86815 MARCH 2014 • Number 136 Why Is Reducing Energy Subsidies a Prudent, Fair, and Transformative Policy for Indonesia? Ndiame Diop If there was one bold and timely policy to transform Indonesia, this is it. In 2012, spending on energy subsidies claimed more than one-fifth of the central government’s budget, that is, more than three times the allocation for infrastructure such as roads, water, electricity and irrigation networks, and three times the governmentwide spending on health. In addition to crowding out high-priority spending, subsidies disproportionately benefit households at the top of the income distribution and throw sand on Indonesia’s remarkable record of prudent macroeconomic management. Not to mention how subsidies create disincentives for saving energy, developing alternative energy sources, and reducing carbon dioxide emissions. Given their adverse short- and long-term economic consequences, reducing them—with the appropriate safe- guards to protect the poor—is a fair, prudent, and transformative policy. How Large Are Energy Subsidies? Naturally, the fiscal burden of energy subsidies closely tracks the vagaries of global oil prices. Over the past decade, Indonesia has been subsidizing fuel (gasoline, diesel, kero- the world experienced several peaks in global oil prices, for ex- sene, and liquefied petroleum gas [LPG]) since the 1970s, ample, in 2005 and 2008, and in February 2011, when oil when the world experienced its first oil price shock. The prices again breached $100 per barrel and have stayed above government fixed and kept the price of fuel at a very low this level ever since (figure 1). Mimicking oil prices, the cost of level (below $.201 per litre) until 2005, with the budget bearing the cost differential between the administered and Indonesia’s energy subsidies rose sharply in 2005 and 2008, market price. In 2012, the market price of gasoline, reflect- triggering two major fuel subsidy reforms. In 2005, the gov- ing the world oil price in U.S. dollars and the dollar-rupiah ernment more than doubled the price of fuel. After this move, exchange rate, averaged Rp9,500 per litre. The adminis- the fiscal burden of energy subsidies declined significantly, un- tered price for the product stood at Rp4,500 per litre, im- til 2007, when world oil prices began to rise again. In May plying a subsidy rate of a bit more than 50 percent. The sub- 2008, when the global oil prices reached a record high, the sidy for gasoline and other fuel products translated into a government raised the prices of gasoline and diesel by nearly budget allocation of Rp212 trillion ($21 billion), or 21 per- 30 percent. When world oil prices rallied again in 2010–12, cent of the central government’s budget and 2.6 percent of following a sharp drop in 2009, the government tried to un- gross domestic product (GDP). Adding the subsidy spend- dertake another series of fuel price hikes, but could not imple- ing for electricity (Rp94.6 trillion, or about $9.4 billion), ment them.2 As a result, energy subsidies have remained total energy subsidies reached Rp306.5 trillion ($30 bil- slightly above 20 percent of the central government’s total lion), or 3.7 percent of GDP in 2012. spending since 2011, against 10 percent in 2009 (figure 2). 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 1. International Crude Oil Prices However, the subsequent rise in rupiah-denominated subsi- 160 dized fuel prices has again increased the gap between subsi- 140 dized prices and the market price, pushing subsidy spending higher, notwithstanding the decisive and most-welcome June Brent crude U.S. dollars 120 price adjustment (figure 3). 100 Why Is Reducing Energy Subsidies the 80 Prudent Thing to Do? 60 The magnitude of the energy subsidies reduces Indonesia’s 40 available fiscal space, while the country’s sensitivity to volatile 20 global oil prices and exchange rates blurs the its fiscal outlook. 