Indonesia’s energy subsidy costs are rising, which international rating agencies have warned about in their forecasts on the country’s economy, and that will likely result in a wider budget deficit this year.
Energy subsidies, which include fuel and electricity, will rise to Rp 306 trillion ($32.4 billion) this year, 51 percent more than the government’s initial forecast, according to a document by the Finance Ministry presented to the House of Representatives on Thursday.
Data from the ministry showed the government had spent Rp 124.4 trillion on energy subsidies in the January-June period, equivalent to 62 percent of its full-year allocation and almost four times that of the Rp 30.6 trillion set aside for to finance infrastructure projects.
Southeast Asia’s largest economy heavily subsidizes gasoline, diesel and electricity to shield the country’s poor from being impacted by the global slowdown. The World Bank estimates that about half of Indonesia’s 240 million population lives on less than $2 a day.
Economists and analysts in Jakarta said raising the price of subsidized fuel and electricity was politically and socially sensitive. The House rejected the government’s proposal to raise subsidized fuel prices by 33 percent in late March after widespread protests across the country.
Indonesia, which became a net oil importer in 2008, pegs the subsidized gasoline price at Rp 4,500 a liter, the cheapest in the region.
Spiraling subsidy costs this year have eaten up the nation’s funds, which could be used for health care as well as much-needed infrastructure projects such as seaports, airports and dams.
Andrew White, executive director of the American Chamber of Commerce in Indonesia, said foreign investors were concerned about Indonesia’s infrastructure, or more specifically lack of it.
“The deficit is relative,” he said. “It’s rather how the money is being spent. To the extent these subsidies divert government spending away from infrastructure improvements, there is an opportunity cost by way of suboptimal foreign investment.”
Economists in Jakarta such as Juniman at Bank Internasional Indonesia shared White’s point of view, saying that the government needed to improve the nation’s infrastructure to remain competitive in the global economy.
“The development of infrastructure is the backbone of the economy,” the economist said.
Standard & Poor’s Ratings Services, the only major rating agency that has not upgraded Indonesia’s sovereign debt rating to investment grade, warned in April about the rising costs for energy subsidies.
“If the government’s subsidy spending alters the fiscal outcome or markedly deteriorates the quality of expenditure or if policy measures deter fresh foreign direct investment, then the ratings could stabilize at the current level,” S&P said in its summary analysis.
“The abandonment of a planned electricity tariff rise, the inability to implement fuel subsidy cuts despite rising oil prices and a host of proposed or actual policy measures in industry and trade point to a rising level of policy uncertainty.”
The rising subsidy spending will result in the budget deficit widening to the equivalent of 2.3 percent of this year’s gross domestic product from the original forecast of 2.23 percent, the Finance Ministry document showed.
Still, the projected budget shortfall would be within the 3 percent limit allowed by state financial law.
Indonesia, which has been running a budget deficit since the 1997-98 Asian financial crisis, sells dollar- and rupiah-denominated bonds to help plug its deficit. It started selling rupiah bonds in December 2002 and dollar bonds a year later.
Aviliani, an economist at the Institute for Development of Economy and Finance, said foreign investors would demand high rates of return if the government sold debt to finance its budget. Indonesia’s 10-year note currently yields 6.14 percent, according to the Indonesia Bond Pricing Agency, which compiles bond data.
“Bond investors will ask why we are borrowing the money if we just burn it like that,” Aviliani said. “It will be costlier for us to borrow.”
Nonetheless, the International Monetary Fund, which helped arranged billions of dollars during the 1997-98 Asian financial crisis, said in a statement on Friday that the government remained committed to increasing the pace and quality of economic growth in the medium term through sustained increases in infrastructure investment.
“While the overall 2012 budget stance is consistent with the government’s strong commitment to fiscal sustainability and strong public finances, increasing fuel subsidies are distorting the structure of the budget,” Milan Zavadjil, the senior resident representative for the IMF in Indonesia, said in a news release on Friday.
The IMF said that Indonesia should have used the funds allocated for energy subsidies on other forms of government programs and projects, namely infrastructure.
“Therefore, fiscal policy needs to be re-oriented away from poorly targeted subsidies, which could be replaced with cash transfers to the vulnerable,” Zavadjil said. “This would also free up resources to increase necessary infrastructure and social spending.”
Capital expenditure, consisting of funds to finance development of infrastructure, was estimated at Rp 153.4 trillion this year, down from the original forecast of Rp 168.7 trillion.