Indonesia Economy: Fuel Subsidies
British Embassy Jakarta
Parliament approves a revised 2013 state budget which paves the way for cuts to fuel subsidies. But this is a sensitive issue and public protests have already started. 2013 is proving a more difficult year for the Indonesian economy but growth, although reduced, remains strong.
One of the key challenges facing Indonesia’s economy has been the ballooning cost of fuel subsidies, which currently consume around $21 billion p.a. Successive attempts to tackle them have not succeeded. On 17 June, however, parliament finally gave the green light to increasing subsidised petrol prices by 44% (to approx 42p per litre), and diesel prices by 22% (to approx 36p per litre). The new price for fuel was implemented on 23 June.
The economic case for change has long been clear. However, at the same time, through a four month programme of temporary direct cash assistance for 15.5 million households, the Government is seeking to offset the impact of the price hike for the most vulnerable.
The pressure to cut subsidies (20% of the state budget and rising) has grown inexorably in recent months. It has created a hole in the government budget and led to an increasing trade and current account deficit. The price increase should contain the deficit at 2.4%of GDP, and release an additional US$ 4 billion for infrastructure and social programmes. But there are fears about the inflationary impact, which could be as high as 2.5 % and the Bank of Indonesia has increased its inflation target to around 7.5% by end of the 2013. The inflationary spike is expected to be worse as the fuel price increase is now expected during Ramadan, when inflation traditionally peaks.
This decision comes against the backdrop of mounting economic problems. Indonesia, like other emerging markets, saw a sharp outflow of funds in early June (US $1 billion as compared to a net gain of US$ 6.7 billion in the first 5 months), putting pressure on the exchange rate (the Rupiah fell below the psychologically important level of Rp 10,000 to the dollar before intervention) and a 10% decline in the stock market from its peak.
There are concerns here too about the impact of a possible reduction of quantitative easing in the US and downward revisions to global growth. . The Bank of Indonesia has taken pre-emptive measure to dampen inflationary pressures and to support the rupiah. Earlier in June, they increased benchmark interest rates from 5.75% to 6% and the overnight bank deposit rate from 4% to 4.25%. Markets expect further rate rises. Both the rupiah and stock market have rebounded on the back of these increases and news of the approval of the fuel subsidy measures. Increased inflation and tighter monetary policy is nevertheless expected to result in reduced growth. The government is now forecasting GDP growth of 6.2% (down from 6.8% at start of the 2013).
With foreign investors owning 32% of Indonesian government bonds, and 40% of stock market trading undertaken by international investors, the Indonesian economy remains vulnerable to external pressures. These proposed cuts will help maintain confidence but the government will need to continue to reassure the markets that it is serious about tackling structural inefficiencies. That said, the outlook for Indonesia remains enviable. Both the IMF and World Bank predict that by 2014 growth will be back at the higher end of 6%, supported by strong fundamentals.
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