0 At the same time, the large size of oil imports (partly driven Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 by energy subsidies) is becoming an underlying source of con- Source: Indonesia’s Ministry of Finance. cern for the trade balance. This is all exacerbated by the changing global environment, the softening of global com- Figure 2. Energy Subsidies modity prices, and the tighter international financial condi- 25 tions. Reducing the fiscal and trade balance exposure to global oil price risks is the prudent option. Adding clouds to the fiscal outlook percent of government spending 20 In a world where countries’ resilience to external shocks is constantly tested, prudent macroeconomic management is 15 crucial to reducing volatility and stabilizing growth. Indone- sia has a solid track record of prudent macroeconomic and fiscal management, and that has served the country well. 10 Over the past decade, stable growth, averaging 5.7 percent, has gone hand-in-hand with low fiscal deficits (1.2 percent of 5 GDP, on average, during 2003–12) and rapidly declining public debt (from 100 percent of GDP in 1999 to 24.5 per- cent in 2012). By law, the fiscal deficit has been capped at 3 0 percent of GDP since 2003. Prudent macro-fiscal manage- 03 04 05 06 07 08 09 10 11 12 20 20 20 20 20 20 20 20 20 20 fuel subsidies electricity subsidies Figure 3. Gasoline Prices and the Rupiah, 2006–13 total energy subsidies 14,000 Source: Indonesia’s Ministry of Finance. 12,000 Although often overlooked, energy subsidies also highly 10,000 correlate with the exchange rate. Indeed, because Indonesia is a net importer of oil, the market price in the domestic market IDR 8,000 reflects the international price of oil in U.S. dollars and the U.S. dollar–Indonesian rupiah exchange rate.3 A weakening 6,000 of the rupiah translates into an increase in the price of energy 4,000 products in the domestic market and a rise in the energy sub- sidy if the administered prices of energy products are not ad- 2,000 justed accordingly. Figure 3 shows that the domestic market price (that is, the unsubsidized petrol price) has been sensi- 0 tive to the U.S. dollar/IDR exchange rate in recent years and Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 would have sharply increased the subsidy gap in 2013 if a fuel US$/IDR subsidy gap price did not occur. Indeed, in June 2013, a decisive fuel price unsubsidized petrol price subsidized petrol price (Pertamax 88, IDR/liter) (IDR/liter) adjustment took place, with the price of subsidized gasoline Source: Bank staff using Ministry of Finance and Bank of Indonesia data. and diesel increased, on average, by 33 percent. This helped Note: The subsidy gap is the difference between the unsubsidized and subsidized reduce the subsidy gap sharply and generated fiscal savings.4 monthly price. 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise ment has allowed Indonesia to weather a range of external (for example, from more than 1.15 million barrels per day in shocks, including the 2009 global financial crisis, and main- 2003 to 840,000 in 2012) and limited investments into re- tain high and stable growth over the past four decades. Going serve replacement, which is reducing supply, as well as rising forward, good macro and fiscal policies remain central to sus- consumption, which is increasing demand. Oil and gas im- taining Indonesia’s rapid and stable economic growth. ports have become a very large component of Indonesia’s total The current framework of fuel subsidies, however, exerts imports. In 2013, oil and gas accounted for 24 percent of total a sort of “Damocles sword” on fiscal management, perma- merchandise imports, up from 19 percent in the early 2000s, nently blurring the country’s fiscal outlook. For instance, al- and from under 10 percent in the 1990s (Badan Pusat Statis- though the fuel-price hikes in June 2013 have reduced energy tik, or BPS). subsidy spending, relative to doing nothing, the government By making energy artificially cheap for end users, energy is still highly vulnerable to exchange rate and global oil price subsidies clearly encourage domestic consumption of energy volatility. A 10 percent increase in the oil price, or a 10 per- products, although the exact magnitude of their impact is dif- cent depreciation of the rupiah against the U.S. dollar, would ficult to measure precisely, and economic growth remains the increase subsidy spending compared to a baseline in which largest driver of consumption and imports overall.6 In re- the oil price or the exchange rate remain unchanged (figure sponse to rising oil demand, crude oil imports have increased 4). According to World Bank calculations, a 10 percent in- significantly in recent years. Indonesia’s limited onshore oil- crease in the oil price would add about 0.3–0.4 percentage refining capacity means that processed oil imports have risen points of GDP to the baseline fiscal deficit. A 10 percent ru- as