Persistent delays to fuel subsidy reductions are credit negative for Indonesia - Moody’s | Outlook data
(The Insider Stories) - Persistent delays in reducing fuel subsidies that cost Indonesia over 2% of its gross domestic product are credit negative for the country, although modest government debt, adequate foreign reserves and strong economic growth support a stable outlook on the country’s sovereign debt, Moody’s Investors Service says in a Moody’s Credit Outlook report.
The following is an extract from the report.
Last Tuesday, Indonesian President Susilo Bambang Yudhoyono announced that reductions to fuel subsidies would be forthcoming only if parliament approves offsetting cash assistance for the poor. With healthy economic growth in Indonesia (Baa3 stable) – we forecast real GDP growth of 6.0% in 2013 versus 6.2% in 2012 – spurring greater fuel consumption, the government’s inability to effect subsidy reform is credit negative.
In the absence of reducing fuel subsidies, the president noted that this year’s fiscal deficit could balloon to 3.8% of GDP. This is higher than the Ministry of Finance’s early April estimate of 2.4%, its October 2012 original budget projection of 1.7% and the legal fiscal deficit cap of 3.0%. In addition, the current account deficit is apt to widen, exacerbating pressures on the rupiah and inflation.
At the same time, reducing fuel subsidies poses upside risk to inflation, which at 5.6% year on year for the 12 months ended in April already breaches the central bank’s year-end inflation target of 3.5%-5.5%. In addition, a prolonged weakness in the balance of payments could lead to further rupiah depreciation and consequently increase inflationary pass-through from imported goods.
Over the past two years, the Indonesian parliament has failed to approve the government’s proposed changes to the subsidy framework, including restricting the availability of subsidized fuel based on types of vehicles or geographic location. In the 2013 budget law, however, the government secured the authority to circumvent parliamentary approval to increase fuel prices.
The president’s call for cash compensation as a prerequisite to a hike in fuel prices thus negates the usefulness of having secured this authority. It is also a tactical change from recent pronouncements of an imminent across-the-board increase in fuel prices. As the parliament may be as unwilling to push through unpopular reforms in the run-up to next year’s elections, this situation will be an important test of Indonesia’s heretofore sound policy framework, given the government’s prevailing fiscal rules and inflation mandate.
Subsidies are a prominent feature of Indonesian government finance. The subsidy bill accounted for an average of 20.0% of total government expenditures from 2003-12, with subsidies for fuel products composing 58.2% of the total. Fuel subsidies were last revised in 2008 as the record run-up in global crude petroleum prices led to then-record IDR139.1 trillion (2.8% of GDP) spending on this particular budget item. However, higher subsidy spending was offset to a large extent by higher revenues that year, resulting in a fiscal deficit of only 0.1% of GDP.
Following the global financial crisis, Indonesia has been one of the fastest growing G-20 countries with real GDP growth averaging 6.3% during 2010-12, increasing demand for subsidized fuel. Over the same period, the fuel subsidy bill has more than doubled to IDR211.9 trillion (2.6% of GDP) in 2012 from IDR82.4 trillion in 2010 (1.3% of GDP). However, revenue growth has not adequately offset this rise and the deficit widened to 1.8% of GDP last year from 0.7% of GDP in 2010.
The demand for imported refined fuel products is artificially propped up by subsidies and, when combined with a decline in Indonesian crude oil production, contributed to a reversion of the current account to a deficit in 2012, the first since 1997. Indonesia’s net oil imports rose to $20.3 billion in 2012 from $8.6 billion 2010. The resulting strain on the balance of payments has led to considerable volatility of the rupiah, which depreciated against the US dollar by more than 6% in 2012 alone. Through March, Indonesia’s international reserves have fallen to $104.8 billion from $112.8 billion at the end of 2012, implying continued pressure on the balance of payments by oil balances, among others.
Nevertheless, moderate government debt, sufficient international reserves to cover more than the next two years’ maturing debt and the continued strength of economic growth support the stable outlook on Indonesia’s sovereign rating.
