Postponement is not a Choice;   Fuel Subsidies is growing “Time Bomb” that is Holding the Economy Hostage

By : Dr. Rimawan Pradiptyo[1]

 

History Repeated

For the umpteenth time, during the reformation regime, Indonesia faces a dilemma which is associated with reducing fuel subsidies. Various road maps on how best to reduce fuel subsidies have been proposed since 2008, neither of which as it turned out, were a far cry from interests of politicians. Our collective memory is still fresh with government proposal to regulate and control the consumption of fuels in 2010, which was supposed to implemented in phases starting with Jakarta, and afterwards to cover the whole country by late 2013. However, apparently the plan failed to get off the ground due to the difficulty of acquiring requisite land for expanding storage fuel tanks that refuelling stations faced, which was compounded by the DPR rejection of research findings on the   fuel policy and the best policy forward , by the team that comprised three Universities UGM-ITB-UI.

 

In its research report, the UGM-ITB-UI research, noted the two proposals by bureaucrats and politicians to regulate and control the consumption of subsidized fuels, were inefficient and ineffective. This was because the estimates of the cost of implementing the two policies far outweighed the benefits.   Moreover, the policy posed the danger of creating horizontal conflicts among refuelling stations and between consumers and refuelling station operators. In fact, the policy recommendations continued, the two programs, in implemented as designed would have the potential of changing the venue of demonstrations from Presidential offices (Istana Negara) and DPR/MPR premises to refuelling stations all over the country from Sabang to Merauke.

 

To that end, the joint research team of UGM-ITB-UI researchers, proposed a decrease of reduction of fuel subsidies through a gradual increase of subsidized fuel prices by Rp 500, which should be implemented overtime (for instance once every 6-12 months) until the price of Premium fuel reaches the free market price. The phased reduction of subsidized fuels, should be go hand in hand with the implementation of a subsidy compensation program, targeting poor families. The proposed increase of IDR 500/liter , was considered to be the right figur, which would accommodate both the interests of the economy and politicians. However, the government rejected policy proposal out of hand and the coalition of political parties in government failed to support and advocate for the implementation of the policy.

 

During early 2012, the rising burden of subsidized fuels on government finances came into the limelight once again.   And once again, the government requested three a team of researchers drawn from three Universities (Unpad-ITB-UI) to conduct a research on the policy of subsidies. The research team proposed that the price of Premium should be raised by Rp1500/liter, which received stiff opposition from various elements in country, especially University students , manifested in demonstrations staged in various cities in the country. The spate of demonstrations against the policy programs was attributable to the fact that policy recommendation to raise premium fuel by IDR 1500/liter failed to take into account political repercussion which is often associated with hiking fuel prices. To that end, the increase of IDR 1500/liter, which Upad-ITB-UI team proposed, was higher than IDR 500/liter and gradual reduction of fuel subsidies that UGM-ITB-UI team recommended.

 

Once again, in 2012, the ruling party showed its reluctance to raise fuel prices, and eventually fuel prices remained intact. In the meantime, the intensity of discussions on the prospects of raising fuel prices with no data set to effect the policy, created inflation expectations among economic agents, especially traders. This assertion is very much in line with research findings by Pradiptyo et al. (2010) , which showed that the expectation of a potential increase in fuel prices is the main source of information traders use in forming inflation expectations.

 

Since February 2013, the burden of fuel subsidies on the government budget came into the spotlight, once again. The Budget deficit for 2011 and 2012 was 1.1% and 1.84% of GDP, respectively, but still lower that maximum limit of 3% of GDP. This year, the budget deficit will rise to 3.38% of GDP if the policy on reducing fuel subsidies is not implemented. What is also worth noting is that Indonesia has been a net importer of petroleum oil since 2004. This means an increase in the consumption of subsidized fuels will translate into heavier burden on the balance of payments due to higher import volumes and value of Pertamax fuel[2].

 

Thus, the recurrence of the fuel subsidy problem over the last three years , does not mean serious measures to deal with it, are easy to come any time soon. Nonetheless, what is apparent from the pattern of efforts to deal with the problem is the significant shift in policy from relying on hard evidence (reality) to anecdotal evidence (myths).

 

Fuel Subsidies is increasingly becoming a Time Bomb

The subsidized fuel policy, despite being touted as tailored to support low income earners, is by and large, to the benefit of middle and high income consumers. Consumption of subsidized fuels constitutes compensated consumption phenomenon, which means that the government has to meet the demand for fuel consumption by anybody, and for any activity.   This means that the government pays all the quantity /volume of subsidized fuels, which Pertamina oil Tanks fill into refuelling stations.

