A new paper from the International Monetary Fund (IMF) argues that the fall in energy prices provides an opportunity for governments in the region to reduce fuel and electricity subsidies.
A February 2015 paper* published by researchers at the International Monetary Fund (IMF) found that across Latin America and the Caribbean, government fuel and electricity subsidies (to reduce costs for consumers) amounted to 1.8% of GDP, on average, over the three years to the end of 2013. Fuel subsidies were equivalent to 1.0% of GDP, while electricity subsidies were slightly lower, at 0.8% (see chart).
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Pre-tax energy subsidies
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(% of GDP, average for 2011-13)
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Total
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Fuel
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Electricity
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Low-ranked*, and oil producers
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5.1
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3.7
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1.4
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Venezuela
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8.9
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7.1
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1.8
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Ecuador
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7.5
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7.0
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0.4
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Bolivia
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6.2
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6.1
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0.0
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Argentina
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3.9
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2.1
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1.8
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Belize
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2.7
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0.0
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2.7
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Suriname
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1.7
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0.0
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1.7
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Low-ranked*, and oil importers
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1.5
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0.3
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1.1
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Guyana
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3.0
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1.7
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1.3
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Haiti
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2.9
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0.2
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2.7
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El Salvador
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2.2
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0.7
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1.5
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Nicaragua
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2.1
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0.0
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2.1
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Dominican Republic
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2.0
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0.1
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1.9
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Honduras
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0.9
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0.0
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0.9
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Grenada
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0.9
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0.4
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0.5
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Guatemala
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0.4
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0.0
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0.4
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Jamaica
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0.1
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0.0
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0.1
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Paraguay
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0.1
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0.0
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0.1
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High-ranked*, and oil producers
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1.2
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0.9
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0.3
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Trinidad & Tobago
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2.7
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2.0
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0.6
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Mexico
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1.8
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1.1
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0.7
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Brazil
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1.2
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1.2
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0.1
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Colombia
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0.4
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0.2
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0.2
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Peru
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0.2
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0.2
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0.0
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High-ranked*, and oil importers
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0.4
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0.2
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0.2
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Antigua & Barbuda
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1.2
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0.5
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0.8
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Bahamas
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1.0
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0.4
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0.5
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Panama
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0.8
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0.3
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0.5
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Barbados
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0.8
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0.6
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0.2
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St Kitts & Nevis
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0.6
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0.1
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0.5
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St Lucia
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0.3
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0.3
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0.0
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Dominica
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0.1
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0.0
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0.1
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Uruguay
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0.0
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0.0
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0.0
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Chile
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0.0
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0.0
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0.0
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Costa Rica
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0.0
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0.0
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0.0
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St Vincent & the Grenadines
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0.0
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0.0
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0.0
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REGION
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1.8
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1.0
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0.8
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Ex. Low-ranked* and oil producers
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1.0
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0.4
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0.6
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Low income** countries
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2.2
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0.5
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1.7
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*In terms of institutional aspects, such as budget transparency, rule of law, competitiveness and ease of doing business.
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**Bolivia, Guyana, Haiti, Honduras and Nicaragua.
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Source: IMF Working Paper 15/30 of February 2015
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A separate study by the IMF in 2013 entitled 'Energy Subsidy Reform: Lessons and Implications’, found that, globally, energy subsidies typically ranged between 0.7% and 2.5% of GDP.
The latest paper found that, by this metric, subsidies varied very widely across the region. At one extreme, the governments of Uruguay, Costa Rica, Chile and St Vincent & the Grenadines provided essentially no subsidies. At the other, subsidies amounted to 8.9% of GDP in Venezuela. The country’s massive subsidy for fuel, which is effectively free at the petrol pump, accounted for the vast majority of this, representing 7.1% of GDP.
The IMF researchers classified the countries in four groups. The first group comprises oil producers with weak business operating and legal environments, as ranked by independent research institutes and non-government organisations (which consider institutional aspects like budget transparency, the rule of law, general competitiveness and the ease of doing business).
The second group included oil-importing countries with weak business operating and legal environments. The third group comprised oil exporters with strong operating environments, while the final group comprised oil importers also ranked highly for their institutional aspects.
As a general rule, fuel subsidies tend to be higher in countries that are oil producers. In this respect, the region is no different from other parts of the world. Globally, fuel subsidies are larger as a percentage of GDP in Saudi Arabia and Iraq than they are in Venezuela, with Algeria not far behind. The IMF paper also found that fuel subsidies tend to be higher in countries that are rated poorly for their institutional aspects. In the region’s oil producing countries, subsidies normally take the form of administered pump prices. In theory, this is a mechanism to spread the benefits of mineral wealth across society: in practice, it is usually the richer households (who consume the most fuel) that benefit disproportionately.
