Indonesia’s Fuel Subsidies and 2014 Presidential Election: Country Risks, Opportunities, and Outlook

  • “Out of control” fuel subsidies seen as hampering economic growth

  • Top Indonesian presidential candidates want to reduce fuel subsidies

  • Fuel-related industries likely to suffer; infrastructure projects may benefit

  • Minor protests can be expected as a result of subsidy cut


On July 9th, Indonesians will go to the voting booth to elect their next president. Two frontrunners have emerged: Joko Widodo, the current governor of Jakarta, and Prabowo Subianto, a businessman with ties to the Suharto regime. Widowo is widely favored to win, but his victory is far from certain. The only certainty is that the new leader will inherit Indonesia’s complex fiscal environment and will need to deal with the country’s increasingly urgent fuel subsidy crisis.

Understanding Indonesia’s economic climate

In the last decade, President Yudhoyono has taken Indonesia through a boom period, growing at an average of 5.8% per year over the last 10 years. With a GDP of US$878 billion in 2012, it is now the world’s 16th largest economy, ranking above the Netherlands.

However, Indonesia’s economic growth has slowed in recent years. A depreciating currency and an increase in its current account deficit have contributed to the slowdown. In 2014 Q1, the economy only grew 5.2%, the smallest growth it has seen in the last 4 years.

President Yudhoyono expects the deficit to increase, recently adjusting his budget deficit forecast for 2014 to an estimated 2.5% of GDP. This is much higher than the original forecast of 1.69% and higher than its 2013 budget deficit of 2.38%. This forecast is also notable for being within striking distance of Indonesia’s legally mandated threshold for its GDP deficit, set at 3%. Fuel subsidies are one of the chief reasons for the newly inflated forecast.

Economic impact of the fuel subsidy

Indonesia’s fuel subsidies create a situation where the price of fuel is dramatically lower than what consumers would normally pay. This leads to consumer overuse of resources, leading to waste and an increasing financial burden on the government. This is evidenced by the following table, illustrating the country’s soaring fuel subsidy budget from 2010-2013. In practical terms, this translates into a subsidy of 35% for every liter of gasoline bought.

Indonesian Fuel Subsidies 2010-2013

Indonesia's fuel subsidy deficit

Instead of producing its own oil, Indonesia is now at the mercy of international oil prices. Indonesia has been a net importer of oil since 2004. With its weakening currency, Indonesia has had to spend much more to get the same amount of fuel: every 100 IDR (US$0.00842) weakening of the currency results in an additional 3 trillion IDR (US$254 million) worth of spending on fuel subsidies. It’s an acknowledged problem, and observers are hoping that incoming leadership have promising ideas on how to solve it.

Presidential candidates’ stances on subsidies

indonesia-presidential-election-jokowi-prabowo

For the upcoming presidential election, Widodo and Subianto have both made controlling the country’s soaring fuel subsidies one of their key campaign issues. For Widodo, this means a slow reduction of fuel subsidies over a period of 4-5 years. Subianto’s proposal involves policies that hold fuel prices steady, but only for poor and lower middle-class income citizens.

There is agreement among election front-runners, politicians, and the Indonesian media that fuel subsidies have to be decreased. But what impact might this have on Indonesia?

Analysis: Political Risks

The biggest impact that a fuel subsidy cut will have on Indonesia is its political stability. Fuel subsidies is a legacy of the country’s original founding father, Sukarno. Under him, and every succeeding leader of Indonesia, fuel subsidies have been implemented to soften the blow of high inflationary prices for the country’s lower income citizens.

Looking to historical precedents suggest caution: it was a combination of fuel subsidy cuts, inflation, and high food prices that led to Jakarta’s city-wide riots that overthrew President Suharto in 1998. President Wahid (1999-2001) and President Megawati (2001-2004) also faced protests and dissent before each subsidy cut.

The exception is President Yudhoyono (2004-present), who conducted campaigns to mentally prepare the population before the roll out of his fuel subsidy cut. He also gave handouts to lower income citizens to hedge against any dissent.

With Indonesia’s growth and increased economic power in the last decade, it is unlikely that a fuel subsidy reduction will trigger a repeat of the 1998 events. Furthermore, each subsequent protest has been focused solely on towards government policy, where the 1998 Jakarta riots were also focused on inflicting violence towards companies and businesses.

Analysis: Industry Risks & Opportunities

The industries most negatively impacted by a fuel subsidy cut will be downstream fuel companies and sectors involved in automobile, transportation, or shipping in Indonesia. With an estimated 1 million new cars and 8 million new motorcycles hitting the streets each year, this number may dramatically decrease once fuel prices normalize to market equilibrium. Expect families to begin carpooling to reduce fuel costs or to move their families closer to offices and schools. The money saved from cutting subsidies may also be invested in public transportation infrastructure.