well. In fact, 70 percent of oil imports in the first half of piah depreciation would have a bigger impact—0.7 percentage 2013 were refined products such as petrol ($13.7 billion, or points of GDP. 115.2 million barrels), more than double the imports of The current approach of episodic and politically charged crude oil ($6.5 billion, or 60.6 million barrels). negotiations over potential subsidy reform creates uncertain- Against the backdrop of a sharp decrease in nonoil and ty for the budget outlook and is not always effective in adjust- gas exports since 2011, the large and rising size of oil imports ing fuel prices (as in 2012). Because of changes in the oil price helped push Indonesia’s current account into a deficit in and the rupiah–U.S. dollar exchange rate, actual spending on 2012, thus increasing the country’s external financing needs. fuel subsidies tends to overshoot budget allocations, often If Indonesia’s economy continues growing at a rate above 5 forcing the Indonesian government to revise the budget mid- percent in the medium term, the rise in fuel import demand year. Changes in spending plans during the fiscal year increase will be difficult to curb. In August 2013, the government in- the risk of reduced disbursement and reduce the quality of creased biodiesel-blending requirements for domestic fuels to spending.5 An improved framework for subsidy reform (one help reduce reliance on imported, fossil fuel–based diesel. that locks in a gradual move toward market prices) will help However, this measure is longer term in nature; the imple- reduce Indonesia’s fiscal exposure to international fuel prices menting regulation sets out annual increases of biodiesel in (in rupiah), while securing the fiscal space to address high- the fuel mix until 2025.7 Most of the weakening in Indone- priority spending needs. sia’s overall current account balance since late 2011 has been An underlying source of risk to the trade balance due to the collapse of the nonoil and gas surplus, driven main- The impact of energy subsidies on the trade balance (and the ly by declining commodity export prices. However, Indone- economy in general) has attracted attention since 2004, when sia’s oil and gas balance, which has moved into deficit since Indonesia shifted from being a net exporter to a net importer August 2012, remains a major drag on the overall trade bal- of both crude oil and refined products, coinciding with the ance and current account.8 increase in world crude oil prices. The country’s shift to a net Why Is Reducing Energy Subsidies importer status for oil reflects steadily declining production a Fair Policy? Figure 4. Energy Subsidy Costs: Baseline and with 10 Percent Energy subsidies were introduced during the administration Rupiah Depreciation/Oil Price Increase of former President Soeharto, ostensibly for the social reason 400 of making energy (a basic need) affordable to the people. 350 Since their introduction, energy subsidies have been taken for IDR trillions 300 250 granted, and perhaps seen as a tangible government policy to 200 ease people’s daily lives. Evidence suggests that fuel subsidies 150 100 energy subsidies (baseline) do help the poor by keeping the prices of essential items lower 50 energy subsidies (10% IDR depreciation) than they would otherwise be. World Bank calculations sug- 0 2009 2010 2011 2012 2013 2014 gest that, in 2011, total fuel subsidies were equivalent to giv- Source: World Bank calculations based on Indonesia’s Ministry of Finance data. ing each poor Indonesian Rp6,000 per month. 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise However, fuel subsidies disproportionately benefit is cheaper to import oranges from China than to source them households at the top of the income distribution: 84 percent from Kalimantan (that is, within Indonesia). of all benefits (that is, Rp178 trillion out of the Rp212 tril- How did Indonesia land in this situation? Because invest- lion, or $18 billion out of $21 billion, in 2012) go to the top ment in infrastructure as a share of GDP has remained low, half of households by consumption, and only 16 percent notwithstanding increases in nominal allocations in recent (Rp33 trillion) to the bottom half. Forty percent of subsidy years. The central government invests less than 1 percent of benefits go to the richest 10 percent of households, and less GDP in infrastructure, and governmentwide investment than 1 percent