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## Indonesia's Energy Policy: A Lesson in Failure

September 6, 2005

Disruption, high prices, and dislocations of all sorts have led to call for a new "energy policy." Let us consider the case of Indonesia, which has an energy policy of an unusual sort. As the Sunday Times of Singapore reported on September 4, 2005: "Jakarta subsidizes heavily the cost of fuel for ordinary Indonesians and faces a subsidy bill of as much as 138.6 trillion rupiah this year because of high crude oil prices."

Which begs the question: Just how much is 138.6 trillion rupiah? At the current exchange rate of U\$1=Rp10,500 (Sept 2, 2005), this amount converts to a whopping U\$13.2 billion, approximately half the current estimated cost of the damage caused by Hurricane Katrina in the New Orleans disaster. But what does this astronomical number mean to the ordinary Indonesian citizen? Let us try some hypothetical calculations.

If, for example, instead of giving this money to those who own cars, trucks, motorcycles, anyone who buys gasoline (i.e. those economically better off than the average Joe in that oil rich country) in the form of gasoline subsidies, the authorities were to re-distribute this Rp140 trillion (give or take a few hundred million) equally among every man, woman, child in that country, each person would receive from the state the amount of Rp5,785,123! Every citizen of Indonesia would be an instant millionaire almost 6 times over! In Indonesian rupiahs, that is. (My basic calculator could not get in all the digits, the Indonesian population stands at 241,973,879 as of July 2005, source CIA)

But this is no laughing matter. Just how much really is Rp5.8 million? To average Indonesian Joe, again at U\$1 to Rp10,500, this amounts to U\$552. Compare this figure to the per capita income of Indonesia of U\$810 in year 2003 (published by the World Bank), this basically means that every citizen of Indonesia will not have to work for over eight months in the year! This may sound like very good news for average Joe, but it would terrify the Keynesian economists and government policy makers as unemployment would suddenly explode to 67% annualized!*

But the real losers will be the state supported industries; the automobile importers, transportation companies, car assembly plants, highway toll operators etc. Gasoline subsidy is a legacy of the Suharto era. Powerful ruling elites of the Suharto family and its cronies needed to have as many cars & trucks on the roads in order that the highways populated with frequent tolls can be money spinners for them.

For example, there are no less than five toll-collection points between Jarkarta’s city centre and the international airport (about an hour’s drive), all owned and operated by the sons & daughter of the ex-Indonesian President Suharto. All car distribution businesses and assembly plants are either owned directly by the members of the Suharto family or in partnership with foreign investors. Again it is in their interest to encourage car ownership and usage. They couldn’t and wouldn’t give gasoline away, so the next best thing was to strong-arm the government into a costly subsidy scheme. Thus, the government’s predicament today.

Also, in the same Sunday Times report, Lee Hsien Loong, the current Prime Minister of Singapore is reported to have said:

“…(Indonesian) President Yudhoyono has stated in his broadcast this week promised comprehensively the measures which Indonesia is to take…as a fiscal policy, monetary policy, of course subsidies of oil products…and also structural adjustments he has to make, to make Indonesia more attractive for investments…Resolving problems quickly can help strengthen confidence in ASEAN economic management…”

Now, it would be interesting to briefly assess the options open to the Indonesian President Susilo Bambang Yudhoyono vis-a-vis this situation with high crude oil prices and how this particular problem of crippling subsidies can be resolved quickly. Note the four options identified are fiscal policy, monetary policy, oil subsidies and structural adjustments (that the President has to make).

First, fiscal policy. This basically means looking into the government coffers to see if there is any money left that the government has not yet spent. And since every government official is on the take, there isn’t much left in the budget kitty, as is to be expected. But crude oil has to be paid for in US Dollars. And where do the extra US\$ come from? The government can either borrow it from someone e.g. the central bank of some friendly government with a lots of US\$ reserves or more expediently, as a second option, it could instruct its own compliant central bank to print more of its fiat money i.e. a loose monetary policy.

Printing more rupiahs has proven tricky as this could ignite inflation in the domestic economy and frighten foreign investors who will swiftly take their capital out and flee the country (as has happened during the Asian Financial Crisis of 97/98 which resulted in the toppling of the Suharto government). In fact, at the news of the Indonesian government’s selling of rupiahs (lots of it) in order to purchase US\$ to pay for evermore expensive crude oil, the rupiah promptly depreciated 5% within two weeks! Worried that the rupiah would collapse further if this policy were to continue, the government then quickly turned around and announced that it would raise interest rates so as to calm the financial markets and stem the rupiah’s slide. (Some analysts were predicting for the rupiah to plunge to 1998 levels, if crude oil prices continue to rise.)

