Consumption
in Indonesia has hummed along nicely, shrugging off negative sentiment from the
euro zone crisis. Consumer confidence has continued to push new highs since
September, and this has been reflected in buoyant retail sales in recent
months.
Much of this can be attributed to the favorable domestic environment of declining inflation, steady wage growth and low interest rates (the policy rate sits at an all-time low of 5.75 percent).
Inflation slowed for a fifth straight month in January, to 3.65 percent. Bank Indonesia maintained its inflation target at between 3.5 percent and 5.5 percent this year and next. The central bank also unexpectedly cut its benchmark interest rate by a quarter percentage point this month.
Against a backdrop of weak external demand this year, private consumption, which makes up close to 60 percent of the GDP, becomes an even more important driver of growth. As such, there are worries that the upcoming change in subsidized fuel policy could emerge as a threat to consumption.
It will not. Neither of the two scenarios outlined below would have a big impact on consumer spending, as demonstrated by the previous instances, in 2005 and 2008, when fuel prices were hiked.
• Scenario 1: Private cars will be banned from using subsidized fuel, leading to a 78 percent increase in fuel prices for car owners, while motorcycles and public transportation vehicles are exempt.
• Scenario 2: Subsidized fuel prices are hiked across the board by up to 44 percent.
Increase in fuel prices can be offset by rising wages
In either scenario, wage increases should be more than sufficient to offset the rise in fuel spending. As such, there should be limited impact on both private consumption growth and vehicle sales. In the first scenario, only private car owners would be affected by the change in fuel prices.
Essentially, the amount that each car owner pays for a liter of fuel increases from Rp 4,500 to around Rp 8,000, a jump of almost 78 percent. However, this does not necessarily mean that overall consumer spending will be sharply affected. Firstly, the sales of motorcycles are 10 times great than that of cars. This implies that a smaller proportion of consumers will be affected.
Data from the Ministry of Manpower and Transmigration indicate that average nominal wage growth from 2006 to 2010 is around 10 percent.
In the second scenario, similar arguments can be made. If fuel prices increase by 30 percent, the incremental rise in spending by the average person would be around 2 percent. This increase would be easily absorbed by a trend increase in wages this year. Empirical evidence from 2005 and 2008 suggests that the average consumer can absorb a 30 percent fuel price increase with no impact on vehicle sales and private consumption growth.
The 2005 and 2008 experience
In 2005, the price of subsidized fuel was raised twice, from Rp 1,800 per liter to Rp 2,400 per liter (33 percent) in March and then to Rp 4,500 per liter (88 percent) in October. When the March hike was implemented, car sales moderated but motorcycle sales were unaffected. Private consumption growth as measured in GDP did not move from trend. However, the October hike did more damage. From peak to trough, car sales dropped by over 50 percent while motorcycle sales dipped by 45 percent and sequential private consumption growth stalled for two quarters before a recovery took place.
In May 2008, fuel prices were raised again, this time to Rp 6,000 per liter (33 percent). In the three months following the increase, there was no discernible impact on car or motorcycle sales and private consumption growth stayed at trend.
From these experiences, it is clear that consumers can handle a 30 percent increase in fuel prices comfortably and there should not be any discernible negative impact on vehicle sales or GDP growth. A 30 percent increase may be the limit that the government is willing to raise prices by without putting the consumer story at risk.
Eugene Leow
Much of this can be attributed to the favorable domestic environment of declining inflation, steady wage growth and low interest rates (the policy rate sits at an all-time low of 5.75 percent).
Inflation slowed for a fifth straight month in January, to 3.65 percent. Bank Indonesia maintained its inflation target at between 3.5 percent and 5.5 percent this year and next. The central bank also unexpectedly cut its benchmark interest rate by a quarter percentage point this month.
Against a backdrop of weak external demand this year, private consumption, which makes up close to 60 percent of the GDP, becomes an even more important driver of growth. As such, there are worries that the upcoming change in subsidized fuel policy could emerge as a threat to consumption.
It will not. Neither of the two scenarios outlined below would have a big impact on consumer spending, as demonstrated by the previous instances, in 2005 and 2008, when fuel prices were hiked.
• Scenario 1: Private cars will be banned from using subsidized fuel, leading to a 78 percent increase in fuel prices for car owners, while motorcycles and public transportation vehicles are exempt.
• Scenario 2: Subsidized fuel prices are hiked across the board by up to 44 percent.
Increase in fuel prices can be offset by rising wages
In either scenario, wage increases should be more than sufficient to offset the rise in fuel spending. As such, there should be limited impact on both private consumption growth and vehicle sales. In the first scenario, only private car owners would be affected by the change in fuel prices.
Essentially, the amount that each car owner pays for a liter of fuel increases from Rp 4,500 to around Rp 8,000, a jump of almost 78 percent. However, this does not necessarily mean that overall consumer spending will be sharply affected. Firstly, the sales of motorcycles are 10 times great than that of cars. This implies that a smaller proportion of consumers will be affected.
Data from the Ministry of Manpower and Transmigration indicate that average nominal wage growth from 2006 to 2010 is around 10 percent.
In the second scenario, similar arguments can be made. If fuel prices increase by 30 percent, the incremental rise in spending by the average person would be around 2 percent. This increase would be easily absorbed by a trend increase in wages this year. Empirical evidence from 2005 and 2008 suggests that the average consumer can absorb a 30 percent fuel price increase with no impact on vehicle sales and private consumption growth.
The 2005 and 2008 experience
In 2005, the price of subsidized fuel was raised twice, from Rp 1,800 per liter to Rp 2,400 per liter (33 percent) in March and then to Rp 4,500 per liter (88 percent) in October. When the March hike was implemented, car sales moderated but motorcycle sales were unaffected. Private consumption growth as measured in GDP did not move from trend. However, the October hike did more damage. From peak to trough, car sales dropped by over 50 percent while motorcycle sales dipped by 45 percent and sequential private consumption growth stalled for two quarters before a recovery took place.
In May 2008, fuel prices were raised again, this time to Rp 6,000 per liter (33 percent). In the three months following the increase, there was no discernible impact on car or motorcycle sales and private consumption growth stayed at trend.
From these experiences, it is clear that consumers can handle a 30 percent increase in fuel prices comfortably and there should not be any discernible negative impact on vehicle sales or GDP growth. A 30 percent increase may be the limit that the government is willing to raise prices by without putting the consumer story at risk.
Eugene Leow
Business & Investment Opportunities
YourVietnamExpert is a division of Saigon Business Corporation Pte Ltd, Incorporated in Singapore since 1994. As Your Business Companion, we propose a range of services in Consulting, Investment and Management, focusing three main economic sectors: International PR; Healthcare & Wellness;and Tourism & Hospitality. We also propose Higher Education, as a bridge between educational structures and industries, by supporting international programs. Sign up with twitter to get news updates with @SaigonBusinessC. Thanks.
No comments:
Post a Comment