Indonesia’s fuel subsidy policy is estimated to have a large influence on investors’ confidence in the financial or fiscal fundamentals of Southeast Asia’s largest economy and thus on the performance of the local stock index and currency. New president elect Joko Widodo (popularly known as Jokowi) is expected to raise prices of subsidized fuels after taking office in late October 2014 in an attempt to combat the country’s wide current account deficit (mainly caused by expensive oil imports to meet domestic fuel demand).
In the second quarter of 2014, Indonesia’s current account deficit widened to USD $9.1 billion, or, 4.27 percent of the country's gross domestic product (GDP), a level which is generally considered unsustainable. For the international investor community this indicator is an important one as it signals whether the local economy can ‘finance itself’ or is dependent on foreign capital inflows. Therefore, in times of global shocks, countries that show a wide current account deficit will be highly vulnerable to capital outflows as the majority of global investors will move their money to the safest-possible assets. When the US Federal Reserve decides to raise its key interest rate (possibly in the second or third quarter of 2015), the world can prepare for another shock. It is therefore important for Indonesia to limit the impact of this shock on the local economy. One strategy to limit the impact is to improve the country’s current account balance to - at least - a sustainable level (below the three percent of GDP mark). Following the local media, a price increase of IDR 1,000 (USD $0.08) or IDR 2,000 (USD $0.16) per liter for both gasoline (premium) and diesel (solar) can be expected at the end of the year. On the other hand, the shock caused by higher US interest rates may be limited as the Eurozone, China and Japan still maintain their loose monetary policies.
Investors will be happy to see higher prices for subsidized fuels in Indonesia, especially if the new Jokowi-led government will use the new available funds (saved by reducing fuel subsidies) for economic and social development (for example infrastructure, education and healthcare).
In the past ten years, Indonesia’s energy subsidies, most notably fuel subsidies, accelerated sharply (see table below). In the Revised State Budget of 2015 (RAPBN 2015), which was prepared by the incumbent Susilo Bambang Yudhoyono administration, the government allocated IDR 291.1 trillion (USD $24.7 billion) to fuel subsidies; a figure that is roughly equal to 14.4 percent of total planned government spending in 2015. Jokowi immediately reacted to this budget, saying that these subsidies are too high and needs to be reformed.
Indonesian Energy Subsidies:
| Fuel Subsidies
in trillion rupiah
If Jokowi can tackle the fuel subsidy issue, it will translate into enhanced confidence in the economy of Indonesia which will limit the harm done by future capital outflows brought on by monetary policy change in the USA. An improved current account balance will also imply reduced pressure on the Indonesian rupiah exchange rate. As stock traders have to carefully watch the rupiah volatility (a weakening rupiah can ‘eat’ gains made from stock trading), a stronger and stable rupiah will make investors more enthusiastic to engage in stock trading on the Indonesia Stock Exchange (IDX). However, it is important for the government to curb inflation which generally accelerates sharply in case of administered price adjustments. Indonesia’s central bank (Bank Indonesia) may react by raising its benchmark interest rate (BI rate) from the current level of 7.50 percent (to combat accelerated inflation and avert the impact of looming US interest rate hikes). Although this implies that GDP growth continues its slowing pace, for Indonesian stocks and the rupiah it is expected to be positive.
However, there are more matters than just the fuel subsidy policy that are influential for Indonesian stocks in the remainder of the year. The market hopes that Jokowi will appoint professionals (technocrats) on ministerial positions in his new cabinet, particularly the key ministries of Finance, Economy, and Energy & Mineral Resources. Up to date, Jokowi refuses to mention any names but the market was a bit disappointed to learn that 16 new ministers will be party politicians (who are generally unpopular in Indonesia). This move is probably done to obtain (more) support from certain political parties.