Is Fuel Subsidy Reform Finally On the Way in Southeast Asia?

Indonesia and Malaysia are two of Southeast Asia’s major oil giants. The 1970s and early 1980s were a boom time in Indonesia thanks, in large part, to high crude oil prices, which made the New Order government flush with foreign exchange from exports. Oil exports are also a major part of Malaysia’s public revenue, as the government earns billions of dollars in dividends every year from state-owned oil and gas firm Petronas.

When a country has lots of oil, it will often export it to global consumers at the highest price that the market will bear. Many of these same exporting countries will then provide local consumers with fuel at subsidized prices, which they are in a position to do because they have so much control over supply and production networks. This way they get the best of both worlds.

Malaysia and Indonesia have historically followed this approach, with the retail price of gasoline in the domestic market being heavily subsidized. But this is now starting to change. Malaysia cut its diesel fuel subsidy in June, allowing the price to increase by about 50 percent. In 2022, Indonesia allowed the price of its primary subsidized gasoline, Pertalite, to rise by around 30 percent.

The Indonesian government is now sending signals that it may tighten restrictions on who can purchase Pertalite, or possibly other forms of subsidized fuel like diesel. Currently almost anyone can buy it, including people who probably don’t need it, like drivers of expensive cars and SUVs. The final plan is still being deliberated, but it seems likely the government will soon take steps to try and target the subsides more efficiently.

Subsidy reform in these countries is something many observers, especially economists, have long called for because they distort markets. But subsidies, once enacted, are hard to walk back as no government wants to tell its citizens they have to pay more for a staple good that historically they could always get at below market price. So why is this happening now?

The obvious reason is to save money. By reducing its diesel fuel subsidy, the Malaysian state will reportedly save around $850 million this year alone. For Indonesia, the financial incentive is even greater. Indonesia’s oil reserves are being depleted and it is no longer a major global exporter. Generous fuel subsidies are a legacy of a time when Indonesia had more oil than it does now. With the incoming Prabowo administration committed to costly high-profile infrastructure and social programs the state would certainly like to save on fuel subsidies and direct those financial resources toward more productive undertakings.

There is also likely a political component to this. Both Malaysia and Indonesia are eager to increase investment in clean energy, and in order to do that they have to be seen as taking subsidy reform seriously. Any clean energy policy that relies on prices to coordinate economic activity will not work when fossil fuel is subsidized, because the price at which the fuel is bought and sold sends the wrong signal to investors and consumers. Reducing subsidies saves money, but it also reflects a sort of grudging acknowledgment that the world is moving toward cleaner energy, and even countries that have historically been big oil exporters will need to make some concessions on fuel subsidies.

Such concessions are almost certainly going to be gradual, however, and we should be careful not to over-interpret the modest reforms we are seeing. Although Malaysia has reduced subsidies, fuel for domestic consumers still remains well below its market price in most other places. The same is true of Indonesia, where the government continues to set aside billions of dollars in the annual budget for energy subsidies even as it looks to target them better.

This is an important point to keep in mind when considering how to make market-based clean energy initiatives, like the Just Energy Transition Partnership, work in countries with large fossil fuel reserves. Indonesia and Malaysia are showing a willingness to address fuel subsidies, both to save money and to encourage investment in things like clean energy, but they are probably going to slow-walk reforms. Efforts to try and speed things up may be met with resistance, because at the end of the day policymakers in these countries are accountable to domestic constituents, and years of access to inexpensive fuel makes price increases a hard pill to swallow.