Indonesia's Move To Cut Fuel Subsidy Could Make A Difference For The Country's Economic Future

Analysis

on June 20 2013 5:49 AM

The Indonesian parliament voted to cut a fuel subsidy that would effectively increase gas prices in the country by 44 percent. The move will greatly benefit the country’s economy by cutting its growing budget deficit as well as free up resources for social programs and investment in infrastructure, but as the protests in response to the cut prove, these benefits may come at a high cost to the administration and its people.

Asian countries have long subsidized gas prices. As of late, however, some countries in the region, China and India included, the largest and the third largest oil consumers, respectively, have made moves toward market-based pricing for fuels, Reuters reported.

RTX10QP3 Student protesters wear masks as they rally outside the parliament protesting against the government's plans to raise fuel prices, Jakarta, June 17, 2013.  REUTERS/Beawiharta

Lowering or eliminating subsidies would encourage efficiency and improve economic output per unit of fuel, as such subsidies usually benefit the rich. For Indonesia, at one time Southeast Asia’s most robust economy, the subsidies cost about $20 billion in 2012. The Indonesian government’s statistics show that it spends more on fuel subsidies annually than it does on social programs and capital expenditures combined.

The President of Indonesia, Susilo Bambang Yudhoyono, who brought the bill to cut the subsidy to the parliament, warned that if no adjustment is made, the subsidy could cause Indonesia’s budget deficit to break the legal limit of three percent of GDP this year, according to Reuters.

"We must unite to protect our economy, we must unite to face our problems, and we must unite when the fuel price increases,” the president said in a news conference last week, according to CNN.

In April, Indonesia reported a trade deficit, after exports contracted for 13 consecutive months. If left alone, the country’s economy, which grew 37.5 percent in its best year from 2009 to 2010, could very well be facing a tough time.

While the benefit of cutting fuel subsidy on the Indonesian economy seems immense, in a country where about 100 million people live on less than $2 a day, any small price change could mean a great deal of inflation and see the poor’s lives become even harder, New York Times reported.

Gasoline price will rise by 44 percent to 66 cents per liter and diesel by 22 percent to 55 cents per liter with the subsidy cut. These prices are still much lower compared to prices in China and India. Currently, China’s gasoline costs about $1.08 per liter and $1.12 per liter for diesel. In India, gasoline costs $1.14 per liter and diesel, which is still being subsidized, is 86.6 cents per liter.

No date has been set for the fuel price increase, but economists have warned that when it does take effect, the increase could push inflation to above 8 percent in Indonesia, from 5.5 percent in May, according to Reuters.

The fear of inflation is what kept the government from embracing a price increase for a long time, Didik Rachbini, a prominent economist and a member of President Yudhoyono’s National Economic Council, said, according to New York Times. The last price increase was in 2008.

“If we increase fuel prices for everyone, the price of 15 to 20 basic goods will also increase, such as rice,” Rachbini said. “It would reduce the purchasing power of the poor.”

Already, with the passage of the bill, prices of goods have started increasing in local markets in Jakarta, Indonesia’s capital city, according to BBC News.

"People have been expecting the price of fuel to go up," said Ade, a street vendor who sells fried rice to office-goers in Jakarta's business district. "So already the price of all the basic food like rice and vegetables has gone up too. Also it is the beginning of the fasting month soon -- and prices traditionally go up then too."

As such, to buffer the poorest citizens of the country, the fuel price increase will come with a $910 million cash handout for 15 million poor families, which amounts to about $15 per month for a period of four months, before the price increase to help offset the effect, BBC News reported.

Despite the hard consequences the price increase will have on the country’s poor, it is a bitter but necessary pill for Indonesia to establish a more stable, sustainable economy. The move -- if replicated across other Asian countries, many of which still have a fuel subsidy -- will also affect global economy.

In 2008, when oil surged toward $150 a barrel, consumers in much of Asia were unaffected as the retail fuel prices remained largely steady, according to Reuters. If they had been exposed to the run-up in fuel prices, it might have led to demand destruction earlier, which in turn may have resulted in a milder global recession.

In addition, oil demand from Asia-Pacific has skyrocketed in recent years as nations in the region grew wealthier. The International Energy Agency forecasts Asia-Pacific demand to rise by 500,000 barrels per day in 2013, to 29.9 million bpd, while the rest of the world is expected to boost consumption by a combined 300,000 bpd. Removing subsidies, and ultimately levying taxes on fuel would be the best way to slow that growth down, according to Reuters.

Cutting government spending on the costly subsidy also frees up resources that could be used for crucial public social programs, including health care, as well as investment in infrastructure. These programs will prove to be more beneficial for the Indonesian people and the nation’s economy in the long run.

 

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