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Fuel price hike and domestic consumer spending patterns

Jakarta Post - September 28, 2022

Andry Asmoro and Teguh Yudo, Jakarta – The government decided to increase the prices of subsidized Pertalite and Pertamax gasoline and Solar diesel on Sept. 3 to manage the energy subsidy quota not to exceed Rp 502 trillion (US$33.5 billion). The government's calculations reveal that the subsidy could increase to more than RP 690 trillion this year if the consumption of Pertalite and Solar were not managed. This will affect the spending posture in the 2023 state budget as the government has decided to lower the budget deficit to the pre-pandemic level of below 3 percent.

The impact of domestic gasoline prices, as many predicted, will result in a higher inflation rate, lower purchasing power and, in the end, affect growth in the fourth quarter of 2022. We forecast that rising prices of Pertalite, Pertamax and Solar will increase this year's inflation rate to 6.3 percent (versus our initial inflation forecast of 4.6 percent) while affecting lower growth of 5.0 percent through consumer spending.

We saw Indonesia's economic growth accelerate further to around 5.3 percent to 5.4 percent this year on the back of a stellar performance in the second half of 2022 at 5.23 percent. Indonesia's recovery was broad-based and highly correlated with several supporting factors: subdued COVID-19 cases and mobility relaxation, commodity price recovery and responsive regulations from the government and Bank Indonesia.

Now, the million-dollar question will be how the fuel price-hike affects Indonesia's consumer spending pattern. Currently, though quite resilient, spending levels in the third quarter of 2022 continue to be restrained amid rising inflation. After experiencing normalization post its peak during Idul Fitri, consumer spending has remained stuck at pre-Ramadan levels since June.

This is shown by the Mandiri Spending Index (MSI), where the index remains flat in the last four months, a pattern that has never been seen before. During this period, annual inflation rose to above 4 percent, the highest in the last 5 years. Nonetheless, the current spending level is still quite resilient, being 29 percent above pre-pandemic levels.

The impact of rising prices keeps pressures on durable and service consumer spending, suggesting that consumers may be defensive. In general, spending for all categories (durable/non-durable/service) grew cumulatively from January to August compared to the same period in 2021. Nevertheless, there are variations in the growth rate. Spending on durable goods (e.g. household and electronics) and services (e.g. entertainment, sports, travel, or hotels) tend to slow down while non-durable consumer spending remains strong, driven by a strong demand as shown in increased volume.

Consumers are now prioritizing spending toward basic necessities. In terms of value, year to date growth in the first eight months of 2022 for durable goods and services was 6.6 and 2.8 percentage point (ppt) lower compared to growth in the first eight months of 2021. In contrast, non-durables, such as food and groceries, recorded an increase of 12.9 ppt. The increase in non-durable growth, at a time when spending on durable goods and services declined due to rising inflation, indicates that consumers are shifting toward basic day-to-day spending. Thus, consumers tend to be more defensive.

We anticipate that the national household (HH) spending in the third quarter of 2022 is likely to be lower than the second quarter of 2022. As a proxy for national HH spending, we estimate that the MSI in the third quarter of 2022 will be lower than the previous quarter. This also happened in the third quarter of 2021 when spending was hampered by tightening of mobility due to the Delta variant outbreak.

Given that the MSI pattern is generally in line with the national HH spending, we think that in the third quarter of 2022 Indonesia's GDP is likely to be lower than that of the second quarter of 2022. This is also confirmed by the Real Sales Index surveyed by Bank Indonesia, which shows that third quarter of 2022 retail sales will be lower than the second quarter of 2022. However, the positive side of the third quarter of 2022 spending growth will be from the low-based effect in the third quarter of 2021 when the domestic economy was severely hit by the Delta variant from July to September 2021.

While the policy is aimed at reducing fuel subsidies, increased fuel prices would tighten household spending since it would burden typical households. Based on the 2021 National Socio-Economic Survey (Susenas), the wealthiest 10 percent of consumers spent around 61.7 liters of fuel and on average around Rp 561,000 per month for fuel. Their spendings accounts for a quarter of the national fuel consumption. This is much higher than the poorest 10 percent that accounted for only 3.7 percent of total fuel consumption.

Despite being much lower, the poorest households apparently bear the highest burden. We conducted the simulated impact on the real fuel price hike for both Pertamax and Pertalite. With old fuel prices, the 10 percent poorest had fuel spending of around 4 percent. The price increase of 30.7 percent for Pertalite and 61 percent for Pertamax raised the burden to 8.6 percent. It suggests that the burden increased by around 4.6 percentage points. Meanwhile the impact on the middle class, i.e. households ranked in the 50-70 percent of income distribution, is around 6.6 percent due to the new hike of fuel prices.

The fuel price-hike has halted spendings across all income groups. A month before the fuel price-hike, the government disseminated the price-hike plan, including arrangements for fuel rationing. At the same time, consumers might have anticipated the fuel increase, reflected in their spending patterns. Between August and early September, while we observed an increase in fuel purchase, the overall spending tended to decline – suggesting that households shifted spending on other things than fuel. This occurred across all income groups. Up to one week after the price hike, the average spending of all groups continued to decline, especially for the lower income groups.

Cash transfers aimed at helping the poor lower the burden, but with the current amount, the effect is limited. To cushion the impact of the shock, the government announced the social assistance program (BLT) on cash transfers for the poor and wage subsidies amounting to Rp 24.17 trillion. On cash transfers, the government allocated Rp 150,000 per month for four months to 20.65 million household beneficiaries.

Meanwhile, the wage subsidy (BSU) will be disbursed to 14.6 million workers who earn below Rp 3.5 million, the average minimum wage in big cities. Our simulated impact of the BLT shows that the amount of Rp 150,000 per month reduces the burden. Yet it appears to be very small. Our data reveals that with cash transfers, the burden of the poorest 10 percent of households is down from 8.6 percent to 8.3 percent, which is 0.3 percentage point lower. The impact on the middle class is also rather small.

The wage subsidy may be effective in spurring middle class consumer spending in the short term. Our observation on previous data confirms it. Some evidence from 2021 shows that the BSU disbursement was generally followed by a significant increase in consumer spending. However, given the magnitude of the fuel price increase, the wage subsidy needs to be larger to maintain purchasing power that can be heavily affected by current surging prices.

Overall, the impact of the fuel price hike on inflation should be temporary and one-off. However, we should note that external factors (a war, rising energy prices and a global recession) will put more pressure on domestic purchasing power in the future through lower commodity prices, more expensive imported materials and rising interest rates. Thus, we believe the government's fiscal support in 2023 will be very important to maintain purchasing power and to avoid the middle to poor income from receiving negative impacts from higher food prices.

[Andry Asmoro is a chief economist and Teguh Yudo is head of the Mandiri Institute.]

Source: https://asianews.network/fuel-price-hike-and-domestic-consumer-spending-patterns