The Ongoing Quest for the Reduction in Indonesia's Fuel Subsidy
The heavily subsidized fuel price of Indonesia is likely to be raised next month according to Indonesian media sources. Various high officials, including Economic minister Hatta Rajasa, discussed the possibility to raise the fuel price from IDR 4,500 (USD $0.46) to IDR 6,500 (USD $0.67) per liter starting from May. This increase will only apply to private passenger cars, and not to motorcycles and public transportation. However, president Susilo Bambang Yudhoyono has not made up his mind yet.
In recent years, one major problem for the Indonesian government's annual budget deficit has been high and increasing spending on energy subsidies (electricity and - in particular - fuel). As such, a sharp rise in the global oil price creates a large gap between the market price and the subsidized fuel price in Indonesia; a weight that needs to be carried by the state budget. In other words, Indonesia's state budget is closely (and dangerously) linked to the volatile global oil price. Not unimportantly, it needs to be mentioned that Indonesia's oil production has experienced a steady downward trend in recent years due to a lack of exploration and investments, turning the country into a net oil importer (a situation that is partly responsible for the country's current trade deficit).
We should not forget that the recent annual increases in allocated funds for fuel subsidy are in fact evidence of Indonesia's economic success as rising incomes result in more people using fuel, or, more people using more fuel. But the government policy is about to backfire as it entails significant budgetary costs. Moreover, by keeping energy prices artificially low, price signals are blurred, consumption and investment decisions are distorted, and - as mentioned above - the vulnerability of public finances to international oil-price volatility is increased. Many voices are heard to redirect energy subsidy spending to infrastructure development in order to foster economic growth of over seven percent. Indonesia has a lack of quality and quantity of infrastructure which blocks the economy from expanding at a faster pace than the current annual 6.0 to 6.5 percent. This year, the state budget allocates IDR 216 trillion for public infrastructure spending, equivalent to about 2.4 percent of Indonesia's gross domestic product (GDP). This year's total energy subsidies, however, stand at IDR 300 trillion (including the fuel subsidy), which is equivalent to about 20 percent of the government's total budget.
Of course, the philosophy behind the state's fuel subsidy is good: to support (business activities of) the poorer segments in Indonesia's society. However, it is a worrying fact that most people who enjoy the subsidy are actually members of Indonesia's middle class. As such, the government has been more-or-less sponsoring Indonesia's record car sales last year (when 1.1 million car units were sold, not to mention the terrible effect it has on traffic congestion in cities like Jakarta due to the lack of infrastructure). Cheap fuel is an important factor in deciding to purchase a car. When in late 2005 the Yudhoyono administration decided to increase the subsidized fuel price by 33 percent to IDR 6,000, cars sales immediately plummeted by 40.3 percent in 2006. In the following two and a half years, however, there was a double digit revival in car sales, meaning that the fuel price increase was only a temporary shock and the car market quickly recovered. Inflation, however, was a bigger concern as the 2005 fuel hike led to double digit inflation figures until late 2006. From 2008 onwards, the government decided to gradually decrease the price of fuel until it was back at IDR 4,500 in 2009 (not coincidentally just before the elections in which Yudhoyono was re-elected).
By only limiting private cars from using the heavily subsidized fuel, the government will save a limited amount of IDR 21 trillion (USD $2.2 billion) only. In contrast, this year, the Indonesian government allocated IDR 193.8 trillion from its state budget (USD $20.0 billion) for fuel subsidies. It is thus not a significant amount that will be saved as the government intends to find a compromise between releasing pressure on the state budget and continuing to support the needs of the poor. But the situation in which there are two fuel prices being applied is likely to give ample opportunity for the (further) development of a black market.
There are currently about 11 million private cars driving around in Indonesia. In contrast, there are about 85 million motorcycles that hit the Indonesian roads. And although private cars indeed account for most of the country's subsidized fuel consumption, motorcycles do not lag behind far. A consequence of prohibiting cars from using the more heavily subsidized fuel can be a significant increase in the number of motorcycles, which will again burden heavily on the state budget soon.
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