Balancing the short and long term in Indonesia fuel subsidy debate

Author: Keoni Indrabayu Marzuki, RSIS

Despite having won the president and vice-president posts respectively, Joko Widodo and Jusuf Kalla will possess little control, if at all, on the formulation of the next Indonesian budget for fiscal year 2015–16. One particular issue that concerns the new administration is the large portion of funds for energy subsidies, particularly fuel subsidies.

To ensure his administration would have more fiscal space to fund new government projects and minimise the budget deficit, President-elect Joko Widodo (Jokowi) asked outgoing president Susilo Bambang Yudhoyono to increase the price of subsidised fuel as his final policy gesture before stepping down. President Yudhoyono turned down the request on the grounds that increasing the price of subsidised fuel would increase the economic burden on the Indonesian people.

Amending the fuel subsidy budget would be an important step towards fuel subsidy reform. The government allocated 300 trillion rupiah (about US$25 billion) to energy subsidies in 2014. Around 80 per cent of the energy subsidy fund, or about 250 trillion rupiah, is spent on fuel subsidies alone. In his proposed 2015-16 budget, Yudhoyono allocated 290 trillion rupiah for fuel subsidies.

The new budget also forecasts a relatively large fiscal deficit: 2.32 per cent of GDP. Finance minister Chatib Basri estimated that by increasing the price of fuel and thereby reducing the subsidies, the government could reduce the deficit ratio to 1.32 per cent.

External influence such as the end of quantitative easing by the US Federal Reserve may negatively affect the rupiah in the coming months. The weakening of the currency would mean that the new administration would have to spend more to buy oil on the international market. Consequently, fuel subsidies may impose a severe burden on the budget.

Fuel subsidies are ineffective. They were initially intended to help the poor access affordable energy supplies. But as the economy grew, fuel subsidies benefited the middle and upper classes instead. The Ministry of Energy and Mineral Resources estimated that around 70 per cent of subsidised fuel is consumed by the middle and upper classes.

Fuel subsidies also hinder much-needed infrastructure development. As fuel subsidies consume about 20 per cent of the state budget, it constrains the remaining fiscal allocation for infrastructure development. Consequently, Indonesia still suffers from basic infrastructure deficiencies in numerous public sectors, including clean water, sanitation, health, public transportation, communication, education and electricity despite the booming economic growth in recent years.

Ultimately, fuel subsidies undermine Indonesia’s energy security by encouraging extravagant demand as fuel prices are relatively low. With Indonesia’s oil production output stagnating, the government would have to import more oil. Dependence on foreign sources renders Indonesia’s energy security vulnerable to supply disruptions and rapid price fluctuations.

In addition, heavily subsidised fuel consumption also undermines Indonesia’s effort to diversify its energy intake, as demand for cheaper fuel will undermine demand for other forms of available energy. Furthermore, excessive consumption could also lead to a supply crisis as it boosts fuel consumption far beyond the allotted quota.

The path to reallocating fuel subsidy funds is politically difficult. First, Jokowi would have to convince the opposition to pass the proposed revision to the budget, which was approved by parliament in September. The government’s coalition would have to secure an additional 20 per cent of parliamentary votes to acquire a simple majority. Golkar and the Democrat Party (PD) would be ideal allies. However, political developments in Golkar, combined with the Indonesian Democratic Party of Struggle’s (PDI-P) rivalry with PD, may have closed this opportunity in the short term.

The infancy of the new administration will also be a challenge. Putting forward such a bold program so early in the life of the government may invite a severe public backlash. Anger would be directed at the PDI-P as the party has always rejected President Yudhoyono’s policy to increase the price of fuel. Such a flip-flop would weaken PDI-P’s popularity in the future.

Ultimately, time is not on Jokowi’s side. The primary concern is how to cushion the poor from the negative implications of expected price hikes. The new administration would have to introduce temporary relief to minimise such impacts. Finding a solution within a tight deadline may be challenging for the administration.

There are a series of steps to enact fuel subsidy reform, but considering the challenges Jokowi faces, it is of utmost importance to develop a plan to cushion the poor from the adverse economic effects.

Direct cash assistance schemes may be a viable short-term option. But such a policy would not tackle the fundamental problem of economic empowerment, as the poor will face the same economic hardship after the cash assistance program ends.

The best solution would be to redirect the fuel subsidy fund into infrastructure development to encourage job creation, thus increasing the purchasing power of the poor. Unfortunately, such a program would take too long to materialise. The new administration would have to find a balance between short and long-term measures to alleviate potential negative consequences.

Most importantly, the public needs to be assured that the fuel price hike does not mean that fuel subsidy funds are being reduced, but rather reallocated into other sectors essential for the people’s social welfare.

Keoni Indrabayu Marzuki is a research asociate of the Indonesia Programme at the S. Rajaratnam School of International Studies (RSIS), Nanyang Technological University.

This article was first published here, as RSIS commentary CP14198.

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