Although reducing or eliminating subsidies will increase consumer costs, lower prices mean that the effect of removing subsidies is less dramatic. Therefore, low oil prices ease the pain of adjustment and allow governments to implement policy reforms that would otherwise create major political turmoil under high oil prices. Indeed, until the recent drop in oil price, popular opposition unravelled many reform efforts.
IMF urges energy-subsidy reform to ease squeeze on budgets - Reuters
In , Suharto of Indonesia announced increases in diesel and gasoline prices of 60 and 71 percent , respectively, spurring massive protests in a fatal blow to his regime. Yudhoyono achieved partial success in fuel subsidy cuts in and , only to reverse them , facing popular protests in Protests by political opposition, trade unions, and non-governmental organisations, however, ensured the reforms were partial and reversible by successor governments. In addition to popular opposition, vested interests complicate fuel subsidy reforms Overland ; IISD ; Vagliasindi To give an example, low gasoline prices benefit truckers with gasoline engines, while low diesel prices benefit farmers who use diesel in their tractors and irrigation pumps.
Out of self-interest, these groups often lobby against reforming subsidies. Low oil prices similarly reduce interest group pressure to maintain fuel subsidies. Under low oil prices, the cost to vested interests of subsidy removal is less severe.
Fossil fuel subsidy reforms and their impacts on firms
Although groups may anticipate oil prices to increase in the future, low current prices limit the cost of removing subsidies. Rational interest groups will therefore shift political efforts towards more pressing issues. Even so, Widodo shielded critical constituents from the effects of reforms, capping subsidies on diesel instead of abolishing them because diesel is the main fuel for public transport and fisheries. Even during a low-price environment, where opposition would be muted, certain sectors were still protected.
Similar to Indonesia, special considerations were made for public transport and fishing , shielding them from the effects of reforms. As the frustration felt by motorists at petrol stations and other consumers suggests, however, the government will need to continue treading carefully as to avoid overburdening the middle and lower middle classes , particularly in the scenario that oil price begins to rebound. Higher-capacity governments can implement more effective social safety nets.
The third political problem we highlight is low institutional capacity Victor ; Cheon et al Government that can implement a range of public policies will find less costly alternatives to fuel subsidies that can meet social welfare goals.
Energy Subsidy Reform: Lessons and Implications (IMF)
For example, effective governments can administer large direct monetary transfers, to low-income households. If the government can implement a cash transfer scheme, it can avoid the distortionary effects of subsidies on energy prices while continuing to give visible and salient benefits to the people. However, the implementation of cash transfer schemes requires institutional capacity. If not done properly, a cash transfer scheme may fail to produce benefits for the poor.
Here again, oil prices can be helpful.
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When oil prices are low, the size of the cash transfers or other benefits required to compensate for the higher fuel prices is smaller compared to times of high oil prices. Low oil prices mean that the government need not implement ambitious social policies; instead, modest benefits should be enough to secure popular support for replacing fuel subsidies with other policies.
Along with fuel price reforms, Widodo has launched social-protection programs such as Indonesia Health Card , Indonesia Smart Card , and Family Welfare Fund , lending substantial credibility to his commitment to improving social services. Although his partial reforms came with increased cash transfers to compensate the poor for their losses, there were still a lot of protests by the political opposition, trade unions, and non-governmental organisations.
After oil prices declined, Razak was able to push through more ambitious reforms. The current low oil prices present an opportunity to eliminate economically costly and environmentally destructive fuel subsidies with limited social and economic backlash. In September , the price of CNG for transportation was reviewed. Subsidy reform must be complemented by mitigation measures for the lower-income groups. The Government and authorities acknowledged the potential impact of price reforms and higher costs on households and businesses, especially among vulnerable groups such as low-income consumers, middle-income urban households, young working adults and senior citizens.
As such, in addition to cash transfers to these vulnerable groups, the government enacted the Price Control and Anti-Profiteering Act to reduce profiteering by businesses and firms. Savings from the subsidy reform process have been redirected to cash transfer programs intended to alleviate the potential negative impact of energy price increases on the poorest households and individuals.
In , the cash transfer program benefitted 7. Effective stakeholder engagement and communication with political backing is important.
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In the reform process, the government of Malaysia engaged with vulnerable communities at risk of being negatively impacted by the increase in energy prices by monitoring possible economic distortions and communicating the overall purpose of the reforms. Even so, it would have been even better for relevant information to have been communicated prior to the beginning of the reforms. It is important that a clear communication plan be in place prior to the start of the reform process.
- Energy Subsidy Reform - Lessons and Implications?
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Transparency and clarity around the price adjustment is crucial to reducing information asymmetry. The Malaysian Government continued to inform citizens of what the energy prices would be in relation to global market prices, thereby creating transparency and public trust, and assisting people in preparing for potential price shocks.
This paper discusses how firms are affected by, and respond to, energy price increases caused by subsidy reforms. It highlights that cost increases both direct and indirect do not necessarily reflect competitiveness losses, since firms have various ways to mitigate and pass on price shocks. View via Publisher. Save to Library. Create Alert.