Tuesday 11 December 2012

Tackling Jakarta's soaring fuel subsidy

By Salim Osman, The Straits Times, 10 Dec 2012

FOR many weeks, petrol stations across major cities in Indonesia were a scene of chaos as motorists queued up for hours to buy subsidised petrol that had suddenly become a scarce commodity.

There was violence in some regions as tempers flared when angry motorists lost their patience after failing to buy fuel that had been in short supply.

The tension started to ease only last week as additional supplies of the fuel were rushed to the stations by Pertamina after President Susilo Bambang Yudhoyono called for a solution to the fuel shortage.

The fuel crunch occurred because of increased consumption and vehicle sales that spiked demand for petrol. Rushing supplies to the regions is only a short-term measure as fuel shortages are likely to recur as the economy grows.

At the heart of the problem is the availability of cheap petrol, made possible by fuel subsidy that the government has been granting since the 1960s to keep fuel within the reach of poor Indonesians.

A litre of premium-grade petrol or diesel in Indonesia costs 4,500 rupiah or about 58 Singapore cents. The cost of a similar grade in Singapore is $2.09 while in Malaysia, it is RM3 or S$1.20.

While the subsidy scheme makes petrol in Indonesia the cheapest in the region, it has also become a perennial headache for policymakers.

First, maintaining the scheme is costly as the government must set aside at least 20 per cent of the annual budget to pay for a volume of fuel.

In the 2013 state budget passed in October, the government will spend 193 trillion rupiah as subsidy for a quota of 46 million kilolitres of fuel. The value of the subsidy exceeds the combined national expenditure on education (66 trillion rupiah), health care (31 trillion rupiah), and public works (69 trillion rupiah).

The quota provided each year is never enough because of rising consumer demands. For example, the 44 million kilolitres of fuel provided for this year ran out last month. Parliament, the DPR, had to approve an additional fuel quota of 1.23 million kilolitres on Tuesday to meet demand.

The fuel subsidy is also a strain on the budget because of the deficit that it produces.

Second, the scheme distorts the allocation of resources because its intention is to make fuel artificially cheap but at the expense of work on poverty alleviation, health care and infrastructure development.

As fuel is cheap because of the subsidy, there is also no incentive to develop alternative energy sources to fossil fuel. This should raise concern as Indonesia's energy resources, namely oil and gas, are fast depleting.

Third, low fuel price has some unwanted effects. One of them is that people are not deterred from driving around unnecessarily, as they are unconcerned about the volume of petrol that their cars are guzzling. As more cars are on the road, the demand for fuel would go up, bringing about enormous economic costs in managing traffic congestion and the effects on public health.

Another effect of the scheme is the smuggling of subsidised petrol across borders between Indonesia's East Nusa Tenggara and neighbouring Timor Leste where the price of petrol is higher. Hoarding of the low-priced fuel by syndicates for sale later at a higher price is yet another problem.

There has been renewed pressure on the government to rethink the subsidy scheme which is meant to help the poor but benefits the rich far more. This has been proven by many studies which found that the majority of the consumers of subsidised petrol or diesel are high-income households who own private cars, not the lower-income groups who rely on public transport.

As the subsidy bill is expected to soar, the government will be cash-strapped as the scheme will be a drain on the state finances.

Should the government ban high-income earners from buying subsidised petrol and get them to use the more expensive but unsubsidised Pertamax petrol? At present, wealthy Indonesians owning luxury cars are already using unsubsidised fuel because their vehicles can only take petrol of a higher grade than the subsidised premium of only 88 octane. The Pertamina Plus has 95 octane and costs 8,750 rupiah per litre.

As the fuel subsidy is a sensitive issue, doing away with the scheme is not an option for the government as Indonesians are so used to having cheap fuel. At the very least, the government can raise the price of subsidised fuel to cut the surging subsidy bill.

It will make the fuel more expensive and hence rein in demand as consumers will have to shoulder part of the burden of fuel cost while the government saves several trillion rupiah in subsidy cost. The money saved can be used to fund programmes to alleviate poverty and develop infrastructure.

But raising the price of subsidised fuel is not easy because of possible backlash amid mounting public fears of high inflation and higher living costs.

When the fuel price was first raised by then President Suharto under pressure from the International Monetary Fund during the 1998 financial crisis, it aggravated the social unrest which later led to his downfall.

That episode has since haunted successive presidents. President Abdurrahman Wahid raised fuel price once in 2000 but shelved a second round because of possible mass unrest.

His successor, Ms Megawati Sukarnoputri, announced a price hike but rolled it back following public demonstrations in 2003. President Yudhoyono also raised the fuel price in 2005 from 4,500 rupiah to 6,000 rupiah per litre despite public protest but sweetened it by offering cash transfers to millions of poor households to cushion the impact of high energy cost.

But he decided to cut the fuel price to 5,000 rupiah in 2008 and to 4,500 rupiah in 2009 to win back popular support. Dr Yudhoyono shelved a plan to raise fuel price in April because of violent protests that threatened stability.

The issue is now back in the spotlight with an expectation of a new round of price increase to reduce the soaring subsidy bill in the new year.

But with the 2014 elections looming, neither the ruling party nor the opposition would relish the prospect of having to craft a policy to cut fuel subsidy. They may well leave the task to whoever is elected as the new president.

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