The global experience in subsidy reforms

Subsidies lead to higher energy consumption, exerting pressure on the balance of payments of net energy importers, while also promoting smuggling to neighbours with higher domestic prices.

By IMF

Published: Thu 23 Jul 2015, 12:00 AM

Last updated: Thu 23 Jul 2015, 2:00 AM

While aimed at protecting consumers, subsidies aggravate fiscal imbalances, crowd out priority public spending, and depress private investment, including in the energy sector.
Subsidies also distort resource allocation by encouraging excessive energy consumption, artificially promoting capital-intensive industries, reducing incentives for investment in renewable energy, and accelerating the depletion of natural resources. Most subsidy benefits are captured by higher-income households, reinforcing inequality. Even future generations are affected through the damaging effects of increased energy consumption on global warming.
Subsidies for petroleum products, electricity, natural gas, and coal reached $480 billion in 2011 (0.7 per cent of global GDP or two per cent of total government revenues). The cost of subsidies is especially acute in oil exporters, which account for about two-thirds of the total. On a post-tax basis-which also factors in the negative externalities from energy consumption-subsidies are much higher at $1.9 trillion (2.5 per cent of global GDP or 8 per cent of total government revenues). The advanced economies account for about 40 per cent of the global post-tax total, while oil exporters account for about one-third. Removing these subsidies could lead to a 13 per cent decline in CO2 emissions and generate positive spillover effects by reducing global energy demand.
Country experiences suggest there are six key elements for subsidy reform. These are: (1) a comprehensive energy sector reform plan entailing clear long-term objectives, analysis of the impact of reforms, and consultation with stakeholders; (2) an extensive communications strategy, supported by improvements in transparency, such as the dissemination of information on the magnitude of subsidies and the recording of subsidies in the budget; (3) appropriately phased price increases, which can be sequenced differently across energy products; (4) improving the efficiency of state-owned enterprises to reduce producer subsidies; (5) targeted measures to protect the poor; and (6) institutional reforms that depoliticise energy pricing, such as the introduction of automatic pricing mechanisms.
Why subsidy reform is difficult
Subsidy expenditures aggravate fiscal imbalances, and crowd out priority public spending and private investment, including in the energy sector. Underpriced energy distorts resource allocation by encouraging excessive energy consumption, artificially promoting capital-intensive industries (thus discouraging employment creation), reducing incentives for investment in renewable energy, and accelerating the depletion of natural resources.

50 per cent of energy subsidies in Mena

Middle East and North Africa region accounted for about 50 per cent of global energy subsidies. Energy subsidies totaled over 8. 5 per cent of regional GDP or 22 per cent of total government revenues, with one-half reflecting petroleum product subsidies. The regional average masks significant variation across countries. Of the 20 countries in the region, 12 have energy subsidies of 5 per cent of GDP or more. Subsi-dies are high in this region for both oil-exporters and importers.

Subsidies lead to higher energy consumption, exerting pressure on the balance of payments of net energy importers, while also promoting smuggling to neighbours with higher domestic prices. As most subsidy benefits are captured by higher-income households, energy subsidies have important distributive consequences that are often not fully understood. Even future generations are affected through the reduced availability of key inputs for growth and the damaging effects of increased energy consumption on greenhouse gas emissions and global warming.
Yet energy subsidies have been difficult to reform. Subsidy reform has been a frequent topic of discussion between IMF staff and member countries-in some cases over decades. The adjustment of prices for subsidized energy has often led to widespread public protests by those who benefit from subsidies and to either a complete or partial reversal of price increases.
The absence of public support for subsidy reform partly reflects a lack of confidence in the ability of governments to reallocate the resulting budgetary savings to benefit the broader population, as well as concerns that vulnerable groups will not be protected. This is particularly challenging in oil-exporting countries, where subsidies are seen as a mechanism to distribute the benefits of natural resource endowments to their populations.
Governments are also often concerned about the inflationary effects of higher domestic energy prices and their adverse impact on the international competitiveness of domestic producers. Furthermore, subsidy reform can be complex when it involves efforts to reduce inefficiencies and production costs, as is often the case for the electricity sector. - IMF
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