset the increase in state spending, she said.
“This means that our state budget will close in 2024 relatively healthy and safe, which will be a strong position for 2025,” she said at a ceremony marking the first stock trading of 2025. The budget deficit for this year is estimated at 2.53% of GDP, well below the 3% legal limit.
Indonesia’s last-minute decision to scale back its VAT hike came after a series of policy flip-flops last month. Prabowo said in early December that the increase would only affect luxury goods. Days later, the finance ministry announced that it would be implemented across the board, as stipulated in the law. Then on Tuesday, hours before the hike was set to take effect on January 1, Prabowo reverted to his earlier plan.
“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.”
While an across-the-board VAT hike had been expected to raise roughly 75 trillion rupiah ($4.6 billion), the watered-down increase will likely bring in only 3.2 trillion rupiah in state revenues, Mukhamad Misbakhun, who chairs the parliamentary commission overseeing financial affairs, said in a statement on Wednesday.
“This is a difficult choice that President Prabowo’s government must make for the sake of supporting purchasing power,” Misbakhun said.
Prabowo’s decision came after economic growth dipped to a one-year low in the third quarter as Indonesia struggled with weak consumption and a spate of job layoffs in the manufacturing sector.
In a sign of waning spending, headline inflation cooled to the low end of the central bank’s 1.5%-3.5% target for 2024. Business and labor groups had warned that a VAT hike could further sap momentum from Southeast Asia’s largest economy.
However, it will be a delicate fiscal balancing act for the government. Prabowo plans to ramp up spending this year to fulfill his campaign pledges, including a $30-billion free meal program, school renovations, free medical check-ups, and other big-ticket projects.
Indrawati said the government will still continue with efforts to accelerate growth, including rolling out stimulus that was planned to mitigate the impact of a broad VAT hike had it materialized. “We will still give the stimulus,” she said.
--With assistance from Claire Jiao and Norman Harsono.
(Updates with inflation data in 14th paragraph.)
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