PDI-P has to bite the bullet or face fuel-subsidy bomb
Vincent Lingga ; A senior editor at The Jakarta Post
JAKARTA POST, 23 Maret 2014
The Indonesian Democratic Party of Struggle (PDI-P), so far a staunch supporter of the hugely wasteful government spending on the fuel subsidy, will have to bite the bullet if its candidate wins the July presidential election to lead the next government.
Stubbornly resisting the urgent need to reform the energy policy could set off a fuel-subsidy time bomb, causing fiscal distress and market turbulence and eventually social and political upheaval as well.
The PDI-P would be well advised to realize that its leader, Megawati Soekarnoputri, refused to raise fuel prices a few months before the presidential election in 2004 despite the steep rises in oil market prices, apparently with high hopes of being reelected.
But she lost miserably to Susilo Bambang Yudhoyono, who was immediately forced to increase fuel prices twice in 2005 in the face of an unmanageable fiscal deficit. This simply shows that the wasteful fuel subsidy has nothing to do with gaining voter support because the subsidy benefits mostly private-car owners.
It would be better for the PDI-P, so far seen as the most likely party to win the presidential election, if it drastically changed its stance on the fuel subsidy early in the upcoming deliberation of the draft 2015 state budget that President Yudhoyono will propose to the House of Representatives in mid-August.
The latest World Bank report cites the ballooning fuel subsidy and the big risks of widening trade and current-account deficits, with their multiple ramifications on the rupiah exchange rate and inflationary pressure, as the biggest downside risks to Indonesia’s economy this year and in 2015.
The World Bank estimates that the steady increase in fuel consumption and a weakening rupiah will increase the fuel subsidy to Rp 267 trillion (US$22.6 billion) this year (2.6 percent of gross domestic product), far higher than the Rp 211 trillion budgeted for this year.
The report says that including the Rp 40 trillion in fuel subsidy carried over from last year, total subsidy for this year could skyrocket to over Rp 300 trillion, or more than 3 percent of GDP and almost 20 percent of central government spending.
The amount of the fuel subsidy could even be much higher than the World Bank estimate because average daily oil output this year will most likely be 60,000 barrels short of assumed production in this year’s state budget.
This means that oil imports will have to increase to cover the shortfall, thereby causing a bigger oil trade deficit. This deficit, combined with the $5 billion to $6.5 billion export losses caused by the ban on unprocessed mineral exports, will sharply increase the current-account deficit, setting off stronger downward pressure on the rupiah and stronger inflationary pressure.
The World Bank has suggested two reform scenarios to reduce and control the fuel subsidy along the same idea that Finance Minister Chatib Basri started promoting soon after his appointment last May.
Under the current fuel-subsidy regime, it is the price of subsidized fuel that is fixed (currently at Rp 6,500 per liter against the market price of Rp 11,200)). But the ultimate amount of the subsidy depends on the average oil market price and the rupiah’s exchange rate. Since oil prices and the rupiah’s exchange rate tend to fluctuate wildly, the final amount of the fuel subsidy also tends to increase steeply.
The plan that Chatib has been promoting will fix the amount of the fuel subsidy per liter irrespective of eventual oil market price developments and the rupiah’s movements. Under this regime, the amount of fuel subsidy per liter would not fluctuate along with oil market prices or rupiah rate quotations because it would be the price of subsidized fuel that would rise or fall monthly following oil market quotations.
This plan actually amounts to floating the price of subsidized fuel at market prices as the Megawati government did in 2002 but stopped a few months before the 2004 legislative and presidential elections..
Hopefully, the PDI-P faction at the House will take the initiative to support the stipulation of the fixed fuel-subsidy plan in the draft 2015 state budget, which will be tabled for deliberation in August.
The fixed-subsidy plan should be attractive because the automatic monthly price adjustment would provide policy predictability for the market and the general public, protect the economy from sharp price adjustments and their shocking inflationary pressure.
Yet more politically encouraging is that such a plan would spare the government the wasteful political bickering at the House every time international oil prices fluctuate widely. Past experience shows that any time the government moves to raise fuel prices, irrespective of the amount, there is always political turbulence at the House, not to mention street demonstrations and the temporary shocking impact on general price levels.
Still most important is that floating the price of subsidized fuel at market prices would free the government from being held hostage by the wildly volatile international oil market and remove the fuel-subsidy time bomb from government fiscal management.
However, the uncontrolled fuel subsidy is not only the issues of fiscal and current-account deficit.
The wide price disparity between market and subsidized fuel prices is a big incentive for export smuggling but hinders energy efficiency and conservation.
Yet more damaging in the long term is that the huge subsidy that made fuel prices artificially low has hindered the development of renewable energy, such as biofuel and biodiesel, which has huge potential to grow in the country, already the world’s largest palm oil producer with an annual output of more than 25 million tons. ●