Bhima Yudhistira Adhinegara – The world is in turmoil. The geopolitical chaos in oil-producing countries has created a direct shock to the oil market and disrupted the global supply chain.
As a result, inflationary pressures are hurting Asian countries, forcing Vietnam to urge people to work from home, Thailand to reduce air conditioning use, and India to switch to alternative electric stoves due to LPG shortages.
Indonesia, home to the world's fourth-largest population, is in no way immune to the economic shockwaves of the raging war between the United States-Israeli alliance and Iran
The surge in global oil prices has affected not only fuel prices at gas stations but also the costs of petrochemical products such as plastics and fertilisers. Small- and medium-sized enterprises have already suffered from recent price hikes in plastic products, such as thin-walled food packaging containers.
All of these cost increases will inevitably lead to volatile food inflation, and Indonesian middle- to lower-class consumers are not ready for price hikes.
But while many countries are already bracing for a longer and more severe impact of the oil crisis on daily life, and taking steps to reduce its impact, Jakarta is still weighing options to weather the crisis.
An 'overconfident' government?
There is a sense that President Prabowo's economic team is playing down the potential impacts of the oil crisis. The government has long been criticised for being overconfident about the state of the country's economic fundamentals, even before the Iran War broke out.
When rating agencies such as Moody's and Fitch revised Indonesia's sovereign bond outlook from stable to negative, the government claimed it was merely a matter of 'miscommunication'. It refused to address the problems causing the downgrade.
Instead it chose to stick to its problematic fiscal policies.
The free nutritious meal (MBG) program and the Koperasi Merah Putih (Red and White rural cooperatives, Kopdes MP), which cost 20 billion USD and 7 billion USD, respectively, have led to a higher debt service ratio. There have been clear indications that the energy crisis could widen the budget deficit, which is expected to exceed 3% of GDP. The Prabowo government should have made emergency fiscal adjustments, but it has refrained from doing so.
Clearly, the government cannot afford to keep the MBG program as it is if it wants to get inflation under control. It needs to at least reduce its scale. The logic is simple: the MBG program exacerbates inflation amid rising oil prices because it acquires staple foods such as rice, chickens, eggs, and vegetables from direct producers or large distributors. It cuts out the middlemen.
The US$20 billion budget for MBG is disrupting the food supply chain, leaving traditional sellers and household consumers with higher retail prices. The Prabowo government claims that it is doing consumers a favour by avoiding retailers as middlemen, but we need to ask whether the alternative – passing the MBG money to the military, the police and political allies to cook meals for students – is a more efficient policy?
Moreover, the MBG budget now faces higher costs due to changes in energy prices. When fuel and LPG prices rise, the kitchens that provide free meals face greater bills. Cutting the size of each meal is not an option because it could harm students even further, reducing nutrition and increasing susceptibility to health issues.
Moreover, Indonesia is facing El Nino this year, posing further challenges for crop production. Soaring food prices, combined with energy pressures, will create a perfect storm, and El Nino will drive palm oil shortages. So, even as prices rise, stocks may decline.
Prabowo needs to reconsider his ambition to increase production of B50, a blend of palm oil and diesel. More blending means more palm oil use. With El Nino approaching, there won't be enough palm oil to produce enough fuel and food. The 2022 cooking oil crisis could happen again.
Out-of-the-box solutions
There is no sign that the government is changing its approach to the energy crisis.
The latest cabinet meeting of the Prabowo administration was overly focused on the silver linings in the current economic situation. It highlighted, for example, that household consumption is still growing and that the manufacturing PMI is still expanding.
During the event, Finance Minister Purbaya Yudhi Sadewa even slammed economists for spreading pessimism. Prabowo doubled down on Purbaya's claim, saying that some economic observers were driven by hatred of the government and were unpatriotic. Statements like this clearly send the wrong signal to the markets.
The reality is that the government's fiscal space is only narrowing. Coordinating Economic Minister Airlangga Hartarto has raised the possibility of increasing the budget deficit limit to more than 3%. This is a risky bet. Without spending cuts, the budget deficit may reach 3.6% of the GDP. To put things in perspective, Indonesia's budget deficit in February was almost 4 times that of the corresponding period last year. An increase in tax revenue from rising oil prices does not compensate for seemingly reckless government spending.
Purbaya needs an out-of-the-box solution to plug the budget deficit. Among many new revenue streams that will not hurt the middle class, the windfall profit tax should be made a priority. Additional tax from the abnormal profits of mining and palm oil companies could help.
The United Kingdom government, for example, introduced the Energy Profits Levy in 2022 for North Sea oil companies and then increased the rate from 25% to 35% by 2023. Indonesia should learn that profit spikes of extractive companies do not necessarily come from increased productivity or advanced technology.
The profits that should be taxed more are purely abnormal, a bonanza coming from conflicts among the oil producers. While the rest of the people are facing a dramatic price surge in daily spending, companies that enjoy a windfall should share their profits. The money can also support energy diversification through renewable energy and the grid.
It is also never too late to look back at the structural holes in Indonesia's economy. Prabowo will have to sacrifice his populist programs and be creative to increase tax revenue, as foreign debt rises and the budget deficit widens.
This is the moment of truth for the Prabowo administration. Poor policymaking could turn the energy crisis into a severe cost-of-living crisis, triggering social unrest and political instability. The government urgently needs a robust strategy to cushion the economy from internal and external pressures.
The last thing it needs is to alienate independent analysts for giving their informed opinions.