Part III of IV: Why Indonesia needs further energy subsidy reform

Part III of IV: Why Indonesia needs further energy subsidy reform

The Indonesian government has been hesitant to cut subsidies out of fear of public unrest and political backlash. As domestic energy demand continues its historic growth, however, the economic cost of subsidies may become too great to bear.

The fourth most populous country in the world, Indonesia has long been a haven for steady economic growth and strong investment potential in Southeast Asia. The nation has seen average GDP growth of roughly 6 percent per year since 2008, coupled with a growing population and mature business environment. But with such rapid growth, Indonesia has struggled to meet rising energy demand at home.

Formerly a net oil exporter and OPEC member, Indonesia’s energy consumption increased some 44 percent over the past ten years. In order to shield its large population from shocks in energy prices and keep fuel costs stable, the government levied subsidies on everything from natural gas to kerosene. And while these subsidies have been popular politically, they cause a unique strain on the budget of a nation in dire need of infrastructure investment.

Fuel subsidies cost the Indonesian government at least 7 percent of its budget since 2005, exceeding 25 percent of total outlays in 2009. The Indonesian subsidy regime has pushed domestic oil demand beyond supply, forcing the government to import the majority of its energy from abroad. The nation forewent its OPEC member status in 2008.

Indonesia oil consumption

Since 2003, Indonesia’s oil consumption (bpd) has greatly exceeded its production capabilities. Source: IISD

As discussed earlier in the series, although subsidies are intended to help the poor, the upper and middle classes receive the majority of the benefits. In Indonesia, 90 percent of fuel subsidies went to the richest half of households.

Indonesian subsidies have also contributed to wasteful use of the nation’s most heavily subsidized form of energy: Liquefied Natural Gas (LNG). Demand for LPG grew 80 percent between 2007 and 2012. By artificially setting energy prices so low, the government offers little incentive for investment in new energy capabilities designed to improve efficiency.

To help curb imports, increase energy efficiency and reduce budget stress, the Indonesian government enacted a series of reforms. In June 2013, President Susilo Bambang Yudhoyono cut subsidies, causing LPG prices to rise by 44 percent.

Although the government distributed cash to the poorest residents to help with rising fuel costs, the reforms still proved wildly unpopular. In the run-up to the spring elections, politicians, including Presidential-hopeful Joko Widodo, have denounced them as harmful for Indonesian standard of living.

While a populist approach may help the current Jakarta mayor become president, returning to the status quo will leave him unable to fund projects designed to improve Indonesian transportation and infrastructure.

The Indonesian archipelago encompasses over 17,500 islands, posing unique challenges to a nation experiencing rapid growth. The nation spends just 5 percent of GDP on infrastructure, and has the lowest ratio of road distance to land area in Asia.

Enacting further subsidy reform will allow Indonesia to channel more funds to projects that secure its infrastructure and provide basic services for its growing population. When it comes to cutting subsidies, however, sound economic policy often takes a back seat to domestic politics. Whether this will continue to be the case in Indonesia remains to be seen.

About Author

Rami Ayyub

Rami is an analyst with a US Defense and Space firm, where he works in strategic planning and finance for Civil and Defense programs. He holds Bachelor degrees in Finance and Classical Music from the University of Maryland, College Park.