DecisionIn a long-awaited decision, Indonesia raised the prices of subsidised fuel products over the weekend. The gasoline variant, Petalite, has been raised to IDR10,000/l i.e., 30.7% increase from prevailing prices, besides diesel by 32% to IDR6,800/l with immediate effect. Concurrently, RON92/ Pertamax fuel price is also up to IDR14,500/l, 16% from the month before and up a sharp 60% from late-2021 levels, factoring in previous price increases.The decision to adjust fuel prices does not come as a surprise and had been flagged in the past few weeks, over the growing fiscal strain from high subsidy allocations and compensation to state energy suppliers. Despite this adjustment, prices are still below market levels.The government also plans to restrict sales of subsidized fuel based on vehicle engine size, details of which will be announced in the coming weeks. This aims to support the low-income households but will pose operational challenges.
Economic assessment and impact
A cut in subsidies is justified and crucial from two angles.Firstly, allocations towards subsidies and compensation to state-owned suppliers made up 16% of total expenditure this year. Any delay in price adjustments might have required an additional IDR100-200trn (25% increase).From the budgeted crude price of $63/bl, the Indonesia crude price assumption had been raised to above $100bl and is likely to settle around $105bl, according to the finance minister. This necessitated the 2022 subsidy allocations to be raised three times since the initial budgeted estimates, narrowing the available headroom.As DBS Group Research noted here, 2022 fiscal math is in good health, with the Jan-Jul22 fiscal balance in a surplus of 0.57% of GDP compared to full-year budgeted target of -4.85%. Total revenues stood at a little over a third of state budget by Jul22, whilst expenditure lagged. Revenues (21% yoy) benefited from economic reopening, corporate taxes (boosted by processing industry), strong non-tax collections comprising of resource-based earnings, and implementation of the Harmonised Tax Law (HPP) i.e., VAT increase, crypto tax etc. Spending disbursements were slower due to lag in ministerial spending, whilst allocations towards subsidies and social assistance programs increased to shield the populace’s real purchasing power. This revenue-spending mix backs the government’s conviction that the 2022 fiscal deficit could narrow sharply to -3.9% of GDP (IDR 732.2trn) vs earlier indication of -4.5% and budgeted -4.85%. DBS Group Research’s forecast for 2022 stands revised to -3.5% of GDP.Importantly, the fuel price hike is more supportive of 2023 finances than 2022. The MOF estimates 2023 subsidies and compensation outlays at IDR337trn, down from IDR 502trn this year. At the same time, strong revenue tailwinds from the processing industry and natural resources might moderate next year. Hence, the mandate to lower 2023 fiscal deficit back to -3% of GDP and energy subsidies cut by a third, suggests a fuel price adjustment was baked into next year’s math. With elections looming in early 2024, the window to undertake this politically sensitive decision was also fast narrowing.Secondly, the significant wedge between non-subsidised and subsidised fuel has influenced consumption patterns. Minister of Energy and Mineral Resources Arifin Tasrif[1] had indicated that fuel consumption quotas might run out by October if the current pace of consumption continues. As of Jul22, subsidised diesel had reached 9.9mn kl i.e., two-thirds of the total quota for the year and subsidised gasoline at 16.8mn kl i.e., 73% of the quota, according to Pertamina. As of August, gasoline was likely at 80% of the threshold.Notably, the ~30% fuel price increase is within the range of past hikes. At the last such fuel price increase in 2014, headline inflation spiked from 5.3%yoy average in the six months prior to 6.8% after the hike. In the run-up to these price adjustments, DBS Group Research drew scenarios here and here. Following the actual announcement, DBS Group Research calculations show that the scale of price adjustments will give a first-round lift-off to full-year inflation of ~94-100bps, with a larger net impact of an additional 50-60bp as the fuel price hike percolates through other sub-segments including food, transportation charges and other related segments over the next 3-6 months.Between Jan-Aug22, headline CPI inflation averaged 3.5% yoy, on track to DBS Group Research’s full-year forecast of 4%. Factoring the subsidy cut, DBS Group Research assume that YE22 headline inflation will head towards 6.5-7%yoy and lift the full-year average to 5.0%. DBS Group Research also raise average 2023 inflation to 3.8% vs 2.7% earlier, owing to high readings in 1H23 and base effects driven pullback in 2H of the year.
Policy outlookDuring the last fuel price hikes in 2013 and 2014, benchmark rate was adjusted by 125bp (year of the taper tantrum) and 25bp respectively within three months of the hike. This year, following the pre-emptive rate hike of 25bps already delivered in Aug (took BI rate to 3.75%), DBS Group Research expect the BI to tighten policy by 25bp each in the remaining meetings of the year, to take the end-year rate to 4.75%, before drawing a pause. DBS Group Research will closely monitor the BI’s forward-looking commentary.Consumer sentiments are likely to take a knock following this decision. While the low-income households will receive cash handouts as compensation, the government has maintained that high income households had been enjoying these subsidies and will thereby better balance their demand with these price adjustments. Support measures for low-income households had been announced via an aid package worth IDR 24.2trn ($1.6bn), consisting of a) IDR 12.4trn to direct cash assistance via monthly handouts of IDR150k till year-end; b) IDR 9.6trn for salary assistance for workers with income <IDR3.5mn/month; c) IDR 2.17trn to subsidise transport costs. Other drivers i.e., strong external demand, and capex spending are expected to offset any slowdown risks this year.A cut in fuel subsidies is a medium-term positive move for the authorities. Any adverse impact on the financial markets and sentiments might be temporary as a reduction in subsidies, liberalisation of fuel prices and ongoing fiscal consolidation are viewed as prudent and judicious policy moves.
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Radhika RaoSenior Economist – Eurozone, India, Indonesiaradhikarao@dbs.com
