In contrast to previous deliberations of bills where disagreements between the House of Representatives and government seemed unbridgeable, politicians seemed generous when they approved an increase to the fuel subsidy in the revision of the 2011 budget.
In fact, the House gave more than the government had requested when it approved Rp 130 trillion (over US$15 billion) for fuel subsidies in 2011, or about Rp 10 trillion more than the government had proposed.
Both sides realized the political sensitivity of the issue and this time agreed there was no room for economic considerations.
It was a highly risky political decision. The government had been considering several options to reduce its spending on the subsidy, ranging from prohibiting the use of subsidized fuel by private cars, to introducing a smart card to control fuel usage.
A price increase, however small, was out of the question. Sensing increasing anger and disenchantment among the public over several unresolved high-profile corruption cases and various other issues, the government shied away from a move to increase fuel prices since it could have led to political unrest.
So, it is final. There won’t be any fuel price increases this year. The current two-tier price system for gasoline — one for the public and one for industries — will remain in place. The impact of this decision, in the absence of effective government control, is predictable. Illegal sales to industries and smuggling are flourishing.
As more and more gasoline is diverted via illegal trade, shortages of gasoline at filling stations are spreading in several cities, mainly in Sumatra and eastern provinces. This has caused massive difficulties for drivers and passengers, as they are forced to wait in long lines and must sometimes stay overnight at filling stations just to get a meager supply of gasoline.
The impact of this problem on the flow of goods in Sumatra is also worrying. In some cases, trucks carrying goods from Java have been forced to wait several days at Merak port because of congestion before making the crossing to Sumatra.
Then, continuing their journey through Sumatra, they also encounter fuel shortages in cities they pass through. This has an adverse affect on economic activities on the island, as disruptions in the flow of goods have worsened.
The illegal fuel trade has also cost the government considerably. Downstream oil and gas regulator BPH Migas has estimated that the volume of fuel smuggled is between 10 and 15 percent of the total consumption.
If this estimate is credible, it means that between Rp 16 trillion and Rp 20 trillion of taxpayers’ money is being wasted each year.
Because of the budget revision, the government will have to set aside an additional Rp 48 trillion for subsidies. The deficit will thus increase to Rp 151 trillion, or 2.2 percent of GDP, compared with 1.8 percent GDP in the original budget. But since the amount of subsidy depends on oil prices, there is a great deal of uncertainty in the outcome of the budget deficit.
This, in turn, could influence the pricing of government bonds, which is why the yield required by investors tends to be on the high side, which also means there are additional interest costs for the government.
The government planned to issue Rp 200 trillion worth of bonds this year, or 73 percent of the total funds that must be raised by the government to meet its gross financing needs.
The impact of not increasing fuel prices is a lost opportunity. Instead of channeling Rp 35 trillion in additional subsidies into social expenditure, infrastructure and other productive investments, the precious fiscal resources will go to waste.
The other victim of escalating fuel subsidy is capital investment that creates additional productive capacity for the economy. In 2008, at the peak of oil prices, fuel subsidy surged to four times as much as capital investment.
Fuel price adjustments in subsequent years have brought down the ratio. But in the revised 2011 budget, although capital expenditure was significantly increased by 85 percent, the amount remains 25 percent below subsidies.
Indeed, without fuel price increases there would be less inflationary pressure and Bank Indonesia would not have to worry about tightening monetary policy. But starting next month, inflationary pressures will increase as Muslims begin fasting during the holy month of Ramadhan.
Food prices have been going up in many parts of Indonesia, and it is likely that inflation next month will surge above the average rates of previous months.
Increasing fuel prices amid increasing food prices could amount to political suicide for the government of President Susilo Bambang Yudhoyono.
In addition to fiscal and economic costs, the fuel subsidy also poses several other problems. Most importantly it is highly regressive, and benefits the rich disproportionately at the expense of the poor.
A National Household Socioeconomic Survey (SUSENAS) found that in 2008 around 85 percent of subsidized fuel was consumed by the top 50 percent of richest households.
Only 17 percent went to the poor and near poor. Translated into monetary terms, this means the rich received an equivalent of Rp 138,000 in fuel subsidy per month compared with only Rp 23,000 per month received by the poor.
The fuel subsidy also distorts investment and consumption decisions that result in other massive economic costs and negative impacts on society.
The subsidy encourages higher fuel usage and wastage and creates traffic congestion, pollution and health problems. If these problems are not addressed urgently, the situation will get much worse.
There are now 60 million motorcycles and 14 million cars using Indonesia’s roads.
As a result of strong economic growth, increasing income levels, cheap loans and access to the fuel subsidy, the number of vehicles has grown enormously over the past few years.
The number of motorcycles has climbed by around 8 million a year, and this year automobile production is expected to increase by 800,000 units.
Consumption of fuel is also escalating, and if the government does not have the courage to curb fuel subsidy, its fiscal sustainability will be put in danger.
That is why the subsidy reforms, which were initiated in 2005 when oil prices reached their historic peak, need to be continued.
The government has come a long way in subsidy reform by reducing fuel subsidy significantly in 2005 and again in 2008, and replacing kerosene, the most heavily subsidized fuel, with LPG in 3 kilogram canisters.
Now subsidy reform has suffered a setback and the government has not given a dateline as to when the subsidy reform will be revived.
The writer is an economist.
