"Energy Subsidy Reform: The Way Forward" — Presentation by David Lipton, First Deputy Managing Director, International Monetary Fund

IMF News, March 27, 2013

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Bibliographic details

• Published: March 27, 2013

Overview

• Presentation delivered as prepared for delivery on March 27, 2013.
• Focus on three broad topics: (1) the consequences of energy subsidies; (2) the magnitude of these subsidies; and (3) the ingredients for successful subsidy reform.
• Key framing: energy subsidies are pervasive globally, affect fiscal sustainability, growth, equity, and the environment, and have proven difficult but feasible to reform.

Consequences of energy subsidies

• Fiscal and growth effects:
  • Subsidies reduce incentives for private and state-owned investment in energy production, constraining supply and service quality (example: electricity suppliers in Africa).
  • Installed per capita generation capacity in sub-Saharan Africa, excluding South Africa, is about one-third of that of South Asia and one-tenth of that in Latin America.
  • Subsidies crowd out public spending on infrastructure, education, health care, and social safety nets; some countries spend more on energy subsidies than on public health and education.
  • Subsidies misallocate resources toward capital- and energy-intensive activities and discourage R&D in energy-saving and alternative technologies.
  • Subsidies put pressure on balance of payments for net energy importing countries.
• Environmental and distributional effects:
  • By boosting energy consumption, subsidies increase emissions, aggravate climate change, local pollution, and congestion.
  • Eliminating pre-tax subsidies alone would reduce CO2 emissions by about 1-2 percent.
  • If countries implemented emissions reduction pledges from the 2009 Copenhagen Accord, global greenhouse gas emissions in 2020 would be reduced by 7 percent below levels that would otherwise occur if lenient targets were met — implying that stopping pre-tax subsidies could achieve about 15-30 percent of that key global emissions reduction objective.
  • Tackling post-tax subsidies would reduce CO2 emissions by 4½ billion tons, a 13 percent reduction.
  • Subsidies reinforce inequality: on average, the richest 20 percent of households in low- and middle-income countries capture 43 percent of fuel subsidies; many poor households (e.g., in Africa) gain little because they lack grid connections.

Magnitude of subsidies (estimates for 2011 dataset across 176 countries)

• Definitions:
  • Pre-tax subsidies: consumers pay less than the supply cost of energy (including transportation and distribution).
  • Tax subsidies: energy taxes are too low to account for negative externalities (climate change, local pollution, congestion).
  • Post-tax subsidies: sum of pre-tax and tax subsidies.
  • Producer subsidies: losses of state-owned enterprises due to inefficiency rather than consumer price controls.
• Key figures:
  • Pre-tax subsidies: 0.7 percent of global GDP, or about 2 percent of global tax revenues; mostly petroleum products and electricity.
  • Regional concentration: Middle East and North Africa (MENA) accounts for about half of pre-tax subsidies.
  • Pre-tax subsidies in MENA reach 8.6 percent of GDP and 21.8 percent of government revenues.
  • Post-tax subsidies worldwide: 1.9 trillion dollars, equivalent to 2.7 percent of global GDP, or 8 percent of government revenues.
  • Post-tax distribution: advanced economies account for 40 percent of the global total; some 159 economies are subsidizing energy on a post-tax basis.
  • As a share of GDP, post-tax subsidies are highest in MENA and lowest in advanced economies; as a share of revenues, highest in MENA and emerging and developing Asia.
  • Top three subsidizers in absolute terms: the United States (US$ 502 billion), China (US $279 billion), and Russia (US$ 116 billion).
  • Across regions, under-pricing for externalities accounts for a large share of post-tax subsidies.
  • Worldwide, more than a quarter of post-tax subsidies is devoted to coal.

Ingredients for successful subsidy reform (lessons from 22 case studies)

• Six key ingredients:

1. Spell out a comprehensive reform plan

• Articulate long-term objectives (e.g., full price liberalization, improved service quality).
• Assess fiscal and macroeconomic effects and identify winners and losers (example: Ghana commissioned an independent poverty and social impact analysis in 2005).
• Consult stakeholders and invite participation (example: Kenya’s negotiations with large consumers).

2. Implement a far-reaching communications strategy

• Inform the public of subsidy size and potential benefits, including scope to raise priority social spending (examples: Namibia, the Philippines for fuel; Armenia and Uganda for electricity).
• Strengthen transparency: publish subsidy size, funding sources, and price-formulation details (examples: Ghana and South Africa publish petroleum product pricing details).

3. Phase and sequence price increases appropriately

• Phasing depends on size of required price increases, fiscal position, and political/social context.
• Phased increases give time to adjust consumption and strengthen safety nets; trade-off between short-term budgetary savings and softening household impacts.
• Consider phasing across products (e.g., larger initial increases for gasoline, which is consumed more by upper-income households).

4. Improve efficiency of state-owned enterprises

• Improve cost information, set performance targets and incentives, introduce competition where appropriate.
• Improve collection of energy bills (electricity).

5. Implement mitigating measures to protect the poor (described as in some ways the most critical)

• Preferred approach: targeted cash or near-cash transfers (e.g., vouchers) to give beneficiaries flexibility and reduce distribution costs and abuse.
• Where cash transfers are not feasible, rapidly expand existing programs (school meals, public works, subsidized urban transport) while improving targeting; example: Ghana also eliminated fees for state-run primary and secondary schools.
• Sector-specific measures may be needed to mitigate impacts on workers and facilitate restructuring (example: coal sector reform in Poland included social assistance and job training for unemployed miners).

6. Depoliticize price-setting

• Implement automatic price mechanisms with smoothing rules; assign implementation to an independent body to make reforms durable.

• Case examples of successful reforms: Philippines and Turkey (petroleum), Kenya and Uganda (electricity).

Policy implications and concluding messages

• Energy subsidies have adverse effects on public finances, economic growth, equity, and the environment, but reform is feasible.
• Successful reform requires planning, targeted mitigation for the poor, transparency, stakeholder engagement, appropriately phased pricing, SOE efficiency measures, and mechanisms to depoliticize pricing.
• The IMF will support countries pursuing reform and emphasizes that "subsidy reform is needed, but it is better to do it the right way, than to do it right away."

Presentation by David Lipton, First Deputy Managing Director, International Monetary Fund; March 27, 2013.

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References

• PRESS CENTER
• David Lipton
• Press Release: IMF Calls for Global Reform of Energy Subsidies: Sees Major Gains for Economic Growth and the Environment
• Reforming Energy Subsidies
• Webcast
• https://www.imf.org/en/home