Phasing out fuel subsidy

Automatic monthly fuel price adjustments to Mid Oil Platts Singapore (Mops) quotations and the rupiah's exchange rate seem to be the most economically and politically feasible one of the three alternatives for removing fuel subsidies the government proposed on Monday to the House of Representatives.

This policy would lift fuel subsidies only gradually, thereby protecting the economy from shocking inflationary pressures, and would spare the government 'trouble' with the House every time it wanted to change fuel prices.

The other two alternatives -- altogether increasing domestic fuel prices to Mops quotations and gradual price adjustments to Mops but set in absolute numbers -- would be extremely difficult to implement. Adjusting prices to Mops quotations by one stroke would cause a devastating shock to the economy, while setting price adjustments in absolute numbers would be like shooting a moving target, given the oil price fluctuations.

Under the price-floating scheme, subsidies for regular gasoline and automotive diesel oil will be phased out until they completely end in January, 2007, and those for kerosene will gradually be removed within two to three years. Minister of Energy and Mineral Resources Purnomo Yusgiantoro did not propose a specific date for the introduction of the planned fuel-pricing policy, however October or November have often been cited as the most appropriate launching dates.

The removal of fuel subsidies is one of four major policy agendas President Susilo Bambang Yudhoyono announced last Wednesday to cope with the melting rupiah and rising fiscal deficit. The three other programs cover monetary measures to control inflation -- the responsibility of the central bank -- and further reforms in the overall energy policy and investment climate.

Certainly, setting the prices of fuels at their economic costs will indeed have an immediate bearing on fuel conservation and the viability of new investments in fuel-efficient machinery. However, these measures will not by themselves help develop a more diversified base of energy and reduce the country's vulnerability of being too heavily dependent on fossil-based fuels. Hence, a comprehensive energy development policy, complete with fiscal and financial incentives for the development of renewable energy sources, should supplement fuel-conservation programs to enhance the fuel efficiency of our economy.

A better investment climate--lowering the costs of doing business through improvements in governance practices such as less red tape, less illegal levies, more efficient tax and customs services -- is also more imperative now to offset the additional burdens caused by costlier energy and the higher interests as a result of the tighter monetary policy imposed by the central bank to curb inflation.

Indonesia has performed very poorly in all international ratings of economic competitiveness and always ranks well below all other founding members of ASEAN. Various surveys have shown that overall, businesses in Indonesia bear almost twice the administrative costs and have to struggle through bureaucratic procedures that are twice as arduous as their counterparts in other ASEAN countries.

Increasing our domestic fuel prices, which are now only 40 percent as high as Mops quotations, will certainly exert strong inflationary pressures on the economy, especially because the government is to accelerate the disbursement of more than 70 percent of its 2005 development (investment) budget during the remaining four months.

The central bank will consequently keep tightening its monetary policy -- many analysts even expect Bank Indonesia's short-term benchmark interest rate to rise steadily to as high as 11 percent this year -- and this will impose additional burdens on businesses.

The government, therefore, should reduce its bureaucratic and regulatory costs and step up the battle against corruption to help businesses cut their production costs.

Without significant reduction in bureaucratic and regulatory costs and illegal levies, many businesses may not be able to weather the strong inflationary pressures and higher interest costs within the next few months. This in turn could cause many credits to turn sour, consequently affecting the still fragile banking sector and setting off a vicious circle within the economy.