Indonesia grapples with inflation dilemma as subsidies cut

JAKARTA: What’s good for Indonesia’s fiscal chiefs is proving a headache for the central bank.

President Joko Widodo’s push to phase out electricity subsidies that have drained the budget of billions of dollars is boosting prices in the economy and threatening the bank’s 3% to 5% inflation target.

For reform-minded Widodo, getting rid of the subsidies and building fiscal space has been a focus of his two-year-old presidency.

It’s won him support from international investors and credit-rating companies, but now presents a test for Bank Indonesia: how to manage the short-term pain for consumers without halting the nascent recovery in the economy.

“Inflationary pressures have largely arisen from administered price hikes such as electricity tariff hikes,” said Weiwen Ng, an economist at Australia & New Zealand Banking Group Ltd in Singapore. Higher power costs “are a necessary evil” and structural reform that the economy needs, he said.

The government raised electricity tariffs twice this year, and delayed a third hike initially planned for June because it would have coincided with Ramadan, the Muslim fasting month when food prices generally spike.

Inflation, which reached a 14-month high of 4.3% last month, could have broken through 5% if power costs were raised a third time, said ANZ’s Ng.

After reducing interest rates six times last year, Bank Indonesia has since kept its benchmark interest rate unchanged at 4.75% and will probably maintain that stance today, according to all 28 economists surveyed by Bloomberg. A separate survey shows most economists expect the rate will be higher in a year’s time.

The rate outlook is also being shaped by the Federal Reserve’s moves to tighten US monetary policy, which may affect foreign inflows to emerging markets and currencies.

Bank Indonesia’s rate decision today will follow several hours after the Fed is expected to raise borrowing costs.

The rupiah has gained 1.4% against the dollar this year and was trading at 13,287 as of 10 am in Jakarta yesterday.

Subsidising electricity costs have long been criticised for drawing resources away from other much-needed priorities, such as infrastructure projects. The Canada-based International Institute for Sustainable Development, which has produced regular reports on energy policy in Indonesia, estimated subsidies reached a peak of 101.8 trillion rupiah (US$7.7bil) in 2014. The budget allocation for this year is 45 trillion rupiah, it said.

“Fiscally, the subsidies are wasteful,” said Lucky Lontoh, a researcher on energy policy at the institute’s Global Subsidies Initiative in Jakarta. “They aren’t the best way to use Indonesia’s resources for the good of the people.”

The government is mandated to keep its budget deficit under 3% of gross domestic product, a line that is getting closer as tax revenue comes under pressure.

Widodo has ordered government departments to review their spending plans this year to help keep the budget under control.— Bloomberg