Oil Subsidies Impact on a Government Budget in Indonesia - Essay Example

Oil Subsidies Impact on a Government Budget in Indonesia Iran and Venezuela al Affiliation Introduction It is reported that global oil consumption will reach 90 million barrels per day reflecting commitment of many countries in providing subsidies for gasoline and oil. Subsidies on fuel products normally influence the steady state level of macroeconomic aggregates such as consumption and may further lead to crowding out of non-oil consumption and other alterations in macroeconomic variables (Davis, 2013). Although subsidies on fuel are significant for many governments, there absolute cost associated with them and attempts to remove the subsidies have always hit a deadlock (Iwaro & Mwasha, 2010). It is worth noting that subsidies on fuel consumption have critical macroeconomic consequences and that many subsidies fail to serve their purpose thus causing unsustainable development. This paper attempts to analyze oil subsides’ impact on a government budget in Indonesia Iran and Venezuela. Concept of Energy Subsidies Globally, all governments are greatly concerned with their energy sectors because of the key role energy plays in the economic development. Energy consumption calls for public interventions such as use of direct grants and all sorts of tax break that are hidden in public and economic structures (Gavish & Gavish, 2012). Two-thirds of all subsidies flow to fossil fuels where subsidies to energy production are common in industrialized countries while support to energy consumption dominate developing countries (Davis, 2013). Different categories of subsidies have different impacts that include low energy prices that enhance overuse and waste while underpricing hurts energy producers. On the other hand, producer subsidies promote overproduction characterized by protection and quantity regulations that trigger further distortions in the local economy. Effect and Impact of Oil Subsidies Rationale to subsidize energy has always been to stimulate economic growth but the notion changed after the oil crises in 1970s. The growth motive was no longer considered important because governments thought it necessary to safeguard domestic energy supply while developing countries subsidized energy consumption to fuel economic growth. According to Davis (2013), energy subsidies are believed to avert possible barriers to growth although this concept has been proven ineffective especially in stimulating economic growth. According to Gavish & Gavish (2012), there are studies that show that energy subsidies hamper economic growth and therefore eliminating them (subsidies) may provide incentives for a more efficient resource allocation and spur economic growth. Moreover, energy subsidies pauses environmental threats by increasing carbon dioxide emission because acquiring fossil energy becomes cheap thus raising demand (Iwaro & Mwasha, 2010). However, removing the subsidies would hike fossil energy prices and provide a fair playing ground for cheap renewable energy in the market. Subsidies impact on Indonesia Dartanto (2012) explains that Indonesia subsidizes the retail price of fuel and their experience is a good example of positive and negative effects of subsidy on government budget on developing countries. Indonesia’s revenue and oil subsidy is key to its economic agenda policy considering that the subsidies and other expenditures outgrow oil revenues. Indonesia’s economy suffers from fiscal pressure because of ever increasing subsidiaries of energy products thereby creating a challenge of reducing macroeconomic instability that arise from the growing drain on fiscal resources (Dartanto, 2012). Although the intention of price subsidy was intended to avoid social instability, relating retail prices to movements in world prices has seen an outpacing of government’s attempts to bring local energy prices down (Graefe, 2009). Indonesia’s central government spends much in oil than any other sector such as education and healthcare. Financing needs for the subsidies has gone extremely high thus stretching the government’s budget. It is clear that higher oil prices imply higher energy subsidies, which stretches the national budget. Funds used in subsidizing fuel may well be used in other important projects such as healthcare that may greatly help in promoting the welfare and infrastructure of Indonesia. Although leaving the forces of market to control oil prices in Indonesia may worsen the condition of the larger poor population, subsidizing oil is soars because of the rising fuel consumption and prices. The government’s budget deficit was projected to swell to 3.8% of GDP in 2013 in case the issue of subsidy is not carefully handled. Fuel subsidies cost is projected to be 199.9 trillion rupiah, a figure that represents 13.3% of the revenue (Sovacool, 2010). Amidst all these negative effects of oil subsidies, the public do not seem happy even with the government’s attempts to cut subsidies. Recently, Indonesia’s government announced its plans to hike oil prices because the subsidies used in keeping the prices down are seriously causing a huge strain on the budget. According to the Indonesia’s Finance Minister, fuel subsidies over $23 million are used in fuel subsidies and that much is spent on fuel subsidies yearly than on social programs and capital expenditure put together (Dartanto, 2012). However, an increase in fuel prices and lack of fuel subsidy also worries the government because it will affect all other prices such as transportation cost and all other commodities. Upon announcement of the plans to increase fuel prices, there were strikes and demonstrations from various paper including labor unions students and environmentalists. Sovacool (2010) explains that Indonesia has many oil production fields and is ranked amongst the top 25 oil producing nations but heavy subsidies has seen the country recording heavy fuel prices. However, this trend may not continue because further subsidy may continue eating up on the government expenditure (Sovacool, 2010). Unfortunately, reducing fuel subsidy may lead to crucial public social programs such as healthcare and much needed infrastructure investment. It is clear that oil subsidies exert great pressure on Indonesia’s budget making the country not to concentrate on social and national development programs. According to Dartanto (2012), oil subsidies is an issue that has heightened political debate as well as triggering emotional issue causing some of the unrest