goes to the poorest 10 percent. Fuel subsidies (that is, central and subnational) is only about 2.5 percent of are, in fact, generous transfers of taxpayer money to the rich. GDP, slightly less than the amount spent on the fuel subsidy Moreover, about two-thirds of poor and near-poor house- in 2012 (2.6 percent of GDP), and about one-third of the holds do not consume any gasoline at all, although the likeli- amount spent by Indonesia’s Asian neighbors on average. As a hood of them consuming gasoline, and the actual volume that result, Indonesia’s core infrastructure stock (roads, ports, and they would consume, would rise if their incomes increased. electricity and water networks) grew by only 3 percent annu- With respect to diesel, few households report any consump- ally during 2001–11, compared with GDP growth of 5.3 per- tion. Therefore, commercial and other users are estimated to cent. Inadequate investment has resulted in serious capacity account for virtually all (98 percent) consumption of subsi- gaps (roads, ports, electricity, water, and more), congestion dized diesel. If the objective was to provide social assistance to problems, and high logistics costs, which are undermining the poor and the near poor, the energy subsidy has been high- productivity, competitiveness, and poverty reduction. ly ineffective. Challenges in the social sectors are equally daunting. Because raising fuel prices temporarily augments head- Over the past decade, income inequality (measured by the line inflation (the June 2013 fuel subsidy reform added 2.9 Gini coefficient) has increased by 10 percentage points to percentage points to inflation by August, year on year), it is 0.42, in line with the rapid rise in commodity and other asset important that poor and vulnerable households are cush- prices (including land and properties), which proportionately ioned from the immediate adverse impacts of higher energy has benefited the rich. Rather than offsetting this trend, en- prices. Indonesia has systematically been able to soften the ergy subsidies have actually exacerbated it (World Bank impacts so far. In 2005 and 2008, the government introduced 2014). Furthermore, large disparities remain across income temporary unconditional cash transfers, with monthly cash levels and geographical areas regarding access to key services. payments distributed to 19 million people with low incomes. In health, the maternal mortality ratio, recently estimated at In 2008, the government funded additional compensation 220 per 100,000 live births, is higher than that of India and programs, such as the distribution of rice, control of rice pric- the Republic of the Union of Myanmar, and much higher es, financial support for education (school fees), and subsidy than what would be expected for Indonesia’s income level. increases for small-scale credit facilities. In June 2013, the Indonesia still spends only 0.5 percent of GDP on social as- government again extended temporary unconditional cash sistance, compared with 1–1.5 percent of GDP in emerging transfers to 15.5 million households through post offices us- economies such as Brazil, Turkey, and Thailand. The country ing newly printed Social Protection Cards. In addition, the is gradually building a modern social protection system; how- Indonesian government expanded three existing social assis- ever, improving social outcomes would require a significant tance programs: the conditional cash transfers (PKH), schol- increase in social protection allocations and greater quality of arships (BSM), and the “rice for the poor” program (RASKIN). spending (World Bank 2014). Energy subsidy reform is perhaps the single most impor- Why Can Reducing Energy Subsidies Help tant instrument to finance an increase in infrastructure in- Transform Indonesia? vestment and social protection, while dramatically reducing Indonesia faces some significant, well-known development macroeconomic risks and accelerating the Indonesia’s jour- challenges. Perhaps the biggest one is the need to close the ney toward greater and shared prosperity. World Bank simula- country’s infrastructure gap. The country has foregone more tions show that fully phasing out the energy subsidies by than 1 percentage point in additional GDP growth due to un- 2018 in four equal increments would free up spending to a derinvestment in infrastructure, chiefly in transportation cumulative 3.3 percent of GDP in 2018, relative