Swallowing a bitter pill

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.