Not being able to “print” itself out of trouble, the Indonesian government then resorted to borrowing from the Chinese central bank to the tune of US\$2 billion (ST, Sept 2, 2005). A quick calculation shows that, if crude oil prices remain at current levels i.e. close to U\$70 a barrel, US\$2 billion will only provide for 15% (1.8 months) of the annual subsidy of US\$13.2 billion. Whilst the Americans are praying for Hurricane Katrina to blow over quickly, they can rest assured that the Indonesian government’s prayers are with them, in that crude oil prices will return to saner levels within a month or so.

Now, how about the third option of reviewing the policy of gasoline subsidies? This is not very popular politically as the last time the government reduced gasoline subsidies in March 2005, it sparked wide spread rioting in Jakarta and the police and military had to be mobilized to take control of the capital city. In fact, when the President announced that he would have to consider further reducing gasoline subsidies recently, angry protesters flooded the streets of Jakarta. It will take a very courageous government to tempt its faith again this way, especially when the Yudhoyono government has only been in power less than a year.

So that leaves us with the fourth option i.e. structural adjustments. What “structural adjustments” could Mr. Lee be thinking of that the Indonesian president should make?

The Singapore government has always pride itself on being farsighted, competent and efficient. It is also well know for running the city state in a highly autocratic manner. If President Yudhoyono were to follow Singapore’s example of tough government, he will have to seriously consider the following policy measures (many currently in place in Singapore) in order to be able to (to paraphrase Mr. Lee) resolve this “gasoline subsidy problem” quickly:

1. remove all forms of subsidies for petroleum products immediately and channel the annual saving of US\$13.2 into other state redistributive programs,
2. introduce a 35% excise tax on all grades of gasoline & diesel to discourage automobile usage (in the name of environmental protection),
3. nationalize all taxi companies and introduce a ‘fuel surcharge’ on all fares (to encourage use of public transport system, operated by the government)
4. increase tariff on all car imports and introduce non-tariff barriers e.g. hefty vehicle registration fees on all new vehicles (if he needs it, he will pay)

These are just some of the policy measures that President Yudhoyono could consider implementing for a start. Such highly unpopular measures will have to be backed up by the appropriate propaganda machines i.e. state controlled press and broadcast media. Riot police and the military will be on standby to deal with any unhappy demonstrators or riot crowds on the streets. Curfews may even have to be imposed should things get out of hand. After all, the government has just found itself a fat wallet with US\$13.2 billion inside, with which it can buy an awful lot of enforcement power! It can now also look forward to a handsome stream of fresh income from newly introduced gasoline taxes and indirect vehicle tariffs, all thanks to rising crude oil prices.

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But alas, Indonesia is supposedly a democratic country with a President elected by the people, for the people. The above “structural adjustments”, although seemingly sensible, and would prove sincere and well meaning policy advice from the Prime Minister of its friendly neighbor, could only spell disaster for the Indonesian state.

Managing a great archipelago with an ethnically-diverse population of 242 million people spread over some 17,000 islands is not quite the same as controlling a city state of 3.5 million politically docile citizens. Economically and politically, the state’s long arm will truly be stretched in Indonesia. And for those of us who believe that “government is best which governs the least” and that government interventions in the economy often lead to chaos in the marketplace, the choice between a state with a US\$13.2 billion gasoline subsidy problem, and its peaceful neighbor with a myriad scheme of direct and indirect expropriations, is really no choice at all.

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K.Y. Leong is in business in Singapore. vertex_18@yahoo.com.sg. Commenton the blog.

* This cranky calculation assumes that every citizen in the country, regardless of age or gender, would be employable by definition of the Labor Ministry and thus qualified to benefit from the imaginary re-distribution exercise. But if we were to fine tune this computation (as many governments would) by classifying all children aged 15 or under, and all persons aged 55 and over as “unemployable”, and make this payout only to “employable” adults, we could end up with an even crankier result – an unemployment rate of over 100%! Such is the power of government statistics.

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