Saturday, January 18, 2014

Indonesia Mulls Reforms

Indonesia’s government is considering reforming its fuel subsidy policy. Under the current rules, the government has to pay the difference between market and subsidised fuel prices, the gap of which has been intensified by the rupiah depreciation in 2013. With the policy change,
the government will only fix the amount of subsidy per litre, which means that subsidised fuel prices will move according to market prices.

While the planned reform is definitely encouraging, any change is unlikely ahead of the elections this year. Clearly though, this fuel subsidy reform will represent a major breakthrough from the government to correct some of the structural problems associated with the current account deficit.

As previously discussed, the bulk of the pressure in the current account has come from the oil and gas trade balance. Daily oil production has been on a decline while fuel consumption continues to remain strong. The latest auto sales data also still show close to double-digit expansion in December. Structurally, lower fuel subsidy spending would also allow the government to increase its development spending. This is crucial as infrastructure bottlenecks have continued to impede investment growth.

Bank Indonesia currently expects the current account deficit to slip below 3% of GDP this year and then further to 2.5% of GDP in 2015. The fuel subsidy reform, if implemented at some point this year, will accelerate the narrowing of the current account deficit. Indonesia’s central bank may then feel less need to extend its policy tightening.