Widodo Launches Reform Agenda with Fuel Price Hike

On 17 November, Indonesia’s new President, Joko Widodo, announced that the price of government subsidized fuel would be raised by more than 30%. In addition to fulfilling his election promise to reduce government spending, the move also suggests that Widodo is serious about implementing economic reforms that are crucial for the country’s long term growth, even if they are unpopular and may limit short-term economic activity. The price hike is designed to relieve pressure on government finances, narrow the current account deficit through reduced fuel imports, and provide funds for much-needed infrastructure and social spending.

Indonesia’s annual fuel subsidy bill is greater than USD 20 billion, accounting for more than 3% of GDP and about 20% of total government spending. Under the new policy, gasoline and diesel fuel prices were both hiked by IDR 2000 (USD 0.16) to IDR 8500 per liter and IDR 7500 per liter, respectively. The government said that it expects to save more than USD 8 billion in 2015 as a result. Analysts tend to have more conservative estimates, but when combined with the substantive positive impact of falling global oil prices, the savings generated should represent between 1.0% and 1.5% of GDP. The 2015 budget will be revised in Q1 2015 to determine specifics on where the savings will be channeled.

Higher fuel prices will drive inflation up in the coming months and put a pinch on consumer purchasing, but the government announced a series of measures to mitigate the impact on lower-income earners. Moreover, while the new fuel policy will likely boost investor confidence, there is uncertainty as to whether Widodo will be able to overcome political challenges to push further subsidy reform in 2015 if he even has the intention to do so. Lavanya Venkateswaran and Euben Paracuelles, analysts at Nomura, explain:

“There is no doubt that Jokowi’s decision to raise fuel prices is a step in the right direction. However, there are few indications that more subsidy reforms can be delivered next year. If Jokowi were to deliver on his promise to phase out fuel subsidies over the next few years, he would need a credible medium-term plan and a more comprehensive approach to subsidy rationalization. This is so far missing.”

While there is some uncertainty about the prospect of additional reform measures being introduced in Indonesia, Widodo’s big decision to hike fuel prices should have a positive impact on the country’s macroeconomic fundamentals.

Author: Carl Kelly, Economist

Date: December 2, 2014

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