Focus on energy subsidies

The International Monetary Fund (IMF) recently released advice on Energy Subsidy Reform. Robin Harding wrote an excellent article on the issue for the Financial Times.

IMF signals push to scrap energy subsidies

The world could solve a large part of its fiscal problems by scrapping $1.9tn* in energy subsidies, the International Monetary Fund said recently.

The fund’s call suggests higher fuel prices could become a central condition of IMF help in the future, with subsidies proving a sticking point in its talks with countries such as Egypt, Pakistan and Ukraine.

David Lipton, first deputy managing director of the IMF, said countries should scrap fuel subsidies and charge for the cost of pollution – but that the fund was not yet ready to make carbon taxes a condition of its lending programmes.

“There are 20 countries that spend more than 5 per cent of GDP on energy subsidies,” said Mr Lipton. “It leads to a fiscal problem because the subsidies are so big that it threatens the fiscal sustainability of the country.”

For the first time, the IMF has put a price on the worldwide fiscal cost of energy subsidies. It says that regular subsidies, where the price of fuel is lower than the cost of producing it, amount to $480bn, mainly in developing countries.

“Our projections are that eliminating the $480bn of pre-tax subsidies would cut carbon emissions by 1 to 2 per cent for the world. It’s that big,” said Mr Lipton.

But indirect subsidies, where countries do not fully charge energy users for the costs of pollution and congestion, add another $1.4tn*, with 40 per cent in the developed world, the IMF says. Those figures are likely to be controversial because they count untaxed carbon emissions as a subsidy but do not include tax breaks for renewable energy such as wind.

In absolute terms the top three energy subsidisers are the US, at $502bn; $279bn in China; and $116bn in Russia, according to the fund.

Mr Lipton said that fuel subsidies reduce energy production in developing countries, cause them to use inefficient technologies that demand too much energy, and raise costs for the industrial sector.

“A lot of countries have inadequate energy production or inadequate electricity generation because the subsidies make production less remunerative,” he said. “So they end up with less energy overall.”

Subsidies also fail to help the poorest people because they do not use much energy anyway. “If you have no car and no air conditioning you can’t get too much subsidy,” said Mr Lipton.

The IMF is calling on developing countries to replace fuel subsidies with cash payments to the poorest people. Introducing the payments first can help to make scrapping the subsidy more politically palatable, it says.

Subsidies are largest in the Middle East and North Africa, where they amount to 8.5 per cent of regional output and 22 per cent of government revenues.

“Egypt is a country where the subsidies are something like 7 or 8 per cent or GDP, in a country that traditionally has had 8 or so per cent budget deficits, so it accounts for virtually the entire budget deficit,” said Mr Lipton.

“Using a good portion of that 8 per cent for infrastructure and modernisation – that it would leave the country better off is, I think, a quite reasonable proposition.”