Although it is widely considered to be an ineffective policy, a number of developing countries offer universal fuel subsidies. However, the prolonged implementation of fuel subsidies creates a misallocation of resources as a subsidy targets the fuel rather than the consumer. Consequently, fuel subsidies benefit the affluent more than the poor. A number of countries implement fuel subsidies, including Algeria, the People’s Republic of China, Ecuador, Egypt, Indonesia Iran, Iraq, Malaysia, Nigeria, Russia, Saudi Arabia, Thailand, and Venezuela.
Granado et al (2010) reported that in countries that have subsidized fuel, on average, the top income quintile consumed about six times more subsidized fuel than the bottom quintile. For gasoline subsidies, the top income quintile consumed about 20 times more subsidized fuel than the bottom quintile.
A similar pattern has been found in Indonesia. Indonesia’s Coordinating Ministry for Economic Affairs (2008) reported that the top 40% of households by income consumed 70% of subsidized gasoline. The World Bank (2011) reported that the top 50% of households by income consumed 84% of subsidized gasoline, whereas the lowest 10% of households by income consumed less than 1% of subsidized gasoline. Further analysis using Indonesia’s National Socioeconomic Survey 2010 data shows that the top 5% of households consumed 82 liters of subsidized gasoline per month, whereas the bottom 5% consumed only 1.7 liters of subsidized gasoline per month (Pradiptyo and Sahadewo 2012).
The Ministry of Energy and Mineral Resources of Indonesia (2010) reported that about 90% of subsidized gasoline went to land transportation, of which 53% was consumed by private vehicles, 40% by motorcycles, 4% by delivery vehicles, and only 3% by public transportation. This is clear evidence that by far the majority of the subsidy goes to fuel the vehicles of high-income households, as opposed to public transport, which low-income groups rely on.
The cost of fuel universal subsidies places a heavy burden on the Government of Indonesia’s budget. The fuel subsidy accounted for 22% of the revised 2011 budget, of which Rp130 trillion went on fuel subsidies, and Rp66 trillion went on electricity subsidies. The fuel subsidy accounted for 55% of total subsidies in 2011, much higher than other non-energy subsidies such as food (6%), fertilizer (8%), plant seeds (0.04%), and small-scale credit assistance (0.8%)—Pradiptyo and Sahadewo 2012.
The government always compensates for subsidized fuel at the end of every budget year, regardless of the volume. As a result, every year the realization of the fuel subsidy exceeds the budget. In 2011, the fuel subsidy cost Rp165 trillion (an increase of 27%) and the electricity subsidy Rp904 trillion (an increase of 37%). The value of fuel subsidies exceeded central government spending on education Rp91 trillion (10%), defense Rp61 trillion (7%), health Rp14 trillion (2%), the environment Rp10 trillion (1%), and social security Rp5 trillion (0.6%)—Pradiptyo and Sahadewo 2012.
Political business cycle
The political cycle has kept the government under President Susilo Bambang Yudhoyono from reducing the subsidy. In 2005, the government hiked the price of subsidized fuel from Rp4500 to Rp6000 per liter. However, in 2008, it cut the price to Rp5000. In 2009, ahead of the general elections, the government again cut the price of subsidized fuel to its 2005 level of Rp4500 per liter.
The government has failed to implement a plan to cut the fuel subsidy by 33% in 2012 in the face of strong resistance from students and opposition parties. In response to protests in Jakarta earlier this year, Indonesia’s opposition parties rejected a government plan to cut the subsidy and allow fuel prices to rise. Opponents of the plan believed it would increase inflation and hurt low-income households. The government provided low-income households with a direct subsidy in the form of cash transfers in 2005, but many people who qualified did not receive it and those who were not qualify were provided with subsidies because of the deficient database on low-income households.
By the end of 2012, total fuel subsidies for transportation and electricity may hit Rp300 trillion, or about 30% of the central government budget of 2012. Although Indonesia’s debt to GDP ratio is low (24%), expanding the debt to compensate for the burden of the fuel subsidies may not be a wise policy. Despite the mounting burden of subsidies on the budget, the president and the ruling party appear to lack the will to reduce it.
A reduction of fuel subsidies should be carried out in a way that does not spark a public backlash. One alternative would be to gradually increase the price of subsidized fuel, for instance by Rp500 per year until the market price has been reached, while strengthening the direct, targeted cash transfer system. Another possible strategy would be to offer a better quality gasoline by combining lower-quality, subsidized gasoline with superior, non-subsidized fuel.
With the 2014 general elections approaching, a policy to cut fuel subsidies may not be attractive for the ruling party or the opposition. The fuel subsidy saga has not benefited any political party in Indonesia.
After the 2014 general elections, the new president and the ruling party will face the dilemma of either cutting fuel subsidies to ease the budgetary burden at the risk of losing popular support, or of maintaining subsidies and further straining the budget. Any attempt by the new president to cut the subsidy will be a herculean task that will require great courage. Policy on fuel subsidies will be a huge challenge for whoever wins in 2014. Establishing a credible, well-functioning targeted cash transfer system for low-income households is increasingly an urgent prerequisite for cutting universal fuel subsidies.
References cited in post
Coordinating Ministry for Economic Affairs. 2008. The Government’s Explanation on its Policy in Fuel-Subsidy Cuts and Accompanying Policies. Coordinating Ministry of Economic Affairs.
Granado, J. A. D, D. Coady, and R. Gillingham. 2010. The Unequal Benefits of Fuel Subsidies: A Review of Evidence for Developing Countries. IMF Working Paper. WP/10/202.
Ministry of Energy and Mineral Resources. 2010. Laporan Akhir Tim Subsidi Jenis BBM Tertentu. Final Report: Specific Fossil-Fuel Subsidy Team. Ministry of Energy and Mineral Resources.
Pradiptyo R, and G. A. Sahadewo. 2012. A Growing Pain: An Experimental Approach to Discover the Most Acceptable Strategy for Lifting Fuel Subsidy Scheme in Indonesia, mimeo. Faculty of Economics and Business, Universitas Gadjah Mada, Yogyakarta. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2015279
World Bank. 2011. Indonesia Economic Quarterly: Current Challenges, Future Potential.
Coordinating Ministry for Economic Affairs and Bank Indonesia. 2011. Indonesia Economic Observation 2011-2012: Membangun Sinergi untuk Menghadapi Gejolak Ekonomi (Indonesia Economic Observation 2011-2012: Synergy to Challenge Economic Fluctuations). Coordinating Ministry of Economic Affairs.
Ministry of Finance. 2010. Data Pokok APBN 2005-2010. Basic Data of National Budget of Revenue and Expenditure 2005-2010. Ministry of Finance.
Again, and as I have written so many times in Indonesian Strategic Review, Yale Global, Jakarta Post and many other Indonesian and International journals, tacking consumer subsidies is NOT where the problem lies. It is in PRODUCER subsidies, such as the abusive Production Sharing Contract scheme big oil uses in Indonesia the rest of the developing world. POINT: These ivory tower economists need to tackle corporate largess first BEFORE sticking it to the man in the street!
This post makes all the right arguments, but the question is: will the government have the political will to reduce the subsidy, especially in election season? The president needs to be strong on this and to ride out the inevitable protests. Fuel subsidies can never be justified on environmental or economic grounds.