IMF Survey: Costly Mideast Subsidies Need Better Targeting

IMF News, May 14, 2012

Source details

Well-intended energy and food price subsidies in the Middle East and North Africa (MENA) are increasingly weighing on government budgets and debt levels and are not necessarily the most efficient way to channel aid to the most vulnerable.
Seminar context: held on the sidelines of the 2012 IMF–World Bank Spring Meetings in Washington, DC; moderated by Al-Jazeera; participants included IMF Deputy Managing Director Nemat Shafik and regional and international officials.

IMF Middle East and Central Asia department estimate: cost of subsidies at about $212 billion in 2011, or over 7 percent of regional GDP, of which about 80 percent reflect fuel subsidies.
International Energy Agency: MENA accounted for almost two-thirds of petroleum price subsidies worldwide in 2009.
Examples of country fiscal burden: overall food and fuel subsidies accounted for more than 8 percent of GDP in Egypt and Jordan in 2011.
Comparison of spending priorities (Jordan example): more than 8 percent of GDP spent on subsidies in 2011 versus only 1.4 percent of GDP budgeted for investment in health and education.

Generalized price subsidies are not very effective in helping the poor:
- Only 20 percent of those subsidies reach the poor while the remaining 80 percent benefit the non-needy.
- Subsidies to fuel: 20 percent reaches the poor.
- Subsidies to food: 35 percent reaches the poor.
Panel consensus: blanket subsidy systems often allocate the majority of benefits to higher-income groups rather than the needy.

Recommendation: replace wasteful generalized price subsidy regimes with targeted social safety nets and social insurance.
Advantages of targeted approaches:
- More cost effective and leave fiscal resources for priority spending (infrastructure, education, health).
- Well-designed cash transfer systems in MENA can typically result in about 50–75 percent of spending reaching the bottom 40 percent of the population.
Targeting methods discussed:
- Targeting by social category (children, pensioners).
- Geographical targeting to poor regions.
- Coupons or lifeline allocations for essential subsidized goods.
- Conditional and unconditional cash transfers.

Jordan: food subsidy reform in the early 1990s used coupon system to ration sugar, rice, and powdered milk at low, administered prices.
Mexico: Tortivales scheme (introduced in 1990) allowed urban low-income households to receive 1 kilogram of tortillas every day by using “smart” cards issued on the basis of a means test; later phased out and integrated into Oportunidades, a conditional cash transfer program.
Turkey: phased elimination of generalized price subsidies starting in the 1980s and ending in early 2000 in the context of broader macroeconomic adjustment; revenues from fuel taxation were used to spend on education, health care, and cash transfers to the poor.
Iran: designed a cash compensation scheme to accompany a sharp rise in fuel prices; cash transfer was originally intended for poor households but later extended to the whole population.

Subsidy reform should be part of a broader economic reform strategy emphasizing sound macroeconomic and structural policies to sustain growth, reduce unemployment, and cut poverty.
Mexico experience (José Antonio González Anaya): reforming generalized subsidies is “inevitable” and helped Mexico grow faster than countries that retain generalized subsidy regimes.
Turkey experience (Mehmet Şimşek): costly price subsidies contributed to large chronic deficits and high debt in the 1990s; reform helped bring the budget deficit close to zero, reduce the debt-to-GDP ratio significantly, and provide more support to the poor.
Political transitions in MENA complicate reform, but maintaining unsustainable subsidy systems leads to accumulating fiscal and current account deficits.

Successful subsidy reform requires a public communications campaign to:
- Highlight advantages of reform.
- Create political momentum.
- Establish realistic expectations.
Key messaging: budgetary savings will be used for public benefits such as education, health, and infrastructure.
Policy design principles to reduce political cost: accompany subsidy removal with alternatives (free education and health care for the poor, reduced taxes on essential food items, increased taxes on automotive and fuel consumption).

IMF can provide technical advice and lessons from across its membership to:
- Improve the quality of government expenditure.
- Tackle subsidies to respond to social needs, raise investment, enhance human capital, create jobs.
- Reduce fiscal deficits that increase debt levels and crowd out lending to the private sector.

Source: IMF Survey online, May 14, 2012.