Background

The Republic of Indonesia is located in Southeast Asia and consists of about 17 000 islands. It has a tropical, hot and humid climate. With a population of 234 million, growing at a rate of 2.45% per year, Indonesia has considerable environmental problems. Agriculture, forestry and mining make up around 25% of Indonesia’s GDP. While Indonesia has the second highest level of biodiversity in the world, it suffers from large-scale deforestation and over-fishing, which destroy habitats and endanger many species. For example, one recent study found that the rate of deforestation had doubled to about 2 million hectares per year in 2011/2012.

Overall Fiscal Profile

Indonesia is expected to slow its growth rate to roughly 5 – 5½ per cent in 2014, from 6¼ in 2012, particularly due to slowing investment, weak external demand and limited funding conditions. Inflation is expected to peak in the latter part of 2013 at 9.5 per cent, as a result of fuel price increases in June, and the depreciation of rupiah amounting to 17 per cent as of 2013. In 2013, the account deficit was projected to widen at 3.5 per cent, which is expected to improve in 2014 on a modest global recovery and due to a softening of commodity prices.  As FDI and portfolio inflows begin to slow, the balance of payments is expected to show a larger deficit, as of 2013.

Policy and Legal Framework for a Green Economy

The Second United Indonesia Cabinet launched a green economy program in 2010 as part of its sustainable development plan to promote growth, jobs, and poverty alleviation. In 2009, Indonesia signed the Manila Declaration on Green Industry, which highlighted the government’s determination to transition to a resource-efficient and low-carbon industry through policy, regulations, and institutional reforms that are favorable to clean production technology and that harness renewable sources of energy. The Ministry of Finance has also released a Green Paper Report in 2009 promoting  both economic and fiscal policy strategies for climate mitigation efforts. The report outlines areas for fiscal reform in the future: the implementation of a carbon tax/levy on fossil fuel combustion, slated at IDR 80,000 (US$ 6.8)  per tonne with an increase of 5 per cent  per annum in real terms to 2020. Additionally, a gradual phasing out of fossil fuel subsidies is proposed, with the use of fiscal transfers to incentivize carbon abatement and reduction in the land use and forestry sectors, and enhancing regulatory frameworks that relate to climate change, including the development of new milestones for CO2 reduction. As of 2009, the country committed to reduce its emissions by 26 per cent in 2020 compared to business as usual.

Fiscal Measures for a Green Economy

Fiscal incentives have played a role in Indonesia’s movement towards a green economy transition. In 2007, a scheme was announced by the Indonesian government to financially support renewable and geothermal energy.  This scheme was later recognised as a focal point in the Green Paper Report released by the government. Under the scheme, the government supports deployment of clean energy by offering tax incentives for renewable energy projects and particularly geothermal energy projects. Incentives include an investment credit of 20% for capital investment, and a tax loss carry forward period  of up to 10 years), accelerated depreciation rate and a cap on dividend withholding tax of 10 per cent.  A fiscal stimulus package was also launched in 2009, amounting to US$6.3 billion in 2009, equivalent to 1.5 per cent of 2008 GDP. Roughly 7 per cent of these funds were used to boost energy saving investments. As of 2010, the budget for the Ministry of Environment was approximately 0.06 per cent of total government spending, signifying potential for increased efforts in this regard.

Indonesia has also integrated the use of fiscal instruments in its climate change activities as outlined in the Medium Term Plan (MTP) (2009-2014) and the National Action Plan for GHG Emission Reduction. Trust Funds have been set up, including the Indonesia Climate Change Trust Fund and the Indonesia Green Investment Fund, have which receive funding from grants and donors that are then allocated to green projects and climate initiatives. The aim is to provide loans and grants to green initiatives that simultaneously promote economic growth.

There are also several user charges for water and other municipal services and some taxes and fees on industrial pollution and extraction of natural resources. For example, in the mining sector, those with mining licenses pay ad valorem royalties, with rates between 2 and 7 per cent of revenue, dependent on the mineral. Additionally, land taxes are charged based on the surface area mined. These are deductible from taxable income (which is charged at a rate of 25 per cent).  In 2010, the mining sector contributed to 6% of total tax revenue, indicating room for improvement in order to preserve natural capital and stimulate resource protection. 

The Ministry of Finance has also considered a carbon tax since 2009, although no action has yet been taken.

Fossil Fuel Subsidy Reform

Fossil fuel subsidies were introduced in Indonesia in order to insulate parts of the population from high prices of essential commodities and to stabilize fuel prices. Gasoline, diesel, kerosene, and liquefied petroleum gas (LPG) were historically sold below their market price. In 2011, fuel subsidies amounted to 2.2% of GDP and as of 2012, the state budget proposed an allocation of 168.6 (US$ 19.15 billion) for energy subsidies with IDR 123.6 trillion (US$ 14.05) and IDR 45 trillion (US$ 5.1 billion) allocated for fuel and electricity subsidies respectively. However, these subsidies have mostly benefitted the wealthy; promoted smuggling because of a price gap and encouraged an overconsumption of energy. This has helped make the case for fossil fuel subsidy reform within the country.

