Indonesia Uses Savings from Fossil Fuel Subsidy Reform to Finance Development

GENEVA—June 14, 2016—Indonesia’s deep cuts to subsidies for fossil fuels have been matched by a substantial increase in spending on other areas of the state budget, which bodes well for the country’s economic and social development.

In one of the first studies of its kind, the IISD’s Global Subsidies Initiative, the Faculty of Economics and Business (P2EB) at the University of Gadjah Mada, and the Asia Foundation delved into budgetary documents to identify, broadly, where the government had changed spending patterns following fossil fuel subsidy reforms in 2015.

The resulting analysis—Financing Development With Fossil Fuel Subsidies: The Reallocation Of Indonesia’s Gasoline And Diesel Subsidies In 2015—finds that that the majority of areas where extra funds were allocated were linked to social protection and infrastructure, through transfers to Ministries, state-owned enterprises (SOEs) and transfers to regions and villages.

“For a long time, the international community has talked about the benefits that can be gained by reforming subsidies, but there’s generally been a lack of detailed information about where the money goes after a policy change,” said co-author Christopher Beaton, an associate at the International Institute for Sustainable Development. “Does it really go to something better? Indonesia’s process of re-budgeting in early 2015 offers a sort of ‘natural experiment’ we can use to explore this compelling question.”

Major Investments in Social Protection and Infrastructure

Indonesia’s original 2015 budget allocated around IDR 276 trillion (USD 20.4 billion) to fossil fuel subsidies. Following retail price hikes and falling world oil prices in late 2014, Indonesia was able to eliminate the majority of gasoline and diesel subsidies by January 2015, requiring the budget to be revised very early in the year. The savings were equal to around IDR 211 trillion (USD 15.6 billion), or 10 per cent of all government expenditure.

One of the challenges of tracking subsidy reallocation is that most governments—including Indonesia’s—do not explicitly link savings in one area with additional spending elsewhere. However, the country’s large subsidy savings made it possible to reasonably assume that any substantial increases in planned expenditure were possible because of reforms.

The analysis found that budgets for Ministries were increased by 23 per cent, from IDR 647 trillion to IDR 795 trillion (USD 47 billion to USD 59 billion), with the highest increases given to the Ministries of Agriculture (106 per cent), Transportation (45 per cent), Public Works and Housing (40 per cent) and Finance (37 per cent). A number of “priority” programs were set out where it was expected that increased budgets would be used to achieve targets. This included programs related to education, health insurance, housing, clean water and transportation. One, for example, targeted the provision of housing for 60,000 poor households: another, clean water access for 10.3 million households.

Budgets for state-owned enterprises (SOEs) were increased over 11-fold, from IDR 5 trillion to IDR 61 trillion (USD 0.4 billion to USD 4.5 billion). This “capital injection” was designated to investments in infrastructure in five main areas: infrastructure and connectivity; food sovereignty; economic autonomy; maritime; and security and defence. This included distributions to SOEs responsible for air services, sea transport, construction, housing, plantations, agriculture, fisheries, shipping, mining, rail, tourism and ports.

Finally, the revised budget saw a 2.8 per cent increase in transfers to regions and villages, from IDR 647 trillion to IDR 665 trillion (USD 4.8 billion to USD 4.9 billion). Some of these funds were tied to special projects determined by the government, including food sovereignty, traditional local markets, regional connectivity and health services; while some funds were to have their exact use determined by local authorities according to local need.

Evaluating the Reforms

It is difficult to determine the exact impacts of Indonesia’s reallocation because much of it takes the form of investments that will take years to yield their full benefits.

A preliminary analysis of the budgetary reallocation, however, found that it scored well in three areas. First, the budget was well aligned with the needs that have been identified in Indonesia’s medium-term development plan. Second, the reallocation was projected to boost the economy and jobs, as most of the sectors that received increased funds are associated with higher economic growth and rates of employment than fuel subsidies. Third, the budget was judged to be much less vulnerable to fiscal risk following the reform, largely because smaller fuel subsidies made the budget less prone to unpredictable variation as a result of world oil price fluctuations and currency changes.

The study was conducted before data was published on actual budgetary expenditure in 2015, so it remains to be seen how well planning has been followed through by implementation.

What Could Be Done Better?

The research team, with support from the Asia Foundation, conducted interviews to collect opinions from Indonesian civil society organizations (CSOs) that specialize in government expenditure and government officials.

Generally, the reallocation was viewed positively: no interviewees considered the previous budget to have performed any better.

At a more discrete level, a range of viewpoints emerged. Among CSOs, the effectiveness of the capital injection to SOEs was debated. Some argued the types of infrastructure would disproportionately benefit big companies and already-affluent regions, while others had concerns about how confident the public could be in the SOEs’ use of public funds.

Energy also emerged as a topic of debate. Some interviewees argued that large investments in roads would only encourage private transport use, while others noted the distinct lack of investment in clean energy, despite the need for Indonesia to transition away from carbon-intensive energy sources, particularly amid plans to significantly expand coal power generation.

Government officials noted the need to strengthen planning and coordination, so that government agencies have the capacity that they need to make the most of additional funding.

Such issues led to recommendations that future reallocation of subsidies—such as for electricity and liquefied petroleum gas, likely to see reforms in 2016 and 2017—should involve more public consultation and dissemination, more capacity building, and greater levels of transparency and accountability to track what has been achieved.

The Big Picture

The analysis concluded that Indonesia has brought together a compelling case for what can be achieved by redirecting subsidies from wasteful consumption to investments in medium- and longer-term development. It has also suggested lessons for how future reallocations could be made more effective.

As world oil prices rise once more to levels of around USD 50 per barrel, Indonesia—along with other reforming countries around the world—must avoid public pressure to reintroduce subsidies. Tracking and explaining the benefits of a “year without subsidies” is surely one of the most compelling strategies to resist backsliding.

For more information please contact Damon Vis-Dunbar, dvis-dunbar@iisd.org, +41-22-917-8848 (in Switzerland).