MENA needs subsidy reform for sustainable development

Updated 12 July 2014
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MENA needs subsidy reform for sustainable development

Global spending on energy subsidies totaled $492 billion in 2011. Middle East and North Africa (MENA) countries alone accounted for nearly half of that amount, making the burden of subsidies on public resources quite substantial. While total spending on energy subsidies in MENA reached 8.6 percent of GDP in 2011, there was significant variation among the countries of the region. In countries like Iraq and Egypt, spending on energy subsidies reached 11 percent of GDP while it was 3 percent of GDP in Tunisia. Within the GCC, spending on energy subsidies ranged from 10 percent of GDP in Saudi Arabia to around 6 percent in the UAE and 3 percent in Qatar. Countries in MENA could therefore benefit from reforming their subsidy systems for a number of reasons.
First, large spending on subsidies consumes a large portion of public resources rendering them unsustainable even in the short-run for some countries. Furthermore, for energy-importing countries, subsidies tend to create external imbalances, increasing the risk of a balance of payments crisis.
Second, subsidies could also hamper economic growth as the government directs its resources away from growth-enhancing spending towards paying subsidy costs. In many countries in the region, subsidy costs far outstrip spending on education or health. This can have long-term consequences on the economic welfare of the region’s populations. Moreover, subsidies make the cost of capital artificially cheaper relative to labor wages, creating incentives for firms to switch from labor to capital-intensive industries. This leads to lower job creation in a region with high unemployment and a young population.
Third, empirical evidence suggests that the benefits of energy subsidies tend to be skewed toward high-income sectors of the population. The richest 20 percent of the population in developing countries is estimated to receive six times more in fuel subsidies than the poorest 20 percent. In some cases, the numbers can be even more extreme. The IMF estimates that the richest fifth of the population in Egypt captures 71 percent of the benefits from diesel subsidies compared with 1 percent for the poorest fifth.
Finally, there are other distortions created by subsidies beyond the direct economic consequences. Subsidies keep fuel prices artificially below the price determined by market forces. This leads to an overconsumption of energy with adverse impact on the environment, health and traffic congestion. It also creates incentives for smuggling as the domestic price is pushed below prices in neighboring countries. For example, reportedly Algerian fuel is smuggled into Tunisia and Yemeni oil is smuggled into Djibouti.
While the case for subsidy reforms is strong, their success is far from guaranteed. The IMF has recently documented 28 episodes of energy subsidy reforms worldwide. Five of these episodes failed to achieve their objectives while 11 others were only partially successful. Among the successful reform programs, two measures were particularly crucial.
The first is appropriate phasing-in of price increases. Too fast an increase in energy prices can generate a backlash against reforms. This is what led to the failure of the Mauritania attempt to reform energy subsidies in 2008. Conversely, removing subsidies too slowly can result in partial and incomplete reforms.
Second, it is important to provide social safety nets to the poor as subsidies are removed. Despite capturing a smaller share of the overall benefit, poor households would still be impacted both directly, as subsidies are removed, and indirectly as their removal is likely to result in higher consumer prices, squeezing the real income of poor households. Ideally, targeted cash transfers to the poor should replace energy subsidies but these tend to be complex to administer. However, the positive experience of Iran in 2010 shows that even indiscriminant cash transfers to all segments of the population can play a key role in the success of the reforms and in redistributing the resources from the rich to the poor.
Implementation concerns notwithstanding, MENA countries could benefit from reforming spending on subsidies to rebalance their economies, boost growth and employment and support more sustainable and efficient economic development.


Oil rises after US Navy destroys Iranian drone

Updated 19 July 2019
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Oil rises after US Navy destroys Iranian drone

  • The International Energy Agency is revising its 2019 global oil demand growth forecast to 1.1 million barrels per day
  • Speculators have exited options positions that could have provided exposure to higher prices in the next several years

TOKYO: Oil prices rose more than 1 percent on Friday after the US Navy destroyed an Iranian drone in the Strait of Hormuz, a major chokepoint for global crude flows, again raising tensions in the Middle East.
Brent crude futures were up 82 cents, or 1.3 percent, at $62.75 by 0100 GMT. They closed down 2.7 percent on Thursday, falling for a fourth day.
West Texas Intermediate crude futures firmed 61 cents, or 1.1 percent, at 55.91. They fell 2.6 percent in the previous session.
The United States said on Thursday that a US Navy ship had “destroyed” an Iranian drone in the Strait of Hormuz after the aircraft threatened the vessel, but Iran said it had no information about losing a drone.
The move comes after Britain pledged to defend its shipping interests in the region, while US Central Command chief General Kenneth McKenzie said the United States would work “aggressively” to enable free passage after recent attacks on oil tankers in the Gulf.
Still, the longer-term outlook for oil has grown increasingly bearish.
The International Energy Agency (IEA) is reducing its 2019 oil demand forecast due to a slowing global economy amid a US-China trade spat, its executive director said on Thursday.
The IEA is revising its 2019 global oil demand growth forecast to 1.1 million barrels per day (bpd) and may cut it again if the global economy and especially China shows further weakness, Fatih Birol said.
“China is experiencing its slowest economic growth in the last three decades, so are some of the advanced economies ... if the global economy performs even poorer than we assume, then we may even look at our numbers once again in the next months to come,” Birol told Reuters in an interview.
Last year, the IEA predicted that 2019 oil demand would grow by 1.5 million bpd but had already cut the growth forecast to 1.2 million bpd in June this year.
Speculators have exited options positions that could have provided exposure to higher prices in the next several years, market participants said on Thursday.
US offshore oil and gas production has continued to return to service since Hurricane Barry passed through the Gulf of Mexico last week, triggering platform evacuations and output cuts.
Royal Dutch Shell, a top Gulf producer, said Wednesday it had resumed about 80 percent of its average daily production in the region.