Targeting subsidies key to efficiency

Alex Dziadosz
8 Min Read

To see why public outrage follows every rumor that subsidies will be removed here, one need not look further than Egypt’s winding queues for subsidized bread and gasoline.

For over half a century, subsidies have been central to the Egyptian economy. But this year, fluctuating commodity prices revealed some of the difficulties posed by the current system, under which the state pays the difference between a subsidized sale price and market price of many fuels and foodstuffs.

Soaring prices at the start of the year ate into the state’s budget, forcing officials to raise energy prices ahead of expectations. Now, an impending slowdown has further complicated matters.

The state has already delayed one phase of a three-year plan to cut subsidies for energy-intensive industries. And though most believe they will continue with this push, how and when are under debate.

The background

Subsidies swelled under the post-revolution reigns of Presidents Gamal Abdel Nasser and Anwar Sadat, growing to one-seventh of the state’s expenses by 1980, according to a report by American University in Cairo (AUC) professor John Salevurakis.

Between 1986 and 1991, subsidy-fueled deficits reached as high as 15 percent of the country’s gross domestic product, before falling to 1.3 percent between 1992 and 1996, Salevurakis wrote.

The current system has been through decades of policy changes and broader economic shifts. Food subsidies are now limited mostly to bread, sugar and food oils. Energy subsidies go to kerosene, butane, natural gas, mazot (fuel oil), diesel and gasoline. The state also issues a clutch of smaller subsidies to promote local industry, housing, transportation, agriculture, exports and a few other sectors.

While Egypt’s subsidized bread program is reputedly among the largest in the world, energy subsidies have accounted for as much as 85 percent of the nation’s subsidy budget in recent years.

Subsidies related to fuel are also more likely to benefit the rich than are food subsidies, and so breed more controversy.

So far, there have been few realistic suggestions to ensure that fuel subsidies better target the poor, said Abdel-Fattah El Gebely, an economist at the Al-Ahram Center for Political and Strategic Studies.

One reason is geography, he suggested. “For instance, the bread. You cannot say that I will sell this bread in a poor area, not in a rich area. Because in rich areas, there are poor, in poor areas there are rich, he said.

This also applies to energy subsidies, he added. Both 90-octane gasoline, which is widely used by the rich, and diesel, which is mostly used by the poor, are both subsidized, for instance.

There is also enough space between market and local prices for a sizeable black market to thrive. Cases of bakers selling subsidized flour at big markups were widely reported this year.

“If you take the food subsidies, especially those going to wheat, we have a lot of problems with misuse of this money, said El Gebely.

The vagaries of market prices also make it hard for the state to budget accurately. Subsidies expectations are based on the likely cost level of commodities like wheat and oil, said Reham ElDesoki, senior economist at Cairo-based investment bank Beltone. “But the cost level is sort of a moving target, she said.

Scaling back

Faced with a stagnating economy in the late 70s, President Anwar Sadat turned to the World Bank for loans. Responding to the bank’s criticisms of the by-then expansive subsidy system, he announced the state would repeal its support of many food prices. The “bread riots that followed were so severe that many observers compared them to the anti-colonial uprisings of 1919.

Food subsidies were eventually restored, but the state continued to restructure the system – often at the behest of the International Monetary Fund – throughout the late 80s and early 90s.

In September 2004, officials began a round of hikes for local fuel prices, first raising natural gas and diesel prices. Hikes followed in July 2006 and January 2008.

This year, soaring oil prices led the state to spend LE 57 billion of the budgeted LE 65 billion by midway through the fiscal year 2007-2008.

In May, Parliament approved another increase for a variety of fuels. Although the state had announced its plans to phase out energy and gas subsidies for energy-intensive industries, the timing of the decision surprised many.

Adel Beshai, an economics professor at AUC, criticized the speed of the move. “Even the father of laissez-faire, Adam Smith, says, ‘when you change policy do so by slow gradations,’ he said.

The road ahead

The state allocated LE 67 billion for subsidies this fiscal year, assuming an oil price of $100 per barrel. Commodity prices have since fallen well below these levels, but it is unclear how much the state will save, analysts say.

Market shifts take time to transfer to local spending because many contracts for food and fuel are signed in advance, ElDesoki said.

“When they buy wheat today, it is not same-day delivery, she said, referring to government purchases for food subsidies.

Accordingly, subsidy spending is expected to rise into 2009. “It’s just an improvement from a very bad situation they were going to be in, she said.

ElDesoki and other analysts expected the state would raise energy prices in the second half of 2009, when inflation is expected to cool to single digits. But the state recently announced that it will not raise gas and electricity prices until the end of 2009, as they try to spur the economy through the global slowdown.

So while the economic crisis will complicate spending, subsidies will likely remain intact for now. What is important in the meantime, analysts say, is ensuring that subsidy money is well-spent.

While spending is substantial, the benefits of subsidies are limited, said El Gebely. “We should increase the subsidies, but it should go to the people who [need it], he said.

Food subsidies, he said, should be distributed more carefully so that the black market is curtailed. They should also be targeted differently for areas with different incomes, he added.

As for oil and energy prices, El Gebely said, they should be raised gradually to meet market prices, as long as those which benefit the poor most are protected.

For instance, the prices of fuels commonly used for farm equipment and microbuses should be increased at a slower rate than those used for luxury cars.

“Increases in any of these will increase the burden of the poor, El Gebely said.

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