Why did Indonesia cut its gasoline subsidies?

President Joko Widodo declared during the last week that the government will be cutting back on fuel subsidies and raising the price of gasoline in Indonesia. IDR 7,650 ($0.51) was added to 10,000 ($0.67) for one litre of the commonly used Pertalite gasoline. The cost of higher octane Pertamax increased from IDR 12,500 to 14,500 earlier this year.

The decision has sparked a vigorous discussion on the merits of cutting subsidies, who stands to gain, how it will affect inflation, and more. It has also brought attention to the paucity of public transport infrastructure in the nation. When the price of a necessary item like gasoline rises by 31%, this type of critical reflection is to be anticipated.

However, there is a crucial distinction that must be drawn. Gasoline costs did not increase. The subsidy decreased, bringing the price of gasoline closer to its true market value. Pertalite, at 67 cents a litre, is still considerably more affordable than it ought to be in a world where petroleum is trading for $90 per barrel since the subsidy has only been lowered and not entirely eliminated. The government has just decided that it wishes to reduce the amount of the discrepancy between market pricing and retail price that is paid for directly from the state budget.

In general, since these kinds of wide subsidies are ineffective, cutting back on fuel subsidies is a desirable long-term solution. The subsidy is available to anybody who uses Pertalite, regardless of their financial level. This is also the reason why fuel subsidies are so well-liked and, once implemented, become firmly entrenched, since no one wants to risk political backlash by changing them. In Indonesia, reforming these subsidies has long been on the agenda, but Jokowi believes that the current period is ideal given the high price of oil as a plausible justification. He can also act in an unfavourable manner because he is not seeking reelection and has more political capital.

While there are legitimate worries about how higher fuel prices will affect the poor and inflation, it would be preferable for the government to spend less on general fuel subsidies and direct aid at lower-income groups, or use those funds to invest in things like renewable energy and public transportation. In general, this is a good concept, and there has already been discussion about moving in this direction through some form of social assistance that would protect low-income people from increased gas prices.


Questions about how the government is spending money are also raised by the subsidy problem. Spending levels in Indonesia’s projected 2023 budget are anticipated to be high even as the budget deficit decreases. Higher excise and consumption taxes are used to raise more money, and adjustments to the subsidy system are used to increase spending. This may not sit well with some people because the money saved from lowered subsidies will be used, among other things, for contentious projects like the new capital. It might not be popular for people to pay extra at the pump to support it.

All right. However, cutting back on gasoline subsidies today will eventually be recycled into a wide range of other government expenditure initiatives. Fuel subsidy reforms today will improve the resources the state may spend in other areas for years to come, even after the building of the new capital city is finished. In contrast to 2019, the 2023 budget proposes generous expenditure levels across the board, not simply for the new capital city. Additionally, a greater amount of the cost of fuel is being passed on to the customer. The question of whether the government finally uses those moneys wisely is, in my judgement, a different one.

Another possible advantage is that increased gas costs put pressure on government authorities to invest in renewable energy and public transportation in order to really reduce the use of fossil fuels. That is what has been occurring, for example, in Thailand, where rising oil costs prompted an increase in investment in renewable energy. Policymakers have considerably less motivation to address these concerns if customers are protected from market prices and gasoline is artificially kept at a low price as a matter of policy.

I don’t know if a 31 percent rise in Pertalite’s pricing would make much of a difference here, but I think it’s safe to say that today more people will be aware of Indonesia’s lack of reliable public transportation and electric vehicle charging stations than they were last week. Despite the drawbacks, cutting fuel subsidies will likely have a long-term positive economic impact when all of these factors are taken into account.

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