Oil price decline: A lost chance to get rid of a bad policy

The following article was published in The Jakarta Post on 2 January 2009. It was syndicated in The Brunei Times on 3 January 2009. I have reproduced it for your reading pleasure.

The Indonesian government has once again lowered the subsidised price of petrol. Since last week, the price of premium petrol sold at Pertamina has been set at 5,000 rupiah per litre. The falling international price of oil has allowed the government to take this step without seriously jeopardising the budget bottom line. President Yudhoyono must feel great relief that he has been able to reverse the most unpopular decision of 2008 before he faces re-election in 2009.

Unfortunately, the government did not make the decision that was needed. In saying this, I am not suggesting that the petrol prices should have remained constant. On the contrary, the current circumstances would seem to warrant a reduced price of petrol. However, this price reduction should have taken place outside the constraints of retail price subsidies. The government should have seized the opportunity to allow retail petrol prices to float in line with market prices. In all likelihood, the price of petrol would have fallen from the previous high of 6,000 rupiah a litre. By following this course, the government would have been in a stronger position support the economy and the people of Indonesia in a time of increasing international economic uncertainty.

Subsidising the retail price of petrol is poor public policy. It is of far greater benefit to the rich and middle classes than it is to the poor. The subsidy represents a government welfare payment to middle class people in place of development and welfare projects that benefit Indonesia’s most disadvantaged. To highlight why this is the case allow me to provide you with two hypothetical examples.

The first example is that of Suparman. Suparman lives in Bogor. He works in central Jakarta in a bank. His monthly salary is 13 million rupiah per month. He has recently received a pay rise and has saved enough to purchase a house and a brand new Toyota Kijang Innova. Each day he drives to work along the toll road that links Bogor to Jakarta. On his salary, Suparman does not struggle to pay for food, healthcare, education and other essential goods/services for him and his family. Each month, he spends around 1,500,000 on subsidised premium petrol. Assuming a petrol price of 5,000 rupiah per litre and a government subsidy of 300 rupiah per litre, the government subsidy is worth 90,000 rupiah each month to Suparman.

The second example is that of Suprapto. Suprapto is a farmer just outside Wonosobo, Central Java. He grows chillis. His small landholding provides an income of 700,000 rupiah a month. He lives in a small wooden house on his land. He is the proud owner of a 1976 Vespa that his father gave him as a younger man. Suprapto uses his old Vespa to get around the village, to take his products to the market and to purchase supplies for his farm as he needs them. Although Suprapto can afford to buy food for his family each month, he struggles to cover the costs of educating his children. He is afraid that if he or his family were to get sick they would not be able to afford the high cost of healthcare. Each month Suprapto spends 80,000 rupiah on petrol. Assuming a petrol price of 5,000 rupiah per litre and a government subsidy of 300 rupiah per litre, the government subsidy is worth 4,800 rupiah each month to Suprapto.

How can the government justify a policy that can result in a relatively well off person like Suparman receiving 90,000 rupiah a month from the government while a poorer person like Suprapto receives only 4,800 rupiah a month? Can parties like the PDI-P, which protested against the reduction of the petrol subsidy earlier in the year, honestly claim to represent the wong cilik if they support the perpetuation of such inequitable policies?

Continuing to subsidise the retail price of petrol is a misuse of public money. Investment in infrastructure, schools, hospitals, public transport and programmes that provide a social safety net to Indonesia’s poor are all better options that will provide returns long into the future. Furthermore, it is investments such as these, particularly in infrastructure, that will have a stimulatory economic impact to support Indonesia’s economy in the global downturn.

Policies that involve subsidies on the retail prices of goods are devilishly hard to reverse. If a government artificially insulates consumers from price rises, the consumers become dependent on the low price of the good. As prices rise, pressure is placed on the government’s budget as it maintains the price. Any attempt to remove the subsidy is greeted with anger by the consumers that have built artificially low prices into their expectations.

Significantly lower oil prices were a gift for the government. They presented the opportunity to remove a damaging policy and not have their budget held hostage to a fluctuating international price for oil. They should have seized this opportunity. It was perhaps one of the only times that they could have taken this welcome step without unduly affecting the nation’s consumers. Unfortunately, however, Indonesia is entering an election year. Undoubtedly, this fact guided the government’s hand as it took the politically easy road.

The writer is an advocacy consultant to the Indonesian Consumers’ Organisation (YLKI)