Thursday May 19 2022

Withdrawing fuel subsidies: Lessons from Indonesia

A representational image of a person fueling up a car. — Reuters/File
A representational image of a person fueling up a car. — Reuters/File

If there was ever a "delicate turn" in Pakistan’s history, it is perhaps this current moment. Never has the state ever faced so many crises at once and found itself utterly clueless in its response.

The immediate crisis is one of the economy. The historic verdict delivered on April 9, 2022, led many to assume that the new government will not dither, like the previous one, on the many pressing economic decisions that are needed to be taken. Yet, five weeks later, the only thing that has been transferred between the two governments seems to be the general paralysis restricting the Shehbaz Sharif government from taking the "bold" decisions that many believe it must take to rescue the economy from the grips of uncertainty and a possible collapse.

The economy is truly in shambles. The subsidies announced by Imran Khan earlier this year were non-funded — as in they were implemented without a plan to find a revenue source for them. This simply means that the subsidies would have to be debt-financed thus widening the fiscal deficit. The finance minister, Miftah Ismail, is on record saying that these subsidies will cost the government more than it does to run its affairs.

With the political uncertainty that ensued after the vote of no confidence, the rupee has also come under considerable pressure and by the time of writing this article had hit Rs195 to a dollar.

One of the bold decisions being asked of the current government is to remove the PTI’s government fuel subsidies that it announced earlier this year. What is surprising is that many experts and non-experts, particularly many journalists, seem to have adopted this line of argument rather uncritically. It is argued that such an action would relay the signal that this government means business and wants to take the challenges confronting the economy head on. The idea is that a "shock treatment" given to the economy by the sudden removal of subsidies and a large increase in interest rates would calm nerves down in the market and help address the prevailing uncertainty.

If the history of such policy actions taken elsewhere in the world is anything to go by, then one must be even more cautious in suggesting this. My intention is here not to suggest keeping the fuel subsidies intact. That they must go is a forgone conclusion. I do, however, want to suggest that the way they are removed must not be the same as is being suggested on our TV screens these days. Before I elaborate on that, let me compare Pakistan with Indonesia of circa 1997-1998, where such shock treatments were applied in the wake of the Asian currency crisis of Summer 1997.

Indonesia was the worst-hit country of the Asian currency crisis. The economic crisis spiralled quickly into a political crisis as well, where first the government’s inaction and later its stability and ability to stay in power fed the economic uncertainty as well. Between September 1997 and July 1998, the Indonesian government signed four different agreements with the IMF, which entailed accepting its bailout packages in exchange for implementing the Fund’s suggested reforms.

The first one was signed in October 1997 that required the Indonesian government to close down 16 banks as part of the agreement. One of the other IMF demands was to raise the interest rates to control inflation. The agreement with the IMF was approved by the Indonesian government on October 31, 1997, and the closure of 16 privately owned banks took place on November 1, 1998. This resulted in a bank run in Indonesia and instead of raising the interest rates the Indonesian central bank had to supply the remaining banks with liquidity just to ensure that their banking sector doesn’t collapse.

The IMF later realised and agreed that demanding a sudden closure of these banks was perhaps not the best move to make to deal with the crisis in the Indonesian economy. By the time the third agreement was signed in April 1998, the IMF was also pushing for removing the subsidies on fuel but had agreed to let the Indonesian government implement it over a period of six months. Yet, the Suharto government decided to remove the fuel subsidies in a ‘shock’ move all at once at the beginning of May 1998. This immediately led to riots on the street in which five students were killed in Jakarta. The riots spiralled out of control over the next few days and by the time the situation calmed down around 1000 Indonesian had lost their lives. The Suharto government resigned on May 14, 1998. It took Indonesia another year or so to recover from its political and economic crises.

Of course, the above narration is not an attempt to create an exact similarity between the current crises facing Pakistan and those that Indonesia faced back in 1997-1998. I only intend to make two points using the Indonesian example. First, when an economic and political crisis builds up, it becomes impossible to disentangle the effects of one from the other. Second, a "shock treatment" administered to the economy in such a scenario can quickly have consequences that no one anticipates. Instead of calming down the situation and removing the uncertainty, it can easily result in even more uncertainty and economic hardship for the people. How must we deal with the crisis we are faced with now? This is particularly important when almost all analysts seem to agree that the sudden removal of subsidies will increase the inflation rate to as high as 20%.

First, the government must not reduce fuel subsidies all at once. Instead, it must negotiate a three-to-six-month timeline with the IMF in which the subsidies can completely disappear. This must be accompanied by a clear road map of a minimum price increase each fortnight to let businesses and households incorporate them into their costs and expenditure plans, respectively.

Second, as reported in the National Human Development Report of 2020, the elite enjoys vast privileges that amount to Rs2.66 trillion in 2017-18 (over 7% of the then GPD). A mere 24% of these if redirected to the poor would see a doubling of the state’s social protection spending. Our analysts, experts, and otherwise, seem especially keen on removing the fuel subsidies but seem to believe that ‘mum is the word’ on the vast privileges enjoyed by the elite. These subsidies must also be phased out to the extent possible with a clear road map and over a comparable time period and any gains realised must be redirected to providing a social safety net to the poor.

Third, the budget for FY2022-23 must not simply be an accounting exercise but must be accompanied by a clear road map of how to address the myriad challenges facing the economy right now. Fourth, and perhaps many may argue that this ought to be the first, the government should not extend its stay in power beyond the approval of the budget – and announce the general elections as soon as it is possible to hold them. The longer we extend the political uncertainty in the country, the deeper our economic crisis may become, despite our well-intended efforts to rein it in.

Finally, the Pakistani gig – as we have known it so far – is up. It’s time someone reads the riot act to the elected and the non-elected power stakeholders. The party’s over, gentlemen! It’s time to act now or we may have no one left to even rue the consequences later.

The writer is an economist and assistant professor and dean of the Faculty of Humanities and Social Sciences at the Information Technology University of Punjab.

The writter can be reached at Twitter/@econalif

Originally published in The News