Indonesia subsidizes all sorts of energy costs, and as a result, it has all sorts of unintended consequences. It’s also getting expensive. Mriganka Jaipuriyar, in this week’s Oilgram News column Petrodollars, discusses the hard choices facing Indonesian leaders trying to get a handle on the growing bill for this government benefit.
As the Indonesian parliament debates a hike in subsidized fuel prices, economists are closely tracking the impact of artificially low prices on the country’s current account. Indonesia reversed to a current account deficit last year after 14 years, with the deficit in oil trade blamed for the reversal.
Artificially propped up demand due to subsidies, and falling exports because of declining domestic crude production has led to a surge in Indonesia’s net oil import bill. Net oil imports rose to $20.3 billion in 2012 from $8.7 billion in 2010, according to data from Bank Indonesia, the country’s central bank.
An overshoot in consumption, and hence imports, is the biggest fallout of the subsidized fuel prices in the country, according to Deutsche Bank.
“Structurally, domestic fuel consumption will increase over time, as the economy is growing. The real bane is the artificial consumption [demand for smuggling purposes] that has emerged, given the steep price disparity, and this can be addressed only if the discount gap is closed,” the bank said in a research report published last month.
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Indonesia subsidizes 88 RON gasoline, gasoil and kerosene. The price of 88 RON gasoline and gasoil have been fixed since 2005 at Rupiah 4,500 (46 cents)/liter, against a prevailing market price of around Rupiah 10,000/liter.
Because of the artificially low prices, demand for subsidized fuels has been regularly exceeding their annual quota set in the budget. In 2012, the government set a quota of 40 million kiloliters (251.5 million barrels), but actual consumption was over 45 million kl. For 2013, the quota has been set at 46 million kl, but actual demand is expected to come in at 49 million kl, according to government estimates.
Deutsche Bank said in its report that there is strong evidence of artificial consumption, or export smuggling outside of Indonesia. “We have noticed that fuel import volume increases when the gap between the international fuel price and the domestic subsidized price becomes larger; the reverse holds true as well,” it said.
Indonesia’s oil trade balance reached a deficit of $2.5 billion a month in January and February, representing a decline of more than $1 billion compared with last year, the bank said, adding that a $2.5 billion oil deficit eats into foreign exchange reserves and Indonesia could see a depletion of $1-2 billion per month in its FX reserves.
“We believe the perennial oil trade deficit may continue, as the core problem (fuel subsidy reform) has not yet been properly addressed by the government,” the bank said.
The country’s foreign exchange reserves stood at $112.8 billion as of end 2012, according to the central bank. But had fallen to $104.8 billion as of end March, Moody’s said in a recent report, adding that this implied continued pressure on the balance of payments and in turn on the Indonesian Rupiah.
Without a retail fuel price hike, the oil trade deficit is likely to worsen as consumption picks up, whilst production volume weakens, according to investment bank Morgan Stanley.
The government’s expenditure on fuel subsidies has also ballooned leading to the fiscal deficit reaching close to the legal limit of 3% of GDP. The fuel subsidy budget for 2013 has been set at Rupiah 193.8 trillion, or around $20 billion, but half way into the year and the government has already proposed raising this to around Rupiah 210 trillion.
President Susilo Bambang Yudhoyono earlier this month proposed in parliament a 44% price hike for gasoline and 22% for gasoil. But to soften the blow on the country’s poor—especially ahead of the 2014 elections—said that he would implement the price hike only if parliament approves a cash compensation plan for the poor. A price hike last April was blocked by parliament at the last hour.
This time, however, the government may have no choice but to implement a price increase given that the country’s fiscal deficit is close to exceeding the legal limit of 3% of GDP, the current account is already in deficit and foreign exchange reserves are eroding.
Moreover, the government need not worry about the economy’s capacity to withstand a price hike. As Deutsche Bank put it: “Today subsidized gasoline at Rupiah 4,500/liter is the same price as in 2005, while salaries have risen three to four times. The 100% and 33% fuel price hikes in 2005 and 2008 translated into 7% and 3% incremental costs for the lowest income bracket, whereas this one would be only 1.5%,” the bank said.
“If the previous hikes could be withstood, the economy now should be able to endure an extreme scenario of complete subsidy elimination thanks to the robust economic growth over the last seven years (203% GDP growth in FY05-FY12),” it added.
–Mriganka Jaipuriyar in Singapore