Release: S&P: RI fuel price hike encouraging
Tuesday, October 4 2005 - 02:18 AM WIB
SINGAPORE (Standard & Poor's) Oct. 3, 2005--Standard & Poor's Ratings Services said today the Indonesian government's (foreign currency B+/Stable/B; local currency BB/Stable/B) 126% average fuel price rise implemented on Oct. 1 is an encouraging move that should relieve immediate pressure on fiscal and external balances, and assuage concerns on progress in fiscal consolidation. The magnitude of the increase was considerably larger than the 29% increase in March this year, the 30%-70% initially considered by the government, or what was thought to be within the risk tolerance of a president worried about possible social unrest.
Therefore, the move should restore investor confidence somewhat by alleviating perceptions that the government was coerced by adverse market reaction to its apparent indecision and unwillingness to address the subsidy issue in a forceful, timely manner.
Although the size of the fuel price hike appears to stamp the president's authority on the government and is a statement of leadership, its belated nature highlights the risks posed by a seeming inability to formulate appropriate and timely policy responses when faced with external shocks. Given the remaining level of price subsidy and expectations of continued high world oil prices, further increases could be necessary, which the administration will be reluctant to risk after this year's hikes. This should turn attention onto boosting stagnant domestic oil production and increasing the use of alternative fuels.
With the subsidy bill threatening to rise to more than 5% of GDP this year, the fuel price increase was necessary to enable the authorities to limit the fiscal deficit to a targeted 1% of GDP in 2005. Indonesia has been assiduous in cutting its deficits, with general government deficits falling to 1.3% of GDP in 2004 from close to 3% in 2001. The attendant primary surpluses, in turn, were instrumental in reducing the country's large public debt burden to about 68.0% of GDP by the end of 2004 from 94.6% in 2001. Besides the fiscal considerations, the fuel subsidy cut was also necessary to relieve some pressure on the beleaguered rupiah.
By making fuel available at about 60% below world market price, subsidies contributed to Indonesia's increasing fuel import demand by leaving consumption unbridled. Rising import volume together with increasing oil prices meant a steep surge in foreign exchange demand for oil imports (estimated at US$1 billion per month), adding to pressure on the rupiah. Skyrocketing oil prices and the impact on fiscal expenditure and the currency seem to have caught the authorities by surprise, with the delay and apparent lack of coordination to effect appropriate policy response denting investor confidence.
The latest fuel price increase, together with a more robust monetary policy stance, should reassure markets about the administration's commitment to fiscal consolidation, and its willingness and ability to implement unpopular measures in the interest of prudent macroeconomic management. Yet, although the new price/subsidy ratio makes the fiscal impact of high oil prices less threatening, the subsidy issue and accompanying pressure on the rupiah could surface again.
The new fuel prices of Indonesian rupiah (Rp) 4,500 for a litre of gasoline (US$0.44), Rp4,300 for diesel, and Rp2,000 for kerosene leave retail prices at an estimated 20%, 49%, and 66%, respectively, below world prices. These numbers underscore the need for the administration to keep a gradual removal of fuel subsidies on its reform agenda. Aside from cutting subsidies, boosting Indonesia's domestic oil production has to be part of the solution to alleviate the associated fiscal and external balance problems.
This ties in with the need to improve the general business environment, which holds the key to more investment and trend growth rates higher than the current relatively modest 4%-5%. Improving the investment climate was a key election promise of President Yudhoyono; indeed, he appears to have staked his political fortune on boosting economic growth. Investor confidence is benefiting from positive news flow on the ongoing fight against corruption, the resolution of a four-year dispute between state oil firm Pertamina and Exxon Mobil, and the end of separatist conflict in Aceh. However, for a sustained turnaround, much remains to be done in areas such as the regulatory framework, and reforms of the judiciary and labor markets. Progress in these areas will be key to a positive rating trajectory for Indonesia.
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