By Kanupriya Kapoor and Jonathan Thatcher
JAKARTA (Reuters) - Indonesia's parliament debated measures on Monday to open the way for a jump in fuel prices after months of delay that have undermined confidence in the government and the ability of Southeast Asia's biggest economy to continue rapid growth.
The price hike of 33 percent would allow the government to cut costly fuel subsidies and could give support to the struggling rupiah after the central bank scrambled last week to prop up the currency, which was caught in an emerging market selloff. President Susilo Bambang Yudhoyono would have to sign off on the measures.
The surge in fuel prices, which would boost inflation and in turn spark labor union wage demands, is testing Yudhoyono's already uneasy ruling coalition of political parties, which are increasingly focused on next year's general and presidential elections.
One member of the coalition has very publicly opposed a proposal to protect the poor from the impact of higher fuel prices with cash compensation, a measure Yudhoyono had insisted on before he would agree to raise prices.
The change has been seen as a key test of Yudhoyono's commitment to economic reform in the final 1-1/2 years of his term as prospects for rapid economic growth soften.
Thousands of protesters took to the streets in cities across the giant archipelago, but there were no reports of serious violence.
"We reject the proposed cash handouts because it doesn't address the real issue of poverty. Instead, they're trying to be like Santa Claus before next year's general election," head of the largest labor union, Said Iqbal, told reporters.
About 20,000 security officials had been placed on alert in the capital, the police said. Protests have marked previous attempts to raise fuel prices.
On Saturday, about 70 percent of members of the parliamentary budget committee backed 2013 budget revisions, which includes some 9 trillion rupiah ($910 million) in compensation for the poor.
These measures will pave the way for the fuel price rise if passed by parliament.
"We support the cuts in fuel subsidies because Indonesia has to spend billions on fuel imports every year ... And make no mistake, we will withdraw support if the government doesn't protect poor people," said Teguh Juwarno, an MP with ruling coalition party PAN.
Fuel subsidies last year cost the former OPEC member some $20 billion and is putting pressure on the current account deficit. The finance ministry has said the price rises could save the state about $4 billion if they are implemented this month.
Rumors late last week that Jakarta was about to raise fuel prices helped lift the rupiah off its lowest level against the dollar in almost four years as the currency came under fire from investors cutting their emerging market exposure over uncertainty in the future of U.S. monetary policy.
The pressure on the rupiah and concerns of the inflationary impact of costlier fuel, prompted surprise increases in two of the central bank's key interest rates last week. It expects inflation to top 7 percent after fuel prices rise from the current level of around 5.5 percent.
The finance ministry has warned that the growing subsidy cost of fuel, unless prices rise, could exceed 3 percent of GDP. The initial budget had put the deficit at just 1.6 percent.
Pointing to concerns over stalling reform momentum, ratings agency Standard & Poor's early last month downgraded its outlook for Indonesia's sovereign credit to stable from positive.
The move was especially galling for the Indonesian government because at the same time S&P upgraded its rating for the neighboring Philippines.
While Indonesia's technocrats have been shouting for fuel prices to rise, the issue has become largely hostage to politics ahead of next year's elections.
Of the three parties to oppose the measure in Saturday's budget committee meeting, one was ruling coalition member PKS, the country's biggest Muslim party.
Analysts say the PKS is hoping to use the issue to divert attention from allegations that senior party members were involved in a beef import scam and sexual impropriety, charges which threaten to wreck its election hopes next year. ($1=9,882 rupiah)
(Additional reporting by Adriana Nina Kusuma: Editing by Neil Fullick)