JAKARTA, March 27 (Reuters) - Protesters rallied across Indonesia on Tuesday against a government proposal to increase fuel prices by a third as parliament prepared to vote on a divisive subsidy that cost Southeast Asia's largest economy some $18 billion last year.
Motorists in Indonesia, home to almost 240 million people and Asia's largest importer of diesel and gasoline, pay the least for fuel in Asia because of decades-old subsidies that halve pump prices compared with the market rate.
The subsidy has shielded politicians from any fallout from a recent rally in crude oil prices, but at a cost that President Susilo Bambang Yudhoyono and his government are no longer willing to pay: a budget deficit that could balloon to 4 percent of gross domestic product, over double the 1.5 percent target for 2012.
National police spokesman Saud Usman Nasution said about 80,000 people across Indonesia were expected to demonstrate against a fuel price increase on which, after months of debate, parliament will vote on Thursday.
"The richest half of households use almost 84 percent of the total subsidised gasoline. So the poor benefit the least from it," said Edimon Ginting, a senior economist at the Asian Development Bank in Jakarta.
"But the politics of it are very complex and reducing fuel subsidies everywhere is not an easy process."
Just over a decade ago, protests over fuel price increases contributed to the downfall of former autocratic president Suharto, an event still fresh in the minds of many politicians eyeing 2014 presidential elections.
Several political parties have said they will vote against the fuel price increase in a country where tens of millions still live hand-to-mouth despite a reduction in poverty levels and a rising middle class.
"I reject the planned hike. I am poor, life is difficult, and this will make life even more difficult," said Ngadlan, a construction worker in east Jakarta, one of hundreds of protesters gathered at a central roundabout in the capital.
Indonesia's government is also in a difficult spot.
Analysts expect higher fuel prices to hurt domestic discretionary spending, although it is not clear whether higher prices would clip the growth of fuel demand.
Increasing fuel prices could push up inflation, which eased to a 22-month low of 3.56 percent in February, to above 7 percent later this year, the central bank says. That could further weaken the rupiah, which has depreciated 1.3 percent this year to become the worst performing currency among Asian emerging markets.
Recent government bond auctions have seen limited demand while corporate issues are being held up, as investors eye prospects for higher inflation.
But if fuel prices remain unchanged, Indonesia faces a rapidly widening gap in its state budget, especially as oil prices are forecast to remain high on concern about disruption of supplies from Iran, which is being subject to Western sanctions, and other oil exporters.
A larger deficit would lead the government to raise more funds from the debt market, leading to higher bond yields which would raise its borrowing costs.
Economists say the government is better off putting the fuel subsidies - which last year were equivalent to almost 13 percent of the total budget - into building much-needed infrastructure.
The country's largest party, Golkar, part of the ruling coalition, has also said it would rather the money goes straight to infrastructure, and its stance may be critical to deciding whether the price rise goes ahead next week.
The government has said it wants to use some of the money saved to directly help the poor with cash payments, but opposition lawmakers have labelled that vote buying. ($1 = 9,175 rupiah) (Additional reporting by Umesh Desai in HONG KONG; Editing by Neil Chatterjee and Miral Fahmy)