Indonesia's energy subsidy reforms

Long known for maintaining low fuel prices despite its large population, Indonesia has recently begun to take meaningful steps to reform a decades-old policy that has bloated federal budgets and often fallen short of its purported aim of helping the less fortunate. Policymakers in Indonesia, as in many countries around the world, have long seen energy subsidies as a quick and easy way both to appease voters by offering cheaper electricity and fuel, and to entice large, power-hungry industries to invest by offering cut-rate energy prices.

Rising Costs

For such purposes at least, these policies have worked. Yet the rising cost of hydrocarbons in the past decade has also made them increasingly painful. States were forced to allocate an ever-greater slice of their budget towards energy costs or else face the unpleasant prospect of rising domestic prices, thus risking voter ire. Not only do these subsidies eat up valuable state funds, diverting them from other pressing areas, they also help widen the current-account deficit by artificially propping up demand for fuels.

In Indonesia these costs have grown wildly over the past decade. Total energy subsidies jumped more than 163% in just eight years, from Rp113.9trn ($9.4bn) in 2005 to Rp299.8trn ($24.8bn) in 2013, according to the Ministry of Energy and Mineral Resources (MEMR). The bulk of this came from fuel costs, with oil subsidies of Rp210trn ($17.4bn) in 2013 exceeding preliminary estimates of Rp199.85trn ($16.5bn), according to the Bank of Indonesia. This was down slightly on the Rp211.9trn ($17.5bn) in 2012 (estimates had been for Rp127.38trn, or $10.5bn), but far above the Rp45.04trn ($3.7bn) in 2009 and Rp69.03trn ($5.7bn) in 2004.

Besides fuel subsidies, another Rp100trn ($8.3bn) were paid out to subsidise electricity in 2013, bringing the total energy cost to just under Rp300trn ($24.8bn) for the year. The state electricity provider, Perusahaan Listrik Negara (PLN), put the figure even higher, at Rp101.21trn ($8.4bn), or some 40% of its annual revenues of Rp253.41trn ($20.9bn). The power subsidies, like those for fuel, were down slightly on the Rp103.33trn ($8.5bn) in 2012 but above the Rp93.18trn ($7.7bn) the year before. In 2014 the government budgeted for a total of Rp282.1trn ($23.3bn), but actual expenditures have historically outpaced such projections.

Drag On The Economy

These sustained costs act as a significant drag on the country’s economy, and constrain the government’s ability to spend money where it is needed. Subsidies continue to account for a sizeable chunk of state expenditures each year, ranging from 14.7% in 2009 to 27.9% in 2008, according to the Ministry of Finance. More recently, they have consistently made up just over one-fifth of federal outlays, tallying 22.8%, 23.2% and 21.7% in 2011, 2012 and 2013. Energy costs still make up the bulk of these, with fuel subsidies taking up 12.8% of the total budget in 2013; electricity subsidies ate up another 6.1%.

Compounding the financial challenges is a paradox of implementation: corporations and the well-off often benefit more than lower-income groups, the intended beneficiaries. In Indonesia’s case, this was the result of loopholes in the regulations, whereby car-owning middle-class citizens reaped most of the gains. The subsidy also made other types of energy less competitive – particularly renewables – and encouraged commuters to use personal vehicles rather than public transport, further congesting the already traffic-heavy roadways.

Bold Moves

Living up to his reformist reputation, upon taking office in October 2014 President Joko Widodo quickly made subsidy reform a priority. Less than a month into his first term, he acted on his pledge to ease the subsidy burden by raising the per-litre price of subsidised petrol from Rp6500 ($0.54) to Rp8500 ($0.70); diesel prices followed in November, rising from Rp5500 ($0.45) to Rp7500 ($0.62). This move proved short-lived, however: on the first day of 2015, citing the fall in global oil prices, the government reversed course and lowered fuel prices, slashing the per-litre price of Petrol RON 88 (premium) by 10.5%, from Rp8500 ($0.70) to Rp7600 ($0.63), and cutting diesel prices to Rp7250 ($0.60), though keeping kerosene at Rp2500 ($0.21).

More crucial still was a new fixed-subsidy scheme announced on the last day of 2014. This uses separate pricing mechanisms for three different classes of fuel product: specific, designated and general. The first category, which includes diesel and kerosene, still receives a subsidy, but, unlike its precursor, under a fixed subsidy for diesel and a fixed price for kerosene. This allows for much more fluid pricing for diesel, which will mirror global oil prices while maintaining a subsidy cushion of Rp1000 ($0.08) per litre. By contrast, the price of kerosene will stay fixed, and the cost of the subsidy will depend on the spread between market and domestic prices during the year. The scheme’s nuances soon became apparent: as oil prices continued to fall in early 2015, diesel prices sank by 11.7% in the first two weeks of the year, from the Rp7250 ($0.60) per litre set on January 1 to Rp6400 ($0.53) on January 16. Kerosene prices, which are set independently of market forces, remained static at Rp2500 ($0.21) per litre.

The second two categories, designated fuels and general fuels, include premium petrol (RON 88). Special designed fuels include petrol intended to serve remote areas and, though described as non-subsidised, will still receive a subsidy in the form of “distribution compensation” to keep prices in remoter locations more in line with national norms. General fuel encompasses the same petrol but is fully non-subsidised, to be distributed at its full market price in the Java-Madura-Bali area. Much like with diesel, petrol prices sank to Rp7600 ($0.63) per litre on January 1 and then to Rp6600 ($0.55) two weeks later.

Reaping The Benefits

After some fine-tuning, subsidies have come down from their initial levels in late 2014, but the new scheme and lower global oil prices are still expected to have a big effect on the government’s bottom line. In its revised 2015 budget, the Widodo administration proposed lowering the energy subsidy to Rp183trn ($15.1bn), 47% lower than initially proposed. This would free up Rp155trn ($12.8bn), of which 60% would go to infrastructure projects, and increase capital spending by 85.3% to Rp290trn ($24bn), though lower oil prices also curb state revenues. In the final version of the 2015 budget, subsidies were bumped up slightly to Rp212.1trn ($17.5bn), divided among fuel oil, liquefied petroleum gas, biofuels and electricity. For the first three, the government allocated Rp64.7trn ($5.3bn), with another Rp73.1trn ($6bn) earmarked for electricity. Such dramatic overall cuts were a milestone for the country, with non-energy subsidies exceeding energy subsidies for the first time – some Rp74.3trn ($6.1bn) was set aside for food subsidies.

At some point, oil prices will inevitably rise again – indeed, as of early May 2015, they were up by around 50% on three months earlier. It is as yet unclear whether the administration will be able to maintain its policy stance when consumers begin to feel the impact of higher prices at the pump. Should oil prices continue to rise, this will certainly test the decision to remove subsidies.