Indonesia Takes Its Foot Off the Gas

The government risks unrest by cutting generous fuel subsidies | It “took over a year of hand-wringing, to-ing and fro-ing”

Bruce Einhorn and Yudith Ho

Supraman is concerned about the price of gasoline. The 32-year-old Jakarta bakery owner uses his motorcycle to make restaurant deliveries every day. On June 22, Indonesia’s government cut fuel subsidies for the first time since 2008, effectively raising gas prices 44 percent and diesel prices 22 percent. “Food, clothes, everything gets somewhere using fuel, so the prices of everything will definitely rise,” says Supraman, who like many Indonesians uses only one name.

As smoke from forest and plantation fires on the Indonesian island of Sumatra billows over southeast Asia, government officials in Jakarta have their eyes on another potential conflagration. After contemplating the idea for years, President Susilo Bambang Yudhoyono is cutting subsidies that threatened to swell to $30 billion in 2013, pushing the budget deficit well beyond the legal limit of 3 percent of gross domestic product. In doing so, he risks sparking street protests and inflation. In the 1997 Asian financial crisis, the then three-decade-old Suharto regime cut subsidies under pressure from the International Monetary Fund; the government collapsed a year later in the face of a popular revolt.

SBY, as the current president is known at home, had to weigh the threat of social unrest against the risk that international investors will desert the country. GDP growth in each of the last two years has topped 6 percent, prompting talk that the country should be inducted into the BRIC — Brazil, Russia, India, and China — club of emerging markets.

That impressive streak is endangered by the slowdown in China, the top market for Indonesia’s exports. Meanwhile, the combination of a mounting budget deficit and a weakening currency — the rupiah has lost 5 percent of its value in the past 12 months, making it the second-worst-performing currency in Asia — has sapped investor confidence. Indonesia, like many emerging markets, faces tougher times as the world braces for an end to low interest rates in the U.S. For years, investors borrowed in dollars and bought high-yield securities issued by governments such as Indonesia’s. “Southeast Asia enjoyed the ride,” says Rajeev Malik, an economist in Singapore with securities firm CLSA. “The end of easy money is going to be payback time.”

With foreigners holding more than 30 percent of local-currency debt, Indonesia is “much more susceptible” to a reversal in investor sentiment than countries such as India, says Christian de Guzman, a vice president and senior analyst with Moody’s Investors Service. Also, the protests in Turkey, like Indonesia a mostly Muslim country with a fledgling democracy, hit close to home for Yudhoyono and his cabinet. “We need to take steps to boost our economy,” said Coordinating Minister for the Economy Hatta Rajasa at a June 21 press briefing.

While most analysts welcomed the cut in fuel subsidies, some say the government needs to do more. “It’s a stopgap measure,” says Agost Benard, associate director of Standard & Poor’s Singapore, adding that the government’s handling of the process did not inspire confidence. The cuts “took over a year of hand-wringing, to-ing and fro-ing with all sorts of schemes proposed and then abandoned, until finally they managed to implement this,” he says.

Yudhoyono might have acted more forcefully if his party were not facing critical elections next year. (He’s barred from seeking a third term.) “We believe an expected increase in political noise is also likely to limit the scope for reform,” wrote Barclays Capital analyst Prakriti Sofat in a June 14 report.

Indonesians seem resigned to the price increases. Jakarta’s streets have been quiet since the move was announced. Supraman, the baker, says he’s figuring out ways to cope with the fallout. “We will probably find a way to cut costs somewhere,” he says. Perhaps in the pastries his wife makes: “Maybe we will reduce the filling a little.”

The bottom line Indonesia has sharply cut fuel subsidies to rein in its budget deficit and placate foreign investors.


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