Subsidy Rationalisation: Some Pointers From The IMF

(H/T Jason)

The cost of petrol and gas subsidies in Malaysia are likely to be in the region of RM45-50 billion this year, if not higher. Some of that comes directly from the government, while the rest are borne by Petronas or TNB.

Whether or not they appear on the government’s books, these subsidies simply have to go. First because of the actual fiscal costs of keeping the present subsidy system in place; second because of the opportunity costs for both the government and Petronas in terms of investment; and third because of the economic inefficiencies engendered by distorted prices. On top of that are the negative externalities arising from hydrocarbon use and the fact that the primary beneficiaries are corporations and the higher income households.

This is not a Malaysian problem alone, and a new IMF staff paper looks at country experiences over the past 20 years or so in dealing with fuel subsidy reductions (from the Executive Summary):

ENERGY SUBSIDY REFORM: LESSONS AND IMPLICATIONS

Energy subsidies have wide-ranging economic consequences. While aimed at protecting consumers, subsidies aggravate fiscal imbalances, crowd-out priority public spending, and depress private investment, including in the energy sector. Subsidies also distort resource allocation by encouraging excessive energy consumption, artificially promoting capital-intensive industries, reducing incentives for investment in renewable energy, and accelerating the depletion of natural resources. Most subsidy benefits are captured by higher-income households, reinforcing inequality. Even future generations are affected through the damaging effects of increased energy consumption on global warming. This paper provides: (i) the most comprehensive estimates of energy subsidies currently available for 176 countries; and (ii) an analysis of ―how to do‖ energy subsidy reform, drawing on insights from 22 country case studies undertaken by IMF staff and analyses carried out by other institutions.

Energy subsidies are pervasive and impose substantial fiscal and economic costs in most regions. On a ―pre-tax‖ basis, subsidies for petroleum products, electricity, natural gas, and coal reached $480 billion in 2011 (0.7 percent of global GDP or 2 percent of total government revenues). The cost of subsidies is especially acute in oil exporters, which account for about two-thirds of the total. On a ―post-tax‖ basis—which also factors in the negative externalities from energy consumption—subsidies are much higher at $1.9 trillion (2½ percent of global GDP or 8 percent of total government revenues). The advanced economies account for about 40 percent of the global posttax total, while oil exporters account for about one-third. Removing these subsidies could lead to a 13 percent decline in CO2 emissions and generate positive spillover effects by reducing global energy demand.

Country experiences suggest there are six key elements for subsidy reform. These are: (i) a comprehensive energy sector reform plan entailing clear long-term objectives, analysis of the impact of reforms, and consultation with stakeholders; (ii) an extensive communications strategy, supported by improvements in transparency, such as the dissemination of information on the magnitude of subsidies and the recording of subsidies in the budget; (iii) appropriately phased price increases, which can be sequenced differently across energy products; (iv) improving the efficiency of stateowned enterprises to reduce producer subsidies; (v) targeted measures to protect the poor; and (vi) institutional reforms that depoliticize energy pricing, such as the introduction of automatic pricing mechanisms.

You can read a Q&A by the team leaders here.

The numbers for Malaysia are sobering – pre-tax subsidies are calculated at 1.88% of 2011 GDP which is a little higher than the regional average of 1%. Two thirds of that figure is from petrol subsidies alone.

Post-tax, which includes non-fiscal costs to the economy as well as taxes not collected, the measure leaps to 7.21% or nearly 4 times higher, again with more than two-thirds coming from petrol.

The post tax figure is approximate as the IMF hasn’t yet done country specific estimates, so environmental costs for instance use a global average. Nevertheless, it’s a pretty startling difference. Just for comparisons sake, the post-tax cost is bigger than the government’s budget deficit in any year since 1987.

More importantly, the IMF staff paper includes a wide ranging, if not very deep, country case study covering 22 countries, with 14 involving petrol subsidy reform and 8 involving subsidies on natural gas. These would provide useful pointers to our own efforts, when the time comes.

Technical Notes:

1. “Energy Subsidy Reform: Lessons and Implications", IMF Staff Paper, January 2013
2. "Case Studies On Energy Subsidy Reform: Lessons And Implications", IMF Staff Paper, January 2013