Front Matter

Author(s):
Carlo Sdralevich, Randa Sab, Younes Zouhar, and Giorgia Albertin
Published Date:
July 2014
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    © 2014 International Monetary Fund

    Cataloging-in-Publication Data Joint Bank-Fund Library

    Subsidy Reform in the Middle East and North Africa : Recent Progress and Challenges Ahead / Carlo Sdralevich, Randa Sab, Younes Zouhar, and Giorgia Albertin. – Washington, D.C. : International Monetary Fund, c2014.

    pages ; cm

    Includes bibliographical references.

    ISBN: 978-1-49835-043-3

    1. Subsidies—Middle East. 2. Subsidies—Africa, North. I. Sdralevich, Carlo. II. Sab, Randa. III. Zouhar, Younes. IV. Albertin, Giorgia. V. International Monetary Fund.

    HC415.15.Z9 S9 2014

    Disclaimer: The views expressed herein are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its member countries.

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    Contents

    Acknowledgments

    The authors would like to thank Masood Ahmed, Director of the Middle East and Central Asia Department, and Daniela Gressani, Deputy Director of the Middle East and Central Asia Department, for their guidance and comments.

    Special thanks are due to Andreas Bauer, Paul Ross, and Samah Mazraani for their contributions; Ozgur Demirkol for the box on Iran; Gohar Abajyan, Mark Fischer, Kamal Krishna, Anna Maripuu, and Rafik Selim for research support; Kia Penso for editorial assistance; Norma Cayo and Cecilia Pineda for administrative support; and Joanne Johnson of the Communications Department.

    The authors would also like to thank Khaled Abdelkader, Prasad Ananthakrishnan, Alberto Behar, Nabil Ben Ltaifa, Abdelrami Bessaha, Martin Cerisola, Benedict Clements, David Coady, Valerio Crispolti, Javier Arze del Granado, Ozgur Demirkol, Stefania Fabrizio, Andrea Gamba, Edward Gemayel, Claire Gicquel, Christopher Jarvis, Andrew Jewell, Kadima Kalonji, May Khamis, Roland Kpodar, Prakash Loungani, Alina Luca, Edouard Martin, Amine Mati, Samah Mazraani, Luc Moers, Eric Mottu, Sanaa Nadeem, Lawrence Norton, Sergio Rodriguez, Issouf Samake, Marika Santoro, Gazi Shbaikat, Robert Sierhej, and SeokHyun Yoon, as well as Shantayanan Devarajan, Thomas Laursen, and Maria Vagliasindi, World Bank staff, for their comments.

    Executive Summary

    In the Middle East and North Africa (MENA) countries, generalized price subsidies have for many years been part of the “social compact” and are still common, especially on food and fuels. Yet, generalized price subsidies are neither well targeted nor cost-effective as a social protection tool. Though subsidies may reach the poor and vulnerable to some extent, they benefit mostly the better off, who consume more of subsidized goods, particularly energy products: for example, in Egypt in 2008, the poorest 40 percent of the population received only 3 percent of gasoline subsidies.

    Subsidies are not only inefficient in supporting the poor, but they also impose a much heavier burden on the public finances than more targeted social protection tools. In addition, subsidies—especially those on energy products—impose welfare costs by distorting relative prices in the economy, which fosters overconsumption. Overconsumption, in turn, reduces exportable resources and thus limits wealth accumulation for energy-exporting countries, and weakens the current account of energy-importing countries. In addition, it leads to adverse impacts on congestion, health, and the environment, and inefficient specialization of domestic production, often in less labor-intensive industries.

    Subsidies also discourage investment in the energy sector and crowd out growth-enhancing public spending. Finally, subsidies encourage smuggling and black market activity, which can lead to shortages of subsidized products. All this has a dampening effect on growth potential, deriving from price distortions, which reduce efficiency in the allocation of resources, crowding out productive spending on human and physical capital, and higher inequality linked to inefficient support of the poor.

    MENA countries spend on average much more on subsidies than other regions, and have increasing difficulty financing them. Total pretax energy subsidies in 2011 cost $237 billion—equivalent to 48 percent of world subsidies, 8.6 percent of regional GDP, or 22 percent of government revenue. They amounted to $204 billion (8.4 percent of GDP) in oil exporters and $33 billion in oil importers (6.3 percent of GDP). For 2012, preliminary IMF estimates show that pretax subsidies for diesel and gasoline only, which represent about half of total energy subsidies in MENA, were 3.8 percent of regional GDP. Food subsidies are also common in MENA countries, though less costly. In 2011, they amounted to 0.7 percent of GDP for the region, though they were distributed unevenly among countries.

