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Cablegate: Indonesia Still Vulnerable to Rising Oil Price

VZCZCXRO3704
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #1033/01 1481006
ZNR UUUUU ZZH
R 271006Z MAY 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 9112
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 2021
RUEHBJ/AMEMBASSY BEIJING 5079
RUEHBY/AMEMBASSY CANBERRA 2558
RUEHUL/AMEMBASSY SEOUL 4627
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 001033

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SETH SEARLS
COMMERCE FOR 4430/KELLY
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN
DEPARTMENT PASS EXIM BANK
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
USDA/FAS/OA YOST, MILLER, JACKSON
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER
USDA/FAS/OGA CHAUDRY, DWYER
USTR WEISEL, EHLERS

E.O. 12598: N/A
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: INDONESIA STILL VULNERABLE TO RISING OIL PRICE

REF: Jakarta 1023

1. (U) Summary: Government of Indonesia (GOI) senior economic
adviser Chatib Basri stated that the GOI raised the price of
subsidized fuel on May 24 to stop smuggling, restore confidence
within the international investor community and increase the amount
of government funds available for social spending, during an open
forum at the Jakarta Financial Club. Other market analysts at the
forum applauded the GOI policy decision, but challenged officials to
use the savings to tackle significant economic problems such as
infrastructure investment. As the GOI opted to retain a price cap
rather than implementing a market-based price, further world oil
price increases could encourage renewed smuggling and bring the
budget under additional pressure. The GOI plans to begin rationing
subsidized oil this year and is considering gradually requiring
owners of private vehicles to pay market prices for gasoline,
according to Basri. End Summary.

Smuggling, Confidence, Budget Worries Prompt Increase
--------------------------------------------- --------

2. (U) The massive gap between world oil prices and subsidized
domestic fuel has encouraged large-scale smuggling, eroded investor
confidence and pressured government finances due to the rising cost
of fuel subsidies, according to GOI advisor Chatib Basri. These
factors led the GOI to raise subsidized fuel prices on May 24 by an
average 28.7%. As the price gap rose to roughly 4500 per liter
($0.50; Rp 9,000/USD) in 2008, subsidized oil consumption
significantly outpaced growth in economic activity, suggesting
large-scale oil smuggling. Investor concerns about the size of
Indonesia's subsidy bill and future inflation have resulted in poor
stock market performance, a weaker Rupiah, and an increase in bond
yields in 2008. The Rupiah is the only major currency in the region
to depreciate against the US dollar in 2008, according to Basri.
The cost of government bond issuance has already risen by roughly
2.5-3.5% this year in response to investor concerns, increasing the
future interest burden on the budget. With the fuel and electricity
subsidy bill threatening to absorb more than a quarter of the
budget, fuel subsidy spending had also begun to significantly
crowd-out other government priorities such as health, education and
infrastructure (reftel).

Vulnerabilities Remain
----------------------

3. (U) Most analysts at the Financial Club Forum praised the GOI
decision to increase subsidized fuel prices -- a decision that the
cabinet made despite accelerating inflation, the threat of economic
slowdown, and a rapidly approaching election season. The decision
underscored Indonesia's commitment to maintaining macroeconomic
stability. Basri noted that the first 2005 fuel price hike, which
was roughly 30%, did not result in a prolonged dip in consumer
confidence, retail sales, or industrial slowdown. The first 2005
price hike also had limited impact on investment growth in
Indonesia. If the international price of crude oil reverts to close
to $110 a barrel, further price hikes will not be necessary.

4. (U) The GOI also launched its pro-poor policy package, which
includes a cash transfer program for 19.1 million households and
lower rice prices, to offset much of the burden of the fuel price
increase on poor households (reftel). The GOI modeled the new cash
transfer program on a similar plan in 2005 that successfully offset
the cost of higher fuel costs for the poor.

5. (SBU) Nevertheless, macroeconomic and policy risks from high
world oil prices remain significant. The GOI increased the price
cap on subsidized fuel rather than moving to a market-based price,
leaving the budget vulnerable to a rising subsidy bill if world oil
prices increase. The GOI expects the current fuel price hike to
raise inflation to at least 11%, increasing the need for the central
bank to significantly raise rates in the coming months. Additional
fuel hikes would further exacerbate inflation in Indonesia. The

JAKARTA 00001033 002 OF 002


initial 2005 fuel price hike had a limited impact on consumer
confidence, domestic demand and investment. However, the second
2005 fuel price hike, which increased fuel prices 114%, had a
prolonged negative impact on all of these indicators. Analysts at
the forum also noted GOI promises in 2005 that they would divert the
savings from fuel price hikes to longer-term development goals such
as infrastructure spending. The GOI has been slow to implement
these plans once the immediate crisis had subsided.

GOI to Focus on Rationing
-------------------------

6. (U) Since the international oil price remains 33% higher than
Indonesia's subsidized fuel price, the GOI plans to introduce new
policies over the next six to nine months to discourage
overconsumption of subsidized fuel, according to Basri. Officials
plan to use smart cards to ration individual fuel consumption and to
encourage households to convert from kerosene to LPG stoves. Some
observers have questioned the wisdom and feasibility of the smart
card system, given that the system will be complicated to implement
and introduce additional market distortions. The GOI is also
considering gradually excluding private vehicles from using
subsidized fuels in an effort to focus the subsidy on poorer
families who use buses and motorcycles as their primary means of
transportation.

HEFFERN

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