Reforming the Subsidized Fuel Price Policy of Indonesia
The Indonesian government has further reformed its decade-old fuel subsidy policy in a move to streamline - and make more structural use of - public spending. The latest change is effective from today (1 January 2015) and thus Indonesia moved a step closer to applying a market-based price mechanism. The government now uses a fixed diesel subsidy of IDR 1,000 (USD $0.08) per liter, while subsidy for low-octane gasoline is scrapped altogether (however the government will account for gasoline distribution costs outside Java, Madura and Bali).
The new system means that Indonesian authorities will now announce retail prices for diesel and gasoline on a monthly basis; prices fluctuating in line with the movement of international oil prices.
This latest change comes barely one month after Indonesian President Joko Widodo raised prices of subsidized fuels by more than 30 percent in November 2014 despite global oil prices having fallen sharply in recent months. This then resulted in the paradox situation that Indonesia’s subsidized diesel and gasoline prices became more expensive than the real market prices. Hence, the price of diesel will become IDR 7,250 per liter in January 2014 (compared to IDR 7,500 in the previous month), while gasoline becomes IDR 7,600 per liter (from IDR 8,500 under the previous price system). Meanwhile, the retail price for kerosene remains at IDR 2,500 a liter.
Costly oil imports, triggered by ever-increasing domestic fuel demand (amid an expanding economy in combination with declining domestic oil output), have seriously weakened the country’s trade balance and current account balance, therefore leading to diminished investor confidence as the current account deficit indicates that the country depends on foreign funding (making the country highly vulnerable to capital outflows in times of global shocks). Furthermore, generous government fuel subsidies (for diesel and low-octane gasoline) have a negative impact on the economy as these subsidies distort market prices throughout the economy (leading to inflationary shocks in times of administered price adjustments) and limit the size of funds allocated for structural long-term public investments for social and economic development (such as infrastructure, agriculture, healthcare and education). Fuel subsidies were initially supposed to eat up about 13.5 percent of total government expenditure in 2015 (IDR 276 trillion). After the reforms, this figure has been wound down to only 1 percent. Global investors and important international institutions (for example global credit rating agencies) will approve of Indonesia’s latest reform. After the rupiah touched a 16-year low two weeks ago, the currency (as well as bonds and stocks) have strengthened.
Jakarta Composite Index:
US Dollar versus Indonesian Rupiah:| Source: Bank Indonesia
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