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Impact of Fuel Subsidy Removal on the Indonesian Economy

Tri Widodo (), Gumilang Aryo Sahadewo, Sekar Utami Setiastuti and Maftuchatul Chaeriyah

Chapter 8 in Energy Market Integration in East Asia: Theories, Electricity Sector and Subsidies, pp 173-206 from Economic Research Institute for ASEAN and East Asia (ERIA)

Abstract: This research aims to analyze the impacts of fuel subsidy removal on Indonesian economy. Social Accounting Matrix (SAM) is applied to simulate the impact. The simulation shows that removal of fuel subsidy affected income distribution of households, firms, and governments. The impact of reallocation of subsidy to four targeted sectors- i.e. Agriculture; Trade; Food, Beverage, and Tobacco Industry; and Education and Health- would be relatively smaller than that of fuel subsidy removal. Some policy implications can be withdrawn. First, for the reasons of long-term efficiency, competitive advantage and manageable economic, social and political instability, the Goverment of Indonesia (GoI) should have clear, long-term, sceduled and gradual program of fuel subsidy reduction, not the big-bang total removal of the fuel subsidy. Second, the GoI could consider the certain amount of subsidy which is adjusted with the increase of goverment fiscal capacity, and let the domestic fuel price fluctuated as the ICP fluctuated. Societies (both domestic consumers and producers) will learn rationally and adjust logicly with the fluctuation of domestic fuel price. Third, the GoI should not consider the sectoral approach to reallocate the fuel subsidy. The GoI should consider programs such as targeted fuel subsidy to correct the misallocation the fuel subsidy (subsidy is for the poor).

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Handle: RePEc:era:chaptr:2011-rpr-17-08