Category Archives: Indonesia

Indonesia, Natural Gas, Oil, Regulatory Regime, Southeast Asia

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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Indonesia, Regulatory Regime, Southeast Asia

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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