The Vice Chairman of Indonesia's National Economics Committee, Muhammad Chatib Basri, told CNBC he was confident the parliament would approve the government's proposal to cut fuel subsidies by 33 percent when it meets later this week, and that inflation will not spiral out of control as a result.
"Additional inflation will be around 2.5 percent. So, until the end of the year inflation will remain around 7.5 percent. (Keeping in mind) historical Indonesian inflation rates (This is) relatively low," Basri said Tuesday.
The country’s central bank, Bank Indonesia, has forecast inflation at 7 percent this year if the government goes ahead with its planned fuel price hike.
In a statement delivered after keeping borrowing costs on hold at its last meeting on March 8, the central bank said it expected the impact of a fuel price hike to be a one-time shock and “inflation to decline again according to economic fundamentals.”
Indonesia’s average inflation rate in 2011 was 3.8 percent. And Johanna Chua, Chief Economist Asia Pacific at Citi, says the rate could go beyond the central bank’s estimate of 7 percent this year if there is a fuel price increase.
She adds that the "tricky thing" for the government will be to temper inflationary pressures going forward, as in the past whenever there has been a hike in fuel prices, its effects have not be one-off.
“That's something we need to temper in an environment where the central bank in Indonesia has kept rates quite accommodative and has been cutting (rates) until recently,” she said.
Despite the inflation risks Basri says it is imperative to push through the hike calling it a "triple winning policy".
He said the money that would be reallocated by cutting fuel subsidies by a third would first go towards helping the poor and boosting the country's ailing infrastructure. Second, he added it would be good for the environment because it would reduce fossil fuel consumption. And third it would keep the budget deficit within its legal limit. "If we let the subsidies continue we'll have a budget deficit of over 3 percent, which is against the law."
Indonesian Finance Minister Agus Martowardojo said on Monday that the budget deficit would widen to 2.2 percent of gross domestic product this year, up from the 1.5 percent originally forecast if fuel subsidies are not cut.