to a “busi- (World Bank 2013).9 Firm surveys show that transportation ness as usual” baseline. This would enable the doubling of problems are among the top constraints for manufacturing central government spending on infrastructure and on social firms. Household and village survey data show that one-quar- protection spending (World Bank 2014). ter of urban populations and more than half of rural residents Clearly, Indonesia’s growth and development objectives have poor access to transport services. Rural producers find would be much better served by redirecting spending on fuel themselves unable to compete with imports in urban areas. It subsidies toward infrastructure and social sectors (health, so- 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise cial assistance, and community development). Energy subsi- breach in the target. The quarterly limits would be based dy reform would also support a reduction in inequality of on observed fuel consumption patterns and assumed outcomes and opportunity. Today, not only do the poor re- prices, converted into rupiah. This would allow adjust- ceive fewer benefits from fuel subsidies, they also are likely to ment of prices in the subsequent quarter based on the suffer more from the poor infrastructure that is an indirect prior quarter’s total subsidy spending. The basis upon consequence of large subsidies: they live in the most flood- which this could be done would be transparent and rule- prone areas and often have the most difficulty accessing basic based, removing from political and populist pressure the services. government decision-makers. An important component of energy subsidy reform is en- Reform Options suring that vulnerable households are cushioned from the If reforming energy subsidies is fair, prudent, and transforma- immediate adverse impacts of higher energy prices. Imple- tive, how can reforms be effectively implemented? As dis- mentation of fuel price hikes should be accompanied or pre- cussed above, the current approach of episodic, negotiated ceded by the strengthening of social safety nets to protect the price adjustments is not always effective and does not elimi- poor. Indonesia has systematically done that over the past de- nate budget uncertainty due to subsequent changes in global cade and has developed strong expertise for developing and oil prices and fluctuations in the rupiah exchange rate. Thus, managing compensation programs. Going forward, as Indo- a reform framework that offers a more predictable and trans- nesia expands and strengthens its social safety net, all poor parent price-adjustment mechanism, along with an automat- and vulnerable households would receive comprehensive as- ic convergence toward market prices, would be better. A large sistance to protect them from lifecycle shocks and provide number of alternative formulas/pricing regimes exist (Kojima them with opportunities to lift themselves out of poverty. 2013). Technical solutions that could be considered in the Once a solid safety net system is fully established, the poten- context of Indonesia include:10 tial adverse impacts of energy subsidy reform on the poor • Periodically moving prices through a pre-agreed rule. would be greatly reduced. Through a pre-agreed rule, a new domestic price is set, Acknowledgment with reference to recent world prices, on a periodic basis (monthly, quarterly, and so forth). For instance, China The author is grateful for the useful comments and assistance has adopted a formula whereby final consumer prices are from Alex Sienaert, Jim Brumby, Shubham Chaudhuri, Anh adjusted if the base price changes more than 4 percent in Nguyet Pham, and Violeta Vulovic. a 22-day cycle. If Indonesia was to adopt a similar rule, About the Author the price-setting rule could specify how much of the gap between world and domestic prices would be closed in Ndiame Diop is Lead Economist, Indonesia, for the World Bank. successive cumulative years. For example, the rule might be that domestic prices should reach 70 percent of aver- Notes age world prices for 2014 (from about 50 percent in 1. All dollars are U.S. dollars unless otherwise noted. 