Indonesia’s energy subsidy dilemma: how can the government better protect the poor?

10 August 2022

The Indonesian government’s policy of providing subsidies to shield the public from the effects of global energy price hikes will burden the state budget. It’s also potentially insufficient to protect the poor.

To reduce the impact of global price hikes, the government decided to more than double its energy subsidies to help people pay for fuel and electricity. It is also planning on disbursing a total of Rp 24.17 trillion (US$1.63 billion) of social assistance, which includes wage subsidies for those earning Rp 3.5 million a month (US$235.65) or less.

At the same time, the government is mulling an increase in fuel prices, which, without careful deliberation, might disproportionately affect the poor.

We argue that the government should implement long-term assistance programs and subsidy reallocation, instead of relying on energy subsidies.


Rising energy prices, ballooning subsidy costs

After two years of sluggish growth due to the COVID-19 pandemic, Indonesia’s economy finally grew above 5% year-on-year during the first and second quarters of this year.

The country benefited from the surge in commodity prices driven by the geopolitical tension between Russia and Ukraine.

However, the recent surge in global energy prices could affect Indonesia’s economic growth and threaten the poor.

Rising coal prices, the country’s main energy source, have led to higher electricity production costs.

As of July 1, 2022, due to the coal price increasethe government increased the basic electricity rate from Rp 1,447 (US$0.098) per kWh to Rp 1,669 (US$0.11).

Meanwhile, the rise in oil prices have also heavily affected Indonesia – a net importer of crude oil – thus bumping up domestic fuel prices.

To maintain people’s purchasing power, the Indonesian government has more than doubled funding for energy subsidies and compensation in the state budget, from Rp 152.5 trillion (US$10.27 billion) to Rp 349.9 trillion (US$23.56 billion). Fuel received the biggest allotment, rising from Rp 18.5 trillion (US$1.24 billion) to Rp 234 trillion (US$15.76 billion).

But how long will subsidies be able to prop up the country’s economy?


Unsustainable subsidies

We believe this subsidy policy is difficult to sustain, considering there is no guarantee that the country will continue to benefit from the increasing commodity prices.

Moreover, a World Bank report published in June indicates that Indonesia’s energy subsidies mostly benefit middle-class and upper-class households, as they dominate fuel consumption, using up around 42%-73% of fuel subsidies.

The World Bank encourages the transfer of subsidies to social assistance for poor, vulnerable and prospective middle class groups of people. This reallocation may also help make the country’s fiscal policies more efficient.

It is also important to note that the energy subsidy policy contradicts the government’s efforts to reduce the amount of subsidies, especially for fuel.

For instance, the Indonesian government ceased subsidies for premium fuel, and set fixed subsidies for kerosene and diesel in 2014. The government also started encouraging biodiesel use in 2008. In 2016, Indonesia began aggressively pursuing a 30% biodiesel-fuel mix (B30) to enhance energy security and reduce fuel consumption and imports.

All in all, the government should carefully reallocate current subsidies to better target and help the poor, rather than just increasing subsidies that are disproportionately benefiting the middle and upper-classes.


More effective, targeted spending

A previous study by SMERU recommends long-term solutions – such as the social security program – to assist the poor and those unable to work productively. The study also found that temporary programs may provoke social vulnerability or conflicts.

The government should be selective in determining the type of social assistance for the subsidy reallocation.

SMERU’s long-term research, spanning from 2014 to 2020, found that unconditional cash transfer programs, such as the Family Welfare Savings Program (PSKS), made it easier for targeted households to allocate funds to priority expenses. In addition, local governments can also participate by aligning social protection programs with the local poverty and livelihood characteristics.

The study also suggests taking gender perspectives into consideration when reallocating subsidies.

Indonesia’s fuel subsidy policy impacts men and women differently. More women have taken the role as breadwinners. However, families headed by women have different characteristics and are still lagging behind in managing financial risk compared to those headed by men.

So the government should formulate social protection programs that focus on impoverished women. For example, they can subsidise the costs of Early Childhood Education (PAUD) for children from low-income families. PAUD requires parents to pay for a certain amount of tuition, but some are free because they are supported by the government or non-governmental organisations.

As a pre-school stage, PAUD puts more emphasis on educational support. But the village authorities can integrate daycare services in PAUD to provide additional adequate daycare support for impoverished female breadwinners. Through this scheme, we hope that impoverished parents can be more at ease at work, knowing their children can still get the necessary daycare.

The government should also construct consistent and accurate databases to identify target households through a systemic mechanism, as well as to spread awareness.

Our research sees that “musyawarah desa(musdes)” (village consultations) can potentially improve the accuracy of the central government’s database. By involving all communities and local village officials, musdes can help improve the accuracy of the recipient database by proposing “more deserving families”. To support this, the government must develop assistance and capacity-building programs for sub-district social workers that work on the ground.

A timely disbursement of aid is also important, so that the government support coincides with any energy price shocks due to changes in the fuel subsidy policy.


How to better protect the poor

Thanks to its growing economy, Indonesia’s poverty rate – which previously climbed above 10% due to the COVID-19 pandemic – finally dropped to a single-digit figure in March 2022.

Economic growth does generally help reduce poverty rates in developing countries. However, the extent to which they affect poverty rates is influenced by the degree of which the poor partake in the process of achieving growth, and how well they reap the benefits of it.

If the government fails to address the social impacts of the rising costs of fuel and electricity, the decline in poverty rates may only be temporary, rather than marking the beginning of a positive economic trend.

In the future, the Indonesian government needs to think about how to make its current subsidies more targeted and effective. In doing so, it can keep reducing poverty and better help the poor in the midst of global economic instability.

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Junior Researcher
SMERU's blog posts reflect the views of the authors and do not necessarily represent the views of the organization or its funders.
Senior Researcher
SMERU's blog posts reflect the views of the authors and do not necessarily represent the views of the organization or its funders.