A Drastic Reduction of Fuel Subsidies Confuses Ends and Means

In order to reduce the mounting pressure on government budget due to rising expenditures related to all sorts of subsidies, including those for the banking sector and domestic fuel consumption, the Indonesian Government has opted to cut only the fuel subsidies. Following the surge of the world price of oil, the size of the cut was huge, causing the average domestic fuel prices to increase by more than 120 per cent. It is argued in this paper that such a policy is ill-advised. A partial reduction, not an enormous cut, would have been sufficient if it is complemented with a fractional cut of sovereign domestic debt payments. Based on a set of simulations on a financial general equilibrium model, it is shown that slicing subsidies for the banking sector, providing that the saved money are spent on agricultural-related infrastructures, could produce a favourable outcome in terms of income distribution and poverty conditions without deteriorating the macroeconomic stability or injuring investors' confidence. Compared with the fuel subsidies cut, the number of population affected by such a policy will also be much smaller. Thus, a drastic and massive reduction of fuel subsidies is unnecessary, especially considering the adverse socio-economic and political repercussions of it.