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Indonesia leads on petrol subsidies, but will others follow?

Indonesia leads on petrol subsidies, but will others follow?

The fall in the world oil price has created the opportunity to eliminate petroleum subsidies in a number of Southeast Asian countries. These subsidies have been the long-standing bane of economic reformers everywhere, but until now reducing them involved the deeply unpopular task of raising petrol prices.

But with the 50% fall in the global price of oil since June 2014, the subsidies could be eliminated by the fall in the supply price rather than by raising prices for consumers.

Indonesia illustrates just how sensitive this issue has been: during the 1997-98 Asian financial crisis, the IMF required that petrol prices should rise sharply in order to reduce the budget subsidy, as one of its conditions for providing funding support. The riots that ensued due to the price increase triggered the resignation of President Soeharto in May 1998.

Subsequent presidents have wrestled with the Sisyphean task of keeping the subsidy from overwhelming the budget as global oil prices rose over the past decade.

President Jokowi inherited a budget in which more than 20% of expenditure was allocated for energy subsidies. In November he took the courageous step of raising petrol price by more than 30%, only to find that by the end of the year world prices had fallen so far that, even with the subsidy abolished, nearly half of the November petrol price increase could be reversed. Fortune favours the brave.  [fold]

The case for subsidising petrol in Indonesia has always looked flimsy. Petrol is characteristically consumed by middle- and upper-income groups. Nevertheless, it has proven very difficult to reduce, let alone eliminate. The direct blame rests with an imperfect political process where crass self-interest prevails and opposition parties take every opportunity to be unhelpful. But there is no doubt that this is a 'hot button' issue with the public. Historically, there has been a confused argument relating to Indonesia's role as an oil producer and net exporter: 'the oil belongs to us, the people of Indonesia, and so it should be cheap'. This perverse mind-set lasted long after Indonesia ceased to be a net oil exporter a decade ago.

The biggest subsidies are found in oil producing countries, with Venezuela's US2¢ per litre of petrol the leading example. But many developing economies which are not oil producers also subsidise some petroleum products — usually diesel and cooking energy such as kerosene or LNG. There is some argument for these subsidies on income-distribution grounds. But this policy inevitably runs into the ingenuity of consumers, who find ways to substitute diesel or even LNG for petrol.

Indonesia will continue to subsidise diesel modestly, and kerosene and LNG much more generously. Despite recent tariff adjustments, electricity subsidisation is still an expensive budget item, with the middle- and upper-income groups the main beneficiaries.

The ending of the petrol subsidy is a policy win that fell into Jokowi's lap.

Supporters of policy reform should take more heart from his willingness to take the unpopular action of raising petrol price last November. They might applaud the ending of the subsidy more strongly if the opportunity had been taken to end the authorities' price setting altogether (the price of 'premium' petrol will be set each month, based on world prices), as this would have made it easier to resist restoring the subsidy if world oil prices shift up again.

A truly bold move would have been to keep the price at its late-November level with a tax that could have supplemented Indonesia's inadequate budget. Indonesian budget revenue is only 15% of GDP, and this is expected to fall further. One reason is that Indonesia's own oil production will now be less profitable and raise less tax revenue. Thus the net effect of the ending of the petrol subsidy will be much less than the 200 trillion rupiah (say, US$17 billion) mentioned by the Minister of Finance.

Keeping the price at its higher level would not only have helped revenue, but would represent good policy in response to the substantial negative externalities associated with petrol. Even for non-believers in climate change, a tax would be justified on pollution and congestion grounds alone. A million extra cars and three million extra motorcycles are added to Indonesia's clogged roads every year, and public transport (the only viable longer-term response to this unfolding disaster) needs far more funding.

Still, Indonesia is not unique in being unable to persuade the public of the benefits of expensive petrol. Indonesia's price is now only 20% or so below Australia's, and about the same as in the US. Europe's higher petrol prices have revolutionised the size and technology of cars, but this approach is still a bridge too far for many of us.

Photo courtesy of Flickr user Riza Nugraha.

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