THE EFFECTS OF OIL PRICE INCREASE ON THE INDONESIA ECONOMY

Abstract

Oil is one important factor in the economy of a country and determines the activities of national production. The increase in oil prices is caused among other things by the imbalance between the demand and oil production of the world. The increase in oil prices will have a broad impact on state  economic activities of the state through a domino effect. The increase in oil prices will cause rising product prices by increasing production costs and price increases will further cause inflation. This condition will eventually lower the purchasing power and the declining purchasing power will affect  transaction  demand for money which in turn will reduce the economic growth. Factually, it can be seen that after the oil price increase in October 2005 led to the decreasing in income growth as well as the purchasing power of certain groups of people, especially for fixed and low income communities. Empirically, before  the 2005 oil price increase in Indonesia, the number of poor people was 35.19 million people (22.7%), but after the oil price increase in 2006, the number rose to 39.05 million (29.85 %). The same condition also occurs in West Sumatra in the same period, which prior to the increase in oil prices, poor population was 1.005 million inhabitants (15.97%) meanwhile in 2006 increased to 1.365 million inhabitants (19.85%). The fact above is reinforced by the results of the study INDEF (2005) they concluded that the rise in oil prices (all types of oil) by 5 percent, would increase the Consumer Price Index (CPI) of 1.6 percent and the number of poor people will tend to increase 2,76 percent. If the oil price increase  30% estimated the number of people likely will increase 9.6%. Furthermore, based on Bank Indonesia Scenario in 2006, it was revealed that the first round impact of oil price increase on inflation for every 10% price rise (premium, diesel, and kerosene) will cause 0.37%  increase  in inflation and in the second round 0.41% or 0.78% the total impact. In addition, rising oil prices also pose depreciative pressure on the rupiah exchange rate, caused by a widening differences in price levels and interest rates between the domestic and abroad. The weakening of rupiah exchange rate will eventually reduce the ability to import, if this condition is followed by lowering demand, it will result in a reduction of investment activity. The increase in oil prices by 10% is expected to reduce investment activity approxiamately 0.14% and imports around 0.06%, while the weakening of the rupiah has the potential to increase exports, although not significantly, only 0.01%. The same condition also occurs in West Sumatra, the increase in oil prices tend to influence negatively  the level of consumption and investment, while inflation will tend to rise. Consumption in the first quarter of 2006 contracted by 4.6%, inflation has increased in quarter 1 around 0.09% while 4.38% inflation in goods and services tend to rise further 2.34%. Thus, the inflation rate in quarter 2 will increase to 6.73%. All these issues will lead to the decline of economic growth in both local and national. If before the oil price increase, national economic growth reached 6.82%, the expected growth will be a contraction of 0.14%. The contraction  will occur in all sectors of the economy although the effects are largely determined by sensitivity of each sector as a result of oil price increases. Therefore, government policies to raise the price of oil  must be done with comprehensive consideration  and any policy of oil price increases must be followed by other policies to minimize their impacts on the society and  the economy of the country.