MENA needs subsidy reform for sustainable development

Updated 12 July 2014

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 steadies as demand uncertainty tempers supply cuts

Updated 3 min 5 sec ago

Oil steadies as demand uncertainty tempers supply cuts

  • Rising tensions between the US and China, the world’s largest oil consumers, fuel concerns about the outlook for demand

LONDON: Oil prices, which have been driven higher for the past four weeks, were steady on Monday, with holidays in Singapore, London and New York dampening trade, as rising concerns over demand recovery offset supply cuts.

Brent was flat at $35.13 a barrel, while US oil gained 10 cents, or 0.3 percent to $33.35 a barrel. Both are down around 45 percent so far
this year.

“Uncertainty around the current travel patterns in the US is so great that the American Automobile Association did not release its Memorial Day travel forecast,” Bjornar Tonhaugen, head of oil markets at Rystad Energy, said.

Rising tensions between the US and China, the world’s largest oil consumers, over moves by Beijing to impose security legislation on Hong Kong also fueled concerns about the outlook for demand.

Relations between Washington and Beijing have soured since the coronavirus outbreak, with the two countries already at odds over Hong Kong, human rights, trade and US support for Chinese-claimed Taiwan.

Prices are finding support from global supply cuts with the Organization of the Petroleum Exporting Countries and its allies, known as OPEC+, now nearly a month into a deal to voluntarily withhold 9.7 million barrel per day of production.

And the US rig count, an early indicator of future output, fell by 21 to a record low 318 in the week to May 22, data from energy services firm Baker Hughes showed.

“The huge decline in global oil production has doubtless been the key factor in the latest surge in oil prices,” Commerzbank said.

Forex trading

Meanwhile, the euro steadied around the $1.09 level on Monday in a potentially big week for European policymakers as they debate the outlines of a recovery fund aimed at helping member nations.

Austria, the Netherlands, Denmark and Sweden want loans from a time-limited fund for nations struggling to recover from the pandemic, rather than the grants proposed by France and Germany last week for the EU’s coronavirus recovery plan.

The Franco-German plan sent the euro rallying above $1.10 last week before the much-expected counter proposal by the four countries pushed it back
below $1.09.

The rival proposals come before the European Commission’s own plans for the recovery fund on Wednesday and any watered down proposals from the original plan would be perceived as
euro negative.

On the other hand, “if the Franco-German debt proposal (miraculously) passes the test during the coming week, we reckon that it would be a major euro positive event,” Nordea strategists said.

On Monday, the single currency steadied around $1.09 but remained about 5 percent below a 2020 high of near 1.15 hit in early March.

Elsewhere, the US dollar erased earlier gains and edged lower on the day. The greenback, which tends to behave like a safe haven asset at times of market turmoil and political uncertainty, was steady near a one-week high at 99.74.

The Australian dollar, by dint of its strong trade connections with China and the offshore yuan, led losers against the US dollar.

More turbulence for US-China relations is prompting some investors such as UBS Wealth Management to hold a “defensive” position in Hong Kong. “(The) larger risk for global investors is what happens if it becomes further enmeshed in broader relations,” said Mark Haefele, its chief investment officer.

With financial markets in Singapore, Britain and the US closed for public holidays on Monday, the weekend developments hit risk aversion in broader markets
in early trade.

Sterling was also on the back foot against both the dollar and the euro as political pressure grew on British Prime Minister Boris Johnson to fire senior adviser Dominic Cummings.

Cummings, the architect of the 2016 campaign to leave the EU and widely considered to be Johnson’s most influential strategist, came under pressure after reports he traveled to northern England from London during a nationwide lockdown in March when his wife was ill with COVID-19 symptoms.