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Jun 19, 2013 | 10:56 GMT

4 mins read

Indonesia Enacts a Controversial Fuel Subsidy Cut

Indonesia Enacts a Controversial Fuel Subsidy Cut
(JALIN/AFP/Getty Images)
Summary

Indonesian President Susilo Bambang Yudhoyono's enactment of a controversial fuel subsidy cut will improve Indonesia's short-term fiscal condition, but additional measures will be needed to shift the country's budget away from wasteful subsidies and toward investment and improving Indonesia's infrastructure and economic efficiency. The cut, approved by the country's parliament on June 17, aims to raise end-user gasoline prices by 44 percent and diesel prices by 22 percent per liter. For Yudhoyono, whose ability to manage complex factional infighting among Indonesia's many political parties has waned in line with the approaching end of his second term, the parliamentary vote is only the first step in a longer struggle. Now he must implement the cut in the face of public opposition, or risk further destabilization of the government's budget and the Indonesian currency.

Fuel subsidies have imposed a serious burden on the national budget, accounting for 14 percent of total expenditures in 2012, a number that can increase dramatically depending on oil prices, as it did in 2011 when subsidies accounted for 38 percent of expenditures. The decision to cut the subsidies has not come without additional costs elsewhere, namely, the $900 million Jakarta promised to provide to 15.5 million low-income families to offset the cut's impact on the poorest 30 percent of Indonesia's population. But for Jakarta, the transfers are a political necessity and minor expense compared with the nearly $20 billion spent on subsidies in 2012, the same level anticipated for 2013 with the subsidy cut in effect. Without the cut, the Indonesian government projected the subsidy bill to hit as high as $29.7 billion this year.

Indonesia's fuel subsidy policies are nearly as old as the country itself. Presidents Sukarno and Suharto both utilized fuel subsidization to support the country's early industrialization and to manage social stability. Throughout the late 1970s and 1980s during Indonesia's oil boom, subsidized domestic fuel consumption was a tolerable expense, easily offset by the country's huge crude production and export revenues.

But resource overexploitation, corruption, waste, inefficiency and finally the 1997 Asian financial crisis and subsequent political turmoil all contributed to stagnant oil production in the early 2000s and declining investment in new exploration and domestic refining capacity. In March 2004, Indonesia became a net importer of both crude and refined products — marking a reversal in which energy shifted from Jakarta's top source of revenue to its single-largest budgetary burden. Indonesia's growing vulnerability to international oil prices was reinforced in 2008, when the price of U.S. light sweet crude jumped to $147 per barrel. This caused Indonesia's subsidy expenses to suddenly boom from a planned $5 billion to $17.6 billion in just a few months.

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Over the past decade, Jakarta has successfully removed most fuel subsidies for large industrial consumers, which account for about 23 percent of total fuel consumption. It has also pushed to reduce subsidies paid to PT Pertamina, the state-owned oil and natural gas company, and break up Pertamina's monopoly over upstream and downstream operations on oil and natural gas. But these reforms, designed to ease the state's budget burdens and raise the efficiency of Pertamina and its subsidiaries, have not done nearly enough to relieve budget pressures created by subsidies for consumers. The latter encourage excessive demand for fuel while limiting the profitability for refiners and retailers. Those subsidies, in turn, have emerged as the single-largest constraint on Jakarta's long-term economic development plans.

As has become increasingly clear in recent years, before Jakarta can direct more of its budget to the longer-term investments that it recognizes as critical to moving the country away from overreliance on raw materials exports and toward domestic industry, it will have to rationalize the country's fuel pricing system and reduce the amount of money funneled into subsidies. But that pits one imperative (long-term economic growth and reform) against another (social and political stability).

Social stability is a perpetual challenge for Indonesia. The collapse of the Suharto regime initiated a long process of political decentralization, and mustering the political will to put economic efficiency over social concerns, or long-term stability over short-term stability, will not be easy. Since 2004, the nation has been remarkably stable compared with previous periods, and Yudhoyono has come closer than any leader since Suharto to mobilizing broad political support. Whether this attempt to make the public budget and fuel sector more efficient stays in force or is abandoned will depend in great part on what happens after he steps down in 2014, since the temptation to use fuel subsidies will still exist, and the ability of future presidents to maintain the same level of national support is uncertain.

The cautious approach to subsidy cuts, using targeted subsidies to specific consumer groups to mitigate the wider social impact of price hikes, has achieved notable successes in recent years. But it has been a slow and difficult process, and even with the latest adjustments it will not narrow the gap between domestic and international fuel prices enough to reduce the budgetary burden, but only to contain its growth. Narrowing the gap enough to free key government revenues for investment elsewhere will require more decisive action if Jakarta hopes to meet its long-term economic development targets and, in turn, reassure international investors of Indonesia's potential for economic growth.

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