IMF Survey : IMF Sees Big Gains from Energy Subsidies Reform

IMF News, March 27, 2013

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Published: March 27, 2013

Overview and headline findings

Estimates put cost of subsidies at $1.9 trillion in 2011, the equivalent of about 2½ percent of world GDP, or 8 percent of all government revenues.
Subsidies are pervasive: based on a new database for 176 countries, subsidies in 2011 amounted to $1.9 trillion.
Top three subsidizers in 2011:
- United States: $502 billion
- China: $279 billion
- Russia: $116 billion
Example of reform impact: electricity subsidies in Kenya fell from 1.5 percent of GDP in 2001 to zero in 2008.

Why reform is recommended

Fiscal cost and inefficiency
- Subsidies are expensive and ultimately must be paid by someone.
- They are an inefficient way to support the poor: on average, the richest 20 percent of households in low- and middle-income countries capture six times more in fuel subsidies than the poorest 20 percent.
Growth and environmental consequences
- Subsidies crowd out public spending that can boost growth (infrastructure, education, health care).
- Cheap energy leads to overconsumption, aggravating pollution and climate change.
Distributional and structural effects
- In energy-rich countries, subsidies largely benefit better-off households (automobiles, air conditioning, appliances) and encourage capital-intensive industries over employment-intensive activities.
- Subsidies encourage greater extraction, leaving fewer resources for future generations.

Regional implications and country experiences

Middle East and Central Asia
- Energy-rich countries use subsidies to share resource wealth, but benefits skew to better-off households.
- Reform can free resources for public spending on health, education, and infrastructure to boost job-creating growth without increasing debt.
- Political and technical obstacles: reforms can be reversed under vested-interest pressure or oil price swings; lack of public confidence in the use of savings complicates reform.
- Successful examples: Mauritania’s May 2012 diesel price formula included targeted compensation and faced relatively limited opposition despite a price increase of more than 20 percent over a five-month period; Iran preceded reform with extensive stakeholder consultation and an effective public relations campaign.
Africa and sub-Saharan Africa
- Fuel subsidies are more prevalent in oil-exporting countries; large electricity subsidies are generalized in sub-Saharan Africa.
- Electricity subsidies have discouraged private investment and constrained state-owned utilities from investing in new capacity; sub-Saharan Africa’s per capita energy production has not increased since the mid-1980s.
- Reducing electricity subsidies requires a comprehensive strategy: raise collection rates, reduce inefficiencies in state-owned utilities, increase scale economies, and promote regional trade in power.
- Low public debt in some countries provides an opportunity for investment in cheaper energy production.
- Protection measures used or suggested: expand public-transport buses (Ghana), food distribution programs (Namibia), youth and women’s employment programs (Nigeria), maintain subsidies on items heavily used by the poor (kerosene in Nigeria), or differentiate tariffs and help finance connection costs (Kenya).

Protecting the poor during reform

Preferred approach: conditional cash transfers targeted to income groups most in need (examples: Mozambique and Gabon).
If new schemes are not feasible due to administrative constraints, expand and improve targeting of existing programs.
Alternative or complementary measures:
- Maintain subsidies for items heavily used by the poor (e.g., kerosene) or for electricity consumption below a specified threshold.
- Differentiate electricity taxes by income group or assist low-income households with connection costs.
Communication, transparency, and immediate compensation for the hardest hit are crucial to build public confidence and limit opposition.

Policy recommendations and operational guidance

There is no single recipe; successful reform typically includes six key elements identified from 19 country experiences:

1. Implement a comprehensive reform plan with clear long-term objectives (e.g., full price liberalization, improving quality of service). 2. Execute a far-reaching communications strategy and consult stakeholders. 3. Phase and sequence price increases appropriately to allow adjustment. 4. Implement measures to protect the poor (targeted social protection). 5. Improve efficiency of state-owned enterprises to reduce fiscal burden. 6. Depoliticize the setting of energy prices to make reforms durable.

IMF role:
- Assist country authorities in assessing true costs of subsidies (fiscal costs and those related to competitiveness and growth).
- Make subsidy beneficiaries and costs fully transparent to inform public debate and spending priorities.
- Support design and sequencing of reforms, including targeted protection measures and utility reforms.

Source: IMF Survey : IMF Sees Big Gains from Energy Subsidies Reform (IMF Survey online, March 27, 2013).