Favorable changes are likely to occur in the energy sector. Due to artificially cheap fuel prices, Indonesia has not had the right environment in which to encourage renewable energy or fossil fuel exploration. Investment in these areas will surely increase like it has for other countries in the Asia-Pacific region. This offers a chance for both domestic and foreign firms to invest in Indonesia’s energy future.

Outlook

As Indonesians head to the polls, they’re seemingly being asked to vote against their own best interests. The front-runners are two candidates who have openly pledged to make their daily lives more expensive. Both tout fuel subsidy policies that will harm Indonesia’s automobile, transportation, downstream fuel, and shipping sectors- established industries that employ many Indonesians.

While cutting fuel subsidies may cause some minor political and social unrest, there is wide agreement that it will secure the international competitiveness of Indonesia in the years to come. In 2013, fuel subsidies took 19.5% of the total government budget, amounting to 2.1% of the GDP. This amount can be put toward much needed infrastructure, education, and healthcare; international businesses and organizations dealing in these sectors should be watching closely.

Presidential front-runners Widowo and Subianto view their fuel subsidy reforms as a critical part to putting Indonesia back on the road to growth, and they’re hoping Indonesians see it the same way.

 

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China Thinks They Can Bully Vietnam Over the Paracel Islands — Here’s Why

vietnam-protest

China firmly believes it has the dominant hand over Vietnam as they quarrel over the Paracel Islands

On May 1, 2014, one of China’s leading oil and gas companies, CNOOC, deployed its largest oil rig, the HD-981, to the Paracel Islands. The end location was to be stationed in disputed waters, about 120 nautical miles off the coast of Vietnam.

What are the Paracel Islands?

South China Sea Map

The Paracel Islands are located in the South China Sea and are under territorial dispute by China, Vietnam, and Taiwan. To the Mainland Chinese, the islands are collectively known as Xisha (西沙), whereas to the Vietnamese, they are known as Hoàng Sa.

Like the Spratly Islands, the Paracel Islands are strategically placed in the South China Sea. They are a main sea lane passage point to Northeast Asia and have abundant fisheries around their waters. However, a major factor in the continual dispute is the vast oil and gas resources rumored to be found under the archipelago’s seabed.

The Paracel Islands are only one part of what China deems is rightfully part of their territorial sovereignty within the South China Sea. Other territories under dispute are all located within what the Chinese government calls the “9-Dash Line.”

China is betting that Vietnam has everything to lose

Territorial disputes in the South China Sea are not new. Over the years, countries in the region have vied for sovereignty over a number of islands in order to have exclusive economic control over these waters. However, China’s deployment of CNOOC’s oil rig to the Paracel Islands is uncommon and very provocative.

China has certainly done its homework, and as a result, will be increasing its assertiveness. This situation holds many parallels to Russia’s situation with Crimea. The PRC government is betting that Vietnam is too economically dependent on China, and therefore will treat any Vietnamese threats as empty posturing. China’s calculation depicts Vietnam as having two options: start an all-out war in the name of patriotism and sovereignty, or protest loudly but do nothing.

There are three reasons why the mainland is clearly betting on the latter.

1. China’s increasing influence has backed Vietnam into a corner

Vietnam is isolated internationally and regionally. Vietnam has a communist, authoritarian government whose closest ally has traditionally been China. It has weak ties to the U.S., due to ideological clashes in which the U.S. government backed the opposing Southern Vietnamese government in the nation’s civil war during the 1960s-70s. Vietnam has been warming up to the U.S. in recent years, however, their relationship cannot be compared to neighboring countries like the Philippines, Malaysia, South Korea, and Japan- as evidenced by President’s Obama’s 2014 Asia tour.

In Southeast Asia, Vietnam has little regional support for its territorial disputes with the economic behemoth. This is evidenced by the May 10-11, 2014 ASEAN Semi-Annual Summit in Myanmar, where ASEAN members were unwilling to address Vietnam’s territorial disputes as a collective entity. China is a massive donor and trade partner for the region, and taking China on in such a manner would harm countries like Cambodia, Laos, Singapore, and Thailand who have no territorial stakes within the South China Sea. The incentives do not line up for Vietnam’s neighbors. However, due to these very same factors, China is more than willing to reclaim what they deem is rightfully theirs within the infamous “9-Dash Line.”

