Swallowing a bitter pill

The Indonesian government finally decided yesterday to implement the most painful measures of its economic reform package by raising fuel prices by between 25 percent and 71 percent and electricity tariffs by an average of 20 percent this month and another 20 percent in both August and November.

The government is fully aware that raising the prices of basic commodities after inflation exceeded 25 percent in the first quarter alone and when student demonstrations are gaining momentum is a very big political risk. But the alternative is a deteriorating economy with an exploding budget deficit and the failure of all the painful measures already taken since early this year to stabilize and eventually strengthen the economy.

The price hikes have deliberately been structured on the basis of social justice so that the poor people will feel the least pain. The price of kerosene, the most widely used fuel by poorer people for both cooking and lighting, was raised only 25 percent, the smallest increase of all the fuel products. Likewise, the lowest electricity tariff rise is for small-scale users of electricity and city bus fares for students are maintained at Rp 100 (1.25 U.S. cents) per trip. The basic principle is that the better-off consumers subsidize the low-income ones.

However small the price increases, the move will still inflict a lot of pain on the majority of the people because of the crucial role energy plays in all economic activities. Transportation costs will immediately rise and this will consequently increase the prices of most goods and services. This new wave of price rises is even more painful as it comes at a time when the income of the vast majority of people is on the decline, unemployment on the rise due to massive layoffs by bankrupt companies and the prices of most products have already skyrocketed. All this is due to the impact of the 70 percent depreciation of the rupiah against the American dollar.

The business sector, still reeling from the financial meltdown and the sharp rise in the central bank's benchmark interest rates to as high as 50 percent on April 21 -- which translates into lending rates of 57 percent to 65 percent -- is subject to another devastating shock. Businesses have to increase the prices of their products to offset higher production costs while domestic market demand is being depressed by the economic contraction expected this year. This in turn will increase the risk of more business failures and consequently more worker layoffs and a much higher level of bad debts at banks, most of which can stay afloat only because of huge liquidity injections from the central bank.

Judging from the economic rationale given for the unpopular measure, there is indeed a compelling reason for the government to increase fuel and electricity prices even at the risk of massive social unrest. Without the increase, total subsidies for these two commodities alone will explode to an unmanageable level of Rp 27 trillion (US$3.3 billion) in the current fiscal year and there may be nothing left for subsidizing much more vital commodities such as rice, soybeans and medicines. Faced with such an extremely difficult option, it makes complete sense for the government to opt for fully subsidizing rice, soybeans and basic (generic) medicines while increasing the prices of fuel and electricity in order to cut down subsidies to both sectors to about Rp 8 trillion.

The latest price increases, one of the measures called for by the reform package agreed with the International Monetary Fund early last month, is expected to accelerate the process of regaining public (market) confidence in the prospects of our economy and of stabilizing the rupiah exchange rate at a reasonable level. This is because undertaking the painful, unpopular measure shows that the government and the nation are determined to repair the economy by stopping the massive bleeding (subsidies).

The main question that always arises whenever the prices of basic commodities produced by state companies are raised is whether the companies -- in this case, Pertamina and the state electricity company (PT PLN) -- have maximized their efficiency. For example, there has been a lingering question as to whether such politically well-connected companies as Humpuss, which holds long-term (more than 10 years) contracts for shipping Pertamina's petroleum, petrochemicals and liquefied natural gas, were the most competitive bidders. The government also needs to explain a recent complaint by PLN chief Djiteng Marsudi that he has often been forced to bow to political interventions in the company's project tenders.

More openness and accountability regarding the operations of the state companies, coupled with an appropriate and concrete response to the present demands for the abolition of corruption, crony capitalism, nepotism and implementation of political reform, would help improve the integrity and credibility of the government. This in turn would help create more conducive social and political conditions for the public to bear the pains of the measures and minimize the risk of escalating nationwide social unrest.