Indonesia post $100 per barrel: The impact of oil & gas prices on public finances Wolfgang Fengler and Tim Bulman World Bank Institute: Oil Price Volatility, Economic Impacts, and Risk Management in Asia Wednesday, June 4, 2008 The World Bank Group in Indonesia Poverty Reduction & Economic Management

Outline Indonesia during high and volatile oil prices Energy subsidies, the budget and the lessons of the 2005 price adjustments Challenges and options going forward

Indonesia post US$ 100 per barrel: Four “confusing facts” 1. Since 2004, Indonesia has become a net importer of oil but it remains a net exporter of energy 2. Despite record high oil prices - oil and gas revenues have been hardly increasing 3. High oil prices remain positive for Indonesia's fiscal position - but negative for the central government 4. Although fuel subsidies are rising rapidly, electricity subsidies have been increasing even faster

Outline Indonesia during high and volatile oil prices

Despite high oil prices revenue from oil and gas has hardly increased... Trillion Rupiah

… because production has been falling sharply Indonesian Crude Oil (Production and Price) *2008* 150, , ,000 Source: Ministry of Finance IDR / barrel Kbpd Price (RHS, adjusted for exchange rate) Output (LHS)

Indonesia’s has adjusted gasoline prices but is still trying to catch up with world prices Rp per liter Sources: U.S. Department of Energy; CEIC; World Bank staff calculations US price Indonesia Link with world prices Mar-05: 33% increase Sep-05: 88% increase May-08: 33% increase

Gasoline prices in Indonesia remain among the lowest in the world Gasoline prices in selected countries, US$/Litre - May, 2008

Energy subsidies will reach a new record high in 2008 Energy Subsidies in Indonesia 0% 1% 2% 3% 4% 5% % 4% 8% 12% 16% 20% Source: Ministry of Finance and World Bank staff calculations APBN APBN-P Percent of central gov't spending (RHS) Percent of GDP (LHS) % of GDP % of central govt spending

Fuel and electricity subsidies represent significant share of national budget

Outline Energy subsidies, the budget and the lessons of the 2005 price adjustments

High and volatile oil prices undermine the budget process  Rules on transfer of funds to sub-national governments create an incentive to under- project oil prices Indonesian Government Oil Price Projections US$ per barrel * May 2008 projection. Source: Ministry of Finance Projected Realized *

Energy subsidies: Crowding out productive spending

Regressive fuel subsidy Share of fuel subsidy received directly by households

Regressive electricity subsidy Share of subsidized electricity connections by household consumption level

The inflationary effect of fuel subsidy cuts was significant but short-lived

Impact of subsidy cuts on GDP and household consumption

High subsides are related to increasing borrowing costs

Minimize the costs: Transitory compensation

Challenges and options going forward Outline

Indonesia : Fuel subsidies remain the defining policy issue  If oil prices stay at current levels, fuel subsides will remain the defining policy issue of the next government ( )  There are three broad options: (i) Keeping subsidies unchanged (or only modestly adjusted) (ii) Gradual closing of gap between domestic and world market prices (iii) Radical adjustment: Increase of fuel prices to market rates

Indonesia : Options for fuel subsidy adjustment AdvantagesDisadvantages Option 1: No or limited change to energy prices Limited social and political upheaval Fiscal risks and lost opportunity for public investment Option 2: Gradual closing of gap to world market prices (2 scenarios) Certainty of removing subsidies Gradual increase of fiscal space Continuous increase of energy prices over a prolonger period Subsides remain high until 2010/2011 Option 3: Radical adjustment Realistic pricing of energy Maximizing fiscal space Social and political upheaval Substantial economic downturn (short-term)

Indonesia : Fuel subsidies adjustment scenarios A Scenario for Gasoline Prices Rp per litre 4,000 7,000 10,000 13,000 16, Economic cost Close 8% of the gap per month Close the gap by Dec Increase the price 50 Rp/mth Source: World Bank Staff scenario No change Immediate deregulation

Thank you Terima-kasih

Policy ‘solutions’ that are not an option: Scaling back other spending Borrowing to fund fuel subsidies Rescheduling foreign debt Imposing a windfall profit tax on oil companies Improving the efficiency of SoEs

Legacy of uncertain investment climate means Indonesia not benefiting from today’s high prices Government receives 85 percent of production profits Domestic market obligations at nominal prices Uncertainty re: relevant rules and how they would be applied Overhang of institutional uncertainty means Indonesia getting less than the potential benefit of high oil prices

GoI Policy Measures  Optimalize non-oil tax revenue [Rp 20 trillion]  Cut line-ministries’ spending [Rp23 trillion] and use the contingency fund [Rp8,3 trillion]  Increase bond issuance: Gross Rp157 trillion. But higher yields  Increase program loans from multilateral and bilateral institutions [Rp25 trillion]  Increasing oil lifting : 916  927 thousand KL  Energy savings (Kerosene to LPG conversion program, cut electricity consumption, cut domestic fuel consumption, increase efficiency of Pertamina, restrict access to subsidized fuel via ‘Smart Card’, Energy savings in government buildings, private offices, malls, hotels

Policy responses to high and volatile oil prices: The way forward  Maximize the benefits Create investment-friendly environment Encourage exploration Enables full exploitation  Minimize the costs Move from subsidizing energy to compensating declining real incomes Take energy price decisions out of the political boiler Rules that gradually move retail prices towards the economic costs, not political discretion Build public confidence in gov’t spending Compensate the poorest for the transitory income loss Spending programs that benefit the middle classes Cut energy usage