Comparative Subsidy Reform

Egypt’s difficulties in implementing subsidy reforms are not uncommon. Many countries have encountered challenges while implementing energy subsidy reform. According to the International Monetary Fund (IMF), reductions in energy subsidies have often led to widespread public protests and to either a complete or partial cancellation of price increases.  (1) However, some countries have managed overcome the initial difficulties and have been able to reform their subsidy systems. This article explores three cases where countries in the Middle East that have implemented energy subsidy reforms in order to gather lessons that maybe applicable to Egypt’s current situation.

Jordan has partially reformed its subsidy system on several occasions. In 2005, the government decided to phase out fossil fuel subsidies within three years due to the war in Iraq, which increased the country’s energy subsidy costs from $60 million in 2002 to $711 million in 2005.(2)  In 2008, the government began adjusting retail petroleum prices monthly based on a formula for an international benchmark netback value, reducing its subsidy costs from 5.6 percent in 2005 to 0.4 percent of GDP in 2010.

The reform went relatively smoothly due to a wide-ranging compensation package that included increasing minimum wage, cash transfers, tax exceptions for basic goods and temporary removal of sales tax for taxis and public transport. The subsidy on liquid petroleum gas (LPG) was not removed in order to protect low-income households. A large public communication campaign and consultations with community stakeholders also contributed to the successful implementation of the reforms.

As a result of the reform, fossil fuel prices reached higher than in the US. In late 2010, the government decided to freeze prices in order to protect consumers from the volatility of oil prices. (3) Over the next few years, fuel costs quintupled, reaching 18 percent of Jordan’s GDP. In September 2012, Jordan attempted another fuel subsidy reform that was suspended when protests erupted.(4) The government made a second attempt to reduce subsidies in November 2012, announcing that the price of motor fuel would increase 14 percent and the price of gas used for cooking by 50 percent. Initial protests diminished, possibly due to the compensation of JOD 70 ($100) to individuals with annual incomes less than JOD 10,000.(5) Even though the liberalization of fuel prices has increased inflation, the IMF remains cautiously optimistic about the prospects of the Jordanian economy.(6)

Iran is the first major oil-exporting country in the region to implement comprehensive subsidy reform. The IMF estimates that between 2006-2009 oil, gas and electricity subsidies amounted to more than 20 percent of Iran’s GDP.(7) By 2009, Iran’s subsidies were the highest in the world, reaching $82 billion, according to International Energy Agency (IEA)(8). The government’s 2010 reform initiative sought to replace subsidies on food and energy with targeted social assistance, so that domestic prices would rise to 90 percent of international prices within five years.(9)

In the first phase of the reform, prices of the main petroleum and natural gas products, as well as electricity, water and bread were increased.  Multitier tariffs on electricity, natural gas and water were utilized to minimize the impact on low-income households. An existing smart card rationing program for gasoline remained in place. However, the prices of rationed gasoline were raised but remained significantly below the full price at which consumers could purchase an unlimited quantity.

Initially, the government planned to introduce compensatory transfers only to low-income households. However, due to unreliable data and fear of triggering discontent in higher-income households, monthly compensatory transfers of $40 were made available to all households. The compensation consumed approximately 80 percent of the revenue generated from the price increases, while the remaining 20 percent was set aside for enterprise restructuring.(10)

The reform was preceded by an extensive public relations campaign. Additionally, the authorities deposited compensatory transfers into the bank accounts of households prior to the price increases, boosting public confidence of the reform(11). These strategies helped mitigate public opposition.

The reduction of subsidies successfully decreased consumption. In the first year following the reform, consumption of fuel oil dropped 36 percent, petrol by 5.6 percent, diesel by 9.8 percent and kerosene by 2.9 percent. (12) An exception was natural gas consumption, which grew 6 percent. In addition to reducing consumption, the reform had redistributive effects, as the compensation represented a larger share of income to the lower class.

Despite success in reducing consumption, members of parliament have criticized the government’s “shock therapy” approach for creating uncontrollable inflation.(13) In October 2010, two months prior to the start of the reforms, the inflation rate was around 12 percent, but in April 2012 it reached 22 percent. Fearing public unrest, authorities prohibited producers and retailers from increasing product prices. These price controls combined with rising production costs forced many small- and medium-size businesses into bankruptcy.(14)

Even though sharp subsidy reductions provided the government with funds for compensation transfers, it has been reported that the subsidy program has so far been a financial loss(15). In order to cover the deficit from the compensation programs, the government had to take a loan from the Central Bank, fuelling inflation. In mid-2012, the government postponed the implementation of the second phase of the reform due to parliament’s concerns over inflation.(16) Overall, the IMF views the reform as a partial success.(17)

Turkey is one of the few countries that the IMF considers to have successfully carried out subsidy reform.(18) The country undertook a series of reforms to achieve full price liberalization, privatization of state-owned enterprises and a competitive energy market.(19) Turkey began liberalizing energy pricing in the late 1980s and sustained the reforms under the administration of various political parties. Aided by wider economic reforms to enter the EU, energy sector reforms have experienced little opposition and setback, even though just a few mitigating measures were adopted.

