Indonesia's energy subsidy a boon to public finance?

Reforms in fuel and electricity subsidies could free up funds for a much needed investment in physical and human capital.

According to a report published by Standard & Poor's Ratings Services, Indonesia's public debt has declined steadily in the past decade, but the country's sizeable energy subsidies still weigh on public finance.

The report, titled "Indonesia's Fiscal Vulnerability To Oil Prices Has Lessened, But Subsidy Reforms Are A Work In Progress," said further energy subsidy reforms would add momentum to the ongoing improvements in Indonesia's credit fundamentals, by reducing fiscal vulnerability and freeing up funds for much needed investment in physical and human capital.

"Indonesia's public debt has been falling steadily because of low fiscal deficits and high nominal GDP growth," said Standard & Poor's credit analyst Agost Benard. "However, the country's subsidy regime remains its Achilles' heel."

Fuel and electricity subsidies make up the largest part, at about 73% of the total. These two components are also the most unpredictable, given the volatile price of oil, the underlying commodity.

With energy subsidies being such a politically treacherous subject, successive administrations balked at dismantling the regime, opting instead for piecemeal adjustments when the fiscal cost loomed unacceptably high, Mr. Benard said.

However, despite the recent failures to adjust fuel and electricity prices, a combination of policy measures and structural developments in the energy sector over the past several years have steadily and significantly reduced Indonesia's fiscal vulnerability to oil prices.

The most important among them are, one, an earlier increase in domestic fuel prices; two, a shift in the fuel mix for electricity generation and cooking; and lastly, an increase in gas production and related revenues.

"Indonesia's subsidy reform is still a work in progress," Mr. Benard noted. "We expect that the recent pause on this reform path is just that--not a halt or a reversal."