2013), changing to 80 percent in 2015, 90 percent in World 2. Indeed, asBank. part of 2014.the Indonesia 2012 Budget Development Law, Parliament Policyat- Review: Risin 2016, and 100 percent in 2017. tached DC. hard strings to any reform: government was autho- World Bank. 2014. Indonesia Development Policy Review: Rising or Muddling Along? Washington, • Periodically moving prices set by a pre-agreed rule, with to hike fuel prices only if the 6-month average of the In- rized DC. a price ceiling (a variant of option 1). This option intro- donesia 1 Allcrudedollars are priceU.S.rose dollars 15 unlesspercent otherwise above noted. the budget duces consumers to moving prices, but provides assur- 2 Indeed, as part of 2012 Budget Law, Parliament attached hard strings to a thebarrel. 1 All dollars are U.S. dollars unless otherwise noted. assumption of $105 per ance that there is a maximum fuel prices only if the 6-month average of the Indonesia crude price rose 15 per 2 Indeed, aspricepart of that the 2012 theyBudget will pay Law, inParliament attached 3. The of the coststrings hard tofuel subsidy any reform: for any product government was authorized i can tobe esti- hike barrel. the first year, regardless of international fuel prices only if the 6-month prices. For of average in- the Indonesia crude mated 3 price by therose 15 percent between difference of the Indonesia above the budget fuel subsidyDevelopment the assumption market for any productPolicy price of $105 that per would barrel. is to set the domestic price at World The Bank. cost 2014. i can be Review: estimated Rising or Mud by the differen stance, even if the objective DC. prevail the absence in difference of subsidy (��� ) and the administered price fixed by the g 3 The cost of the fuel subsidy for any product i can be prevail estimated inbythethe absence of subsidy between the market and price the that administered would 70 percent of the worldprevailprice in thein 2014,of absence the monthly subsidy or the administered (��� ) and quantity fixed price price byof fixed the byfuel consumed government the government (�(��).��� The ),,free market multiplied multiplied price, by by in turn, the the quan- is the world pric quantity of quarterly increase is capped, tofuel consumed avoid (�� ). The free exceptionally high market price,tity in turn,Platts is the Singapore world priceorin MOPS U.S. ) times(Indonesia dollars � the dollar–rupiah uses the exchange Mid Oil rate (ER), plus a m Platts Singapore or MOPS) times the dollar–rupiah exchange 1 All of dollars and fuel ratean consumed (are EReconomic ),U.S. plus dollars (q profit a margin ).∝ unless i ( The free otherwise for) transport, and market noted. and value-added storage price, and fuelin turn, taxes distribution, (tax is ). The total fue increases and limit the exposure of consumers in any 2 Indeed, the world as expressed part priceof the in 2012 U.S. Budget dollars Law, Parliament (Indonesia as: fuel subsidies across fuel products i can be attached uses the hard Mid strings Oil to any reform: and an economic profit (∝) and value-added and fuel taxes (tax ). The total given month or quarter. In following years, the price ceil- fuel prices only∑ if the �6-month ���average of � the Indonesia crude price rose 15 percent above expressed as: Platts ∑ � � �� � � � � , � � ��� � ���� exchange . �∝��� � ���� � ��� � barrel. 4Singapore � � � or � MOPS) � times � �the dollar–rupiah � ing can be successively∑� � � � ∑� �� raised, while � � �� closing � � � , the � � �index- ��� � ���� � �∝��� 3 rate � The ( ���� ER), cost A t contemporaneous . of plus the fuela margin subsidy for prices for any and transport, exchange product i can rates, storage direct and distribu- be estimated fiscal by savings from the difference this between ation gap, thus leading A 4 t contemporaneous prices and exchange rates, direct fiscal to an incremental and predictable prevail 2013 savings in the ($3.5from absencebillion), this of and are reform subsidy are ( � �expected estimated ) and the to asrise Rp39 Rp86 to trillion administered trillion forfixed price inby 2014 the ($7.5 billio governmen tion, in and an economic profit � (α) and value-added and fuel 2013 ($3.5 billion), and are expected to rise to Rp86 trillion quantity prices 2014 will ($7.5apply. the billion), first full year in which the higher move to market prices. 