Aug. 13 (Bloomberg) -- Officials from Indonesia’s outgoing government will recommend capping fuel subsidies in policy advice to President-elect Joko Widodo’s transition team, as the nation grapples with economic harm from the measure.
“Not every president would like to take the risk of dealing with this fuel-subsidy reform,” Vice Finance Minister Bambang Brodjonegoro said in an interview yesterday in his Jakarta office. “The political aspect hasn’t been solved since the 1970s.”
The current system of providing set gasoline prices leaves Indonesia, a net oil importer, economically vulnerable. A spike in prices, such as from Middle East tensions or a slide in the rupiah, can bloat the government’s budget deficit and worsen the country’s trade balance.
Failure to scale back the costly system and use the proceeds at least in part to invest in infrastructure would risk Indonesian economic growth slumping below 5 percent in three to five years, said Bambang. A revamp must be done before the U.S. Federal Reserve starts raising interest rates, which could put pressure on the rupiah next year, he said.
“We have to be ready for that,” said Bambang, 47, of the Fed’s eventual rate increase. “We have to reduce potential risks.”
Bambang flagged concern with the rupiah’s exchange rate, signaling a preferred level of 11,000 per dollar. It was steady at 11,685 as of 3:14 p.m. in Jakarta, according to prices from local banks. A weaker rupiah inflates the price of imported refined products that are denominated in dollars.
Shifting the fuel assistance to a fixed subsidy per liter, and a cap on the volume of fuel that is subsidized, would insulate Indonesia from external shocks, the vice minister said. “We will propose this, once the transition period has started,” he said.
Widodo is awaiting validation of his win in last month’s election over Suharto-era general Prabowo Subianto from the Constitutional Court, after Prabowo claimed evidence of fraud. Bambang said talks with the transition team will probably start in September. Bambang, current Finance Minister Chatib Basri and academic economist Sri Adiningsih were among the three most mentioned potential candidates for finance chief under Widodo, a Bloomberg survey of 11 Indonesian analysts and academics showed last month.
“We should have concern about our economic state,” he said, highlighting a slowdown in growth from more than 6 percent in 2011 and 2012 to 5.12 percent in the second quarter. “This is serious.”
To achieve the 7 percent growth target set by Jokowi, as the president-elect is known, reducing the fuel subsidy should be the top priority, said Bambang, was dean of the economics faculty at the University of Indonesia, the nation’s most prestigious college, prior to joining the Finance Ministry.
Second, the incoming administration needs to boost manufacturing, which has waned as a share of the economy since the 1990s. A recent move by Toyota Motor Corp. of production to the country was one sign of the nation’s potential.
The next government should also build “downstreaming” capabilities to process its resources, Bambang said. Derivative products of commodities such as palm oil, petroleum, nickel and copper would offer higher-value exports. The Finance Ministry can help with tax incentives, and other agencies can ease approvals for transactions such as land purchases, he said.
A shift to a capped fuel subsidy system would educate Indonesian consumers that swings in market prices are normal, Bambang said. “People will learn that this is how the oil price is supposed to be.”
The subsidy could potentially start at 3,000 rupiah (26 U.S. cents) a liter, with a total volume cap of around 46 million kiloliters, Bambang said. That would result in a cost of around 143 trillion rupiah, compared with this year’s estimated bill of 246.5 trillion rupiah. Over time, the cap could be reduced, he said.
There would be sufficient support in parliament to back the idea, Bambang said. “In fact in the parliament, there’s now a lot of political support to increase the fuel prices or to have the fixed subsidy.”
Indonesia needs to build two oil refineries to cover its fuel-supply deficit, with the last new one erected in the 1970s, the Energy Ministry said on its website yesterday. Indonesia’s fuel consumption will exceed supply by 640,000 barrels per day next year, it said.
The government is looking for private investors that have land to build the plants, Edy Hermantoro, a director of oil and gas at the ministry, said in the statement.
Turning to the exchange rate, Bambang said that while the rupiah was now stable at around 11,500 to 12,000 per dollar, “our businesses are struggling with this relatively high depreciation.” The Indonesian currency plunged 21 percent last year, the worst performance in Asia. Airlines in particular have been hit by higher fuel costs, and a cheaper rupiah also makes the cost of imported capital goods more expensive, he said.
“For a better economy we still need a stronger rupiah,” Bambang said. “I can’t say how much -- maybe about 11,000 rupiah. Some of the businesses could be helped by this rupiah appreciation.”
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