Leadership change ignites Indonesia’s fuel crisis

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As incoming Indonesian president Joko “Jokowi” Widodo prepares to take the reins on October 20, speculation is growing that the way in which he tackles cutting the huge fuel subsidies may come to define his presidency.

Widodo promised in his election campaign to abolish fuel subsidies within four years, but a slowdown in economic growth and exports suggest the new president may face more immediate pressure to remove subsidies costing the country around $20bn, or a fifth of its budget, every year.

Speaking in Jakarta on October 1 at a book launch, vice-president-elect Jusuf Kalla said the subsidies had deprived the last government of resources to finance more productive activities that could help improve incomes.

But while Widodo’s ruling Indonesian Democratic Party-Struggle (PDI-P) has indicated it might hike the price of fuel by as much as Rp3000 ($0.24) per litre by November, the PDI-P isn’t united behind change. Lawmakers have said that Widodo is not paying attention to the political risks behind the subsidy cut.

Public anger

The issue of fuel subsidies is extremely sensitive. The figure has tripled over the past four years and eliminating it would cause a sharp increase in the price of fuel and anything shipped by road, from food to consumer goods, risking a wave of protest. Violent protests erupted in 2013 when the government, led by outgoing President Susilo Bambang Yudhoyono (SBY), raised prices by 33%.

Petrol in Indonesia costs around $0.54 cents a litre but it pays overseas fuel suppliers around Rp11,500 ($0.98) per litre. The problem has been compounded by a middle class boom that has led to a surge in car sales, with these expected to total about 1.2m in 2014.

Observers say that given the reliance on fuel, Widodo needs to time any changes carefully. The challenge will be to raise fuel prices high enough to narrow a current-account deficit that is making Indonesia vulnerable to capital outflows.

“It is not [an] exaggeration to say that the way the new government addresses the runaway fuel subsidy will be the litmus test of its economic management and policy-making capability,” wrote the Jakarta Post in an editorial. “Reforming the fuel subsidy system will inflict some short-term pain … [and] the new government should conduct a nationwide information campaign to prime the public on the benefits of the fuel reform.”

The SBY government took some measures to prime public opinion on the issue of subsidised fuel, including public awareness campaigns stressing that the main beneficiaries of cheap fuel were the middle and upper classes that drive cars and use air conditioners.

Some critics say a short, hard shock is the best method – at least for the rise planned in November.

"Doing the increase all at once by Rp3000 per litre is better," Norico Gaman, head of research at BNI Securities in Jakarta, told Reuters. "To do the increase by stages will only prolong the inflationary pressures."

Weakening economy

Finding the right time to broach the subject could be difficult in the current climate. Real GDP growth slowed to 5.1% in the second quarter from 5.2% in the first quarter and 5.8% in 2013 amidst declining exports and a slowdown in investment.

"Furthermore, the US Federal Reserve is expected to raise interest rates in 2015, which could spark another round of capital outflows, leading to a weaker currency and tighter monetary policy,” said QNB economists in an analysis published at the end of September. “This would have a negative impact on domestic demand. Indonesia’s short-term outlook is therefore bleak”.

However, most economists agree that the fuel costs are too large for the economy.

"Investors will be happy to see higher prices for subsidised fuels in Indonesia, especially if the new Jokowi-led government will use the new available funds for economic and social development (for example infrastructure, education and health care)," said Indonesia Investment in an analysis piece.

While Widodo’s cabinet has said it has five unspecified options for the rise, economists at Morgan Stanley, ANZ, PT Bank Mandiri and DBS Group Holdings have all predicted that the new government will raise fuel prices by between 15-30% in early 2015.

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