Price-subsidy reform is a key element of IMF-supported programs in many countries because it releases resources for social services, improves efficiency, and facilitates pro-poor growth. Nevertheless, it may have adverse social and political effects. Based on its experiences in a broad range of countries, the IMF has published a guide for policymakers on how to design and implement sound price-subsidy reforms that take into account both economic and social considerations. A brief description of the guide, which was prepared by staff of the Expenditure Policy Division in the IMF’s Fiscal Affairs Department, follows.
Large budgetary savings from price-subsidy reform are difficult to achieve in the short run. Of 23 countries for which data are available, only 2 eliminated subsidies in one year, while 6 achieved significant savings over two years. Many countries needed time to provide protection to the poor through temporary social safety nets before they initiated price reforms. The guide shows that the speed of reform is affected by how quickly the fiscal benefits from the reform can be realized and the cost of protecting the poor, the availability of social protection instruments and administrative capacity to design and implement social safety nets, and the willingness of governments to implement reforms.
Social safety nets should be targeted to the poor with minimal leakage to the nonpoor and be consistent with economic incentives and macroeconomic targets. An accurate means test would provide such efficient targeting, but assessing household income is often not feasible. As an alternative, benefits can be targeted to certain population categories (for example, children, the elderly, and the unemployed) or those living in certain areas. In cases where basic data on the poor are lacking, and governance and the administrative capacity are weak, countries have established self-targeted social safety nets. Self-targeting includes food-for-work programs and public works programs. It can also involve subsidizing lower-quality necessities mainly consumed by the poor, such as brown sugar and coarser rice. Finally, government can protect the poor by limiting subsidies to a fixed low quantity for each household or by providing cash transfers equal to the loss to poor households resulting from price-subsidy reform.
When reform targets the poor, middle-class groups may lose. As a result, public support for reforms may erode. Violence may even erupt, though it has been the exception and is often not triggered by subsidy reform alone. To evaluate political risks, policymakers should quantify losses, identify winners and losers, and assess their political strength. Political fallout can be minimized by embedding subsidy reform in a broadly publicized program that engenders broad support and yields widespread benefits.
The guide draws a number of key lessons from country experiences. Mechanisms for protecting the poor should be established before initiating subsidy reform and should be temporary. The risk of political disruption is highest when rapid reform is attempted without social protection mechanisms and the government is unpopular. Finally, unrest is minimized through wide consultations, avoiding an undue burden on any single group, and mass information campaigns.
Copies of Equity and Efficiency in the Reform of Price Subsides: A Guide for Policymakers, prepared by the Expenditure Policy Division of the IMF Fiscal Affairs Department, are available for $15 each from IMF Publication Services. See page 13 for ordering information.
Photo Credits: Denio Zara, Padraic Hughes, Pedro Márquez, and Michael Spilotro for the IMF, pages 1, 7, 18–20; and the Korea National Statistical Office, pages 11–12.