FOCUS : INCREASES IN FUEL PRICES, INFLATION RATES AND INTEREST RATES

INDONESIAN COMMERCIAL NEWSLETTER

May 2008

FOCUS

INCREASES IN FUEL PRICES, INFLATION RATES AND INTEREST RATES

The new surge in the prices of crude oil hitting an unprecedented level of more than US$130 a barrel has forced the government to break its earlier promise not to raise the fuel prices (BBM) this year.

The 2008 state budget, after repeated revisions, was calculated on an assumption that the oil price will average US$ 95 a barrel. Based on that assumption, the subsidy on fuel prices is Rp 126 trillion.

However, the prices of crude oil has continued to scale up and in May it crossed the level of US$ 130 a barrel. Without raising the fuel prices, the subsidy will swell to Rp 190 trillion. The subsidy would have widened the already large budget deficit that could disrupt all targets in the state budget. Under the Law No 16/2008 on 2008 state budget already sanctioned by the House of Representatives, the fuel prices subsidy is set at no more than Rp 135.1 trillion, which means the government has to take a measure such as by raising the fuel prices if the subsidy is to be kept within that limit.

Table - 1

Developments of fuel subsidies

(Rp billion)

Year Fuel subsidy Total subsidy

2005 89,194 119,095

2006 62,735 107,627

2007 56,261 105,153

2008 126,816 234,405

Source: Finance Ministry, ICN

Further increase in the fuel subsidy would have to be at the expense of subsidies on other sector including subsidy for poor families.

Finance Minister Sri Mulyani Indrawaty said middle to high income people rather than low income members of the community have gained more from the fuel subsidies so far. A large portion of the subsidized fuels are used by cars of higher income people, the minister pointed out.

The budgets set by the government for programs to help low income people such as food aid and small business credits total only Rp 60 trillion as against Rp 190 trillion for fuel if the prices are not raised. If the fuel prices were maintained, the government had to reduce budgets for education, health and food aid and other program to help the low income people.

Fuel prices the lowest in Indonesia

After the increase in the crude oil prices since 2005, the fuel prices in Indonesia have relatively been low compared with in other countries in Asia. Based on data in March, 2008, the price of gasoline in Indonesia was cheaper than in other ASEAN countries. The prices of gasoline in the Philippines, Cambodia, Vietnam and Singapore are above Rp 10,000 per liter or more than doubling the price in Indonesia.

Fuel prices up 28.7%

On 23 May, 2008, the government announced increases in the prices of three types of subsidized fuel - Premium (gasoline) from Rp 4,500 to Rp 6,000 a liter, Automotive diesel oil (ADO) from, Rp 4,300 to Rp 5,500 a liter and kerosene from Rp 2,000 to Rp 2,500 a liter.

The new prices are still below the commercial prices in international market. The price of premium gasoline, for example is Rp 8,600 a liter in international market. The price of ADO is Rp 8,300 and kerosene Rp 9,000 a liter.

The decision to raise the fuel prices by Indonesia, was followed by the same measure by Bangladesh and Sri Lanka on May 25. Other countries including India and Malaysia are expected to follow suit.

With the rise in the fuel prices, the government will save RP 34.5 trillion in subsidy in 2008.

Table - 2

New prices of certain types of fuel on 24 May, 2008 (Rp/liter)

Types of fuel Old price New price Increase % Int'l price

Premium 4,500 6,000 33.3 8,600

ADO 4,300 5,500 27.9 8,300

Kerosene 2,000 2,500 25.0 9,000

Growth on average % 28.7

Source: Finance Ministry

Ahead of the decision to raise fuel prices, the government took a series of steps to keep fuel subsidy from rising as follows:

" Efficiency in spending by government agencies saving Rp 30.2 trillion in budget;

" Increase in state revenues from non oil/gas sector giving an extra income of Rp 20 trillion;

" Use of fiscal risk state budget of Rp 8.3 trillion. Seeking domestic loans by issuing state securities;

" Financing budget deficit through loan programs from (ADB, World Bank and bilateral) maximum Rp 25 trillion;

" Optimization of oil/gas revenue by increasing oil lifting from 916,000 kiloliters per day to 927,000 kiloliters;

" Conversion of kerosene to LPG to reduce kerosene consumption to 2 million liters in 2008;

" Efficiency in power consumption and PLN cost by Rp 5 trillion;

" Efficiency in fuel consumption and Pertamina by Rp 7 trillion including reducing the margin of distribution from 13.5% to 9% in revised 2008 state budget.

All attempt to save fund, however, is not enough to keep the deficit from widening that the government was forced to finally raise the fuel price breaking its repeated assurance not to raise the prices.

The government has taken precautionary steps to forestall adverse effects of its decision by offering cash aid for the poor called BLT and increase the ricer ransom for 24 months valued at Rp 4.2 trillion from only 10 months earlier.

The government also provides an additional Rp 1 trillion in subsidy for working capital of small and medium scale enterprises.

Public reactions

The public gave mixed reactions to the government policy of raising the fuel prices. Some took to the streets to protest the prices rises. Such protests are expected to continue in various cities although it is not as worse as in 205 when the government more than doubled the prices of fuel. Some other including business leaders said the decision gave them business certainty as they had been confused with reports earlier about inevitable price increases.

The fuel price hikes are expected to result in a 15%-20% increase in transport cost, but the increase in transport cost in the manufacturing sector such as textile industry is estimated to be around 1%-1.5%.

Market players are more cautious in reaction to the fuel price hikes. They choose to wait for response from the central bank, which is expected to react to an increase in inflation that follows the fuel price hikes.

The trade minister predicted that the fuel price hikes would result in a 2.1 percentage rise in inflation rate. The inflation this year, therefore, is predicted to reach 10%-12% year on year.

The central bank is expected to raise its benchmark interest rate (BI Rate) after recently raise it form 8% to 8.25%. The central bank board of governors is to meet on June 5, 2008. The leaders of the central banks are expected to raise the BI rate but would not go beyond 10%.

Conclusion

The success in the government's attempt to minimize the impact of the fuel price hikes will depend on a number of factors -- external factors: the prices of crude oil in the world market. If the prices will continue to scale up to as high as US$ 150 a barrel, the fuel price hikes would have little significance in curbing subsidy. A more drastic measure would be needed but the social cost would also rise as the purchasing power of the people already hit the rock bottom.

The success is also determined by the people's confidence in the government. Even the distribution of cash direct aid (BLT) has drawn opposition from some members of the people and observes doubting that it would not miss the target as in the past.

The BLT program, however, would help if the program is properly implemented. Many has expressed fear that BLT would provide an easy target for corrupt officials.

* * *