In oil importing countries, subsidies often arise from price stabilisation mechanisms: at times of high and volatile prices, these mechanisms involve substantial costs to governments.
Electricity subsidies, on the other hand, tend to be largest in low-income countries - and especially those in the Caribbean and Central America. In these countries, it is not uncommon for tariffs to be lower than generation and distribution costs. Moreover, fraud and non-payment for power by consumers is often also a problem.
The IMF identified a number of challenges arising from energy subsidies. Across the region as a whole, governments generally ran fiscal deficits of about 3% of GDP in the three years to end-2013. In a number of countries, there were higher energy subsidies and a worse-than-average budget deficit. Venezuela, where the government was running an estimated fiscal deficit of nearly 15% of GDP, is an extreme example. However, other countries in which energy subsidies were exacerbating relatively large fiscal deficits included Haiti, Mexico, Dominica, Honduras, Guatemala, Argentina and El Salvador. Subsidies represented a sizeable portion of tax revenues in many countries that were rated poorly for institutional aspects and/or were low-income countries. Over the three-year period, examples included Argentina (14%), Bolivia (20%), Haiti (23%), Ecuador (55%) and Venezuela (85%).
Sometimes, fuel subsidies are not accounted for in a transparent way: however, the IMF noted that stabilisation funds, whose balances adjust in response to changes in energy prices, normally provide a clear picture of what is happening. Sometimes governments are exposed to substantial contingent liabilities arising from the need to provide support power companies or state oil companies that are making low (or no) profits as a result of subsidies.
Energy subsidies are normally damaging for state-owned oil companies. In Venezuela, the woes of Petróleos de Venezuela (Pdvsa) have been exacerbated by the requirement that it sell refined products on the domestic market at extremely low prices and supply fuel on concessional terms to regional members of the left-wing Venezuelan government’s discount oil scheme, Petrocaribe.
In Brazil, Petrobras has suffered losses from its domestic refining and marketing operations in recent years, as it has been required by the government to sell refined products at below international prices. However, Petrobras has also enjoyed access to low cost funding through the state owned development bank, Banco Nacional de Desenvolvimento Econômico e Social (BNDES). In Trinidad & Tobago, the government’s arrears, in respect of subsidies, to the state-owned oil company Petrotrin amounted to 5% of GDP in 2013. However, most of the arrears were paid in 2014.
Electricity companies have also suffered as a result of subsidies. Typically, the requirement that utilities provide power at below-cost results in underinvestment over the long-term. In Argentina's case, electricity companies have been unable to meet peak demand for power, with the result that blackouts have been common. The IMF also noted: “Haiti appears to be in a circle of high generation costs, low investment, poor service, and high levels of theft and de facto subsidy”.
Resources allocated to subsidies are resources that are unavailable for other social purposes. The IMF paper observed that, across the region as a whole, energy subsidies were equivalent to around 45% of expenditures on health and education. For low-income countries, the equivalent figure was about 80%. It was 110% or so for oil exporting countries with weak institutions. Electricity shortages tend to have the greatest impact on low-income households, because they have no means to hedge against energy rationing (for instance through the purchase of their own generators).
Finally, another IMF report, 'Getting Energy Prices Right: From Principle to Practice', published in 2014, notes that energy prices in much of the region are too low, even when there are low or no subsidies. In essence, the rates paid by consumers for power or fuel are too low given the externalities associated with energy use - such as environmental damage, traffic congestion and health problems. That study found that gasoline prices were too low in those countries with subsidies, as well as in the Dominican Republic, El Salvador and Panama. Countries in which the price of diesel did not include the costs of externalities included Chile, Colombia and, to a lesser extent, Brazil and Peru.
The IMF argues that the current environment is generally ‘benign’ for the reduction of subsidies. This is partly because of the progress in poverty reduction in Latin America and Caribbean in recent years. It is also because some countries have already embarked on reforms. Furthermore, the fall in energy prices since mid 2014 has served to reduce the cost of many of the subsidies.
The paper acknowledges that a reduction in or removal of subsidies often results in lower growth and higher unemployment in the short term, with the benefits often only achieved in the long-term. Also, reform is often opposed by vested interests. For this reason, a reduction in subsidies needs to be backed by an effective communications program to emphasise to the public that citizens will benefit over the long-term. Finally, reforms need to take into account political cycles. The paper suggests that reforms be undertaken gradually (and with measures to mitigate their impact on low income groups) and be accompanied by a strengthening of governance structures in state-owned enterprises.
[*IMF Working Paper WP/15/30 - ‘Energy Subsidies in Latin America and the Caribbean: Stocktaking and Policy Challenges’, February 2015]