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    Southeast Asia
     Mar 10, 2005
Tigers count the cost of easing fuel subsidies
By Bill Guerin

Tiny but wealthy Singapore does not subsidize fuel costs, unlike neighboring Indonesia, Malaysia and Thailand. Though it's the region's oil trading hub, Singapore has the highest fuel prices in Asia by far, averaging 92-98 US cents per liter, and is used as the price benchmark for most fuel in the Asia-Pacific because of its location and for being the largest refining center in the region. Minister of State for Trade and Industry Vivian Balakrishnan suggested last week that there was a "silver lining" for Singapore in high oil prices because it was spurring investment to find cheaper and more efficient fuel alternatives.

For all three neighboring countries, however, the soaring crude prices have dragged their governments into the horns of a different dilemma. Jakarta, Kuala Lumpur and Bangkok are now more concerned with cutting fuel subsidies than with looking into other energy alternatives.

Crude prices rose to a fresh four-month high of more than US$53 a barrel last week and flirted with $55 this week amid comments by Morgan Stanley analysts that subsidies might actually have encouraged oil producers to keep prices high because they can see that economic growth is resilient, despite the increase in energy costs. Though differing widely in their approach to the issue, all three governments need to rein in unpredictable spending on subsidies because of the uncertainty over crude oil costs, and to keep budget deficits under control.

Even with crude oil prices hitting new highs and persistent budget deficits, the Malaysian government has assured consumers that although it may reduce petrol subsidies it will not remove them altogether. Thailand has implemented subsidy cuts for diesel but has allowed petrol increases by producers. Indonesian President Susilo Bambang Yudhoyono's decision to slash fuel subsidies, with the biggest cut in those for petrol, has been the boldest of all.

Oil sector analysts cite several factors - continued worldwide geopolitical instability, terrorist concerns, a weakening dollar, and speculative futures purchases by hedge funds - to support their predictions that crude oil might soon reach $60 a barrel. The sting in the tail for developing Asian countries is that any increase in their domestic growth spurs further demand for energy and costs taxpayers more in supporting the artificially low fuel prices. The Asian Development Bank in December trimmed its 2005 economic growth forecasts for the region, saying higher oil prices may hurt global demand and push up inflation.

Indonesians, whose country is the only Asian member of the Organization of Petroleum Exporting Countries (OPEC), have been hardest hit of all. Their president, Yudhoyono, was elected by a landslide majority last year, and despite opposition in parliament to his government's planned hike in fuel prices and the certainty that street protests would follow, he authorized a massive slash in fuel subsidies last week, promising to redirect the savings to fund increased spending on social programs and help the needy through job creation and small business programs.

On March 1, fuel prices in Indonesia, though still the cheapest in Asia, were raised for the first time in 14 months by an average 29%. Petrol prices shot up by a massive 33% to Rp2,400 (26 US cents) a liter from Rp1,800. Diesel fuel also went up to Rp2,100 per liter from Rp1,650. However, the price of the socially sensitive commodity minyak tanah (kerosene), widely used for cooking and lighting in poorer homes, remains the same, though kerosene for industrial use jumped to Rp2,200 from Rp1,800. The price of kerosene has always been kept low and is currently only about one-third of the cost of production. Fuel subsidies cost Indonesia almost $7 billion in 2004. "It is a tough and bitter decision, but one we have to take," Yudhoyono told reporters hours before the dramatic hikes went into effect. "What is important is that compensation reaches those who need it, namely those on fixed or small wages."

Soaring world oil prices are a double-edged sword for Indonesia. Although the skyrocketing price means a boost in revenue for exports of crude, the government has to shell out even more to maintain the subsidies. The cuts in subsidies are aimed at reducing the budget deficit to 1% of gross domestic product (GDP) this year, down from around 1.6% last year. Coordinating Minister for the Economy Aburazil Bakrie points out that oil prices even at $35 a barrel would have meant spending up to Rp60.1 trillion on fuel subsidies.

Another problem for Indonesia is the imbalance between the country's production capacity and its need for fuel. There is now little or no new investment in the oil exploration sector and officials from the Ministry of Energy and Natural Resources have warned that total oil production in Indonesia has dropped to a million barrels per day. At the same time, domestic demand for fuel continues to increase, with state oil company Pertamina recording a 15% increase in consumption of all types of fuel in February to 189.7 kiloliters, compared with the same month last year. Latest figures indicate that annual demand has already reached 1.1 million barrels a day.