 

The compensated consumption phenomenon can be described in the following way. Imagine if you have a credit card which has no higher limit[3]. Then, give that credit card to a teenager, who in the morning, revels in going to the highest upscale shopping Mall in this county[4]. You inform the teenager that he has the right to buy anything, regardless of price, as all the purchases using the credit will be on your account. At night, as the Mall closes its doors, you pick up the teenager   and you ask him to hand over all the receipts for all the purchases he/she has made during the day. Is there any person on this planet earth who can guess with precision the value of the purchases the teenager has made during his/her shopping binge all day round? The answer is definitely in the negative. To that end, the above illustration attests to the complexity and magnitude of the problem which bureaucrats face in estimating the ever rising consumption of subsidized fuels. Therefore, it is not surprising that every year, estimating the quantity of subsidized fuel to be consumed is very difficult, which is why the quota set in the budget always turns out to be lower than the quantity consumed.    

 

Essentially, what are the factors that influence the increase in consumption of subsidized fuels? Several factors influence the rising consumption of subsidized fuels . These include: 1) increase in economic activities attributable to economic growth; 2) rising international fuel prices; 3) appreciation of foreign currencies; 4) shift of consumption from Pertamax to premium; 5) increase in black market activities to meet the demand for industries; and 6) smuggling of subsidized fuels to other countries.

 

Of all the six factors that influence the increase in demand for subsidized fuels, it is only economic growth, which is the endogenous factor that the government can exercise control, while the other five factors are exogenous, over which the government has little, if any control. This means that, raising prices of subsidized fuels is the only leverage the government has to control the rising fuel subsidies as other determinants are not in government purview, rather the international market, behaviour of the general public in consuming subsidized fuels, and agents in black markets and subsidized fuel smuggling networks. In other words, leaving the policy on subsided fuel prices as it is, tantamount to relegating the determination and formation of the national budget to   foreign elements and subsidized fuel smuggling rings. Thus, the question, one should poses is where does this fit in the commitment of this country to determine and exercise decision making on issues of sustainable economic development in an independent manner ?

 

It is not farfetched, to describe the rising burden of fuel subsidies on government finances, as time bomb which is growing over time and unless handled in time, will explode anytime. In light of that, considering the adverse impact of subsidized fuels on the national budget and burden on the economy, silence is not a commendable solution to resolve this complex problem. Moreover, rising consumption of subsidized fuels increases the vulnerability of the economy arising from surging imports of Pertamax, which in turn will lead to higher pressure on the balance of payments and exchange of Rupiah against other currencies.

 

The problem becomes the more complex simply because subsidized fuels is available everywhere, and everyone has easy access to it. There is little doubt that with higher purchasing power, the general public has better means to consume fuel, which is why the demand for subsidized fuels is higher among middle and high income earners than is the case with low income earners. A lot of research [5] showed hard evidence that subsidized fuels contribute to worsening income disparity. Data obtained from The Ministry of Energy and Mineral resources shows that the proportion of consumption of subsidized fuel by category of users and region: 1) vehicle owners (53%) compared with motorcycle owners (47%); 2) Java and Bali population (59%); 3) land transportation (89%). Meanwhile based on Ministry of Finance (2008) sources, 25% of high income households consume 77% of subsidized fuels; middle income households consume 25%; and low income households just 15% of subsidized subsidies.

 

Facts attest to the reality that the black market and smuggling networks of subsidized fuels determine the volume of subsidized fuel consumed and by extension, amount of money spent on subsidized fuels. Consequently, the higher the magnitude of subsidies on fuels the government spends, the more lucrative it becomes to perpetrators of subsidized fuels smuggling and black market in subsidized fuels.

The above facts, provide eloquent testimony to the fact that subsidized fuels , by and large, suffers from poor targeting of its intended beneficiaries. In light of that, it is not far fetched to say that any effort to maintain the current level of subsidies on fuels amounts to protecting subsidies which are largely enjoyed by middle and high income earners, as well as perpetrators of subsidized fuel smuggling and black market operators. This argument, therefore debunks the assumption that raising prices of subsidized fuel energy epitomizes betrayal of the people and aggravate their destitution. Abundant evident indicate that rich, are the beneficiaries of the most of the subsidized fuels in comparison with the poor. To that end, any policy that stresses commitment to maintain higher subsidized on fuels undermines efforts to promote justice and fairness for all, as the beneficiaries are largely those who are rich and not the poor.    

