Fuel subsidies strain state budgets

Source: http://web1.iseas.edu.sg/?p=3508

by Michael Richardson, For the Straits Times, 9 May 2011

Taming inflation is a top priority for governments in Asia. They want to prevent the spread of discontent over rising fuel and food prices. But smart politics can be bad economics.

One of the most widely used ways to cushion the impact of inflation is to subsidise consumption of oil, natural gas and coal, either by holding down the prices of petrol, diesel, cooking fuel and other refined petroleum products, or by capping the prices of electricity generated by burning fossil fuels.

In the latest move by regional governments to soften the effects of inflation on the poor, authorities in the Philippines last week (4 May) started distributing fuel subsidy cards to privately owned mass transit buses, known as jeepneys.

However, subsidies strain state budgets, divert funds away from productive spending, discourage energy efficiency, boost demand for fossil fuels, and tend to drive prices even higher in the longer-term.

Asia is critical in this cycle because of rapid growth in China, India, Indonesia and other emerging economies. The policies they adopt will do much to shape the world’s energy future.

The International Energy Agency (IEA) says that based on current policy commitments, global energy consumption is set to rise by 36 per cent by 2035. Emerging economies will account for almost all the increase. In China alone, energy demand will surge by 75 per cent.

China used 8.65 million barrels of oil per day (bpd) in 2010, about 10 per cent of worldwide demand. The IEA forecasts that it will use an extra 570,000 bpd in 2011. This is nearly 40 per cent of projected global demand growth.

Energy subsidies vary from year to year according to changes in oil, gas and coal prices, new government programs and shifts in demand.

The IEA has calculated that fossil fuel consumption subsidies amounted to US$312 billion in 2009, down from US$558 billion in 2008 when the price of oil reached a record high of close to US$150 per barrel. The comparable price today is around $109 per barrel.

Of the 25 biggest state subsidizers in 2009, ten were in Asia. They included India, China, Indonesia, Uzbekistan, Pakistan, Malaysia, Thailand, Bangladesh, Turkmenistan and Kazakhstan.

The IAE survey of fossil fuel subsidies in 2008 covered 37 countries. The subsidies in China and India amounted to nearly 10 per cent of GDP, while in Indonesia they were around 4 per cent of GDP.

The International Monetary Fund estimates that the global bill for fuel subsidies was US$250 billion in 2010 and warns that it is likely to be much higher this year, following the surge in fossil fuel prices in recent months.

Late last week, oil prices dropped sharply. But pent up demand, particularly in Asia, or a new crisis in the Middle East may push them higher again.

The oil price collapse after the global financial crisis in the second half of 2008 provided an opening for Asian governments to start phasing out energy subsidies. But reform was uneven.

Some economies, including India, Indonesia, Malaysia and Thailand, largely missed the chance. The closer elections come, the more difficult it is to cut subsidies.

Still, Vietnam has raised fuel prices by a third this year despite protests. The government was concerned that its budget deficit could become unsustainable,

China has twice raised fuel prices this year. Chinese consumers are now paying at least 27 per cent more for petrol and 25 per cent more for diesel than they did when the oil price peaked in 2008.

Even so, the retail price for petrol in China is 14 per cent below the international market prices while diesel is 35 per cent less.

In India, this gap for petrol is 35 per cent and diesel 20 per cent. In Indonesia, it is 58 per cent for petrol and 67 per cent for diesel. In all countries on the IAE list, the gap is bridged by state subsidies.

Japan, South Korea and Singapore are among the few Asian countries that apply market pricing of energy so that the price of transport fuels rise or fall in line with the internationally traded price of oil. Australia and New Zealand do the same.

Indonesia illustrates the dilemmas facing emerging economies that subsidise fossil fuel consumption. The government has recognized that much of the benefit from subsidized petrol for private vehicle owners goes not to the poor but to those who can afford cars and are relatively well off.

But with inflation expected to reach 7 per cent this year, Indonesia last month delayed the subsidy phase-out for fuel and electricity consumption, although it still says that it plans to do so by 2014 to relieve the burden on the budget.

The government has allocated the equivalent of US$11.2 billion to subsidise fuel in 2011. However, if oil prices continue to rise, the subsidy may increase.

Critics contend that the money could be spent more productively by improving Indonesia’s infrastructure, education and social welfare.

- The writer is a visiting senior research fellow at the Institute of South East Asian Studies.