The pros and cons of cutting fuel subsidies

The price of subsidised petrol in Indonesia could rise by up to a third if the government follows through on plans discussed by ministers this week.

Cutting subsidies in an era of rising oil prices would allow the government to spend more on infrastructure – which the country desperately needs – but the cuts are not without risk.

Parliament must be consulted before prices are adjusted, but Agus Martowardojo, finance minister, told local journalists higher prices should be in place by April.

The size of the hikes has yet to be determined, although ministers and analysts say prices could rise by up to Rp1,500 ($0.17) per litre, or around 33 per cent higher than current, subsidised prices.

“The price of oil is not stable – it is still high, and further increases are possible, which would place pressure on our economy and our fiscal position,” said President Susilo Bambang Yudhoyono earlier this month.

Cutting fuel subsidies will save the government money it can divert to building new roads and ports. The government is well aware that inadequate infrastructure has been impeding economic growth – half the country’s roads are unpaved and two-fifths of citizens have no electricity – and last year it pushed through a land reform bill that will enable it to acquire land more easily for public projects.

But the bill must still be implemented and money allocated to new projects.

Last year, the government spent more on subsidies than it did on capital spending, points out Ferry Wong, an analyst with Citi in Jakarta.

Energy subsidies in 2011 accounted for nearly 20 per cent of government spending, she says. Other estimates put infrastructure spending at around 3 per cent of the budget – in part because of the difficulty in acquiring land, an issue the new bill was designed to clear up.

Citi says the government would cut $4.5bn from its budget if the price of petrol went up by Rp1,000 a litre, and $6.7bn if the price went up by Rp1,500 a litre (the highest potential increase the energy minister has mentioned).

Cutting fuel subsidies, however, could create a different problem: inflation.

The Indonesian central bank is one of the more dovish in the region. As the government has cut its growth forecasts for next year amid the global slowdown, the central bank has cut its reference rate to 5.75 per cent, the lowest since it introduced the rate in 2005.

Higher fuel prices could, ahem, fuel higher inflation, economists warn, and the central bank has said it is keeping an eye on the issue.

“Going forward, if there is no government policy to reduce fuel subsidy, inflation is predicted to continue decreasing. Bank Indonesia will be vigilant on the impacts of government policy on energy that may increase pressure on inflation,” the bank said in a statement accompanying its rate cut this month.

How the government will handle the choice between inflation and subsidy reform remains to be seen but, as Citi’s analysts point out, the historical record suggests investors should look forward to a cut in subsidies.

Equities jumped during past petrol price hikes in 2005 and 2008 as investors were optimistic the government would use the savings for infrastructure-related spending, they say. This time, with the land reform in hand, that spending could even start to come through.-by Sarah Mishkin

http://blogs.ft.com/beyond-brics/2012/02/24/indonesia-the-pros-and-cons-of-cutting-fuel-subsidies/#axzz1nJMOdVHy

 

Category: Indonesia