Phasing out fuel subsidy

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.