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Cutting Back on Fuel Subsidies

Author: Toni Johnson
October 21, 2008

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Escalating costs of food and fuel hit developing countries particularly hard earlier this year, leading to protests and riots. Then the global financial crisis entered the picture. In October, the World Bank released a report showing that the number of malnourished people due to food and fuel price hikes could grow by 44 million people (PDF) in 2008, and bank officials identified more than twenty-eight financially strained (Reuters) countries due to the financial crisis. World Bank President Robert Zoellick says the crisis "will only make it more difficult for developing countries to protect their most vulnerable people from the impact of rising food and fuel costs." The bank's report notes "many governments are using general price subsidies, export restrictions, or tax cuts-measures that can be regressive and expensive" and instead backs subsidies for food and fuel targeted at the neediest people.

A June 2008 International Monetary Fund (IMF) report said increases in household food expenditures in developing countries have exceeded fuel expenditures (PDF) because of a greater preference toward fuel subsidies. Forty-six countries have fuel subsidies compared with twenty-eight that subsidize food. The report says fuel subsidies represent between 1 percent and 14 percent of gross domestic product (GDP) in countries, and expenditures are on the rise. Pakistan's subsidy bill, for example, is expected to be 2.6 times higher (Stratfor) in 2008 than the country budgeted for, amounting to nearly 3 percent of the country's GDP. In an interview with CFR.org, Husain Haqqani, Pakistan's ambassador to the United States, blamed the deepening economic woes on the former government's refusal to either call for decreases in oil consumption or to pass on escalating oil costs on to consumers.

Even before the financial crisis, some governments in developing nations began slashing subsidies for essentials like fuel. Shantayanan Devarajan, chief economist of the World Bank's Africa Region, said in a CFR.org interview that "some African countries are facing serious macroeconomic imbalances quite independently of the financial crisis, mostly brought on by the fuel and food crises." The Nigerian government, facing double-digit inflation, recently warned it will likely discontinue subsidizing (Business Day) fuel by the end of the year. Pakistan slashed fuel subsidies in June and now looks to eliminate energy subsidies (Dawn) entirely as of 2009. Other countries cutting fuel subsidies include Malaysia, China, Indonesia, and Nepal. Meanwhile, India also cut its fuel subsidy this year and the International Energy Agency (IEA) urged India to drop fuel subsidies entirely (India Journal). Oil reached a peak of about $147 per barrel in July, and though it has dropped significantly since then, the need to cut subsidies remains, experts say. Jason Feer, Honk Kong-based bureau chief of Argus Media, points out weakening oil prices (UPI Asia) present an opportunity for governments to "wean their economies away from subsidies."

But lowering or ending subsidies is not popular. Many of the fuel protests of the last year, in countries like India, Jordan, and Indonesia, were prompted by governments' decisions to lower subsidies. "Prices in general will soar after fuel subsidies are lifted and the increase will not meet the minimum needs of citizens," Saleh Armouti, president of the Jordan Bar Association said in January (Jordan Times). Meanwhile, protests have also flared in more affluent states like France, Spain (WashPost), and Chile (Reuters), where truckers, farmers, and fisherman hope the governments will provide new fuel subsidies to ease price pressures.

By some accounts it is the wealthiest in these countries that reap the greatest benefit from artificially low fuel prices (Economist). A 2008 UN report on fuel subsidies and greenhouse gases says middle and higher income households (PDF) tend "to get hold of the bulk of [subsidized] energy in countries where it is rationed, through petty corruption and [favoritism]." Experts, including those at the UN, IEA, and IMF, also say fuel subsidies distort the oil market by encouraging demand through artificially low prices. The UN report says reforming fuel subsidies can help lower consumption reducing greenhouse gas emissions.

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