Indonesia: balancing the opportunities and risks of fuel subsidies reform
In Indonesia, fiscally unsustainable fossil-fuel subsidies can be repurposed to invest in positive incentives for longer-term environmental and social objectives. However, the design and timing of subsidies reform must balance addressing fiscal pressures with creating the necessary socioeconomic conditions to help households absorb higher prices.
Barrels of oil are ready to be transported. Indonesia imports around 320,000 to 360,000 barrels of crude oil per day (Photo: benjamin lehman, via Unsplash)
Why was subsidy reform needed?
Successive governments In Indonesia have attempted fuel subsidy reform 13 times since 1998, aiming to make the subsidy framework more fiscally sustainable. But reforms have often been reversed or scaled back in response to political and economic pressures.
More recent reforms that took place under the Yudhoyono and Widodo governments – with varying levels of success and durability – often became largely political, evidenced by the prominence of subsidies in political campaigns and large demonstrations against reform that in some cases turned violent.
Indonesia’s energy subsidy system was developed when the country was a major oil producer and state ownership of the energy sector and low regulated fuel prices were more financially feasible.
However, since the early 2000s Indonesia has been a net oil importer due to declining domestic production and rapid and ongoing economic growth, which has increased domestic energy demand.
By 2023, Indonesia imported about 1.6 million barrels of oil per day, compared with a surplus of about 344,000 barrels per day in 2000. Around 40% of fuel consumption is now supplied through these imports.
But the fiscal cost has become large and unpredictable. Relying on imports while still controlling prices makes the government cost of subsidies more sensitive to international oil prices and to changes in the rupiah-US dollar exchange rate.
The main objective of fuel subsidies was – and still is – to keep energy affordable. Before the 2022 reform, the subsidy scheme covered several products, including fuel, electricity, LPG and kerosene. State-owned energy companies (SOEs), including Pertamina and PLN, supplied fuel and electricity at regulated prices and each product had its own subsidy and pricing arrangements.
Indonesia’s energy subsidy system combines explicit subsidies in the state budget with implicit subsidies provided to SOEs.
Explicit subsidies are provided based on the predicted cost of supplying energy, using factors such as international oil prices, exchange rates, import and shipping costs, distribution costs and the operating margins of SOEs, with the formula being approved by the house of representatives and the government setting the final price. It considers the availability of public funds, economic conditions and consumers’ purchasing power.
However, retail prices were often set below the cost of supply. In which case, implicit subsidies arose when regulated prices did not cover the cost of supply, meaning predictions were too low. These costs would appear as compensation payments or arrears owed to SOEs, with the government providing transfers or later compensation to cover some of the resulting losses (PDF).
The cost of subsidies increased rapidly during the 1997-98 Asian financial crisis, COVID-19 pandemic and geopolitical tensions. By 2022, high global energy prices, rising domestic consumption and a weaker rupiah caused subsidy costs to increase sharply.
The World Bank estimates implicit energy subsidies reached 1.5% of GDP in 2022, compared with 0.7% in 2021, putting unpredictable pressure on the state budget.
Another key issue was that although the government intended subsidies to support low-income households and economic activity, the system was poorly targeted.
As it focused largely on fuel used for transport, higher-income households consumed more subsidised fuel and LPG because they are more likely to own private vehicles. In 2019, the richest 20% of households received 46.2% of fuel subsidies while the poorest 40% received only 17.8%.
In addition, high fossil-fuel subsidies presented a barrier to a transition to low carbon and renewable energy. Although Indonesia has committed to reach net zero emissions by 2060, energy is the country’s second-largest source of greenhouse gas emissions after agriculture. It increases fossil fuel consumption, reduces the relative competitiveness of renewable energy and can encourage continued investment in fossil fuel infrastructure.
Subsidy reform: an incomplete story
The 2022 reform focused mainly on reducing the fiscal cost of energy subsidies. The government increased the prices of subsidised fuels and introduced measures to reduce the gap between regulated prices and the cost of supply. Parliament approved the changes as part of the state budget process.
To reduce the effect of higher fuel prices on poorer households, the government also introduced targeted social assistance. The main measure was the temporary fuel cash transfer, known as Bantuan Langsung Tunai Bahan Bakar Minyak (BLT BBM). The programme provided 600,000 rupiah to around 20 million beneficiaries (PDF) in 2022. The total cost was about 12.4 trillion rupiah, or less than 0.1% of GDP (PDF).
Providing targeted cash transfers, rather than a blanket subsidy, is often argued to more effectively unburden households from high fuel prices. A forward-looking analysis conducted by the World Bank found that the transfer could offset much of the effect of higher fuel prices for the bottom 40% of households (PDF), though systematic evaluation of the programme has not yet been conducted.
Because the main objective of the reform was fiscal consolidation, most of the savings were used to reduce pressure on the public budget rather than to finance renewable energy or other environmental programmes, through tax incentives or other positive incentives.
