The Jakarta Post
President Joko “Jokowi” Widodo was highly praised nationally and internationally when in November 2014, after only one month in office, he slashed fuel subsidies by 34 percent. And again in January 2015, he drastically reformed the energy pricing policy by virtually floating domestic fuel prices using market mechanisms, thereby saving more than US$15 billion a year for more productive investment.
By just one stroke, Jokowi reduced the high fiscal sensitivity to oil prices and the exchange rate, bolstered budget flexibility and increased the scope for investment in infrastructure, one of his top priority programs.
But such bold reform was simply a piece of cake at that time because, international oil prices had plunged to around US$55/barrel in the third quarter of 2014 from over $110 in January 2014, and falling further to as low as $40 in early 2015. The relatively stable oil price below $50 during the first three years of his rule has enabled the President to accelerate infrastructure development.
But his strong commitment in stopping the hugely wasteful spending on fuel subsidies will be tested as oil prices have been steadily increasing since last year. Oil prices rose to an average of $50 last year, higher than the $45 assumed for 2017 budget calculations, thereby increasing fuel and electricity subsidies to Rp 97.6 trillion ($7.2 billion) or 9.7 percent more than the budget appropriation.
Yet oil prices will likely continue to increase this year because of robust economic growth in developed and emerging economies. Last week, oil prices rose to $60, higher than the $48 assumed for the 2018 budget estimate.
Raising fuel prices this year and next year is politically sensitive ahead of the direct elections in 171 regions in June and preparations for the presidential and legislative elections in 2019. Short-term political objectives may tempt the President to simply allow fuel subsidies to balloon in the hope that oil prices would again fall, thereby avoiding political noise and massive street protests that usually mar fuel price rises.
But such a policy stance would damage the credibility of the government’s reform policy and would plant a fiscal time bomb for the next president. And judging by all political forecasts at present, Jokowi is still the strongest candidate for the next president. Moreover, we don’t think Finance Minister Sri Mulyani Indrawati would agree on such a disastrous fiscal measure and may resort to resigning from the Cabinet if Jokowi stubbornly allowed fuel subsidies to explode to unmanageable levels.
The best compromise, therefore, is to cap the fuel subsidy at a fiscally-sustainable level, even to the point of having to raise subsidized fuel prices by up to 10-20 percent. But this adjustment should be backed up by a better system of targeted cash transfers to those who need them most, as the government has often done.
Doing nothing to cope with the risk of a ballooning fuel subsidy would not only would risk the President losing his most capable and credible finance minister but would also be disastrous for Jokowi’s political future and the longterm good of the country’s economy.