Rupiah Slumps on Scaled-Back Tax Hike Even as Finance Chief Downplays Deficit

(Bloomberg) — Indonesia’s rupiah slumped nearly 1% after President Prabowo Subianto’s surprise decision to scale back a tax hike, prompting the finance minister to talk down concerns over the country’s fiscal health.

After second-half revenues recovered, the 2024 budget deficit will likely come in much lower than the official estimate, Finance Minister Sri Mulyani Indrawati said on Thursday at a ceremony marking the first stocks trading day of 2025. That’s despite increased state spending last year.

“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.”

The comments were her first since 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. The rupiah fell as much as 1% to 16,259 against the dollar, before trading at 16,225 at 10:37 a.m. in Jakarta. 

The rupiah was by far the biggest loser on Thursday among the most-actively traded Asian currencies. Yields on Indonesia’s 5- and 10-year papers were mostly 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.”

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. 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 balancing act for the government as VAT accounts for roughly 25% of total tax receipts. 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 measures planned to mitigate the impact of the VAT hike, had it been fully implemented.

“The stimulus won’t be retracted,” she said. “We will still give the stimulus.”

The budget deficit for 2025 is also estimated at 2.53% of GDP, well below the 3% legal limit.

“While the news looks less favorable 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.”

–With assistance from Claire Jiao and Grace Sihombing.

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