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President Joko Widodo on 17th November 2014 formally made public his government’s plan to deliver much-anticipated cuts to fuel subsidies. As detailed during a press conference at the Presidential Palace, fuel subsidy reform is to entail a 2,000 IDR hike to subsidized gasoline and diesel - effective immediately - with prices rising to 8,500 IDR per litre for the former and 7,500 IDR per litre for the latter.
Indonesia is expected to save upwards of 100 trillion IDR in 2015 through this course of action, freeing up a greater proportion of the revised state budget to programs and projects in dire need of investment. Developing infrastructure, education, and healthcare are thought to be among Mr Widodo’s immediate priorities, and should see greater government funding as a result of lower public spending on fuel subsidies.
As speculated in an earlier business update shown in full below, a 2,000 IDR increase in subsidized fuel price is projected to have a substantial effect on inflation in the short-term. Finance Minister Mr Bambang Brodjonegoro during the press conference said that the hike would likely push inflation up to 7.3% this year (inflation at the end of October stood at 4.83%).
Indonesia’s newly-inaugurated president, Mr Joko Widodo, during the election season made clear his priority of enacting fuel subsidy reform. Having built a political platform on the promise of ambitious social welfare programs and infrastructure projects, Mr Widodo now faces the challenge of delivering cuts to Indonesia’s longstanding fuel subsidy program to fund these initiatives as well as tackle a current account deficit largely driven by oil imports.
Given the importance of fuel subsidy reform to the perceived success of Mr Widodo’s first 100 days in office, market speculation has shifted from the actualisation of this change in policy to the specific details of its expected implementation. Moreover, attention is now rightly being paid to industries most affected by impending fuel subsidy reform, and its impact on the business landscape in Indonesia.
Latest reports from Mr Widodo’s inner circle indicate that the new administration has set its sights on raising subsidized fuel prices by 3,000 IDR. For gasoline, this would mean a 46% increase from 6,500 IDR per litre to 9,500 IDR per litre. The price of subsidized diesel, meanwhile, would jump by approximately 55% from 5,500 IDR per litre to 8,500 IDR per litre. This increase would outstrip Indonesia’s most recent fuel price hikes of 33.3% and 30.6% in 2013 and 2008, respectively.
Until formally enacted, it remains to be seen as to whether fuel subsidy reform under Mr Widodo will involve such a substantial price increase. Certainly, there have already been calls led by opposition lawmakers to limit the hike to 1,500 IDR per litre. As explained by Mr Widodo’s economic adviser, Mr Arif Budimanta, in an interview with the Wall Street Journal, there exists a lack of clarity in the current budget in regards to the government’s ability to raise subsidized fuel prices without approval from the opposition-controlled parliament. Estimates for the expected price increase have therefore fallen with a broader range from 2,000 IDR per litre to 3,000 IDR per litre.
Assuming a 2,000 – 3,000 IDR per liter increase in price, the reform of subsidized fuel policy under Mr Widodo’s administration will have both an immediate and lasting impact on business in Indonesia. Among the industries most likely to be negatively affected in the short-term are those in the automotive and property sectors, on the back of a rise in the benchmark interest rate necessitated by high inflation (See Indonesia’s Automotive Industry and Property in Indonesia: Overview). Bahana Securities in its 2015 Equity Research Compendium projects inflation to rise to 8.38% following a 2,000 IDR per litre increase in subsidized fuel price – a marked jump from the 2015 base level (without a fuel price hike) of 5.5% and nearly double the 4.53% recorded in September 2014.
For their part, Bank Indonesia has intimated that it would be able to maintain the benchmark interest rate at 7.5% should subsidized fuel prices rise by 2,000 IDR, but this is contingent on a much more optimistic estimate for Indonesia’s inflation rate post-reform. Coupled with the US Federal Reserve’s expected changes in monetary policy, greater inflationary pressure from the proposed fuel price hike has Bahana Securities’ analysts forecasting a jump in the benchmark rate to 7.75% as of Q2 2015.
In addition to interest rate sensitive sectors such as the automotive and property industries, other areas of business set to suffer in the immediate aftermath of fuel subsidy reform includes all industries heavily reliant upon logistics and transportation. Already contending with the highest logistics costs in the region (See Indonesia’s Logistics Sector), business in Indonesia will need to bear the burden of higher fuel prices in moving their goods across the archipelago.
At particular risk are fledgling industries such as e-commerce that are dependent upon the cost-effectiveness of services such as door to door delivery (See E-commerce Incoming; An Industry on the Rise). Already faced with challenges such as building trust in a market still not fully accustomed to buying goods online, e-commerce companies can ill afford to try to pass on higher fuel costs to customers. This is not to mention the negative impact of inflation on consumer spending in an economy whose growth has been fuelled by an active consumer base.
The hit to consumer spending and a rise in transportation costs are not expected to outweigh the positives to be gained from a cut in fuel subsidy spending, and the subsequent allocation of funding elsewhere. If implemented as early as November 2014, fuel subsidy reform as proposed by Mr Widodo’s team would save the government 10 trillion IDR this year and 141 trillion IDR in 2015, bringing down the proportion of total government spending on fuel subsidies from the planned 13% to 6.7% (The Wall Street Journal, 20/10). Spending on fuel subsidies, should reform not take place, will reach a record 290 trillion IDR in 2015.
Fuel subsidy reform will see greater funding allocated to addressing infrastructural bottlenecks that are to blame for the aforementioned prohibitive logistics costs. The expedited development of efficient port facilities in creating a sea toll will alleviate some of the added cost of higher fuel prices. This is particularly true for the growing number of businesses gearing up to reach out to areas beyond the main island of Java that are now presenting major opportunities in their own right (See Indonesia’s Economic Potential: A Look Beyond Java).
Greater investment in railway infrastructure will also serve to benefit businesses in Indonesia, as this mode of transportation has quickly gained steam as a smarter way to transport natural resources such as coal and crude palm oil across the country (See The Missing Link: Investment Opportunities in Indonesian Railways).
Much is to be gained by Indonesia through a more efficient allocation of its budget and a move away from fuel subsidies that disproportionately benefit the middle class as opposed to the lower class segment for which the program was intended. In addition to freeing up money to fund social welfare programs and infrastructural development, the country should also prosper from the positive perception of fuel subsidy reform among foreign investors. As a long-overdue change in policy, fuel subsidy reform will reassure overseas entities of Indonesia’s commitment to facilitating business opportunities as well as see the country shed some of its most worrying shortcomings. Such a move has the potential to encourage not only direct investment, but also investment in Indonesia’s rapidly expanding capital markets (See Indonesia’s Capital Markets).
Fuel subsidy reform will also go a long way to setting the stage for Mr Widodo’s Indonesia, as the first major test of the new president’s term in office. Delivering on this promise, despite its running counter to his and his party’s populist leanings, will stand as a key milestone in the evolution of a country no longer willing to rest on its laurels in pursuing economic growth and social development.
Global Business Guide Indonesia - 27th October 2014
Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)
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