TCS Daily

The Case for Cutting Indonesia's Fuel Subsidy

By Christopher Lingle - September 16, 2005 12:00 AM

The Indonesian rupiah has lost more than 5% of its value against the US dollar this year and is at its lowest rate since March 2002. Perhaps the single most important cause of the weakness is the Indonesian government's subsidies on petrol prices. Pump prices are 2,400 rupiah (24 US cents) per liter. The cost of the subsidy now exceeds $14 billion and will constitute about a third of the estimated spending by the central government this year.

With international oil prices at around $65 per barrel, the primary beneficiaries in Indonesia of this largesse are likely to be fuel smugglers and corrupt officials who allow fuels to be bought at low prices locally and sold at higher prices in foreign markets.

Despite high global crude prices, the demand for domestic consumption of fuel remains high. Import costs and opportunity costs have both risen sharply. Because domestic oil output is down due to a lack of new investment, Indonesia has become a net importer of crude and the demand for dollars to fund imports further weakens the rupiah.

Subsidizing the prices of automotive diesel, industrial diesel, and kerosene for industries is a failure of political governance. It places an enormous burden on the state budget and creates opportunities for corruption. Continuing such subsidies will make it difficult for the government to maintain a healthy budget or promote sustainable economic growth. Raising fuel price is actually in the true interests of the vast majority of Indonesians. Failure to do so is a classic instance of politicians choosing political expediency over economic reality.

Reducing subsidies for any goods or services is always a problematic political issue (which should be a good reason for never implementing them). Faced with higher costs in the short-run, politicians inevitably avoid immediate pain even when long-run gains would be substantial. An April 2000 plan to raise fuel prices was scrapped after massive demonstrations against the proposed increases.

But governments must be determined to educate their general public on basic facts to help minimize the inevitable unrest following subsidy cuts.

In this case, the primary beneficiaries of government subsidies on the sale of refined petroleum products (BBM -- Bahan Bakar Minyak) are not the poor. Instead, many of the beneficiaries are those whose income places them well in the middle class or higher and who drive about in large cars.

Furthermore, most of the financial gains from subsidies go to industrial users. While households consume 20 percent of kerosene, the remaining 80 percent goes to industry. Since many of the companies receiving advantages from BBM are exporters, foreign buyers of their products constitute a large but undeserving group of beneficiaries.

In this form, BBM is a form of "corporate welfare" that harms the poor because public funds are diverted from programs that might offer substantially greater benefits to lower income groups, such as improved public transport systems or better schools.

From an economic point of view, there are opportunity losses due to the government not selling refined products at the current high prices. Such sales would yield more dollar earnings and assist in propping up the beleaguered rupiah and strengthening the overall economy.

And then there is the matter of smuggling. The presence of large price differentials in neighboring countries presents a lucrative temptation for smugglers to buy at low, subsidized prices in Indonesia and then sell offshore for considerable profits. These returns are high even when factoring in the bribes that are paid to corrupt officials with Pertamina, the fiscal authorities, customs officials or naval personnel. It is bad enough that smuggling benefits corrupt officials and criminals, but such operations result in Indonesian taxpayers extending a subsidy to foreigners who buy from the smugglers!

Regardless of street demonstrations and denunciations by various groups, steps must be taken to reduce BBM and eventually eliminate it. This will be important in allowing the central government to gain control of its budget by reducing a major source of deficits and mounting debt.

Meanwhile, delaying price increases means that the subsidy burden on the central government will continue to grow. As it is, BBM subsidies for refined petroleum products exceed by almost three times non-BBM subsidies on items like food, electricity, and other items.

Low prices for fuels also have environmental consequences. Much of the air pollution that plagues Jakarta and other large cities arises from low prices that encourage waste and encourage private vehicle use instead of encouraging use of public transit systems.

There is a widespread public misconception that foreign companies are exploiting most of the wealth and profits from Indonesia's oil and gas industry. However, Pertamina takes an average of 85 percent of the profits and some part of these funds disappears through corruption. Allegations have been made that Pertamina and military officials have smuggled subsidized fuels to other countries.

BBM has the perverse effect of rewarding the wealthy, damaging the environment, reducing costs for rich enterprises, and providing benefits to foreigners at the expense of locals!

Professors and students should denounce this corporate welfare and these transfers to the rich that also provide gifts to citizens of neighboring countries. Instead of manning barricades to protest against a reduction in fuel subsidies, time would be better spent finding better ways to spend scarce public funds, increasing economic production and reducing the corruption associated with the fuel subsidies.


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