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Economics: Indonesia
Economics – Markets – Strategy
ID: Fingers crossed
• The government’s decision to raise subsidized fuel prices despite looming
elections bodes well. It is another step towards long-term fiscal
sustainability, following the fuel price hike of 2005
• But larger price adjustments will have to be made in the coming months.
Even doubling the price of subsidized fuel prices is likely to leave the
subsidy:GDP ratio above the government’s threshold of 3%
• Until further policy action is taken, the rupiah and other Indonesian market
prices could remain under pressure. The May fuel hike will slow growth
to 6.0% this year. It will also add to already-high inflation; this year
headline CPI will rise to 10.3%, before cooling to 7.2% next year. Such
would provide cause for Bank Indonesia (BI) to lift its (new) overnight
benchmark interest rate by a further 75bps to 9.25% by end-3Q08
• Further fuel price adjustments would mean downward revisions to our
growth forecasts, and higher inflation and interest rate projections.
Nonetheless subsidy cuts should be interpreted as a positive for the
country’s fiscal balance and macro fundamentals and should boost foreign
sentiment toward the country
INDONESIA
Subsidized fuel
prices were lifted
28.7% in late May
Subsidized fuel prices lifted nearly 30% in May
On May 24, the Indonesian government announced for the first time in almost
three years that it would raise the price of subsidized fuel. Prices of fuels used
by households and consumers were upped by an average of 28.7% (fuel for
industrial use is not subsidized), with premium fuel 33% more expensive at IDR
6,000/ltr, diesel lifted by 28% to IDR 5,500/ltr and kerosene by 25% to IDR 2,500/
ltr. The hike in subsidized prices had been flagged for some months, and given
the pressure of higher oil prices on the country’s budget deficit – crude had
touched a new high of above USD 135/bbl just two days prior – an adjustment
in subsidized prices was inevitable.
With the country importing significantly more refined oil than what it exports
in crude oil (almost 60 times more in 2007, to be exact – Chart 1), the rise in oil
prices had made subsiding fuel prices at home increasingly untenable. For example,
our estimates indicate that for every liter of IDR 4,500 subsidized premium fuel
enjoyed by Indonesians, the government was shouldering a subsidy burden almost
twice that, by buying refined oil at world prices and selling the same at home at
subsidized levels (Chart 2).
Had fuel prices not been adjusted, our calculations suggest that this year’s budget
deficit would have come close to 2.2% of GDP, a seven-year high. More significantly,
the fuel subsidy would have amounted to some 3.3% of GDP – the highest since
2005, and busting the administration’s unwritten rule that the subsidy:GDP ratio
not exceed 3%.
But much more needs to be done
So, kudos to the government for making the politically tough decision to lift
subsidized fuel prices - in contrast to the circumstances surrounding the (much
Lim Su Sian • (65) 6878 1740 • limsusian@dbs.com
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