Theory vs. the Egyptian and Yemeni reality: is reforming fuel subsidies a legitimate tool for growth or an IMF farce?

Published October 7th, 2014 - 11:18 GMT
Arab economists, media and public intellectuals must highlight the role of fossil fuel subsidies as an inhibitor, not facilitator, of economic development in the Middle East.
Arab economists, media and public intellectuals must highlight the role of fossil fuel subsidies as an inhibitor, not facilitator, of economic development in the Middle East.

When fiscal pressure forced the governments of Egypt and Yemen to end fuel subsidies, inflation rates soared. Both Egypt and Yemen have suffered four years of economic stagnation and fuel subsidies account for more than 20 per cent of government spending in both countries. The loss of fuel subsidies falls disproportionately on poor consumers since they face a hike in the price of cooking gas, transportation and food.

Subsidies do not stimulate development or boost social inequality since richer consumers use significantly more subsidised fuel than their impoverished peers, lead to waste and widen government budget deficits.

Fuel subsidy reform, in theory, can enable a country to boost its economic growth rate, a key criterion for political stability and social/human development. This has not happened in Egypt or Yemen since fuel subsidy reform did not lead to cash transfers for the poorest consumers or increased health and education spending with the excess funds released by the reform. Governments also ignore the steep environment costs of energy overconsumption.

The Arab world has a high level of fuel subsidies, estimated at $250 billion a year, half the global fuel subsidy total. Egypt spends $20 billion, or 10 per cent, of its budget on fuel subsidies, huge for a nation where 40 million citizens live on $2 a day and the budget deficit is 14 per cent of GDP and the central bank in Cairo has only $15 billion in hard currency reserves. Fossil fuel subsidies were a feature of development policies under former presidents Nasser, Sadat and Mubarak since 1952. However, only President Abdel Fattah Al Sisi was powerful enough to raise the price of fuel by 78 per cent, after a major hike in electricity prices.

The streets of Cairo and Alexandria are clogged with old vehicles that use 80 octane gasoline, whose price rose most due to President Sisi’s decision. Diesel fuel, used by Egypt’s large fleet of public buses and trucks, rose 65 per cent. The poor in Egypt are hit the hardest since they do not own cars but are dependent on public transport.

Saudi Arabia, Iran, Egypt and Iraq are among the world’s top 10 countries that subsidise fossil fuel. Iran, for instance, spends almost $85 billion in oil, electricity, natural gas and coal subsidies, more than any other country in the world. Saudi Arabia spends an estimated $70 billion, second only to Iran and more than Russia, India or China, in primarily oil and electricity subsidies.

The IEA has estimated that fuel subsidies in the Middle East and Africa (Mena) region are now 22 per cent of government revenues. These subsidies distort the energy markets of the Arab world, inhibit private sector investment as prices for fuel or electricity are artificially depressed and encourage wastage on such a scale that even the oil and gas rich states of the Gulf are forced to build nuclear plants.

IMF economists believe the richest 20 per cent of consumers in the emerging markets get six times the benefit of subsidies than the poorest 20 per cent.

Subsidised petrol is a major contributor to global greenhouse gas emissions linked to a climate change. Fossil fuel subsidies create social distortions and economic catastrophe. For instance, India’s subsidies have so discouraged investment that 300 million poor Indians have barely any access to electricity.

IMF managing director Christine Lagarde has said energy subsidies “helped the people who need them the least. Taking action on this issue could be good for the budget, good for the economy and good for the planet”.

The IMF, World Bank, European Union, G-20 and climate change NGOs have all called for developing countries to slash fuel subsidies.

Governments find it difficult to eliminate fuel subsidy programmes.

It is unrealistic to expect Arab governments to slash subsidies overnight. However, the fiscal black holes in Egypt, Yemen, Tunisia, Lebanon, Iraq etc are simply unsustainable in the long run as long as lavish fuel subsidy regimes stay in place. Arab economists, media and public intellectuals must highlight the role of fossil fuel subsidies as an inhibitor, not facilitator, of economic development in the Middle East.

Some governments argue that fuel subsidies are essential for the poor. True. So why not subsidise cooking gas and kerosene used by the poor but not gasoline and diesel fuel used more by middle class consumers? Why not offset fuel subsidy reforms with social safety nets (e.g., vouchers) to protect the poorest citizens from price hikes? The tens of billions of dollars fuel subsidy reform will release in the Arab world can be spent on desperately needed health education and social welfare programmes. Energy use is correlated to income inequality in the Arab world’s nations without significant oil and gas reserves. However, vested interests also block reforms, from petrol smugglers to owners of trucking fleets. Energy reform is all about legislation, incentives and policy execution.

 

By Sarie Khaled

The writer is a Dubai-based research analyst in energy and GCC economics.


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