Indonesia's vehicle industry is bracing itself for tougher times ahead, as record high oil prices continue to put pressure on the country's economy.

With petrol and diesel fuel still highly subsidised by the government - even after several price hikes in the last two years by state-owned oil company Pertamina, the state budget continues to be stretched to beyond breaking point.

Indonesia has been a net importer of oil since the mid-1990s, as oil production dropped off sharply as a result of much lower investment levels, while domestic fuel consumption has soared. International oil prices have risen by 50% since May alone and this has increased dramatically the cost of subsidies to the government. With fuel subsidies now taking up around 25% of the state budget, the government has no choice other than to continue with fuel price increases.

The most recent fuel price hike, back in March, helped drive annual inflation up to around 8-9%, according to official figures. The rupiah also has lost around 10% of its value since the beginning of the year despite Bank of Indonesia intervention. In the last month or so, it has been forced to hike interest rates on three separate occasions.

Coordinating minister for the economy, Aburizal Bakrie, confirmed on Friday that a further fuel price hike will be implemented on October 1, adding that the increase "will likely add 3-4% to current inflation levels". With oil prices unlikely to fall significantly, Bakrie predicts that the high inflation environment will last at least until the second half of 2006.

Political observers are speculating that fuel prices will be hiked by up to 50% at the beginning of October. There is increasing fear that such a rapid increase may trigger a wave of protests and demonstrations and that political instability could escalate. Consumer sentiment has also been affected by the recent bird flu outbreak which continues to claim lives across the country.

In an interview this week with just-auto, Riswan Alamsjah - marketing director for Mitsubishi distributor PT Kramna Yudha Tiga Berlian Motors, was concerned about a possible drop in sales volumes in the coming months. "The economic environment is changing very quickly" he said, adding that "the sharp tightening of monetary policy, rising fuel prices and an expected increase in the PPN car sales tax next month will affect consumers' ability to afford vehicles in the future".

"Interest rates on finance packages offered by leasing companies and banks have risen from around 12-13% annually to 17-18%", he added. A doubling of the minimum capital adequacy ratio of banks from 5% to 10% "will reduce liquidity in the banking sector and consequently this will also affect the leasing companies". Alamsjah suggests that "the volume of overall loans offered will decline as a result and stricter lending criteria will also be applied. If a bank has less money to offer out as loans, then lenders can afford to be more selective about to whom they lend money".

Alamsjah said that his company, which controls around 18% of the Indonesian vehicle market, is beginning to experience a slowdown in order intake as a result of these tightening conditions, although it is still a bit early to assess the situation accurately.

"Normally demand for delivery trucks rises in anticipation of a high consumption period following the muslim fasting month of Ramadan. This year that has not been the case. We haven't seen the spike in light truck orders that we normally get at this time of year.

"There will be little over two working weeks in November as a result of public holidays and business is normally slow during Ramadan. But we have had a strong first eight months in 2005, with cumulative sales at record levels of around 400,000 units. Monthly sales have averaged 50,000 units so far this year. Even if the monthly average drops to 35,000 units in the last four months of the year, we should still be able to meet our internal targets and come close to the official Gaikindo [a motor trade association] target of 550,000 units for 2005."

But the outlook for 2006 is perhaps a bit more worrying. And while nobody is talking about a crash in demand next year, Alamsjah does not expect the market to significantly exceed 500,000 units - which would represent a decline of around 10% on projected 2005 levels.

Earlier this month, Joko Trisanyoto - marketing director at PT Toyota Astra Motor, the Toyota distributor, also suggested that the demand outlook for 2006 is becoming very uncertain. "The culmination of interest rate hikes, rising fuel and energy costs, inflation and higher vehicle prices will affect the market. It is very difficult to predict at the moment how next year will turn out, so yes, we are much more cautious about the near term."

Tony Pugliese