Indonesia's Fuel Price Increases Are Credit Positive for the Sovereign and Pertamina

The decision of the Indonesian government to raise retail gasoline diesel prices is credit positive for the sovereign as the increases will reduce the country's fuel subsidy bill by IDR100 trillion (US$8.2 billion), or roughly 1% of GDP, from the IDR246.5 trillion budgeted in 2014.

The increase in retail fuel prices followed President Joko Widodo’s election pledge to remove fuel subsidies completely within four years, and signals the government’s commitment to broader economic reform.

The government raised retail gasoline prices to IDR8,500 (US$0.70) per liter from IDR6,500 (US$0.53), a 30.8% increase, and hiked diesel prices to IDR7,500 (US$0.61) per liter from IDR5,500 (US$0.45).

The recent collapse in global oil prices gave the authorities the opportunity to raise pump prices.

"The hike in domestic fuel prices is likely to reduce excessive energy consumption, reinforcing the continued narrowing of Indonesia’s current account deficit," wrote Atsi Sheth, Senior Vice President, Sovereign Risk Group, Moody's Investors Service Singapore Pte. Ltd. and Vikas Halan, VP - Senior Credit Officer, Corporate Finance Group, Moody's Investors Service Singapore Pte. Ltd. in an article from "Moody’s Credit Outlook."

The country’s current account shortfall fell to 3.1% of GDP in the third quarter of 2014 from 4.3% in the previous quarter.

Energy major Pertamina (Persero) (P.T.) will also benefit from a reduction in fuel subsidies, because the government’s action will lower the national oil company’s borrowing requirements, improve its working capital and reduce potential losses arising from insufficient subsidy reimbursements from the government.

"We estimate that the government’s move will lower Pertamina’s annual borrowings by $500-$700 million, which would reduce the company’s debt/EBITDA ratio by roughly 0.1x. The company’s reported debt/EBIDTA was 2.9x in 2013," wrote the Moody's executives.

But, the fuel price hike is likely to lead to a temporary spike in consumer price inflation.

Following a 44% hike in gasoline prices in June 2013, headline consumer price inflation jumped by 3.3% over the course of the month. After taking into account the fuel price hike, inflation over 2014 will probably rise to 7.3% from 4.8% for the 12 months ended in October.

Bank Indonesia’s decision to raise interest rates following the fuel price hike is likely to limit additional inflationary pressures in 2015. The central bank convened an extraordinary policy meeting on 18 November and increased the benchmark interest rate by 25 basis points to 7.75%.

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