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Briefing

Fuel subsidies

Crude measures

May 29th 2008
From The Economist print edition

Not everybody is paying higher prices for oil


HALF of the world's population enjoys fuel subsidies. This estimate, from Morgan Stanley, implies that almost a quarter of the world's petrol is sold at less than the market price. The cheapest petrol is in Venezuela, at 5 cents per litre. That makes China's pump price of 79 cents seem expensive, but even this is a bargain compared with $1.04 in the United States and $2.35 in Germany (see chart).

As the gap has widened between soaring international prices and fixed domestic prices, so has the cost of subsidies. Indeed, budgetary strains are now forcing some governments to lift prices. On May 24th Indonesia raised fuel prices by around 30%. This was the first increase since 2005, but it still leaves petrol too cheap at 65 cents a litre. Dearer oil is likely to push up inflation from 9% to 12%. But without the increase, the government's subsidy bill was heading for an alarming 3% of GDP this year. In the past week Taiwan has also raised petrol prices by 13% and Sri Lanka has lifted them by 24%.

Malaysia has one of the biggest fuel-subsidy bills in the world, estimated at as much as 7% of GDP this year. By holding down the price of petrol, Malaysia now has the lowest inflation rate of all the 32 emerging economies tracked by The Economist. But the government is expected to allow prices to rise soon to curb its widening budget deficit.

In theory, rising crude-oil prices should reduce global demand. But if domestic prices are capped, then emerging economies will continue to guzzle oil, pushing world prices still higher. Emerging economies accounted for more than the whole increase in world oil consumption last year—because demand in the rich economies fell. But recent price increases will make little difference to global consumption unless China and India follow suit.

India's state-owned oil companies face mounting losses, as they are forced to sell fuel at fixed prices below cost. Petrol prices are actually slightly higher in India than in the United States, because Indian motorists pay much higher fuel taxes, but diesel is about 40% cheaper than in America. The oil firms are partly compensated by bonds which the government issues to them—a trick which allows the government to keep the subsidy off its books. At today's prices, the total subsidy (including the full losses of oil companies) could be as much as 2-3% of GDP this year. Morgan Stanley estimates that the government's total budget deficit (central and state governments and all off-budget items) is running at 9% of GDP in this fiscal year. The government must hold an election by May next year, so it is reluctant to raise fuel prices by much. It is thought to be considering a modest rise combined with a cut in excise duty.

In early 2008 Chinese motorists paid roughly the same for their petrol as Americans did. Whereas the pump price in America has since jumped by 33%, Chinese prices have remained fixed, swelling the losses of state-owned refiners. According to Dragonomics, a Beijing-based economic research firm, the retail price for diesel is about 40% below that in America. To cut their losses, oil firms have reduced supply, causing shortages at some petrol stations. However, China is less likely than other countries to lift prices soon. Oil subsidies are estimated at less than 1% of GDP, and its budget surplus and small public debt mean that the government can afford to keep prices down for some time. Most likely, it will delay increasing fuel prices until food-price inflation has eased.

Across the emerging world, governments fear that lifting fuel prices will hurt the poor and so trigger social unrest. Yet fuel subsidies are an inefficient way to protect the poor: they mainly benefit the richer owners of cars and air-conditioners, and favour energy- and capital-intensive industries, rather than those that create most jobs. An IMF study of five emerging economies found that the richest 20% of households received, on average, 42% of total fuel subsidies; the bottom 20% received less than 10%. That money would be better spent on health, education and infrastructure. Not only would this benefit the poor, but higher prices would also help to dampen global oil consumption, and hence the price of oil.


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