Fuel subsidies
Does the steep drop in oil prices provide a rare opportunity to reform fuel subsidies?
As oil prices plunge, Africa’s hydrocarbon producers have hit troubled waters, with their revenues and currencies sinking. Yet the drop is largely good news for net oil importers, which include most of the continent’s economies. Even emerging oil producers are reaping benefits. Stocks rose by 22% in Tanzania, 18% in Uganda and 9.4% in Kenya last year as lower fuel import costs kept inflation down, according to Bloomberg. Over the last ten months, the price of oil has fallen steeply, with major implications for the global economy. Between June and December 2014, oil fell by over 40%, from $112 a barrel to less than $70. Several events have triggered the tumbling oil prices. Oil demand is declining in rich OECD countries and Chinese consumption growth has slowed as the economy matures. US energy supply has increased due to the shale gas revolution, and oil production has been surprisingly strong in Iraq despite political breakdown.
But should African governments simply view the falling prices as a temporary bonus? Or is it an opportunity to tackle their costly fuel subsidies? These handouts are a huge burden for governments. According to IMF estimates, the fiscal cost of fuel subsidies amounted to 1.4% of Africa’s GDP in 2012. In 2011, sub- Saharan Africa’s pre-tax energy subsidies overall amounted to 1.6% of GDP, compared to 0.9% in emerging Asia (though far below the Middle East and north Africa region, at 8.6%). Total energy subsidies exceeded 4% of GDP in Mozambique, Zambia and Zimbabwe, according to a 2013 IMF report. Despite their cost, these subsidies are not effective. On balance, they benefit the rich who consume more fuel than the poor. One IMF study argues that over 80% of petrol subsidy benefits accrue to the richest 40% of households. In Sudan, the poorest 20% of the population receive around 3% of fuel subsidies, while the richest 20% receive over 50%. While the wealthy may benefit more from these subventions, removing them is unpopular because it can still hurt the poor.
Transport, for instance, is one of the main cost-of-living burdens for many people in emerging markets. Protests against subsidy elimination in Nigeria in early 2012 paralysed the economy and forced the government to back-pedal. Fuel price demonstrations also rocked Cameroon in 2008 and Mozambique two years later. Egypt’s economic recovery talks with the IMF during 2013 and the first half of 2014 centred on the thorny issue of energy subsidies. Governments are naturally wary of angering their citizens. The reasons for social unrest are understandable. Higher transport costs affect people’s livelihoods, pushing up the cost of moving their goods to markets and of moving themselves to work. Low-income citizens in Africa have to be mobile due to the fragmented nature of labour markets and the shortage of stable, formal, single-location jobs. Increased fuel costs also drive inflation, which disproportionately affects the poor: they rarely have the protection that wealthier citizens have, such as investments in property, savings products or other assets.
But governments must be aware of the “opportunity cost” of subsidies. Every dollar spent subsidising fuel is a dollar not spent on schools, hospitals and infrastructure. Indeed, transport in sub-Saharan Africa would not be nearly so costly if it were not for the poor state of the roads. In that context, could the current slump in oil prices present a fortuitous chance for governments to implement fuel subsidy reforms without hitting the poor so hard? Removing subsidies while oil prices are low will be less painful: it gives governments the prospect of adopting measures to offset increased costs when the oil price climbs again. If countries want to remove or reduce fuel subsidies, a dramatic drop in oil prices is probably the ideal context to make those reforms. A handful of African governments had been pursuing this goal in the lead up to the oil price fall, due partly to pressure from donors, ratings agencies and the IMF. In the first half of last year, Cameroon, Egypt and Ghana reduced or removed fuel subsidies (Ghana’s had previously been removed, before being re-introduced).
Around the same time, Libya sought to implement a “smart card” system to crack down on large-scale smuggling of its subsidised fuel into neighbouring countries where it was being sold at profit, according to Reuters. Under this system, citizens can only buy a specific amount of subsidised fuel and will pay the normal price for all amounts above this limit. But many other countries have not acted and the subsidies remain widespread. For those considering reforms, what lessons have been learnt over recent years about the best approaches? First, clear communication and public consultation is fundamental. The public can understand and support reforms as long as they trust the government to carry them out properly, and are informed about why the change is necessary. Tanzania, for instance, has set up a specialised regulatory entity that helps the public understand the need for fuel subsidy reforms and reports back on the functioning of the market, according to a 2013 IMF report.
Second, the poor can be protected from the fallout of energy subsidy reforms. In its electricity reforms, Kenya provided households using less than 50 kilowatt-hours per month a “lifeline” power tariff that was below cost of production. Conditional cash transfers are another option. If not too burdensome administratively, countries can keep some subsidies in place for public transport, as in Niger and Ghana. Ghana has also been a leader in pursuing parallel programmes in which public investments are made to counteract the subsidy removal. Back in 2004, the Ghanaian government raised fuel prices by 50%, but this was coupled with an anti-poverty programme that included the elimination of primary and secondary school fees, funding for primary health programmes, rural electrification and the urban transport network. Not everyone was happy, of course, least of all the trade unions. But Ghana’s process was far more constructive than Nigeria’s in which public communication was minimal and significant amounts of the proceeds from the removed subsidy went missing.
If it is well-designed, gradual and includes offset mechanisms to protect the poorest, subsidy reform can put African economies on a sounder fiscal footing. It can free up much-needed resources for the direct public investments that are needed to support long-term, sustainable growth.
