In the past days, Indonesia’s fuel subsidy policy has been in the spotlight of Indonesian media continuously. When it was reported that incumbent President Susilo Bambang Yudhoyono (SBY) and newly elected president Joko Widodo would meet on the island of Bali this week to discuss various transitional matters, speculation emerged that the country’s generous fuel subsidies, which seriously burden the government’s budget as well as current account, might be wound down before the new government is inaugurated in October 2014.
If the current SBY cabinet would have decided to raise prices of subsidized fuels as it did in June 2013 (raising prices by an average of 33 percent) then it would surely have made governance easier for the next cabinet. Enhanced fiscal room would have made it easier to focus on structural improvements within the Indonesian economy and society (for example ramping up infrastructure development to reduce high logistics costs and make Indonesian businesses more competitive). However, Joko Widodo (who is usually referred to as ‘Jokowi’) said on Thursday (28/08) that any fuel subsidy reform will have to wait until after 20 October 2014 when his cabinet is inaugurated. Reportedly Jokowi requested SBY to improve the current account balance by raising prices of subsidized fuels before his term ends but SBY declined on grounds that it is currently not the right moment to raise fuel prices as the recent electricity tariff hike and 12-kilogram liquid petroleum gas (12kg LPG) canisters price hike have already burdened the people in 2014.
Although raising prices of subsidized fuels before October 2014 would come in very helpful for the Jokowi-cabinet and enable it to target for higher economy growth due to improved fiscal room, reluctance of the SBY cabinet to implement such a sudden policy is understandable as it would cause widespread criticism. Reducing energy subsidies entails political and social risks as it triggers demonstrations, public outcry and gives rise to accelerated inflation. If such a policy change is not combined with well organized compensation packages for the poor, then it may lead to a jump in poverty. Currently, about 11.3 percent of the Indonesian population lives below the country’s poverty line. However, a characteristic of Indonesia is that a large number of the population is near poor (about 25 percent of the population), implying that a sudden surge in poverty basket inflation can lead to a rapidly rising poverty figure.
Investors are very concerned about Indonesia’s energy subsidies as these subsidies - when applied long term - tend to distort the economy by keeping all related costs artificially low. At some point, these subsidies cannot be provided anymore by the government and when that moment comes it will cause major economic, political and social turmoil; the longer the wait, the larger the turmoil. Moreover, as domestic crude oil production in Indonesia has been in a state of decline for nearly two decades - while domestic fuel demand has surged over the same period amid robust economic growth - the government has been increasingly relying and dependent on imports of expensive oil. This then seriously burdens the country’s current account balance which has shown a structural deficit since late 2011, mainly because of the oil imports. Recently, Bank Indonesia announced that the current account deficit widened to USD $9.1 billion, or, 4.27 percent of the country's gross domestic product (GDP) in the second quarter of 2014. This widening was much larger than forecasted by analysts and also meant a sharp widening from (a revised) 2.05 percent of GDP deficit recorded in the previous quarter. Generally, a current account deficit below the three percent of GDP mark is considered as sustainable.
Countries that show a wide current account deficit are highly vulnerable to capital outflows, especially in times of international turmoil. Therefore countries like Indonesia and India are expected to be seriously affected by US monetary tightening, unless both countries do their financial homework (and it is also helpful that both countries welcome a new leader that can rely on the support of the investor community). The end of US quantitative easing, which managed to keep US interest rates low, implies an end of cheap US dollars flowing to lucrative (yet more risky) assets in emerging economies. We already witnessed large capital outflows from Indonesia between May and December 2013 when speculation about an end to the US quantitative easing program heightened. When US interest rates are raised in 2015, Indonesia will be affected again. However, the scope of damage will be determined by the Indonesian government's ability to have improved fiscal management (most importantly the fuel subsidy policy issue as it burdens the current account).
Investors were not happy to see Indonesia’s recently announced Revised State Budget of 2015 (RAPBN 2015). This budget allocates IDR 363.5 trillion (about USD $31.2 billion) to energy subsidies, most (IDR 291.1 trillion) of it going to fuel subsidies, and implying that energy subsidy spending accounts for roughly 18 percent of total government spending (IDR 2,019.9 trillion) set for 2015. Jokowi immediately reacted after the publication of the revised budget saying that he believes that these energy subsides, particularly fuel subsidies, are too high and should be reduced to enable public spending on more structural, long-term matters such as infrastructure, education and healthcare. Sofjan Wanandi, Chairman of the Indonesian Employers Association (Apindo), was quoted in Indonesian newspaper Kompas saying that he has received information from Jokowi’s economic advisory team that prices of subsidized fuels will be raised by IDR 3000 (USD $0.26) per liter after the new cabinet has been inaugurated.
Indonesian Energy Subsidies:
in trillion rupiah
For sure, curbing the energy subsidies will trigger public outcry as it temporarily reduces the people’s purchasing power. However, Jokowi now has the chance to make a difference. Instead of seeking short-term popularity, he can reform Indonesia’s financial make-up and target for long-term and higher economic growth as well as social development. However, he will need to present the fruits of his reforms to the Indonesian people within a five-year timespan.