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