The government’s first attempt at subsidy reform was in 1997, when it raised the prices of kerosene, diesel fuel and gasoline by 25, 60, and 71 per cent respectively, in the wake of the Asian financial crisis. This initial attempt was unsuccessful and led to massive street protests which contributed to the fall of the administration at the time. A second attempt was made in 2001, when the government raised prices of fuels by 30 per cent while introducing compensation packages such as health care, a rice program, and village infrastructure support. However, the government was forced to roll back price increases in 2003 after a wave of popular protests. Then in 2005, a gradual reform strategy was used, which was complemented by information campaigns, compensation packages, and unconditional cash transfers to reduce the impacts on the poor, under the Blueprint for National Energy Management.

Faced with particularly high kerosene subsidies, a kerosene-to-LPG conversion program was later introduced in 2007 which supported start-up packages (tanks, LPG stoves, accessories) through investment of an estimated IDR 14.11 trillion (US$ 1.56 billion) between 2007 and 2011 as well as a VAT exemption for government subsidies on tank products. In addition, LPG was subsidized to promote the initiative. This was estimated to save 35.34 trillion (US 3.9billion) on the kerosene subsidy. The total fuel level of subsidies declined from 2.8 per cent of GDP in 2008 to 0.8 per cent of GDP in 2009. The government has introduced a new unconditional cash transfer as well as additional benefits for a rice program, scholarships, and village infrastructure. For example, 15.5 million households were targeted at the bottom 25%, allocating IDR 150,000 (around US$17) per HH per month for a four month period to compensate for high fuel prices. Still, concerns remain regarding the regressive nature of subsidies (90% of Indonesia’s fuel subsidies benefit the richest 50% of households)  and subsidy expenditures are still quite high. This highlights the need for continued reform efforts within the country.

Various ministries and agencies have proposed additional schemes to reduce fossil fuel subsidies moving forward. For example, the Ministry of Energy and Mineral Resources (MEMR) proposed a gradual increase in gasoline prices by increments of IDR 500 (US$ 0.042) per liter, coupled with a smart-card system to support cash-back mechanisms for public transit. Consumption limits on motor vehicles were also recommended by the MEMR. Additionally, task forces are being developed to prepare materials that highlight the negative impacts of subsidies on state budgets and to evaluate infrastructure to determine the feasibility of non-subsidized fuels.

The Ministry for Economy has been assessing various options for subsidy withdrawal, while the Ministry of Finance has helped prepare a road map to phase out fossil fuels at the regional level. As reiterated by the government, the process should become less ad hoc and potentially shift to a subsidy cap or a fixed subsidy, as opposed to fixing prices to allow for market fluctuation and maintain cost control, while demand side management should become a focus, particularly in the transport sector. In June 2013, the government increased subsidized fuel prices: petrol increased by 44 per cent and diesel by 22 per cent; with a temporary cash compensation scheme to cushion the shift.

Additional Reading

GIZ. N.d. Instruments and Mechanisms for Financing of GHG Emission Reduction Programs. Retrieved from:http://www.climatefinance-asiapacific.org/attachments/article/28/BKF%202012%20Financing%20Intrument%20Land%20Based%20Sector%20ENG.pdf

GIZ, 2013. Ready for Climate Finance: GIZ’s Approach to Making Climate Finance Work. Retrieved from: http://www.giz.de/expertise/downloads/giz2013-en-climate-finance-approach.pdf

GIZ, 2014. Climate Finance Approach GIZ Indonesia (http://climatefinance-asiapacific.org/index.php/projects/giz-indonesia)

IISD and GSI, 2014.  “The Future of Social Welfare Programs in Indonesia: From Fossil-Fuel Subsidies to Better Social Protection” – IISD and GSI Working Paper. Retrieved from: http://www.iisd.org/gsi/sites/default/files/ffs_indonesia_briefing_welfare.pdf

IISD and GSI, 2012. Indonesia’s Fuel Subsidies: Action Plan for Reform. Retrieved from: http://www.iisd.org/gsi/sites/default/files/ffs_actionplan_indonesia.pdf

Ministry of Finance, Republic of Indonesia, 2012. Fiscal Policies to Support Renewable Energy Implementation. Retrieved from: http://energy-indonesia.com/03dge/05.pdf

Tumiwa, F., L. Lontoh, T. Laan, K. Lang and D. Vis-Dunbar (2012). A Citizens’ Guide to Energy Subsidies in Indonesia: Geneva.