 

Pradiptyo and Sahadewo (2012) conducted a laboratory-based survey on 335 households in Yogyakarta, comprising those who do not own any vehicles and those who have more than one vehicle. Research results indicated that respondents who do not own any motor vehicle whatsoever, who are categorized as poor, readily accepted and receptive to the idea to raise fuel prices , compared with respondents who own vehicles. For respondents who do not own any vehicle, reducing subsidies on fuels gradually was not considered a problem as long as the relocation of subsidies was channelled to specific subsidy programs ( for instance vaccine, infrastructure and transportation) , which generate direct benefits to households. On the contrary, respondents who own vehicles were not bothered by the way the relocation of subsidies which arise from reduction in subsidized fuels was done, as long as the reduction of subsidies was carried out gradually. In light of that, one can draw the inference that high income households who enjoy the lion’s share of subsidized fuels,   showed higher reluctance to accept the policy proposal to reduce fuel subsidies than low income households.

 

According to Pradiptyo (2012a,b), corrupt individuals enjoy subsidies in Indonesia as the maximum sentence they face based on Law on Corruption is very low. Based on sentences passed out by MA during 2001-2012 period, the explicit cost of corruption hovers around Rp 168.19 trillion, meanwhile, the financial value of the sentences was just Rp 15.09 trillion (constant 2012 prices). To that end, members of society foot the difference between the values Rp.153.1 trillion. In other words, members of the general public subsidized corrupt individuals.

 

This makes the circle of people’s suffering, especially those with middle and low incomes, complete. Ideally, subsidies should be given to disadvantaged members of society who earn low incomes, which is contrary to the reality in Indonesia. The policy of subsidized fuel energy is huge boon for high income earners, subsidized fuel smugglers and black market agents. On the other hand, thanks to loopholes in the anti corruption Law, obedient tax payers have ended up subsidizing corruptors , who are in the main middle and high income earners.

 

Keep the Momentum

The burden of fuel subsidies on the economy can be minimized if the government, and political parties in particular have strong commitment to enhance the independence of the economy in the policies it makes.   Nonetheless, efforts toward that direction, are often undermined by short term political interests. In 2005 the government raised prices of Premium fuels by 160%, but in 2008 as the general elections in 2009 approached, the government reduced prices of Premium fuels to the current level IDR 4500.

 

It should worth noting that in addition to the lack of commitment by the ruling political party coalition, political interests contributed much to rejection by DPR, policy recommendations on dealing with rising fuel subsidies, which UGM-ITB-UI team made in 2011. The same was at work in 2012. As this piece is written, government indecisiveness to reduce subsidies, is attributable to political bickering and differences among political parties in Senayan. The potential danger lies in the fact were the current state of procrastination to continue, the government may fail to take this opportunity and momentum to reduce fuel subsidies.

 

Let us calculate the value of subsidies which the government could have saved, had the government implemented policy recommendation of UGM-ITB-UI research team, of gradually raising the price of premium fuel by IDR 500/liter (for example every 1 April)? If the policy was implemented was 2011, the price of Premium fuel at the pump would no longer be IDR 4500/liter but IDR 6000/liter. If the policy was implemented, taking into consideration that elasticity of premium is -0,16, and assuming that Solar (diesel) also has the same elasticity, and the government did not implement any other policy on subsidized fuels by December 2013, total amount of subsidies which the government would saved would be IDR 134.23 trillion. Meanwhile, if the government goes ahead with its plan to raise prices of subsidized Premium fuel and Solar by IDR 6000/liter, the policy of gradually increasing fuel prices by IDR 500/liter since 2011 would have saved IDR 97,42 trillion.

 

Let us compare the value of government expenditure on subsidies saved with the government subsidies on fertilizers and food stuffs , which in 2013 budget is IDR 17.2 trillion and IDR 16.2 trillion, respectively. Operational cost of UGM is just IDR 2 trillion per year , and it is the largest University in Indonesian, with a student population of 52,000, right from three year diploma to Doctorate level. Let us assume that operational cost of running the University is increased to Rp3 trillion per year in order to finance requisite expenditure on facilities and infrastructure tailored to scaling up the quality of education service provision to such a level that enables UGM to compete with Universities in the developed world. Based on this scenario, it is only IDR 30 trillion per year, that is required to transform 10 best Universities which have the same level and scale as UGM in Indonesia to provide free education right from D3 to S3! Just imagine by spending just IDR 30 trillion per year , 520 000 students in the best Universities in Indonesia would be able to undergo education free of charge! This is the minimum cost, which the Indonesian economy is paying due to procrastination of policy makers in this country.

 

March, April, and May, is the best time for the government to increase prices of subsidized fuels. This is based on the trajectory of inflation over the years, which is lowest in April and ratchets up in May. To that end, the two months provide the right time to reduce fuel subsidies as the impact on inflation is likely to be the smallest.

 

However, current government plan is to increase prices of subsidized fuels in June, which is not ideal given the fact that the fasting month of Ramadhan is around the corner. Nonetheless, the rising budget deficit and worsening balance of payments, mean that the government can no longer delay the policy of raising the prices of subsidized fuels this time around.