The price rises are expected to increase costs for business, weaken consumer purchasing power and push up inflation and interest rates. A good supply of food from agricultural harvests has kept food prices - the biggest component of the inflation index - low, but monthly inflation in January, according to the latest published figures, was 1.43%, the highest in the last three years. Annual inflation jumped from 6% to 7.32%, and the largest factor was an increase in the cost of foodstuffs, followed by beverages and tobacco.

Malaysia is Southeast Asia's second-biggest crude producer after Indonesia. Like its bigger neighbor, it is also a net exporter of crude oil but has the same dilemma to face over the cost of subsidies. The cost of artificially keeping down the retail price of petrol, diesel and liquefied natural gas cost Malaysia RM4.8 billion ($1.26 billion) in fuel subsidies last year.

The government has decided to tackle the diesel subsidies first and leave the issue of heavily subsidized petrol until later. Subsidies for diesel, widely used by farmers, fishermen and road transport operators, added up to about RM3.3 billion of the total fuel subsidies handed out last year. The last diesel increase was on October 1, when the price went up by RM0.05, from RM0.78 per liter to RM0.83 per liter.

On March 1 the regulated diesel price was raised by 6%, up RM0.05 per liter to RM0.88, in the first step toward reducing, not eliminating, fuel subsidies. Prices for petrol and liquefied petroleum gas (LPG) remained the same, although the subsidies for these fuels totaled RM1.09 billion in the previous five months.

The last time petrol prices were raised was in October 2004, for the second time in five months, when premium petrol prices increased to RM1.42 per liter and regular grade to RM1.38. Deputy Prime Minister Najib Tun Razak, in a speech to ruling coalition lawmakers last weekend, though warning that the government faced a continued heavy financial burden because of the cost of fuel subsidies on the back of record-high global oil prices, admitted that the government has no intention of removing petrol subsidies, although it was studying how to reduce them.

Any reduction in subsidies would be made gradually so as not to shock people, he was quoted as saying. "We have to condition the minds of the people first before doing any review," he said at a news conference. Economic Planning Minister Mustapa Mohamed had already confirmed at an earlier news conference, "We are not going to eliminate subsidies completely but are reducing them gradually or on a staggered basis." Mustapa confirmed that though subsidies might be scaled back gradually, they would not be eliminated.

From January, a government quota had been imposed on the sale of subsidized diesel at petrol stations to curb illegal sales to commercial users. This followed the rampant abuse as subsidized diesel cost RM0.83 per liter compared with non-subsidized diesel sold to industries at RM1.36 per liter, a difference of RM0.53 per liter. Unsurprisingly, the sale of subsidized diesel had soared last year to 4.7 billion liters from 3.5 billion liters in 2003. The new diesel price is still the third cheapest in the region, after Brunei and Indonesia, at the equivalent of RM0.72 and RM0.60 a liter respectively, and much lower than Singapore, Thailand and Hong Kong.

Domestic Trade and Consumer Affairs Minister Datuk Shafie Apdal said this was why the government found it more suitable to raise the price to reduce the subsidy. The government felt that if the difference between the retail and industrial price of diesel was lowered to less than RM0.20 a liter, it was possible that such abuse could be reduced, he said, adding that the government's decision to raise the price of diesel and not petrol was right, as the tax exemption and subsidies for diesel were high. He said that even with the price of diesel going up by RM0.05, the government would still be losing a revenue of RM654 million while having to provide RM338 million in subsidies this month to ensure that the prices of petroleum products remained low.

Despite the rise, however, the central bank said growth prospects remained favorable, with the private sector expected to sustain domestic demand even as the government curbs its budget deficit this year to 3.8% of GDP from 4.5% in 2004. It has allocated RM3 billion in total fuel subsidies this year

Prime Minister Thaksin Shinawatra, who took office in early 2001, had pledged diesel subsidies would be safe until last month, which just happened to be the month he was re-elected by an overwhelming majority. Thaksin wasted little time in announcing a cut in subsidies. However, as in Malaysia, it was diesel users who felt the most pain.

Consumers were hit by a 0.60 baht per liter (1 US cent) adjustment of the local diesel price after the government ended a one-year price freeze on diesel prices that cost 63 billion baht to maintain a capped price of about three-quarters of the market rate. Thailand is still spending about 3.58 baht per liter, around 179 million baht every day, to keep local prices of diesel - on which most Thai vehicles run - below the market level. Under Thaksin's new managed float system, diesel prices will be allowed to move up to the actual price.

