Why Indonesia needs to reform its energy subsidy system – The Diplomat

The unprecedented rise in fuel prices due to the Russo-Ukrainian war has prompted Indonesia to significantly increase its energy subsidies. This decision sparked much domestic debate about how best to maintain a balance between economic improvement and Indonesia’s commitment to transitioning to green energy. We believe the government should seriously consider reforming the country’s energy subsidy system if it is to get climate change mitigation back on track without hurting the economy.

Recently, Indonesia’s domestic energy subsidy policy has come under heavy criticism for its sheer scale amid the current global downturn. President Joko Widodo said last month that the state had raised the government’s budget allocation for subsidies from 152 trillion rupees ($10.2 billion) to 502 trillion rupees ($33.8 billion). This significant increase was a result of higher public consumption of fuel and subsidized LPG amid rising global crude oil prices. Without resolving the conflict between Russia and Ukraine, earmarked energy subsidies will continue to rise. On the other hand, this policy is necessary to maintain the purchasing power of individuals and stabilize the economy, which is still recovering from the COVID-19 pandemic. On the other hand, implementing energy subsidies may have a set of unintended consequences.

Indonesia’s energy subsidy policy aims to maintain stable and affordable energy prices for all levels of society. By keeping energy prices below the market rate, it allows those with lower incomes access to energy that they would not otherwise be able to afford. The policy also aims to improve the use of fossil energy in order to boost the Indonesian economy. As the most reliable source of energy, securing fossil energy is critical for developing countries to meet their growing energy demand.

One problem in Indonesia is that the wealthy also have access to subsidized fuel due to the weak government monitoring system. When Indonesia raised the price of non-subsidized fuel products such as Pertamax Plus and Pertamax, most consumers simply switched to Pertalite, a subsidized fuel. The absence of specific requirements for the purchase of subsidized fuel is easy for the middle and upper classes to access. As a result, the demand for Pertalite, despite its lower quality, grew by about 30 percent, which is not surprising given that its price is almost half the price of unsubsidized fuel. Thus, the government must allocate more subsidies, which increases the burdens on the state budget.

The implementation of energy subsidies also hinders the development of renewable energy, as it favors more use of fossil energy. Subsidies make renewable energy less competitive with fossil energy, and thus more difficult to access by the public. The support provided may not be an appropriate price in the negative externalities of the fossil energy used. Therefore, the increased energy subsidy can be seen as a step backwards in terms of efforts to increase the mix of renewable energy in Indonesia and mitigate the effects of climate change.

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With this in mind, the Indonesian government can reform its energy subsidy system by replacing price subsidies with direct subsidies.

Energy subsidies are a sensitive issue for society due to the widely shared desire to have access to energy at the lowest possible price. The more advanced the country, the greater the need for more energy, so the allocated support will be more prominent and affect the state budget. Reducing the burden on the state budget by increasing energy prices often leads to negative reactions. The increase in the price of fuel will reduce the trade balance deficit, especially in oil and gas. At the same time, it can also run the risk of inflation and mass layoffs in the industrial sector.

The introduction of direct subsidies, the actual payment of money to low-income people, is often promoted as a solution to Indonesia’s problem. Implementation of direct subsidies will improve the efficiency of the state budget and directly benefit low-income people, ensuring that the burden of high energy prices will not hurt them badly. Direct subsidies will also improve the competitiveness of renewable energy, allowing energy to stabilize at a market price. Hence, with the rising prices of fossil energy, renewable energy can emerge as an attractive and affordable alternative.

While direct subsidies are intended to maintain the purchasing power of low-income people, they also have economic costs. The subsidy reform will also affect the operational costs of the industry. Allowing energy to reach the market price will increase operating costs, which will prompt the industry to reassess the efficiency of its operations. In a worst-case scenario, companies may lay off large numbers of workers. So the government cannot turn a blind eye to the side effects of introducing direct subsidies.

Reforming energy subsidies through the implementation of direct subsidies cannot alone solve Indonesia’s energy subsidy problem. Implementation of direct subsidies requires government intervention and cooperation between different stakeholders.

Direct subsidies should be implemented in phases. In this case, the government needs to gradually reduce energy subsidies and implement direct support to those in need. This procedure must be done carefully so that the impact of market shocks can be suppressed and foreseen while preserving the purchasing power of individuals. This policy will also encourage the public to know the actual price of energy and start changing their lifestyle in order to become wiser and less wasteful in how they use energy. At the same time, the industry should also encourage business energy efficiency, which will help ensure that changes in energy subsidies have minimal impact on their business activities.

The application of direct subsidies should be followed by efforts to provide alternatives to the affected sectors. These efforts include developing the city’s gas networks, renewable energy plants, and electric vehicles. To support these efforts, the government must ensure the ease of doing business by creating legal clarity and certainty. One of the most important aspects is accelerating the renewable energy bill, as well as encouraging more financial and non-financial initiatives in order to attract more investors and accelerate these efforts. With all of these pieces in place, Indonesia will improve energy security and protect itself from economic vulnerabilities caused by rising global energy prices.

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