By Kanupriya Kapoor and Adriana Nina Kusuma
JAKARTA (Reuters) - Indonesia's parliament paved the way on Monday for a jump in gasoline and diesel prices after months of delay that have undermined confidence in the government and the ability of Southeast Asia's biggest economy to continue growing rapidly.
The average 33 percent price rise will cut the government's costly fuel subsidies and could give support to the struggling rupiah after the central bank scrambled last week to prop up the currency as it was caught in an emerging market selloff.
After a 12-hour, often noisy session, parliament voted 65 percent in favor of a revised budget for the year, which includes cash compensation for the poor to help them cope with the higher fuel costs. President Susilo Bambang Yudhoyono had demanded aid for the poor before he would sign off on higher prices.
The surge in fuel prices, which will boost inflation and in turn could 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.
Outside parliament police used water cannons to disperse demonstrators, among thousands holding protests in cities across the giant archipelago. There were scattered reports of 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, police said. Protests have marked previous attempts to raise fuel prices.
The president has to formally sign off on the measures. He had agonized for months over whether to lift the price of fuel and risk a public outcry. In the end, he thrust the problem on parliament's shoulders by making MPs first agree to come up with help for the poor.
The revised budget sets aside about 9 trillion rupiah ($910 million) in cash compensation for more than 15 million families, which will be paid over four months.
Under the government's proposal, ordinary gasoline would rise 44 percent and diesel by 22 percent. It is not clear when the price rise might take place, but Finance Minister Chatib Basri is due to hold a news conference on Tuesday.
Raising fuel prices 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.
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 minister told MPs that if fuel subsidies were not cut, the budget deficit could reach close to 4 percent of GDP. The initial budget had put the deficit at just 1.6 percent.
Pointing to concerns that the momentum of reform was stalling, 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.
One member of the ruling coalition and Indonesia's biggest Muslim party, PKS, had refused to back the government's position in what analysts said was a bid to turn attention for a scandal over a beef import scam and sexual impropriety that has embroiled the party's leadership and which threatens to wreck its chances in next year's election.
(Writing by Jonathan Thatcher: Editing by Neil Fullick)