Indonesia’s Tax Spinoff May Disrupt Revenues, Fitch Warns

(Bloomberg) -- Prabowo Subianto’s plan to create a new state revenue agency outside of the finance ministry could do more harm than good for Indonesia’s tax collection, said Fitch Ratings.

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It remains “unclear” how the president-elect’s plan would bolster long-term revenue collection, Fitch Ratings’ head of Asia-Pacific Sovereigns Thomas Rookmaaker said in an interview. Removing the tax and customs office from the ministry may worsen uncertainty and lead to operational hiccups, he added.

“In the short term, it could even cause some disruptions,” he said. To boost revenue, the government should remove tax exemptions and raise compliance instead, he said.

Read More: Indrawati Says Tax Body More Credible Under Finance Ministry

Indonesia has long struggled to raise earnings that match the size of its economy. Fitch expects state revenue to decline to 14.6% of gross domestic product this year, the lowest among similarly-rated peers. That ratio is holding the country back from seeing upgrades to its credit rating, which at ‘BBB’ marks the second-lowest investment grade despite an improving external balance and robust growth.

Any disturbance to tax receipts could undermine Prabowo’s planned spending spree, including the free lunch and milk for school children that may cost as much as 460 trillion rupiah ($29 billion). The program will widen the fiscal deficit to near the 3% of GDP legal limit, Fitch said.

Still, the incoming president has promised to refrain from raising tax rates even as he aims to boost the tax-to-GDP ratio to up to 16% during his tenure, from about 10% currently, to keep the deficit within its cap.

“It’s difficult to lift your revenue ratio by a couple of percentage points without raising or introducing new tax or raising tax rates. It’s a gradual process. There are no quick fixes,” Rookmaaker said.

Indonesia will also have to keep an eye out on its external finances, especially as the current-account deficit will likely deteriorate as commodity prices normalize. Foreign direct investments have yet to step up despite the government’s efforts to get companies to set up nickel smelters and battery assembly plants onshore, Rookmaaker said.

“FDI inflows are roughly the same from pre-pandemic. They have not yet shown the benefits of shifting supply chains,” he said in a Fitch Ratings forum on Wednesday.

(Updates with comments on FDI in seventh paragraph.)

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