Indonesian fuel subsidies present primary challenge to Widodo administration

04 Sep 2014

Indonesian fuel subsidies present primary challeng...

The removal of fuel subsidies in Indonesia presents one of the most pressing issues for incumbent President Joko Widodo when he enters office on 20 October. The government faces immense economic pressure to remove subsidies but the move will face vast public opposition, heightening the threat of public unrest during the remainder of the year.

Fuel subsidies are expected to cost the economy USD 31 bn in 2015 – 18 percent of government spending – and they currently contribute to a current account deficit of 2-2.5 percent of GDP. Incumbent President Widodo, popularly known as “Jokowi”, has previously pledged to remove subsidies and invest some of the saved funds in poverty alleviation and development programmes, and many economists have cited the plans as vital to Indonesia’s economic stability. Subsidised diesel and gas have contributed to rapidly rising domestic consumption rates of fuel in the past decade. Indonesia is a former member of OPEC, but became a net importer of refined fuel in 2008 and subsequently left the organisation following a period of declining oil production and high demand for subsidised fuel.

The removal of fuel subsidies faces huge obstacles and will present a major political challenge to Widodo in his first months in office. In August, the rationalisation of subsidised fuel by state-owned Pertamina amid fears over shortages led to panic buying and shortages at some fuel stations. The public response prompted Pertamina to withdraw the policy after several days, illustrating the mismanagement and indecision at the heart of Indonesia’s fuel subsidy scheme. Indonesia operates a quota system for subsidised fuel and current estimates suggest the amount of subsidised diesel will run out in early December, with gas expected to follow suit just two weeks later. The cost of supplementing the deficit of subsidised fuel for the remainder of the year has been estimated at USD 685 million.

It is unclear if outgoing President Susilo Bambang Yudhoyono will cut subsidies before handing over power in October. The move would be a major political boost to Widodo, who will almost certainly face protests if he implements the measures within weeks of assuming the presidency. Yudhoyono’s support would also enable a more phased reduction in subsidies that could be followed by a second reduction in early 2015, potentially reducing the scope for protests. The two held talks in late August over the issue, but it remains unknown if Yudhoyono will implement the subsidy cuts during his last weeks in office.

Past efforts to reduce subsidies have either had an insufficient impact on the economy or have generated mass unrest. In 2013 the government cut fuel subsidies significantly, leading to a 44 percent increase in the price of gasoline and 22 percent rise in diesel costs. Protests were held for a week across multiple cities ahead of the price increase, with demonstrators initiating roadblocks and clashing with police. The extent of unrest was however somewhat dampened by the parallel announcement of mass payouts to the poor as compensation for the prices increases, although the scheme was itself overshadowed by alleged corruption. A global increase in the price of oil, combined with the weakening of the national currency, the rupiah, largely offset the benefit of the cut in subsidies for government accounts. Most famously, price rises in food and fuel in 1998 led to mass rioting that ultimately led to the downfall of the Suharto regime.

Faced by the need to reduce fuel subsidies, Widodo is unlikely to enjoy a ‘honeymoon period’ on coming to office. The decision of President Yudhoyono to implement cuts before the handover of power would be a major political boost but currently appears unlikely, with the two-term president keen to avoid hurting his public image. Widodo cannot avoid the topic and has spoken of his willingness to be “unpopular” in making decisions—as a critical measure for the economy, the subsidy removal will therefore go ahead and will face public opposition. Previous public awareness campaigns over the pitfalls of subsidies have failed to shift public perceptions, and public anger could worsen if the cut in subsidies triggers short-term inflation and rising costs in foodstuffs. Widodo will also face the difficulty of convincing some politicians within his own party, the Indonesian Democratic Party-Struggle, and others in parliament to support the policy, something which could delay implementation and prolong the exceptional capital subsidy expenditure.

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