Kathryn Chelminski, CIES PhD candidate in Political Science/IR and currently visiting as Predoctoral Research Fellow, Kennedy School of Government, Harvard University, summarizes in a blog article published on ClimateHome her recent research insights on Indonesia's fuel subsidy reform.

Widely praised as a success when rolled out in 2014, Jakarta's cuts to domestic oil and gas stored up long term fiscal problems that are now emerging. Starting in late 2014, Widodo began to cut fuel subsidies, particularly to petroleum, projecting that this would free up IDR195 trillion (US$15.6 billion) from the 2015 budget's original allocation of IDR276.0 trillion (US$22.1 billion) to be used instead on mainly infrastructure investments. The reforms were widely praised as a success, not least because, unlike past reforms that led to massive protests, they were accepted by the public.

However, Indonesia had set itself up for future fiscal troubles. There are inconsistencies in how the reforms were presented, and what happened in reality. The fossil fuel subsidy reforms coincided with the crash of the global oil market, which some scholars argued was the best moment to introduce reforms, since price shocks would be low. But then the rupiah depreciated to IDR 13,271 to US$1, levels not seen since the Asian financial crisis.

Since the removal of subsidies was passed by Parliament and signed into law in 2015, the 2016 budget did not include a budget line for gasoline subsidies, but it kept subsidies for 3 kg LPG tanks, diesel and renewable energy.

And instead of being removed completely, the cost of gasoline subsidies was transferred to Pertamina, the state-owned oil company, which now covers the difference between the subsidized price set by the government and market price of fuel. The Indonesian government did not reimburse Pertamina for losses from price controls during 2015, which amounted to US$1 billion (IDR 15 trillion). In March 2016, the government also cut subsidized fuel prices by IDR 500 (US$0.04) to reduce transportation fares by 3%. This casts further doubts on the "stickiness" of the recent reforms and has added to Pertamina's deficit.

If Pertamina is not reimbursed, it will go bankrupt. The situation will only become more precarious if oil prices continue to rise. Since Pertamina is a state-owned enterprise, the government has a fiscal liability (and fiduciary responsibility) to recapitalize it.

Completing the reforms successfully will require two key elements: increased transparency and fiscal buffers to better manage volatility in the oil and currency exchange markets. Removal of price controls requires macroeconomic stability, which in turn requires fiscal adjustments for inflation through coordinated credit, fiscal and exchange rate policies.

Such measures, combined with increased investment and directed social assistance, such as the payments set up in Iran's subsidy reform, soften the impact of higher fuel prices and make reforms more socially acceptable.

Indonesia still has a chance to get fossil fuel subsidy reform right — but it will require political determination, strong communication campaigns and sound macroeconomic policy-making to ensure the "stickiness" of the next attempt at reforms.

Read the full blog post at:
http://www.climatechangenews.com/2016/06/14/lessons-from-indonesias-fue…