that contributed to the ouster of the authoritarian president Suharto. Politicians argue that fuel subsidies raises budget deficit and that the subsidies benefit the rich more than the poor. Subsidies impact on Iran Oil subsidies in Iran have come under scrutiny just like in any other country because of the huge burden it imposes on the government budget (Moshiri et al., 2012). Iran begun subsidizing oil since 1980s to help the citizens manage hardships during the war and avoid political and economic challenges but recently the government have tried to cut back subsidiaries. According to Yazdan and Hossein (2012), Iran’s government came up with bold reform in 2010 to phase out subsidies and introduce national cash transfer but this too has come under great scrutiny because of various challenges. Politically, controversial subsidies issue saw Mahmoud Ahmadinejad winning parliamentary approval because universal price controls were to be replaced with small cash payments to families. According to Mehdi (2012), soaring cost of subsidy have never been tackled appropriately because of fear of political backlash including mobilizing support. However, in 2010, Iran’s main political factions agreed on economic challenges that subsidies exposed them to and the unsustainable nature of the subsidies (Safdari et al., 2012). In 2010, fuel subsidies represented 10% of Iran’s GDP and therefore the only solution that was thought to be effective was instituting strong reforms (Moshiri et al., 2012). It is reported that oil subsidies has been plagued by some flaws such as fostering wasteful behavior including increased energy consumption and massive traffic overload in urban centers. It is believed that fuel subsidy in Iran has made the country one of the least energy efficient economies and although implementation of subsidies was easily implemented, removing them is never easy (Yazdan & Hossein, 2012). However, the position taken by Mahmoud Ahmadinejad in Iran regarding subsidy reform has been very instrumental to the economic recovery of the country. Although it faces numerous challenges after its first two years success, at least the issue of subsidy has been handled and the country’s budget is not as stretched as it used to be. After attempts to institute reforms failed due to political wrangling, Iran focused on eliminating subsidies that have hugely stretched their finance and slowed economic growth. Ahmedinejad’s success in the reform process was a great achievement and surprise considering that he managed to overcome political obstacles and social upheaval (Safdari et al., 2012). It is apparent that success of the reform is likely to boost the regime’s confidence Iran’s foreign exchange went down while subsidies took a greater percentage of the country’s budget thus creating a greater budget pressure (Moshiri et al., 2012). Low prices due to subsidy encouraged greater consumption hence leaving less oil for export and as the oil prices rose, the opportunity cost in loss export increased. The reforms are definitely going to transform Iran’s economy because there will be less strain on budget and the export level will go high (Mehdi, 2012). Subsidies impact on Venezuela Subsidy of oil was among the former Venezuelan president, Hugo Chavez’s strategy of subsidizing basic goods. However, the impact of this popular strategy was fierce on the country’s budget including liquidity issues. According to Hammond (2011), many refineries in Venezuela are in a state of despair and the major crude oil exporter imports gasoline for its local consumption. Subsidy policy that was initially meant to help the poor provided greater benefits to the rich than it did to the poor. According to the International Energy Agency, subsidies made Venezuelan government to spend $27 billion in 2011 and the lost energy revenue formed a significant 8.6% of the domestic gross product (Bucheli & John, 2011). The subsidy issue because of the sizeable amount of money used has hard hit Venezuelan’s economy making it difficult for the government to spend on investment projects as well expenditure on essential services. Venezuelan residents have grown accustomed to the subsidy policy and that now consider it part of their right and fair share. It is therefore hard to take away what they believe belongs to them using new policies intended to eliminate subsidies (Hamilton, 2009). Many people also smuggle fuel out of the country because they buy it very cheap and sell it at higher price across the border in Columbia thus helping them earning income. This shows that the government loses much revenue because of the illegal business. Hammond (2011) explains that Venezuela’s oil and energy policies are at the center of national politics and national economy especially the current and future oil prices. Venezuela does not actually have cash constraint and the major challenge is its peculiarities policies that have seen its declining trend in oil exports (Daguerre, 2011). As most prices go high in Venezuela, oil prices have always remained almost free. Daguerre (2011) asserts that Mr. Chavez’s policy has indeed damaged the long-term prospects for economy and subsidy has exposed the country into unusual situation making the country’s budget deficit reach 12% of GDP in 2012. The consumption of oil also went high by using almost seven times much oil per capita that cost the country $27 billion in 2011. Conclusion Generally, oil subsidy has negative impact on different governments’ budgets. A lot of money is used in subsidizing the product thus enhancing local consumption and reducing oil export. Most governments that initially proposed subsidy reforms are attempting to eliminate the policy because of the disadvantages it is associated with including failure to direct funds on necessary projects (Graefe, 2009). It is apparent that subsidizing oil implies encouragement of environmental damage because of the pollution linked with fossil fuel. Countries subsidizing oil have found it hard to introduce new reforms because of fear for social up rise and political wrangles given that oil price is at the core of every individual’s economic wellbeing and country’s economy. In general, subsidies on fuel consumption have critical macroeconomic consequences and that many subsidies fail to serve their purpose thus causing unsustainable development. References Bucheli, M., & John, J. D. (2011). From Windfall to Curse? Oil and Industrialization in Venezuela, 1920 To The Present. 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