The fuel price debate

The fuel price debate

The World Bank's suggestion to the Indonesian government to
increase domestic fuel prices is only one of the fiscal
tightening measures it recommended recently to reduce aggregate
demand and the risk of economic overheating. But given the
central role of fuel in all economic activities and since any
rise in fuel prices has an immediate and direct impact on the
whole population, the suggestion has naturally incited a most
heated debate.

The government and politicians who are geared up for the
general election next year obviously do not see any political
viability in the suggestion which, given the country's economic
condition, actually makes a lot of sense.

However the World Bank has apparently learnt from its
experiences in monitoring Indonesia's policy-making environment
in the past, in that it knows the government has overruled
political considerations in taking bold, yet rational economic
measures. For example, the government increased fuel prices by
17.7 percent and electricity tariffs by 20 percent in mid-July,
1991, only about 10 months before the 1992 general election. Fuel
and electricity prices were raised again by a range of 10 to 27
percent in January, 1993, only two months before the Presidential
election by the People's Consultative Assembly in mid-March.

There are, however, several reasons as to why the suggestion
for a fuel price increase is not seen as critically urgent at the
moment. Indonesia's current economic condition is not as bad as
at the time of the price increases in 1991 and 1993. Moreover,
domestic fuel prices are now, by and large, on par with those in
neighboring countries. In fact, the government expects Rp 827.8
billion (US$355 million) in profits from domestic fuel sales in
the current fiscal year. Even though domestic fuel sales in April
required Rp 54.3 billion in price subsidies because the crude oil
prices averaged $19.21/barrel in April, (much higher than the
$16.50 estimated in the stage budget), the bottom line for the
whole year may still be positive. The fact is that the higher-
than-estimated oil prices will also increase government oil
revenues and these additional receipts can fund any subsidies
incurred.

But we also reckon that the government does not want to risk
either any public upheaval in the run-up to the next general
election or stronger inflationary pressures at a time when it is
trying very hard to keep the inflation rate at the low range of
the single-digit level.

These factors do not, however, reduce the essence and
significance of the recommendation. Instead, the proposed fuel
price increase should be seen in the broader context of the
imperative need to reduce aggregate demand in order to prevent
the current account deficit from exceeding the estimated $8.7
billion, or almost 4 percent of the gross domestic product. The
recommended measures also include the reduction of public
spending on telecommunications and power generation, raising
forestry fees, imposing a moratorium on personnel, raising
property assessments to increase receipts from the property tax,
slowing down the growth of personnel spending and developing
better sources of non-tax revenues, fees for services and user
charges.

The strongest message behind the suggestion for tighter fiscal
and monetary measures is that Indonesia now needs, more than
ever, sufficient capital inflows to finance the big current
account deficit. But foreign capital will keep flowing in only if
the country is able to keep the deficit within a sustainable
level. Any developments, such as higher-than-estimated imports
growth, which will expand the deficit in excess of the tolerable
level will not only discourage further capital inflows but may
also trigger a wave of capital flight. This would have
devastating repercussions.

The message, we think, is quite relevant especially in the
run-up to the coming general election, a period in which many
governments are often tempted to distribute political goodies at
the expense of prudent macro-economic management.