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Energy subsidies a burden in MENA region

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MENA countries accounted for nearly half of the USD 492 bn spent globally on energy subsidies in 2011. These latest figures provided by Qatar National Bank (QNB) Group in a report indicate that these subsidies are proving to be a burden.

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. The report said large spending on subsidies consumes a big 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.

 


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.

Subsidies make the cost of capital artificially cheaper relative to labour wages, creating incentives for firms to switch from labour to capital-intensive industries. “This leads to lower job creation in a region with high unemployment and a young population,” said the report.

High-income beneficiaries

The benefits of energy subsidies tend to be skewed towards 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.

The IMF estimates that the richest 20 percent of the population in Egypt captures 71 percent of the benefits from diesel subsidies compared to 1 percent for the poorest 20 percent.

Distortions

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 neighbouring countries. For example, reportedly Algerian fuel is smuggled into Tunisia and Yemeni oil smuggled into Djibouti.

Reforms

While the case for subsidy reforms is strong, their success is far from guaranteed. The IMF recently documented 28 episodes of energy subsidy reforms worldwide. Five of these failed to achieve their objectives while 11 others were only partially successful. Among the successful reform programmes, 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 Mauritanian attempt to reform energy subsidies in 2008. Conversely, removing subsidies too slowly can result in partial and incomplete reforms.

Safety nets

“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,” said the report.

Ideally, targetted 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.


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Source: bqdoha.com

 

 


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