T

he Indonesian government needs to redirect spending from the fuel subsidy to public investment to accelerate growth and make it more sustainable and inclusive, the World Bank said in its latest quarterly report published today.

With the recent upward trend in global oil prices, Indonesia’s budget deficit could range between 2.5 and 3.1 percent—nearing or even surpassing the 3 percent threshold allowed by law—if the government did not raise subsidized fuel prices this year to ease strain on the state budget, said Shubham Chaudhuri, lead economist for World Bank Indonesia.

Fuel subsidies were “fiscally unhealthy”, but beyond that, there were “opportunity costs” for infrastructure development, education spending and social safety nets, he added.

“Even without global oil prices going up, fuel subsidies still need to be cut because there are other developmental needs. So, it’s not only about protecting the budget, but also about creating faster and more equitable growth,” Chaudhuri told a limited press briefing on Tuesday.

The House of Representatives has passed a bill that allows the government to raise subsidized fuel prices from Rp 4,500 (50 US cents) per liter, but only if the benchmark of Indonesia’s Crude Price (ICP) six-month average is above 15 percent of the assumed $105 per barrel ICP in the revised 2012 state budget.

In the past six months, the average ICP stood at $116.5, or almost 11 percent higher than the state budget ICP assumption, with economists estimating that the price deviation would reach 15 percent by May at the earliest — allowing the government to raise subsidized fuel prices by June.

“Our projection, given the ICP tracking of Brent futures [global oil prices], is that by June or July we expect the threshold to be breached,” Chaudhuri said.

Politics, however, still plays a big role in the fuel subsidy policy, because the plan has proven to have caused social unrest, with tens thousands of people protesting against it across the country, disrupting the ruling parties’ popularity.

“Politics shifts very quickly in Indonesia. Take a look at the government’s behavior in the past few years. The hike depends on whether the government wants to take the risk or not,” said Wijayanto, managing director at Paramadina Public Policy Institute.

Fitch Ratings, which gave an investment grade credit rating to Indonesia last December, said the momentum for reform, including for the subsidized fuel policy, was “likely to stall between now and the 2014 presidential election”.

“We noted how the informal build-up to the 2014 election had begun, potentially slowing governance as well as economic reform measures that could strengthen the credit profile over the long term,” Fitch said in a statement released on Tuesday.

The government previously proposed to raise subsidized fuel prices by 33 percent to Rp 6,000 per liter — a plan blocked by the House — potentially leading to higher inflation. Without an increase in subsidized fuel prices, inflation expectations have begun rising over the plan, with the World Bank estimating a 5.2 percent increase in the consumer prices index (CPI) by 2012’s end. Inflation may rise further to 8.5 percent if subsidized fuel prices increase according to the government’s proposal, the Bank’s report shows.