2. Taking lessons from Russia, Crimea, and Western non-action

CNOOC’s deployment of their oil rig near the Paracel Islands is timed in the wake of the Crimea crisis, where China has drawn similarities between themselves and Russia. If Western powers did not act in Ukraine, they also will not rush to Vietnam’s side. China has several reasons to expect Western non-action.

First, China has calculated that the U.S. has bigger ties to protecting Ukraine than they do to Vietnam. In 1994, the U.S. signed the Budapest Memorandums promising to protect Ukraine’s territorial sovereignty in exchange for giving up their nuclear weapons. The United States and Vietnam has no security agreements or alliances. If the U.S. did not protect Ukraine’s sovereignty despite having a formal agreement, why would they assist Vietnam?

Second, in the wake of the Crimea crisis, much was said by the U.S. and Europe to denounce Russia but not much action was taken. Sure, U.S. imposed sanctions on Russia’s top seven elite, but there has been little intervention in the aftermath of the Crimea Referendum and Russia’s annexation of the region.

Moreover, the most important factor for China is that the U.S. is tied closer to the Chinese economy than it is to the Russian economy. As seen in the tables below, China is the USA’s number 2 trade partner behind Canada. In comparison, Russia is not even ranked and has only 1% of the U.S.’s trade:

USA 2013 Top 3 Trade Partners Source: U.S. Census Bureau

USA 2013 Trade w. Russia and China

Source: U.S. Census Bureau

If the U.S. and the European Union are not intervening in Ukraine, China is certainly betting that there is even less of a probability that they will intervene on Vietnam’s behalf: getting mired in a dispute over some islands on another continent is simply not worth the risk of potentially damaging relationships with a major trading partner.

3. Vietnam’s Economic Dependence on China

China’s growing economy has benefited Vietnam, with the PRC’s share of FDI in Vietnam peaking in 2013 behind South Korea with $US 2.28 billion.

The third and most important reason for China’s surge of confidence in its territorial disputes with Vietnam is the dependency Vietnam has on Chinese Foreign Direct Investment (FDI) and trade.

Historically, foreign investment in Vietnam have been made by countries like South Korea, Japan, and Taiwan. However, with China’s economic growth, growing influence in the region, and energy interests in Southeast Asia– investment in Vietnam has steadily increased. In 2013, China was second to South Korea in investing $US 2.28 billion. This qualifies as 10.2% of Vietnam’s total FDI inflow for the year. This is in stark contrast to previous years, where China invested $0.3 billion and $0.59 billion in 2012 and 2011, respectively.

In regards to trade flows, China tops out Vietnam’s charts in both 2013 imports and exports. For exports, China ranks fourth after the United States, Japan, and all other exporting trade countries with $US 13.26 billion or 10.5% of Vietnam’s total exports for 2013.

2013 Vietnam's Top Exporting Countries- Graph
Source: General Statistics Department of Vietnam

For imports, China takes the top spot. With Chinese imports coming in with $US 36.95 billion or 28.6% of Vietnam’s total imports for 2013. In total, China makes up 19.6% of Vietnam’s total import and exports for 2013.

2013 Vietnam Top Importing Countries- Graph
Source: General Statistics Department of Vietnam

For Vietnam, this is bad news as the country is still considered a lower middle income country that will require significant trade and investment over the next decade. But with China as a major stakeholder, the Vietnamese government may have to make a difficult choice between patriotism and economic growth.

Outlook

Vietnam’s negotiating stance in the Paracel Island conflict is unfavorable. Vietnam is increasingly dependent on China’s FDI and trade and has few allies internationally and regionally willing to go against the economic giant.

China has hedged its bets by observing Russia’s actions in Crimea. Judging the international response to the Crimea situation, China feels that they can act and raise tensions in the South China Sea with impunity. The United States and Western European powers do not have a stake in Vietnam; count on them to cast critique and judgment, but they will stop far short of sending any military backup to stop China.

What remains to be seen is what happens when China takes the oil rig out of the Paracel Islands on August 28, 2014 to avoid the monsoon season. Will they keep out of the region, or return the very next year and provoke Vietnam again?

Featured image via CNBC

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Indonesia is Betting Its “Negative Investment List” Will Spur Local Oil and Gas Industries

Indonesia's favorite to win the July 2014 Presidential Election- Joko Widodo

Indonesia’s favorite to win the July 2014 Presidential Election- Joko Widodo

Resources like crude oil, natural gas, coal, bauxite, nickel, tin, and copper have been the cornerstone of Indonesia’s growth, but increased nationalism has driven the current government to rethink policies and the role that foreign entities have in the development of these sectors.

