Tuesday,25 September, 2018
Current issue | Issue 1317, (27 October - 2 November 2016)
Tuesday,25 September, 2018
Issue 1317, (27 October - 2 November 2016)

Ahram Weekly

No pain, no gain

Further reductions on fuel subsidies are on the cards, bringing warnings of higher inflation, reports Sherine Abdel-Razek

No pain, no gain
No pain, no gain
Al-Ahram Weekly

While the government has been talking about further reductions in fuel subsidies since it last did in July 2014, it must take this politically sensitive step now to get the IMF loan needed to restore investor confidence in the country and deal with the snowballing foreign exchange shortage.

Earlier this month, IMF Managing Director Christine Lagarde told reporters that prior actions related to both the exchange rate and subsidies needed to be taken before the IMF board could convene to approve the deal.  

Subsidies have long been a heavy burden on the state budget, and those directed to fuel represent the largest chunk, reaching 60 per cent of the total. The subsidies bill between 2008 and 2012 represented around 20 per cent of total public expenditure.

“We are talking about reducing subsidies because they are state expenditures that can be slashed as the government can’t reduce salaries or debt servicing,” economist Amr Adli said. “This expenditure is the most flexible as it can be reduced and retargeted to those who need it the most.” 

For years, many countries including some of the world’s biggest energy producers have used subsidies to lower petrol and diesel prices, supposedly to help the poor. The International Energy Agency (IAE) estimates that countries spent $493 billion on consumption subsidies for fossil fuels in 2014.

Adli said that the problem with energy subsidies was not only their size but also the inefficiency of the system. “The government, a net importer of energy, is subsidising producers by buying fuel at low prices. This does not make sense,” he said.

Many countries worldwide are reconsidering subsidising fuel as it encourages increased energy use. In Egypt, the subsidies have supported industries that are energy intensive like cement, fertilisers, iron and steel. 

“We can’t compete in these industries as we do not have the oil or gas reserves that guarantee their continuation, as the case in Venezuela or Qatar,” Adli explained.

Another problem with such industries is that they are capital intensive, which means they don’t create a lot of jobs, a benefit that if available would have reduced the negatives of expanding such investments. 

Moreover, by default subsidies benefit those who consume more fuel, mainly the upper middle classes and members of the higher income brackets. 

“Fuel prices must rise soon in order to redirect part of the energy subsidies to subsidise the poor and spend more on social issues,” commented investment bank Arqaam Capital in a report issued last week. 

“We believe that the government will move soon on the prices of energy products, excluding 80 octane gasoline, in order to continue to reduce the subsidy bill, redirecting the resources towards other social and investment spending,” Arqaam said.

Egypt started to restructure its energy subsidies in 2008 when it increased the prices of petrol, diesel and natural gas. The international financial crisis followed by the 25 January 2011 and June 2013 Revolutions put the plans on hold. Then came a new wave of price restructuring in July 2014, when subsidies on different fuels were slashed.

The government asserted that it wanted to reduce the overall subsidies and target the less-privileged income groups, monitoring the consumption of different products through a smart-card system to measure demand and prevent smuggling. 

A smart-card system curbing access to fully subsidised fuels has been years in the making without full implementation.

The last couple of years have been suitable for further cuts as the price of oil internationally has declined by half, making the lifting of the subsidies less painful. 

But the shaky economic situation and the repercussions of the low supply of dollars led the government to keep postponing the move until the agreement with the IMF was signed and the government embarked on an expenditure restructuring programme.

“We expect a 15 to 20 per cent increase in the prices of 92 octane gasoline, diesel and mazot, with a probably higher change in the price of diesel, as both it and butane gas have the lion’s share of energy subsidies,” Arqaam noted.

The current prices of 92 octane petrol, diesel, and mazot only cover around 57 per cent of their actual cost, with the government seeking to raise that ratio to 65 per cent at least, added the report. 

This reduction in subsidies is expected to increase GDP by 0.5 per cent in 2016/2017, and by two per cent in the next fiscal year “as the subsidy restructuring programme continues and more savings are created to be redirected to social spending and investment,” Arqaam said.

The decline in fuel subsidies will be translated into higher prices. Adli said diesel alone burns 50 per cent of the subsidies bill. With this mostly used by the goods and service sectors as a fuel for tractors in villages or in minibuses, any price increase will no doubt impact the prices of many goods and services. 

In 2014, the day after the announcement of a fuel subsidies decrease the head of the poultry division at the Egyptian Federation of Chambers of Commerce told Al-Ahram that poultry prices would increase by 25 per cent because of added transportation costs. 

What makes things worse is that lower-income groups could suffer the most as a larger percentage of their income is dedicated to basic needs such as food and transportation in comparison to those with higher incomes. Even a small movement in the prices of these commodities and services could add a significant burden. 

The combined effects of the devaluation of the currency, the new VAT and increased energy prices are expected to raise annual headline inflation to 15 to 16 per cent in October and to 18 to 20 per cent by the end of 2016, Arqaam Capital said. 

The government has been working on securing six months’ worth of commodities, including basic staples and energy products, to rein in the expected hike in prices. “This would probably result in the Central Bank having to direct part of its reserves to financing these imports, further reducing the foreign exchange funds available to inject into the market,” Arqaam stated. 

Adli called for the adoption of compensatory programmes to help the impoverished middle and lower classes cope with the repercussions of the increases in prices. Cars with a capacity of less than 1600 cc could be subsidised or subsidies could be replaced by cash benefits, for example. 

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