VZCZCXRO1541
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 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EAP/MTS, EAP/RSP AND EB/IFD/OMA 
TREASURY FOR IA-BAUKOL, OTA-MCDONALD 
SINGAPORE FOR TREASURY-BAKER 
COMMERCE FOR 4430-BERLINGUETTE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN 
DEPARTMENT PASS EXIM BANK 
 
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