Selected fuel price policy review - Danamon | Outlook Data
(The Insider Stories) - The president has confirmed that the subsidized fuel price will be raised in May, though details on the policy is still not yet clear. The policy was highly anticipated as domestic fuel consumption has currently exceeded its monthly quota in the state budget by around 6%. If the government does not act immediately, the bulging domestic fuel consumption could push the budget deficit to swell above its target. Adding to the pressure, some other budget assumptions have also deviates in the course of 2013. Based on our calculation, these factors could push the overall budget deficit (central and local government budget) to breach the 3% threshold.
One of the factors that possibly deviates is the economic growth assumption. Our estimation of the economic growth this year is at 6.3%, which are far less optimistic than the 6.8% government assumption. Thus the optimistic tax revenue target in the budget may also be underachieved especially because the corporate income tax may still be below expectation on the background of slow global recovery particularly the commodity prices.
However, the main pressure to the budget would mostly come from the deviations of the fuel related assumptions. We estimate that this year, the global oil price could reach USD110 per barrel and domestic fuel consumption could rise to 51-53mn kilo litres (KL), while oil lifting could be lower at 830 tbpd. By our calculation, these deviations could cause the fiscal deficit in 2013 to climb to 2.45-2.55% of GDP, a significant rise from previously 1.65% deficit of GDP. If we assume the regional government deficit at 0.5%, then the overall budget deficit could breach the 3% threshold. If there is no policy action by the government, bigger fiscal deficit could trigger a negative sentiment in the market as investors will question the fiscal sustainability condition.
This year the government has the authority to raise the domestic subsidized fuel price without having to get the parliamentary approval. However, the government may go with a more subtle choice, that is, selectively raising the subsidized fuel price only for private cars (up by 44% to Rp6500,-), while the motorcycles and public transportations can still enjoy the old price of Rp4500,-. The reason behind this is that a nation-wide fuel price hike could trigger a large scale demonstration that could be politically taken advantage by the opposition to pave ways into the next year’s election. Furthermore, a subsidized fuel price hike will usually be followed by an increasing number of
poor people.
Market and Policy Implication
The fuel policy impact will be centered mostly on the inflation rate. Based on our calculation, if the government succeeded to shift at least 75% of the private car users to consume the higher premium price (at Rp6500,-), the impact on the inflation rate would be relatively manageable, at around additional 0.41% to the inflation rate, due to the higher weighted average gasoline prices (premium and pertamax). This selected fuel price policy will also have an indirect impact on the inflation (e.g. the rise of food prices due to the higher transportation cost born by some commercially used private cars) by around additional 0.14% impact to the inflation rate. That would bring our year-end inflation forecast (which currently at 5.47%yoy), to 6.02%yoy.
The policy will also reduce pressure on the state budget, resulting in savings around Rp15tn based on our estimation. Thus, the budget deficit will ease to 2.73-2.84% of GDP avoiding the 3% threshold. For the central government only, we estimate the deficit to be in the range of 2.23-2.34% of GDP (excluding the possibility of under spending); but still a significant increase from the current government budget deficit of 1.65% of GDP.
Unlike the nation-wide price increase, this selected price increase could have only little impact on consumption. As transportation cost would still be relatively manageable, the negative impact will mainly come from the lower purchasing power of some group of people. However higher consumption due to the election preparation could still compensate the decline. Thus, we maintain our optimism that the economic growth this year could still reach 6.3%yoy.
That will leave next question on the BI’s move. The central bank will certainly be happy that this policy might slightly reduce the pressure on the trade deficit particularly on the oil trade balance which will lead to a milder pressure on the current account deficit. However, the slow recovery of exports could still lead the current account to record 2.2% deficit this year.
BI will definitely keep an eye on the inflation rate onwards. BI has recently opened up that it currently does not rule out a possibility of a rate hike if inflation goes beyond its target range of 3.5-5.5%. However, BI also noted in its last monetary policy statement that any impact from the fuel policy would only be short lived and that the core inflation rate up to now, is still relatively contained, suggesting a relatively mild inflation expectation. Thus we have not seen any imminent pressure on BI to raise rate. BI’s move will depend on the level of success of the government in limiting the “premium” gasoline access to private cars. BI may less likely raise the benchmark rate (BI rate), but may raise the interest rates of its monetary instruments (SBI, TD, RR rate) to absorb liquidity.
The selected fuel price increase policy could bring a positive sentiment to the market, as the increase in fiscal deficit will be limited and current account deficit will potentially improve as well. This would bring a positive sentiment on the rupiah, affirming our view for a strengthening rupiah by year end at Rp9502/USD. However, there is also a risk arising from the central bank’s policy response. If the higher inflation pressure is not answered by an appropriate response from the central bank, a deeper correction may happen in the bond market. The 10-yr benchmark yield is currently at 5.44%.
Nevertheless, in general, investors should see this as a positive move to redirect subsidy to a more deserving parties. This would also bring a better sustainability in the fiscal condition as well as the external balance condition.
