Indonesia’s painful medicine

It’s been described as the most important political and economic story in Indonesia this year: the government’s push to reduce the country’s ballooning fuel subsidy, drive political consensus and jump-start its ambitious reform plans.

And on Monday, after a year of political wrangling and public outcry, parliament agreed on a $2.8bn compensation package for the country’s poor to offset some of the financial pain caused by its plans to raise government-controlled fuel prices for the first time since 2008.

Those in favour of lowering the decades-old subsidy, which now costs the government more than $20bn every year, say it’s about time Southeast Asia’s largest economy diverted the much needed funds to some of its more pressing problems: health, education, and its overburdened roads, ports and power plants.

To put the size of this subsidy into perspective, the government has had to allocate more money to keep fuel cheap than it did on social and capital works programmes combined in its annual budget last year.

Policy-makers and economists have long argued this painful reform is vital if Indonesia is to remain an attractive and worthwhile global investment destination.

Effectively, the government needs to convince those with the ability to drive growth in Indonesia the country is a stable and maturing democracy that can make the tough decisions needed to keep growth on track.

Risk-averse investors

This, it should be said, comes at a time when increasingly risk-averse foreign investors are pulling billions of dollars worth of capital out of emerging markets like Indonesia.

Before voting on the president’s multibillion-dollar aid package and thus the higher petrol prices, opposition parties argued the price rise would hurt tens of millions of Indonesia’s poorest people.

Higher fuel prices are expected to push inflation rates upwards, making everything from food to electricity more expensive.

The naysayers are also quick to point out, pre-emptively according to the government, that much of the money saved as a result of the hike will not be spent on programmes for the poor, but rather become entangled in the country’s murky web of corruption.

On the other hand, policy-makers, economist and investors insist cheap fuel is distorting Indonesia’s economy.

For example it has incentivised Indonesia’s middle class and wealthy to buy bigger, fuel-guzzling cars.

Higher state-controlled fuel prices are hardly a cure for all that ails Indonesia, economists say, but it is the right tough decision for the world’s third largest democracy if it wants to keep its debt levels in check and continue to attract the huge amount of investment it needs to continue to expand and create more jobs for its population of close to 250 million people.