Eliminating subsidies, convincing the public

David Sumual, Danareksa Research Institute, Jakarta

Hikes in administered prices leading to student demonstrations, higher transportation fares, higher prices of consumer goods, and possible labor strikes. This news was making the headlines at the beginning of 2002. Although political tensions heightened at the time, the pressure eased as all eyes focused on the severe flooding that badly hit Jakarta and parts of Java.

History has now repeated itself in January 2003. This time, however, Amien Rais and several House factions plan to use their interpellation rights to get the price hikes annulled. Again, like in the Indosat case, these politicians have not come forward with any alternative solutions.

However, such political maneuverings are by no means unusual since the politicians need bullets to shake the credibility of their political opponents ahead of the 2004 general election. And it is worth remembering that the majority of the parliamentarians had previously agreed to the government's plan to cut subsidies in the 2003 state budget.

But such political maneuverings can be very dangerous. Fuel subsidies are a politically sensitive issue especially for urban inhabitants in Jakarta and Java, as well as middle-income households and the spoilt industrialists that have long been accustomed to generous subsidies.

Benefiting from their proximity to the central administration, they have a strong political bargaining position. The situation is worsened further by the negative bias of the media, which seeks to blow up the issue for the sake of attracting readers.

Nevertheless, the complaints are understandable given the government's half-hearted efforts to eradicate corruption and the lack of efficiency gains at the state-run oil, telecommunications and electricity companies -- respectively Pertamina, Telkom and PLN. The general public feel a sense of injustice with the government's policy of letting bad conglomerates off the hook, since there is no guarantee they will not repeat their past mistakes again in the future.

However, the courage of President Megawati Soekarnoputri to push through with such a policy is not without calculation. Security conditions are more conducive now that the government has clamped down on extreme groups in the wake of the Bali bombings, the Cabinet has been more cohesive, international support has been more apparent, and, most importantly, the military has assumed a greater role in improving the national security conditions.

Meanwhile, in terms of strategy, the government has also learnt its lessons. In 2000, the postponement in fuel price hikes doubled its inflationary impact in that year. First, thanks to the psychological effect and opportunist traders, the postponement in hiking the fuel prices in April caused the April- May inflation rate to reach 1.9 percent.

Yet, when the government finally increased the fuel price in October by 12 percent on average, the September-October inflation reached 2.5 percent. As a result, the postponement in the fuel price hikes pushed the 2000 inflation rate even higher.

Then, in August 2001, the government raised fuel prices by 30 percent, causing August-September inflation to reach 3.8 percent. However, because the government raised the other utility tariffs at a different time, the effect on year-on-year inflation was relatively high (12.5 percent in 2001).

In 2002, the government raised fuel prices, telephone tariffs and electricity rates at the same time by 22 percent, 15 percent and 6 percent respectively. As a consequence, the January- February inflation rate reached 3.5 percent. However, the rupiah appreciation, steady flow of rice imports and good monetary management by BI meant that the 2002 y-o-y inflation rate was less than expected at only 10.0 percent.

The Central Bureau of Statistics' social-economic survey shows that the fuel subsidy tends to have an urban, middle income and Java bias. As generally known, most Indonesian oil comes from outside of Java (mostly rural areas), while most of the people who enjoy the subsidies are those in Java and urban areas.

We also know that those who benefited from Bank Recapitalization and SBI (monetary stabilization program/higher interest rates) are middle-income individuals and conglomerates.

Besides helping to reduce the smuggling of fuel, the removal of fuel subsidies will divert funds from Jakarta to the relatively underdeveloped regional provinces and also the underdeveloped oil producer provinces that had been sacrificed for more than 30 years (for more than 30 years their income went to urban and middle income groups who mostly live in Jakarta and urban areas).

Concerns that consumption as the main driver of Indonesian growth would be hampered are also unreasonable. Private consumption should not be hurt, since what is happening is essentially a shift in consumption from Jakarta and Java to other provinces and to the poor, as well as for education, small enterprises credit and health.

The government has provided Rp 25 trillion in compensation funds. And if these compensation funds are audited and supervised correctly, then the poverty figure, which has been on a downward trend from 22 percent, and 19 percent to 17 percent, will fall to just 13 percent next year.

Especially for industrialists, the subsidies have spoilt them and restricted their creativity. The New Order's intention to support industries and conglomerates to gain market share by giving fuel subsidies had failed even before the economic crisis hit the country. They lost competitiveness to Vietnam, Malaysia, Thailand and China.

Moreover, we must also consider other Indonesian alternative abundant energy resources such as coal and gas, since Indonesia will be a net oil importer in 15 year's time. In addition, a petroleum subsidy does not support energy conservation efforts. With the relatively lower oil price, people are not encouraged to use oil energy wisely.

Therefore, the government must reassure the people that it is working for their interests at heart, and not the interests of the powerful and privileged. The extent to which the government can convince the people that it is willing to take decisive action on those troublesome conglomerates will calm the people down. The people are ready to make sacrifices, but it depends on the government to ensure that justice is done.