GCC governments must articulate their objectives, define their strategy and communicate it effectively to successfully reform fuel subsidies, write Georges Chehade, George Sarraf and Yahya Anouti, advisors from Strategy& in the Middle East, based in Beirut and Dubai.
The deregulation of transport fuel prices in the United Arab Emirates as of August 1 is important and timely. The initiative will move the country toward a more sustainable path of development, a goal shared by other Gulf Cooperation Council countries.
Although transport fuel subsidies were established with good intentions, they represent a significant burden. In 2013, they cost GCC governments over $30 billion in pre-tax subsidies – equivalent to 2% of their combined gross domestic product according to the International Monetary Fund. These inadvertently support high per capita emissions of carbon dioxide and local pollutants, urban traffic congestion and accident fatality rates. In addition, subsidies have not been an effective mechanism for sharing the wealth created by the GCC’s abundant natural resources with the less-fortunate. Less than 10% of the value of the fuel subsidies flows to those with the least income.
Reforming fuel subsidies would help GCC states to lighten the pressure on their budgets, reduce the negative aspects of artificially high fuel consumption and stifle smuggling. Moreover, now is an opportunity for government to reform. Countries continue to enjoy strong economic growth and low oil prices. This means that the impact of the reform on people’s pockets will be minimal.
However, this opportunity comes with a caution. Subsidy reform is a sensitive issue as the backlash in Kuwait recently demonstrated. Recent experiences in resource-rich countries suggest that the success of the reform requires an integrated approach that includes three elements.
First, it is key to articulate the reform objectives and formulate a phased plan for removing existing subsidies. Among the objectives that governments may consider are wealth redistribution and improved living standards for the poor, and reduced budgetary burdens. Others include the elimination of economic leakages such as smuggling, economic development for targeted industries and environmental protection. Accordingly, policymakers should choose a pricing scheme best suited to achieving these objectives. They can then create a phased road map that sequences reform to minimise political resistance and the economic burden.
Second, this can be an opportunity to plough the money previously spent on subsidies back into the economy. This can involve more spending on public transport to soften the impact on consumers of any fuel price increase. Dubai, for instance, will repay the cost of its public transport infrastructure in less than three years by using this approach. Countries with large numbers of low-income citizens will require a compensation mechanism to protect these people, especially in high price environments. This mechanism may provide financial assistance, the provision of goods and services, and/or regulatory assistance. It should always take into account the cost and benefits of implementing and maintaining the mechanism and the needs of the targeted beneficiaries. The transparency necessary to track costs, and the potentially unintended consequences that accompany fuel subsidies should also be considerations.
Third, a national communication strategy is essential to make the case for reform and its benefits. This strategy should solicit both internal and external support. Internally, communication can enhance buy-in and alignment with reform among governmental agencies. Externally, it will make the case for reform with the general public and explain to stakeholders how they will be compensated, as well as how the savings generated by reform will be reinvested and fuel prices will be determined in the future.
By ensuring that these three elements are included in the reform, governments will be able to adopt more sustainable policy options and maintain the underlying objective of wealth sharing that originally gave rise to fuel subsidies.