Petroleum sector reform started in 1989 when private companies were allowed to set prices and in 1990, privatization of public companies began(20). In 1998, the government adopted the Automatic Pricing Mechanism, which set a ceiling on the prices of almost all oil products based on international prices and the exchange rate. Then in 2003, the regulatory authority over the petroleum product market moved to an independent agency, ensuring reform consistency. Fuel prices became fully liberalized in 2005.
In the electricity market, the government started moving to full cost recovery in 2008. In January, it raised electricity prices by 20 percent(21). In March, a new pricing mechanism was approved which enabled the adjustment of electricity prices quarterly based on the changes in the cost of supply. As a result, electricity prices were more than 50 percent higher by the end of 2009 compared to before the reform. 

Mitigating measures that were implemented during these reforms included tax exemption for public transportation and for LPG consumption, as well as a rebate for diesel used in agriculture.(22) According to the IMF the impact on household welfare was limited due to relatively high household incomes in Turkey(23). However, research by the World Bank indicates that the removal of subsidies resulted in a larger welfare loss to lower income households.(24) For example, financial loss from the 2008 electricity price increases was 2.16 percent of disposable income for the bottom quintile of the households compared to 0.75 percent for the top.

In Turkey, the short-term negative impact of energy reforms on the population’s welfare has been limited due to relatively high household income(25). Turkey’s economy has grown steadily over the past two decades, accompanied by relatively low inflation, ensuring public confidence in economic liberalization.

Lessons From Reforms
The IMF has identified six key elements for subsidy reform. These are: “(i) a comprehensive energy sector reform plan entailing clear long-term objectives, analysis of the impact of reforms, and consultation with stakeholders; (ii) an extensive communications strategy, supported by improvements in transparency; (iii) appropriately phased price increases; (iv) improving the efficiency of state-owned enterprises to reduce producer subsidies; (v) targeted measures to protect the poor; and (vi) institutional reforms that depoliticize energy pricing, such as the introduction of automatic pricing mechanisms.”(26) As illustrated by the case studies of Iran, Jordan, and Turkey energy subsidy reform requires a well-designed plan that addresses all of the objectives highlighted by the IMF. However, there is no cookie cutter model for successful reform as each country has its own unique challenges. With Egypt’s estimated 13.7 million people, or 17.2% of the population, unable to provide sufficient food for their families, a subsidy reform of both food and fuel subsidies will have to ensure that the poor do not end up worse off in the long run.   Given Egypt’s current financial crisis, the government will inevitably face difficult decisions in designing and implementing energy subsidy reform. The polarized political sphere will necessitate transparency and an effective communication campaign in order to mitigate public opposition. Osama Kamal, Egypt’s previous Petroleum Minister, stated that fuel subsidies would be totally lifted within three to five years, but many are doubtful of that time frame. There are also plans on the table to introduce ration cards for distributing butane canisters and other subsidized fuel, but the government continues to shuffle its feet and had delayed implementing them. Sherif Haddara, Egypt’s newest Petroleum Minister, said in May that these ration cards will be introduced by September, which is the second such delay since they were initially proposed last year.  However, before this plan can work databases of eligible recipients will have to be updated and an effective mechanism for tracking ration cards will have to be implemented to discourage corruption. This may be hard in Egypt where the government doesn’t even have an exact number count of gas stations in the country, making fuel ration card usage hard to track. Additionally, a system like this has never been seen in Egypt and many fear there will be big abuses of the system.
Subsidy reform is a daunting task, but Egypt is faced with no other option as it faces in economic crisis. Whatever the government decides to implement, their ability to use the savings on the safety nets for the poor will be a key determinant of public confidence in the reforms.

  1. IMF, Energy Subsidy Reform: Lessons and Implications. (2013). 
  2. Vagliasindi, Maria. Implementing Energy Subsidy Reforms: Evidence from Developing Countries. (2012).
  3. Ibid.
  4. The New York Times Riots Erupt Across Jordan Over Gas Prices (November 13, 2012).
  5. Jordan News Agency, 70% of Citizens Received Cash in Fuel Subsidies. (December 12, 2012).
  6. IMF, Country Note on Jordan (2013).
  7. Vagliasindi, Maria. Implementing Energy Subsidy Reforms: Evidence from Developing Countries. (2012).
  8. Albawaba Business MENA biggest spender on subsidies (April 24, 2013).
  9. IMF Case Studies on Energy Subsidy Reform: Lessons and Implications (2013).
  10. Ibid.
  11. Salehi-Isfahani, D The impact of Iran’s subsidy reform on households: Evidence from survey data.  (2012).
  12. Ibid.
  13. International Institute for Sustainable Development, Recent Developments in Iran’s Energy Subsidy Reforms. (October 2012).
  14. Ibid.
  15. Salehi-Isfahani, D The impact of Iran’s subsidy reform on households: Evidence from survey data. (2012).
  16. International Institute for Sustainable Development, Recent Developments in Iran’s Energy Subsidy Reforms. (October 2012).
  17. IMF, Energy Subsidy Reform: Lessons and Implications. (2013). 
  18. Ibid.
  19. IMF Case Studies on Energy Subsidy Reform: Lessons and Implications (2013).
  20. Ibid.
  21. IMF Case Studies on Energy Subsidy Reform: Lessons and Implications (2013).
  22. Ibid.
  23. Ibid.
  24. Vagliasindi, Maria. Implementing Energy Subsidy Reforms: Evidence from Developing Countries. (2012).
  25. IMF Case Studies on Energy Subsidy Reform: Lessons and Implications (2013),
  26. IMF, Energy Subsidy Reform: Lessons and Implications. 2013. 

By Maya Moseley and Laura Raus


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