Indonesian consumers have long enjoyed the cheapest oil prices in Asia but this may be about to change as high world oil prices force the government to rethink its pricing policy. In 2004, oil subsidies cost the Indonesian government $US7.4 billion, or nearly 3 per cent of GDP, and this is expected to rise dramatically in 2005.

"If the oil price in the world market continues [to] stay around $US55-60 per barrel then the subsidy will reach about 130-140 trillion rupiah - about $US13-14 billion - which may be about 30 per cent of our budget," said Muhammad Chatib Basri, director of the Institute for Economic and Social Research at the University of Indonesia.

"The question is are we going to spend 30 per cent of our budget only to give a benefit for middle and upper class?" he said.

While oil subsidies benefit millions of Indonesia's poor who use kerosene oil for cooking, Basri says subsidies also provide cheap petrol to Indonesia's well-off and encourage a black market.

Many in the government agree. President Susilo Bambang Yudhoyono, known as SBY, has flagged a 50 per cent retail price rise as early as October to be accompanied by direct compensation to the nation's poorest.

Doubts over compensation plan

The compensation package proposed by the government involves a payment of 100,000 rupiah, or about $US10, to around 15 million families, or one quarter of the population, through the state postal and banking system. But how this will be achieved is unclear.

"The problem in Indonesia is we don't have a very strong infrastructure to do that ... it will be very hard to identify who's really the poorest," said Mohamad Ikhsan Modjo, a PhD candidate at Monash University in Melbourne who also lectures in economics at Jakarta's Airlangga University.

Basri agrees that such a compensation program won't work until better data is available and that will take time.

"In the short term, it is better for the government to reallocate this subsidy for the poor people by providing infrastructure, education and health," he said.

Political fallout

But subsidies are a hot political issue and cutting them has caused widespread demonstrations in the past, says Modjo. The demonstrations which eventually brought down former president, Suharto, started after a fuel price hike.

"There will be huge protests ... It's going to be dangerous, it's a political gamble for SBY."

No firm timetable has been released for the price increases and there is evidence of divisions within the government, Modjo says.

"There's an element in the government who strongly put the case for this increase in oil price - mainly the technocrats and some of the politicians - but many in the government itself, and especially in the legislative and also in the Indonesian senate, tend to disagree with this plan to increase the oil prices," he said.

The problem of subsidies

Despite the risks, the problem has become too big to ignore and the government is under pressure to cut subsidies both to reduce its costs and to support the currency, which has fallen 12 per cent since the start of 2005.

"The steep depreciation in the rupiah has been blamed on Pertamina - the state-owned oil company - having to import so much oil and also on the fuel subsidy situation of the country," said Platts Asia oil and gas analyst, Vandana Hari.

Indonesia is the biggest oil producer in South East Asia but, due to ageing oil fields and underinvestment in exploration, domestic production has been unable to keep up with growing demand. In 2004, Indonesia became a net importer of oil for the first time. But the products are being sold to consumers at much cheaper prices than Pertamina is forced to pay on the world market.

According to the Asian Development Bank, as of April 2005 the Indonesian government owed Pertamina $2.6 billion in subsidy payments, putting pressure on the company's ability to import petroleum products, and raising concern of a potential fuel shortage.

Subsidies are also blamed for the black market trade in cheap petroleum products bought in Indonesia and smuggled out to be sold at higher prices in countries such as Singapore. Eighteen Pertamina officials were implicated in a smuggling ring uncovered this month.

Time is now

Mohamed Chatib Basri believes the time has never been better for phasing out the subsidies because most people realise it is external pressures not internal problems which make them unviable.

"This is the first time in the history that most of the newspapers and editorials in the magazine demand the government raise the fuel price."

He says that while there is bound to be political resistance and demonstrations, reducing subsidies could help avoid a repeat of the 1997 financial crisis, making the fallout easier to survive.

"I'm talking about lesser of two evils. If you don't raise the fuel price then the market economic stability will be in trouble and the rupiah may be 13,000, 14,000, 15,000 (to the US dollar). Then by the time even you introduce the monetary or fiscal policy it won't help because the situation may be back to '97.

"But if you do something related to the fuel price you could solve the problem." he said.