Cablegate: Indonesia - Oil Price Concerns

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RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #3294/01 3370352
ZNR UUUUU ZZH
R 030352Z DEC 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 7235
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 1224
RUEHBJ/AMEMBASSY BEIJING 4544
RUEHBY/AMEMBASSY CANBERRA 1676
RUEHUL/AMEMBASSY SEOUL 4318
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 003294

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E.O. 12598: N/A
TAGS: EFIN ECON EPET ENRG PGOV ID
SUBJECT: INDONESIA - OIL PRICE CONCERNS

1. (SBU) Summary. Minister of Finance Sri Mulyani Indrawati restored
some credibility to Indonesia's budget estimates on November 28 by
incorporating higher global petroleum prices and continued declining
domestic production into Government of Indonesia (GOI) analyses.
Although she downplayed the budgetary impact, some economists remain
concerned about the unrealistic expectations for production volume,
international oil prices and continuing subsidies. Government of
Indonesia (GOI) officials would like to avoid increases in retail
prices before the 2009 elections, but may have to concede to subsidy
cuts if smuggling renews. Even without subsidy cuts, the oil price
will be another factor likely to push inflation beyond the central
bank's target range. End summary.

Analysts Worry about Impact of Oil Price
----------------------------------------

2. (U) During a November 19-21 visit to Jakarta by Regional
Financial Attache, analysts cited rising oil prices and falling
production as the dominant risks to the health of the economy in
2008. Citi's Economic Analyst Anton Gunawan argued that declining
oil production is a more important risk for 2008 than rising
subsidies. Officially, the targeted oil output in the budget is
1.034 million barrels per day (bpd), which Gunawan feels is too high
and not achievable. A drop in oil production will cause government
revenue to fall and imports to rise, resulting in a wider fiscal
deficit and trade deficit in refined oil products. As in 2005, high
oil prices may lead to smuggling and fuel substitution which will
further increase subsidies creating an even weaker overall fiscal
position. Bank Indonesia's Wimboh Santoso voiced concerns that
higher oil prices will push up production cost and hence product
prices, feeding into inflation. A sensitivity analysis done by UBS
showed that if oil prices were at $95 per barrel in 2008, this could
result in a 2.3% decline in GDP (after adjusting for other
spending).

Minister Mulyani Reacts to Concerns on Production Side
--------------------------------------------- ---------

3. (U) Finance Minister Sri Mulyani admitted on November 28 that the
Ministry of Finance (MOF) has discarded the official production
figure of 1.034 million bpd and is using 950,000 barrels a day in
its scenario planning. Mulyani's official budget also uses $60 per
barrel as the average oil price, but she also provided analysis
using higher prices. Using the new production assumption, oil
prices at $100 per barrel and no change in retail prices, Mulyani
estimated that the budget deficit in 2008 widens by a further Rp
54.7 trillion (see Table 1 for details). An analysis by Credit
Suisse calculates that -- absent any offsetting changes -- this
would increase the budget deficit from 1.7% of GDP to 3.0% of GDP,
which is still manageable.

Table 1: Impact of Oil Prices
at $100/Barrel in 2008
------------------------------
Rp trillion
--------------------------------------------- -----
Additional revenue oil & gas (+) 124.0
Of which Distributed to regions (-) 17.6
Additional fuel subsidies (-) 131.0
Additional electricity subsidies (-) 27.8
Decline of revenue from non-oil & gas
sector (-) 2.3
--------------------------------------------- -----
Additional deficit in 2008 54.7
--------------------------------------------- -----

Source: Ministry of Finance Office

4. (SBU) Citi analyst Anton Gunawan argued that the government may
also have to increase retail prices to keep the costs of subsidies
under control. International Monetary Fund (IMF) Resident
Representative Armando Morales also voiced concerns that the
conditions of 2005 -- where high subsidies led to widespread
smuggling -- were returning. However in contrast, Dr. Anggito
Abimanyu, Head of the Fiscal Policy Office said that the oil price
assumption would be only formally reviewed again in June 2008 for

JAKARTA 00003294 002 OF 002

budget purposes. "We are not closing the door on raising fuel
prices, but prefer to increase the use of alternative energy
sources." Indonesia is encouraging the use of LPG for cooking
instead of heavily subsidized kerosene. Consumers have been
reluctant to make the switch, however, due to the higher prices for
LPG.

5. (SBU) As part of its Fast Track Electricity Building Program,
announced in January 2006, state electricity company PLN plans to
build 10,000 MW of coal-fired electricity plants by 2009. However,
to date new coal-fired power plants account for less than two
percent of installed capacity. The Fast Track program has been
mired in delays, pushing back the completion date to 2010. Also,
the GOI has attracted bidders for projects totaling 7700 MW only. A
final problem: thermal coal has doubled in price in the last year,
diminishing some of the budgetary savings. Despite these problems,
economists and citizens alike continue to express reluctance to free
up energy prices. BI's Santoso was also wary of price increases,
noting that the 2005 increase led to "big suffering."

Oil's Impact on Inflation:
Higher Food Prices
-------------------------

6. (U) Both BI's Santoso and Citi's Gunawan agree that the impact of
higher oil prices is not expected to be pass-through to consumer
immediately. Retail consumptions remains subsidized, although the
roughly 40% of oil products used by industry adjust to market
conditions automatically. Absent an increase in retail prices, the
impact on inflation, therefore, is felt only after a lag as
producers try to absorb the increase cost of oil initially.
One main transmission mechanism oil high oil prices to inflation is
through the higher cost of food, which has already been under
pressure due to infrastructure bottlenecks and bad weather. Adding
in higher transport costs, further food inflation, and the higher
costs of imports due to depreciation of the currency, it is not
surprising that analysts expect that inflation in 2008 may come in
at (or above) the upper limit of the BI target. The World Bank
notes in a recent report that the persistent nature of these
pressures has raised concerns that higher food prices may not be a
temporary, cyclical phenomenon.

Budget Credibility Restored - For Now
-------------------------------------

7. (SBU) Minister Mulyani's efforts to combat doubts about the
budget credibility were admirable. However, if continued high oil
prices lead to renewed smuggling, the GOI may be faced with pressure
to increase retail prices to reduce subsidies. In such a scenario,
BI will have to tighten monetary policy further to constrain
inflation. Vice President Kalla (with whom Minister Mulyani does not
always agree) has said publicly on several occasions in October and
November that the GOI will not raise energy prices until after the
2009 elections.

HUME

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