Higher oil prices and Indonesia's political stability

Higher oil prices and Indonesia's political stability

Jusuf Wanandi, Jakarta

It has been a traditional reaction in Indonesia that some
protest is going to happen every time higher oil prices are
announced. If paired with other very negative political
developments, as happened in 1965 or 1998, when the legitimacy of
President Sukarno and President Soeharto were at their lowest,
the protests could have serious implications, and in those two
cases, they did in fact lead to a change of regime.

That is why the Susilo Bambang Yudhoyono government's drastic
reduction of subsidies has been a brave act. Only a major cut in
the subsidies could have brought fuel prices up to the market
level in the near future. This is critical to building a healthy
economy in the future.

The policy of subsidizing oil-based fuels was adopted as
Indonesia was an oil-producing and exporting country, and the
subsidies were meant to alleviate the burden on the public from
higher oil prices. It was also adopted to some extent for
populist reasons.

The subsidies have been taken for granted by the people. It
was never easy for the government to take back what it had given.
All governments after Soeharto have experienced and worried about
the effects of mass protests. As a result, the subsidies have
been compounded, particularly as a result of high international
oil prices. Indonesia has become an oil importing country since
2004, and domestic consumption has continued to grow rapidly.

If we include LNG exports, Indonesia is still a net energy
exporting country, but the surplus only stands at one billion
U.S. dollars.

In the meantime, because of the three-fold increase in oil
prices from a little above the US$20 per barrel mark to over $60
in mid 2005, the projected subsidy spending for 2005 increased by
more than 50 percent, from $8 billion to $14 billion. That means
50 percent more than the whole of the development budget of
Indonesia, amounting to around 25 percent of the total budget.
That is definitely unsustainable as there is no additional income
to cover the increase available unless we amend the budget to
take money away from education and health. This is undesirable as
the allocations on these areas are already minimal. If subsidies
are not cut, overall macroeconomic objectives will be endangered
because of the ensuing higher budget deficit. The government must
also adopt a set of other policies designed to promote
conservation, the development of alternative resources and
increased production of crude and refined products.

Discussions over the past three months or so, involving most
economists, Indonesian and foreign, showed that there was no
alternative than to start cutting the subsidies.

The private sector, despite its complaints about the sudden rise
in the price of diesel for commercial use in March, has supported
the policy too, because it realizes that the sector will suffer
greatly from a collapse of the economy. They are trying to hold
on as long as possible.

For the poor, estimated at about 15 million households,
compensation payments will be provided to assist them in dealing
with the higher prices, especially of kerosene and diesel.

Kerosene was not affected by earlier subsidy cuts as it is the
main source of energy for the poor (especially for lighting).
Thus, it was being sold at Rp 700 per liter, about a third of its
price in the Philippines.

At this juncture, the successful implementation of the
compensation scheme will be critical for the success of the
government's program of cutting subsidies. This is not only
because it is the poor who are most effected by the removal of
the subsidies, and their needs are desperate, but is also due to
the public sense of justice. And if this is attended to
seriously, opposition to government's policy from the poor and
the desperate can be alleviated. And even the opposition from the
middle and upper income brackets will be lessened. Other
immediate actions are also important, especially to rid
Pertamina, PLN and the Department of Energy of corruption.

The cuts of over 80 percent in the fuel subsidies on average
were meant to gradually bring prices up to market levels over the
next one or two years. The big distortions in energy prices in
Indonesia have also wreaked havoc in other fields of the economy.

The policy of reducing fuel subsidies is serious surgery on
our economy and as such will have other impacts and side effects.
Inflation will increase, perhaps to between 12 percent and 13
percent. It will also cause strains for the private sector as it
struggles to adjust to the new prices of fuel and higher costs of
production. Therefore, the government must do its utmost to
eliminate the many other factors that lead to a high-cost
economy, such as excessive bureaucracy, corruption, over-
taxation, etc. For the rest of this year and next year, the
public will have to tighten their belts. But there is no other
alternative to this. In the mid to long term, starting in 2007,
Indonesia can look forward to much healthier and more sustainable
economic growth, which will benefit the Indonesian public at
large.

The writer is co-founder & member of the Board of Trustees and
a Senior Fellow at the Centre for Strategic and International
Studies (CSIS), Jakarta.