The reform can be viewed as a shift from broad, poorly targeted price subsidies towards a smaller subsidy system combined with targeted social protection, but has been deemed incomplete (PDF), and the impact on fossil fuel emissions has not been quantified in a way that links back to the subsidy reform.
What are the key challenges?
There are several factors that both drove reform and have made it more challenging to implement. In fact, many characteristics of this case opposed one another in the way they either enabled or impeded reform and repurposing environmentally harmful subsidies.
First, the sharp increase in global energy prices created a strong fiscal reason for the government to act but also meant that reform risked raising the cost of fuel for domestic households.
This also created financial risks of reform for the government; if state-owned enterprises Pertamina or PLN accumulate large losses, the government may ultimately need to provide compensation or recapitalise these companies, as it is within their fiscal responsibility. The sustainability of reform therefore depends on maintaining a credible pricing system and improving the targeting of remaining subsidies.
Second, subsidy reform in Indonesia is a highly contentious issue, including because the government has attempted subsidy reform multiple times prior to the 2022 reform, that in some cases did include compensation packages that were criticised such as the Energy Subsidy Reduction Impact Mitigation Programme during the Wahid and Megawati reforms.
This means engaging in the topic and reform is politically risky, discouraging governments from taking the bold action required to maximise environmental and socioeconomic outcomes.
Third, a sole target of fiscal consolidation limits options for repurposing public expenditure towards environmental and social objectives. The government could use existing social protection systems to deliver cash support quickly.
The use of temporary transfers helped address concerns about the effect of higher fuel prices on poorer households. However, as stated above, because fiscal consolidation was the primary objective of reform, the social assistance provided is likely to be insufficient to match the rise in consumer costs or the negative impacts on real incomes of Indonesia citizens.
Equally, the reform does not substantially redirect savings towards environmental objectives, limiting its potential to support a wider energy transition.
Traders sell fresh fruit and vegetables from boats at a floating market in Lokbaintan village, South Kalimantan, Indonesia. The country's fuel subsidy reforms aim to reduce pressure on public finances, while protecting household incomes and livelihoods from the impact of rising fuel prices (Photo: Adiwijayanto23, via Wikimedia Commons, CC BY-SA 4.0)
Key lessons from Indonesia
A key lesson from the Indonesia case is that macroeconomic conditions shaped both the opportunity and the risks of subsidy reform. Reliance on imported fuel, rising global energy prices and currency depreciation have increased the fiscal case for reform, but also increased the potential impact of higher fuel prices on households and the financial risks faced by state-owned energy companies.
The design and timing of reform therefore need to account for both fiscal pressures and the socioeconomic conditions that determine how easily households can absorb higher prices.
To maximise the development impact of reform, governments need to consider how savings and accompanying social protection can support vulnerable households while creating positive incentives for renewable energy, nature and sustainable economic activity.
Stepwise reform can help governments manage the political and social risks of subsidy removal – but will ultimately affect the degree to which subsidy reform changes economic incentives. It may also make environmental and socioeconomic outcomes ambiguous and hard to measure.
What happens next?
Subsidy reform presents a huge opportunity for the Indonesian government. But it will not automatically translate into socioeconomic or environmental benefits.
To meet these goals while enabling sustainable development, Indonesia can repurpose the budget previously spent on environmentally harmful subsidies to invest in positive incentives for longer-term environmental and social objectives.
This includes removing incentives for fossil fuel consumption while creating incentives for the renewable energy sector as well as using social protection schemes to reduce the burden of transition on vulnerable households.
It will be important for Indonesia to continue iterating its subsidy framework, to maintain fiscal sustainability, but also to align with Indonesia’s National Determined Contribution (NDC) (PDF) that was updated in October 2025.
Repurposing fossil fuel subsidies can help Indonesia meet its targets on both emissions reduction and achieving 19-23% renewable energy share by 2030, but doing so will require careful consideration of the political and socioeconomic implications domestically. The 2026 climate change conference (COP31) in Turkey will be an important moment for Indonesia to recommit to fossil fuel subsidies reform.
Further resources
News: Indonesian students protest gov’t policies amid economic strain (2026), Aljazeera
News: To help the poor, cash transfers are better than gasoline subsidies (2025), Forbes
Energy subsidy reform report, Yose Rizal Damuri, Deni Friawan, Ardhi Wardhana, Ega Kurnia Yazid, Tim Nasional (2024), Centre for Strategic and International Studies Indonesia research report
Indonesia’s fuel subsidies reforms, Ahya Ihsan, Dwi Endah Abriningrum, Bambang Suharnoko Suharnoko, Anissa Rahmawati, Sara Giannozzi (2024), World Bank publication
Indonesia’s energy support measures: an inventory of incentives impacting the energy transition, Anissa Suharsono, Murtiani Hendriwardani, Theresia Betty Sumarno, Jonas Kuehl, Martha Maulidia, Lourdes Sanchez (2022), IISD report
Durability as a measure of success: an analysis of fossil fuel subsidy reform in Indonesia (2016), UNEP
Author
Anna Ducros ([email protected]) is a researcher on nature and climate finance at IIED