Also in February, state oil giant PTT Plc and other oil companies increased local petrol prices by 0.40 baht a liter, sending the price of premium petrol to 20.95 baht and regular petrol to 20.09 baht. This is still a long way from last year's record highs of almost 23 baht a liter.

Thailand, unlike Indonesia and Malaysia, has to import all of its oil needs. Along with China, it consumes more than twice the oil per unit of output than the average "rich-country", according to International Energy Agency data. Higher import bills have sent Thailand's trade balance into the red. That has depressed the baht, making imported fuel more expensive still, and feeding the inflation the subsidies are supposed to curb.

Back in Indonesia, where fuel prices have been highly distorted for many years, the cost of the subsidies has meant a much-reduced capability to provide subsidies for productive sectors such as labor-intensive agriculture, the nation's prime asset, and has meant the specter of mass unemployment continues to cast a shadow. On the eve of the fuel price hikes, a poll conducted by the Indonesia Survey Institute found the president's popularity had dropped to 66% from 80% in November, with respondents mainly criticizing his efforts to improve the economy.

The government will be hard pressed to convince the public of the compelling need to accept not just the higher fuel prices but also the increased costs of living across the board as the only alternative to keeping the country's fuel prices well below world levels. Even after the cuts, prices are only 50% or less of the international market price. Persuading the public to accept the fuel price hikes will also depend on the government's performance in implementing a key election pledge of Yudhoyono's - curbing corruption.

Fraudulent practices are widespread and subsidized fuel is re-exported by smugglers and sold to industrial consumers. Forged documents are a way of life and the smuggling of paraffin and diesel out of the country commands massive profits, easily able to cover the expense of paying off officials or others who could jeopardize the theft industry.

Though demonstrations against the increases, initially widespread, were more subdued than expected, sporadic protests continue and more demonstrations are expected in the coming days. The protests, however, have raised the stakes in the political arena. Indications are that opposition to the price increases will be more vigorous in the corridors of power than on the streets.

The planned hike was strongly opposed by several factions in the House of Representatives (DPR) with the Indonesian Democratic Party of Struggle (PDI-P), the second largest in the DPR, leading the onslaught. Only the Democratic Party, led and co-founded by Yudhoyono, has said it wholeheartedly supported the decision. Prior to the hikes, Prosperous Justice Party (PKS) legislator Rama Pratama, who sits on the powerful budget commission, said details of the government's compensation program were still unclear and warned that his party rejects the fuel price increases because the government has not yet shown how compensation can reach the right target. "The government also has no clear scheme to deal with the inflation that will be triggered by simultaneous increases in the prices of staple goods," he pointed out.

Not only opposition political parties criticized the subsidy cuts; even factions with members in the cabinet such as the National Awakening Party (PKB) and the PKS, one of Yudhoyono's major political allies in parliament, were prominent in criticizing the cuts. Parliamentary Speaker Agung Laksono, from the Golkar faction, headed by Vice President Jusuf Kalla, has come out in public and opposed the price rise, echoing the same sentiments. "The government has still not provided any satisfactory guarantees on any negative impacts of a fuel price hike," he warned.

The government has chosen compensation schemes to redress the imbalances and programs will cover education, health, social services and help for development of micro-credit businesses. Free schooling for children from poor families has been promised and Rp4.18 trillion has been budgeted for compensation for the education sector. Though there seems little doubt the government will eventually win its case in parliament, the pressing need now is to rein in any unauthorized price increases, get the compensation schemes up and running and win over the public.

Malaysian Prime Minister Abdullah Badawi and Thai Prime Minister Thaksin, even if they were to make sweeping cuts in petrol subsidies, would not have to face the same socio-economic risks in their countries as Yudhoyono does. Fauzi Ichsan, chief economist for Standard Chartered in Jakarta, warns: "This [the cuts] is very politically sensitive and will be blamed on Yudhoyono if it goes wrong."

Bill Guerin, a weekly Jakarta correspondent for Asia Times Online since 2000, has worked in Indonesia for 19 years as a journalist. He has been published by the BBC on East Timor and specializes in business/economic and political analysis in Indonesia.

(Copyright 2005 Asia Times Online Ltd. All rights reserved. Please contact us for information on sales, syndication and republishing.)

Indonesia's rising debt (Jan 12, '05)

Thai energy measures miss the mark (Sep 2, '04)

Indonesia's subsidies powderkeg
(Jan 22, '02)


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