Dec. 17 (Bloomberg) -- Indonesian Finance Minister Jusuf Anwar plans to slash the nation's $7.5 billion fuel subsidy bill to narrow the budget deficit next year. The last two governments to try that ended up with street protests.

``The deficit will certainly balloon if we don't adjust the budget'' for higher oil prices, Anwar, 63, said in an interview in Jakarta. ``It has a social impact, so we have to be careful.''

In his first budget, Anwar aims to roll back a three-decade policy that has given Indonesians some of the cheapest fuel in the world and drained government coffers as crude prices soared. Former President Suharto tried to scrap the subsidies in 1998, sparking riots in Jakarta that helped topple him from power.

``The timing is very important,'' said Fauzi Ichsan, chief economist at Standard Chartered Bank in Jakarta. ``On the one hand parliament understands that the increase in subsidies is exploding the budget deficit, and on the other hand they have an electorate that is demanding justice.''

Anwar said he plans to tackle the dilemma by raising gasoline prices early next year while leaving rates for kerosene, used as a cooking fuel, and diesel, used in farm machinery, at ``low levels'' to help farmers and the poor.

His target is to cut the 2005 subsidy bill to 25 trillion rupiah ($2.7 billion). Indonesians pay about 26 cents per liter for gasoline, compared with about 50 cents in the U.S. and $1.47 in Germany, according to data compiled by Bloomberg.

Indonesia, which has had deficits since its 1998 financial crisis, wants to balance the budget by 2007. The government plans to narrow the deficit to 1.3 percent of gross domestic product this year and to 0.8 percent in 2005.

Safety Net

Anwar, who became finance minister after President Susilo Bambang Yudhoyono took office in October, said the government will unveil a 15 trillion rupiah stimulus package to help soften the effect of higher fuel prices on the nation's poor. About 40 million of Indonesia's 235 million people are either jobless or work fewer than 35 hours a week.

``We have stimulus money, reallocation money, for various poverty alleviation measures such as in education, health, rice for the poor, hospitalization, scholarships,'' Anwar said, without giving more detail.

Fuel subsidies will be reviewed on a product-by-product basis to ensure price increases won't slow economic growth, he said. Indonesia earlier this month raised its forecast for 2005 economic growth to 5.5 percent, the fastest in nine years.

Competing for Investors

Indonesia's oil output has declined for the past five years because existing reserves have dwindled and investment in exploration has slowed.

``The principal challenge facing Indonesia now is to bring investment back,'' said Randal Quarles, U.S. deputy under-secretary for international affairs at the Treasury department.

The Indonesian government is targeting 7 percent economic growth by 2009. The World Bank says the target could be achieved by 2007 if the government wins back the confidence of investors.

``Indonesia is in competition with other countries for investment,'' said Robert W. Haines, international relations manager for Exxon Mobil Corp., the world's largest publicly traded oil company. ``Companies, investors, are looking for opportunities where they can find them. This means they look at the investment environment.''

The reduction and eventual elimination of fuel subsidies will boost the country's competitiveness, economists say.

``There's no reason this country cannot grow at 7 percent within two years'' if the right policies are put in place, said Andrew Steer, the World Bank's Indonesian representative. ``The subsidies are not sound policies.''

`Political Capital'

Yudhoyono's popularity -- he won 61 percent of the vote in October's presidential election -- may help him convince voters that the money saved on subsidies will be used to build schools, hire teachers, provide health care and lay roads in rural areas.

``At least Yudhoyono has political capital,'' Standard Chartered's Fauzi said. ``If he hiked fuel prices it will affect his popularity, but it will not run into negative territory.''

The World Bank and International Monetary Fund have said government spending on subsidies deprives the rural economy and under-developed provinces of money that could be used to broaden the economic recovery, which would boost incomes.

Consumer spending represents more than two-thirds of the $208 billion economy, Southeast Asia's largest.

Still, a rise in fuel prices may stoke inflation and threaten demand that has helped boost profits for PT Astra International, the largest auto distributor, and PT Ramayana Lestari Sentosa, Indonesia's second-largest retailer by sales.

Fighting Inflation

The government last week revised its 2005 inflation forecast to 7 percent from 5.5 percent, because it expects transport costs to rise as subsidies are reduced.

``We have various measures to maintain this inflation rate that will have an impact also on the interest rate,'' Anwar said in the interview. The government expects the benchmark one-month government bills to fetch 9 percent next year. The yield was 7.43 percent in the last auction on Dec. 8.

Higher consumer prices won't affect the rupiah, Anwar said. He reiterated a forecast of 8,900 rupiah to the dollar on average next year. The rupiah has averaged 8,925 so far this year.

``What I am concerned about is maintaining the stability,'' he said. ``That will be an important element for the private sector.''

He is also confident of keeping stability among Indonesians who have baulked at earlier attempts to raise fuel prices.

``The adjustment of the oil price is a pain-sharing exercise between the government and the people,'' Anwar said. ``The people will understand.''

To contact the reporters on this story: Claire Leow in Jakarta at cleow@bloomberg.net; Shanthy Nambiar in Jakarta at 3023 or snambiar1@bloomberg.net.

Last Updated: December 16, 2004 17:40 EST