5 of fuel consumed (�� ). The free market price, in turn, is the world price in U.S. d prices will apply. taxes Platts Over (tax). Singapore the Theorpast few total MOPS fuel ) years, times actual subsidies the spending across on dollar–rupiah fuel energy exchange subsidies products rate (ER can i ), systematical has a plus margin for 5 • Quarterly subsidy spending past few Over thelimits years, actual spending . Announce subsidyon energy subsidies has systematically uncertainty and overshot allocations constraining fiscal in the budget, creating management. uncertainty and constraining fiscal management. andexpressed be an6economic as: profit (∝) and value-added and fuel taxes (tax). The total fuel subsidies limits for the coming6 Indeed, budgeta year by quarter, and then expressed as: a 1 percent increase in real GDP leads to about 0.83 percent increase Indeed, 1 percent increase in real GDP leads to about 0.83 7 percent Potential ��� in domestic � increase distortions � to consumption. 7 adjust prices in subsequent Potential quarters distortions duewhen there to this policyisand ∑� �� � ∑effects a complex spill-over � �� � � (including , due �� � �� substitution this policy � ��� � ���� from crude and complex � �∝��� palm oil spill-over � exports, ���� . effects (includi and so� forth) � also need to be considered. 4 At contemporaneous prices and exchange rates, direct fiscal savings from this reform are and so forth) also need to be considered. 8 Indonesia is a net importer of oil and a net exporter of gas. In 2012, the size o 8 Indonesia 2013 is a net importer of oil and a net exporter of gas.($3.5 In billion), 2012, andof the size are expected the to rise oil deficit wasto Rp86double almost trillionthe in 2014 ($7.5 billion), the firs size of the prices will gas surplus. apply. the gas surplus. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    9 Assuming www.worldbank.org/economicpremise 9 5 Over the Assuming a causal relationship between changes in infrastructure past few a capital causal relationship stock actual years, spending and changes between hadsubsidies on energy in output, changes in infrastructure the growth hasrate capital systematically stoc oversho in infrastructure uncertainty and capital constraining stock fiscal stood at 5 percent instead of 3 percent, real GDP management. in infrastructure capital stock stood at 5 percent instead of 3 percent, real GDP growth would have been 5.8 percent instead 6 of 5.3 Indeed, percent—a a growth 1 percent difference increase of 0.5 percentage points. Real GDP growth would of 5.3 percent—a difference of 0.5 percentage points. Real7 GDP would havein real GDP reached leads 7 percent to if about 0.83 percent real infrastructure increase in domestic growth had been 10 percent. growth Potential had been distortions due10topercent. this policy and complex spill-over effects (including substitu 10 and so 10forth) also need to be considered. 4. At contemporaneous prices and exchange rates, direct fiscal rate in infrastructure capital stock stood at 5 percent instead savings from this reform are estimated as Rp39 trillion for of 3 percent, real GDP growth would have been 5.8 percent 2013 ($3.5 billion), and are expected to rise to Rp86 trillion instead of 5.3 percent—a difference of 0.5 percentage points. in 2014 ($7.5 billion), the first full year in which the higher Real GDP growth would have reached 7 percent if real infra- prices will apply. structure growth had been 10 percent. 5. Over the past few years, actual spending on energy subsi- 10. These examples draw on unpublished work conducted by dies has systematically overshot allocations in the budget, cre- the World Bank team in the Jakarta Office. ating uncertainty and constraining fiscal management. 6. Indeed, a 1 percent increase in real GDP leads to about References 0.83 percent increase in domestic consumption. 7. Potential distortions due to this policy and complex spill- Kojima, Masami. 2013. “Petroleum Product Pricing and Comple- over effects (including substitution from crude palm oil ex- mentary Policies: Experience of 65 Countries Since 2009.” ports, and so forth) also need to be considered. World Bank Policy Research Working Paper No. 6396, Wash- 8. Indonesia is a net importer of oil and a net exporter of gas. ington, DC. In 2012, the size of the oil deficit was almost double the size World Bank. 2013. “Indonesia Quarterly Economic Update.” July, of the gas surplus. Washington, DC. 9. Assuming a causal relationship between changes in infra- World Bank. 2014. Indonesia Development Policy Review: Rising or structure capital stock and changes in output, had the growth Muddling Along? Washington, DC. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 6 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise