Escaping the fuel subsidy trap in Indonesia

Escaping the fuel subsidy trap in Indonesia

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Date: 20th April 2015
Authors: Dina Khan, CDKN Asia
Type: Feature
Organisation: LEAD Pakistan
Countries: Asia, Indonesia
Tags: subsidies, economic cost, impacts on systems and sectors, infrastructure, renewable energy

Dina Khan, Country Programme Manager, CDKN Asia, takes an in-depth look at President Joko Widodo's attempts at overhauling Indonesia’s politically sensitive fuel subsidy programme. Will he have better luck than his predecessors?

Since taking office in 2014, Indonesian President Joko “Jokowi” Widodo has been busy overhauling the expensive national fuel subsidy programme to free up public funds for development spending. The action has been welcomed by global investors and experts as a step towards stabilizing Southeast Asia’s largest economy and introducing much needed reforms. Ever since Indonesia became a net oil importer in the 2000s, sustaining fuel subsidies introduced during Suharato’s era in the ‘70s has been increasingly hard for government - in 2014 fuel subsidies are reported to have cost the state US$ 21.2 billion, or about 15% of the total budget expenditure

By doing away with a large part of gasoline and diesel subsidy at the start of 2015, Jokowi’s government has reduced its forecasted fuel subsidy expenditure from 166 trillion rupiah to just 17 trillion rupiah (US$ 1.3 bn) for the fiscal year.  The government now adjusts pump prices on a monthly basis in accordance with global oil markets, although diesel has been allowed to retain a subsidy capped at Rp 1,000 per litre.

Dismantling the subsidy programme was always going to be a politically risky move, and attempts by previous regimes to do the same had been met with severe public backlash. Fortunately for Jokowi, the drastic decline in global oil prices towards the end of 2014 created better conditions for policy manoeuvring and enabled the government to remove subsidies without unleashing an immediate negative impact on local consumers.

But it has to be seen how steadfast the new government can remain in its resolve to avoid subsidies when fuel prices start to peak again and drive up the cost of living for voters in Indonesia, likely leading to public unrest. Some reports are claiming that regulators in Indonesia are shielding local consumers from the full impact of global oil price and exchange rate fluctuations by keeping recent increases to domestic fuel rates well below market prices.  If accurate, this would reflect government’s unwillingness to leave prices completely free floating and raises possibility of some of the eliminated fuel subsidies being re-introduced in the future.

What is more important, however, is to see where the funds freed from the subsidy programme ultimately end up.  Decision makers have a long list of pressing development needs to choose from, such as upgrading road and railway networks and other infrastructure, bettering conditions for doing business across the country, creating more jobs, meeting housing needs, and improving the quality and outreach of social services. But building up the domestic energy infrastructure and systems is probably most essential for reducing the country’s dependence on imported oil and truly breaking free from the fuel allowance trap.  Policy planners have indicated that the subsidy be moved from consumption to production (in industry) and more targeted energy coverage (to households).  The real challenge for the government is to find more sustainable and affordable ways of providing energy to millions of citizens scattered across the vast archipelago, while also safeguarding national environmental interests and upholding climate change mitigation commitments announced to the world community.

Increasing the share of renewable technologies in the national energy mix is likely the cleanest and most sustainable development pathway to pursue over the medium to long term. Indonesia’s National Energy Policy aims to increase energy use from renewable resources (including large scale geothermal and hydro) to 23% of total energy consumption by 2025, and limit oil’s share to a maximum of 25%. The targets may be overly ambitious, considering that currently just 6% of energy consumption in Indonesia is derived from renewable resources, but the development direction is certainly the right one

To achieve these shifts in the energy system, large investment in new energy generation and dissemination capacity is needed. The existing policy is based on the expectation that substantive amounts of private investment would be mobilized for driving renewable energy growth in the country, and some enabling fiscal measures have been introduced by the government to build the market for this. But according to an assessment  funded by CDKN in 2014, the small and medium scale renewable energy sector has shown limited growth in response to these measures. The study, carried out by the Energy research Centre of the Netherlands (ECN) found that despite the enabling policies and feed-in tariff system piloted in Indonesia, the sector was not taking off as anticipated. Consultations with stakeholders revealed a number of barriers prohibiting the sector’s growth, including limited access of project developers to appropriate finance and issues of revenue stability.

ECN concluded that tailored measures from the government to provide technical and financial support to key stakeholders (IPPs, banks, project developers, government) can help boost the sector and overcome some of the identified challenges. Among these measures, extending much needed project finance to independent power producers (IPPs) and lowering investors’ risks and costs should be high on the agenda.

This is certainly an area that warrants greater policy attention and should feature on the priority list of government as it decides the re-allocation of funds from the fuel subsidy programme. In the long term, such actions and investments will not only reduce Indonesia’s fuel dependence and expenditure, but will also lead to Indonesia meeting its globally pledged climate targets and gaining recognition as a model Asian economy.

Image Courtesy: Asiapathways

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