Earlier this week, the Indonesian government announced the revision of their “Negative Investment List.” This list was established in 2010 in an attempt to increase transparency and list sectors that were completely or partially closed off to foreign and/or domestic investment. The most recent revision for the Oil and Gas sector is as seen below:

2014- Indonesia Negative List Changes for FDI

2014- Indonesia Negative List Changes for FDI

As seen in the above chart, the Indonesian government’s revisions will directly impact the ways in which foreign entities can invest and engage in the Oil and Gas sectors of Indonesia. Limitations will be set for foreign ownership in drilling, maintenance, and construction of oil platforms, pipelines, drilling platforms, and energy storage.

How does the status quo change?

Short-Term

The announcement of this policy change will not change much in the short-term as it will not apply to projects that are already in development. Government officials have also said that it will not affect any existing contracts and will take ministries up to 5 years to start implementing the regulations.

Long-Term

In the long-term, it remains to be seen how this policy will affect the country. If it holds in the next 5 years, then the Indonesian government can expect to see decreased investment in the oil and gas sector, an area that is in dire need of upgrades and expansion.

Five years to implement such a policy is considered short for the oil and gas industry, especially in a country that requires 2 years to get the requisite 25 permits it takes to start oil and gas exploration. The playing field could potentially go as the Indonesian government had planned– a favorable environment for domestic investors. However, if such a stimulus fails, the country may have just crippled its own economic growth by limiting growth in the energy sector and signal to potential investors its volatile regulatory environment.

Resource Nationalism vs’ Practical Economic Policy

The revisions seen in Indonesia’s Negative Investment List is a growing trend in the country’s purported resource nationalism.

It is an attempt to gain greater control over domestic resources and allow domestic companies to better compete, increase value-added services at home, and build domestic expertise. This can be seen via the country’s January 2014 implementation of a ban on mineral ore exports and its November 2013 restrictions on hiring expatriates in the oil and gas industries.

There have also been reports of the government targeting foreign companies with retroactive taxes; factors that all point toward increasingly nationalistic policies that aim to completely control FDI and keep spoils in the hands of Indonesians.

Yet, ironically, the country is currently at an economic crossroads. Despite a high average growth over the last decade, Indonesia’s economy has showed signs of slowing down since 2012. In Q1 of 2014, the country saw a GDP growth rate of 5.21%, the lowest the country has seen since the economic crisis in 2009. Indonesia was also hit hard in 2013 by a drop in the rupiah’s exchange rate, causing the archipelago nation to go into an all-time high current account deficit of 4.4% of GDP in Q2. These numbers were driven by the importation of expensive foreign oil, rising fuel demands, an expanding economy, domestic fuel subsidies, and weak exports.

Indonesia still has quite a ways to go before it can be called a developed nation. In 2012, GDP per capita was $US 5,000, coming in at number 158 in the world. Primary energy consumption grew 44% between 2002-2012, with only 72% of the nation currently having electricity.  What’s worse is that the government only invests about 3% of GDP into infrastructure, when other Southeast Asian countries are investing as much as 10% of GDP.

The Indonesian government has calculated that the nation will require an investment of $US 191 billion for basic infrastructure per year to keep up with current economic growth rates. About one-third of this amount is to be provided for by the Indonesian government, with the difference of $US 140 billion to be met by the private sector.

Foreign and Domestic Investment in Indonesia 2011-2013

When comparing these numbers to the actual foreign and domestic investment seen by Indonesia between 2011-2013, Indonesia is still missing between $US 106-118 billion of investment from the private sector.

Outlook

In order for Indonesia to continue its economic growth it will require investment in infrastructure, an increase in primary energy consumption, and more electrification. However, restrictions such as the revision on the Negative Investment List point toward resource nationalism.

The timing of this policy’s release is likely aimed at bringing the favor of voters in the upcoming July 2014 presidential election. The current President Yudhoyono’s term has been marked with graft and corruption scandals, making it imperative for him and those in his political party (Democratic Party) to take a crack at Indonesia’s increased nationalist sentiments to protect the party and the President’s legacy.

Current President Susilo Bambang Yudhoyono, Chairman of the Democratic Party

Current President Susilo Bambang Yudhoyono, Chairman of the Democratic Party

With 2014′s preliminary legislative results looking at a loss of 50% of votes and fourth place overall, the current ruling party will need all the help they can get to be included in any coalition for the next government. What remains to be seen is whether the Indonesian government will reverse these regulations.

At the moment, with an economy weak from reduced exports in their core mining sector, fuel subsidies that account for 25% of the country’s annual public expenditures, and lack of infrastructure in all core sectors; it is likely that this Negative Investment List will be reevaluated by the new presidential candidate in the later half of 2014.

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