Fuel Subsidy: Whether, When or How the Government Will Remove It

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“The global economy has entered a new dangerous phase”, said the International Monetary Fund’s Chief Economist Olivier  Blanchard.  Just recently the IMF cut its growth forecasts for the global economy to 4.0 percent for 2011 and 2012. Global economic uncertainties have led to high volatility in financial markets across the world. In Indonesia, Rupiah has shown a quite dramatic drop as foreign investors got rid of risky assets amid fears of worsening conditions in Europe which may significantly affect the Indonesian economy. A fiscal stimulus plan has been on the central bank of Indonesia (BI)’s agenda if things get worse to loosen monetary policies in addition to cutting the benchmark interest rates.

About two months ago discussion on fuel subsidy was headlines at various Indonesia’s news portals. However, this issue’s popularity seems to be taken away recently by the Nazaruddin case, Eid Fitr festive season (where thousands of cars, motorbikes, busses and flooded the Indonesian roads) and some other ‘not so important’ news (eg. Bollywood cops).  Should we expect that the government makes some change in terms of their attitudes to fuel subsidy responding to the worsening global economy?

Professor Christopher Findlay of University of Adelaide interviewed the Indonesian Trade Minister, Dr Mari Pangestu, about the role of fuel subsidy in Indonesia.

Listen to the full-interview:

Dr Pangestu explained that the government has allocated approximately US$ 15 billion for fuel subsidy in 2012. This figure represents almost 9% of the overall state spending. There are at least two ways that the government can do to lessen its fuel subsidy burden. The first way is to provide some measures to restrict subsidised fuel use by limiting consumers who can access to subsidised fuel. The second way is to set a general increase in fuel prices combined with the provision of compensation schemes targeting the poor.

Dr Pangestu argued that the second option seems to be the most efficient one. Restricting subsidies fuel use as in the first option implies that an effective system to distinguish between the poor and the not-so-poor must be in place. During my visit to Indonesia last month, I could easily find banners at every gas station I went to saying “Subsidised fuel is only for the poor”. Yet, the saying seems to only be a ‘suggestion’ rather than a regulation. Some luxurious cars were queing to purchase the subsidised fuel and no officials seemed to bother to ask the owners of those cars to purchase non-subsidised fuel. The Ulema Council (MUI) has already taken a role in ‘educating’ consumers by considering to issue a fatwa stating that using subsidised fuel is unlawful (haram) for Muslims.  It was a controversial move and, at the end of the day, it did not seem to impact on the subsidised fuel use.

Whilst a general increase in fuel prices may be the most efficient option, there are some considerations need to be taken too. The government must ensure that they have compensation schemes to effectively target the poor. Nevertheless, Indonesia is pretty much better off in terms of understanding effective targeting. There have been some high quality studies exploring this targeting issue. For example, thanks to a study by Vivi Alatas of the World Bank and her coauthors (forthcoming at American Economic Review) we now know that a community-based targeting might be a good alternative to income-tested targeting in terms of gaining satisfaction and legitimacy. Based on their study, there seems to be little evidence of local elite capture in community-based targeting, that is a condition where local elites use public resources for their advantages.

Increase in fuel prices also requires socialisation by the government. The fear of social tensions as a reaction of increased fuel prices has always been a concern. The upcoming election in 2014 might also be part of the government’s consideration who struggle to manage the political economy aspects of this decision. Exporters might also be worried that increased fuel prices would further lower their profits on the top of decreasing demand from the global market due to the ongoing global financial crisis. However, Dr Pangestu explained that simulations that her team has done suggest that in the medium-term the impacts of increased fuel prices would not significantly affect the inflation rates.

Looking back to Indonesia’s experience in 2005, Minister Pangestu reviewed that 130% increase in fuel prices at that time resulted 30% drop in total fuel consumption. A gradual increase might offer a better outcome. This would not only be good for Indonesia’s budget strain but also the environment and, as Prof Findlay added, to carbon emission. The removal of fuel subsidy is a good example of how a change in domestic policy can contribute to global environmental solutions.

Whilst so far the Indonesian government still views that ‘raising subsidised fuel prices’ as its last resort, there has been a debate on whether now is the right time to actually increase fuel prices. Let us summarise some of the reasons why the government should act now.

Global energy issues are urgent. The process of economic rebalancing from West to East will potentially create energy supply problems and there is strong tendency that increasing trends in energy prices will continue in the future. The development of technology to provide renewable energy supply does not seem to keep up with increase in energy demand. Continuing fuel subsidy will put further burden on the government’s budget constraint and leave very little incentive to Indonesian people to concern about efficiency and the environmental impacts that their daily activities actually cause.

The government should act by 2012 at the latest if they’re concerned about the political impacts of a decision to increase fuel prices. This would at least give the government two years to ‘control damages’, if any. Furthermore, as energy prices tend to continue to increase, it is politically more difficult to remove energy subsidies. So better to act now.

In the midst of this global financial crisis, the inflation rates are expected to decrease due to weaker demand from around the globe. The inflationary impacts of increase in fuel prices would probably be unnoticeable.

Dear government, please do not hesitate to act. We do not blame you. We just want to point out that you do not seem to provide the right response to this fuel subsidy issue (that’s your No.2 problem).

This article is prepared by Risti Permani.

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1 Comment

Filed under Economic Integration, Energy, Indonesia, Poverty

One response to “Fuel Subsidy: Whether, When or How the Government Will Remove It

  1. Pingback: The The ASEAN-BIS Day 3 (18 November 2011) – More on ASEAN-Japan Relationships | GoLive Indonesia

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