Subsidies and price controls can be found in a range of products including petrol, natural gas, electricity, cooking oil, sugar, toll charges and bus fares, which account for about 20% of the consumer price index (CPI) basket.
RISING consumer price pressures and cost of living have exerted pressure on the government to increase subsidies and implement controls (ceilings) to keep prices of food and services at reasonable levels for the poor, lower and middle-income households.
Subsidies and price controls can be found in a range of products including petrol, natural gas, electricity, cooking oil, sugar, toll charges and bus fares, which account for about 20% of the consumer price index (CPI) basket.
It is estimated that without the subsidies (RM51bil) for these products, the inflation rate could have been higher at 11.4% instead of 2.8% in May 2022.
As of now (2022 year-to-date), the government has provided the largest ever subsidies of RM77.7bil: RM37.3bil for petrol, diesel and liquefied petroleum gas; RM4bil for the one-kg packet cooking oil; RM10.1bil for electricity, chicken and eggs; RM11.7bil for the cash handouts and the balance of RM14.6bil for various forms of aid.
The subsidies of RM77.7bil in 2022 are estimated to make up 31.2% of total revenue and 4.6% of gross domestic product (GDP).
This marks the highest amount on record as previous highs were in 2008 (RM35.2bil or 22.0% of total revenue and 4.4% of GDP); and during the period 2011-2014 (between RM36.2bil and RM44.1bil or 18.1% to 21.4% of total revenue and between 3.5% and 4.9% of GDP).
The political economy of reform
These well-intended subsidies and controls offer some relief and protect consumers by keeping prices low in the current environment of rising consumer price pressures and cost of living, but they come at a high cost.
On the face of it, it appears inconsiderate and insensitive to gradually remove such subsidies as it would further aggravate the plight of those who are already struggling.
But these untargeted price subsidies come with high economic and fiscal costs. It is construed as one of the most expensive and regressive fiscal policy.
Though the aspects of fiscal sustainability and equity validate the much-needed subsidy and price reforms, the political consideration of populist messaging to avoid political backlash has made the subsidy reform difficult to take hold.
Consumption-based subsidies such as fuel and food skewed away the distribution of income and further widened the income disparity.
They are typically regressive in nature and the bulk of subsidies benefiting the high percentile of the income distribution. The Finance Ministry has estimated that more than half of the total subsidies have benefited the higher income or the T20 group.
The enormous subsidy bill has also strained the fiscal budget. Unsustainable subsidies can deepen the budget deficit, forcing the government to borrow more and increases debt.
It is estimated that the share of subsidies to total revenue has been increasing from an average of 14.3% per annum in 2012-2019 to 16.6% per annum in 2020-2022.
In 2022, it is estimated that the share jumped to 31.2% of total revenue, largely boosted by fuel subsidies.
It is estimated that the share of subsidies to total GDP declined from 2.7% per annum in 2012-2019 to 1.4% per annum in 2020-2021 before rising to 4.6% in 2022.
Subsidies come with a huge “opportunity cost” to society. It reduces the fiscal capacity as the huge financial resources spent on subsidies have diverted the budget’s allocation from other sectors such as education, healthcare, infrastructure and housing.
Subsidy programmes encourage waste and degrade the environment. When the products’ prices are cheap and heavily subsidised below market prices, it encourages excessive consumption and wastage as demand shifted towards subsidised products.
It also distorts the real market price equilibrium as the artificially low subsidised prices perpetual the misallocation of resources toward less productive economic activities.
Energy subsidy and inefficiency usage also impact the environment. Countries with large fossil fuel and energy subsidies tend to have a poor track record on environmental conservation and energy efficiency.
With cheap and subsidised fuel augmented by easy credit facilities and the car ownership policy, we have more vehicles on the road, causing traffic congestion and pollution through carbon emission and this worsens climate change.
Likewise, the removal of the electricity tariff subsidy will cause the source of generating electricity moving towards green environmental sustainability.
Subsidies foster corruption as the profiteers take advantage to arbitrage on the price differential between the subsidised products and services and consumption. This creates hoarding, black market and smuggling activities across the border.
Finally, in a competitive market, when price subsidies and controls held the prices below real market levels, and in some situations, price ceilings were fixed below the producers’ costs, producer profit margin will be affected while investor capital would leave the industry to seek a better return.
There will be less investment, production and the supply of products for consumers.
A plan for price subsidies and control reforms
Why are subsidies so difficult to reduce? How to manage the disrupted economic and social impact?
To put it simply, many governments have had difficulty reforming subsidies as they are afraid of disrupting the political equilibrium. When subsidy reforms are made, consumers will feel the pinch of rising prices and this has often led to widespread public protests.
Where there is a lack of public confidence in the government’s governance of fuel subsidy savings to implement programmes that compensate the lower and middle-income households, they will find the targeted spending less credible and will resist subsidy reform.
Drawing the countries’ experiences of implementing the subsidy reform, the following 3 “Cs” – credible, compensation and communication – are the important principles.
> Credible – Shifting from universal-access subsidy programme to targeted programme requires a comprehensive and transparent mechanism with clear objectives to identify poor households and to deliver benefits. The introduction of automatic pricing mechanisms and phased-in price increases to smoothen adjustment.
> Compensation – Targeting by social category through targeted cash or near-cash transfers such as limiting benefits to the poor; children or pensioners, or to households in certain geographical regions.
Coupons can be allocated to allow targeted households to consume a certain “lifeline” amount of subsidised food or fuel products. Social safety nets are more cost effective and have a much more profound impact than generalised price subsidies.
> Communication – Transparent and extensive communication to explain why we have to shift from products subsidy to targeted households that will benefit the vulnerable households more; how the resources saved from a universal subsidy programme will be redeployed for other priority spending such as public infrastructure, caring for an ageing population, better healthcare, better education for future generations, or help combat climate change.
In addition, publish regularly information on the size of targeted social assistance programme and how they affect the government’s budget.
Strong political courage is needed to implement difficult subsidy reform. Transparency and stakeholder dialogue are the cornerstone of subsidy reform in determining its design, passage and implementation.
A well-handled removal of subsidies and be replaced by better targeted social spending for the poor and vulnerable households, plugging leakages and wastage, and productive investments can promote sustainable fiscal management and equitable outcomes.Lee Heng Guie is executive director of the Socio Economic Research Centre. The views expressed here are the writer’s own.