    Subsidy spending has risen in response to commodity price increases and the greater social demands that have accompanied the wave of political transitions in the region. In many oil-importing countries, cheap subsidized prices have contributed to a widening of current and fiscal deficits, often against the backdrop of relatively large or rising public debt levels. In these countries, fiscal consolidation through subsidy reform is needed to avoid risking solvency crises, which would be socially and economically costly. At the same time, rapidly rising fiscal breakeven oil prices in oil-exporting countries have also highlighted rising fiscal pressures. In these countries, subsidy reforms that would align energy prices closer to world market or cost recovery levels would increase revenues and support fiscal sustainability.

    As a result of these pressures, subsidy reform has recently gained a new momentum in the region; in particular, several MENA countries have taken steps to lower energy subsidies. Sustained progress in these countries will require additional efforts to consolidate their gains, by introducing or implementing rigorously automatic price setting mechanisms—which could be coupled with smoothing mechanisms to avoid sharp domestic fuel price volatility—and extending the scope of reform to tackle energy subsidies to enterprises and restructure the energy sector. Well-targeted and adequately resourced social safety nets will also be needed to cushion the impact of price increases on the vulnerable. These measures are equally relevant for oil-importing and oil-exporting countries.

    Replacing generalized subsidies with appropriate social safety net instruments could lead to stronger social protection and generate, at the same time, substantial fiscal savings. Social safety nets that target poor households—such as conditional or unconditional cash transfers, in-kind transfers, or nongeneralized price subsidies—are more efficient than generalized price subsidies. Moreover, because targeted social safety nets are more cost-effective, they leave more fiscal resources for other priority spending, such as investment in infrastructure, education, and health, which would also benefit the wider population.

    Removing generalized price subsidies and replacing them with more equitable and efficient social safety net instruments pose, however, a number of challenges. The removal of subsidies will in the short term have inflationary effects and adversely affect the competitiveness of industries that rely on subsidized products and services as inputs. However, in the medium term, subsidy reform will have positive effects on growth by eliminating distortions, rationalizing energy use, increasing export revenues in oil exporters, enhancing competitiveness, and strengthening budget structure.

    Perhaps the biggest challenges to subsidy reform arise from its political economy aspects. Beneficiaries of the status quo will resist losing the tangible benefit that subsidies provide. Obstacles can take the form of resistance from a small but organized group of potential losers from reform, the tension between the immediate loss of subsidies and the future benefit from more targeted and efficient social spending, and the lack of trust in the state’s capacity to introduce and manage social safety nets. These areas of resistance can be addressed through appropriate reform elements, primarily transparency as to the cost and beneficiaries of subsidies, and effective communication of the advantages of reform.

    Successful subsidy reforms that overcome these challenges share common features. Reforms are considered successful if they deliver better support to the poor and achieve significant and durable budgetary or quasi-fiscal savings, while avoiding social and political disruptions that could lead to reversal of the reform. Although experience shows that there is no single recipe for success—and indeed governments should tailor reform strategies to individual country situations—a cross-country study of subsidy reforms finds that initial economic, social, and political conditions are important, and identifies a number of factors that have often accompanied successful episodes:

    • Thorough preparation, including clear diagnostics and careful planning of the pace and breadth of reform. In this regard, the role of partners—in particular, technical assistance from international stakeholders to help guide governments in designing, sequencing, and implementing the reform—is key;

    • Strong ownership and commitment of the government to reform, which can be achieved by building consensus for reform, involving key stakeholders such as political parties, civil society, and the private sector, and communicating clearly and effectively to publicize the costs of subsidy systems, who benefits from them, and the benefits of the reform;

    • The introduction or scaling up of effective social safety nets to mitigate the impact of subsidy reform on the vulnerable;

    • Favorable economic conditions, particularly higher economic growth; and

    • A multiparty government that builds consensus for reform among different parties, and, therefore, makes reform less likely to be reversed.

    Experience also indicates that there are measures that can be taken in parallel or in advance of launching comprehensive reform, to prepare the ground for future action. In particular, governments can improve transparency and awareness about the costs and beneficiaries of subsidies, and gather data and information on household consumption and poverty that will help establish or improve social safety nets. Past reform cases have shown that it takes several years for the preparation, consensus building, and implementation of well-designed subsidy reforms. Thus, governments should start acting now to prepare the ground to achieve successful and durable reform later.

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