Indonesia: Redirected Spending Can Lead to Higher, More Inclusive Growth

April 4, 2012

Jakarta, April 4, 2012 -  The recent sharp rise in international oil prices have increased the costs of Indonesia's energy subsidies. The recently approved hike in subsidized fuel prices – if implemented – will help address the increasing opportunity costs and fiscal risks of the fuel prices, says the World Bank’s latestIndonesia Economic Quarterly update. Redirecting this spending to more productive areas, such as education or infrastructure, could potentially lead to growth of 7 percent or more.

The near-term economic outlook for Indonesia remains closely tied to international developments. Currently, the state budget assumption for Indonesian crude oil prices is set at $105 per barrel. After much debate, Parliament has allowed to increase fuel prices by Rp. 1,500 ($ 0.16) on the condition that the Indonesian Crude Price is above this assumption by at least 15 percent over a period of six months (i.e. to $120.8 per barrel).

In 2011 Indonesia spent nearly $ 19 billion on fuel subsidies, which in itself is symbolic of Indonesia’s economic success: as incomes increase, so too has fuel consumption. However, given that fuel subsidies benefit richer households  more than they do the poorer ones – 40 percent of the direct benefits from gasoline subsidies go to the richest 10 percent of households – there is a clear need to redirect this spending to more pressing development needs: improving the quality of education, social safety nets, the business climate and other areas that can stimulate growth.

“The future of Indonesia’s growth and development is dependent on the Government’s continued progress in improving the quality of its spending. Effective spending on infrastructure and education, along with measures to improve the business climate, could potentially boost Indonesia’s growth rate up to 7 percent or higher,” says Shubham Chaudhuri, the World Bank’s Lead Economist for Indonesia. “These measures, along with an effective social safety net that caters to the poor and vulnerable, can help better distribute the benefits of this growth to the entire population.”

Greater spending and reforms in education over the past five years has led to higher enrollment rates. Building on this success, Indonesia could potentially build more schools in remote areas; make college educations more affordable; and take steps to raise the quality – not quantity – of teachers. 

Not enough however is being spent on the poor and vulnerable, if compared to education or fuel subsidies. In 2011, the Government spent 2.2 percent of GDP on fuel subsidies and only 0.5 percent of GDP on social assistance programs. In comparison, middle income countries like Brazil and India are spending 1.4 percent and 2.2 percent respectively. Although the poverty rate dropped to 12.5 percent in 2011, the reality is nearly 25 percent of Indonesians live below the official “near-poor” line and are vulnerable to even the smallest of shocks. 

“In recent years, half of all poor households in Indonesia were not poor the year before. And this condition need not repeat itself because Indonesia does have the building blocks to form a true social safety net,” says Stefan Koeberle, the World Bank’s Country Director for Indonesia. “To reach that point, the government needs to spend more on reforms to improve the quality and reach of programs like Raskin, Jamkesmas and Program Keluarga Harapan, while also working to ensure that these programs reach the right people at the right time. Spending on human capital to build a healthy, educated and productive workforce will only make Indonesia’s economy stronger.”

The new Indonesia Economic Quarterly also highlight that gender equality is the right and smart thing pursue in Indonesia, where maternal mortality remains high and women still earn less than men in all sectors. World Bank research shows that if Indonesia’s society were to compensate people based on their skills and abilities, not by their gender, per worker productivity could increase by up to 14 percent. This translates to significant economic growth and poverty reduction.

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