Newly elected and reelected leaders in Brazil, India, and Indonesia have a new impetus to jump-start reforms in their countries: falling global oil prices. Since July, the commodity has declined nearly 25 percent in value. While the reasons and benefits behind this cheap oil may be hazy, one policy implication is clear. It’s time to use this windfall to slash wasteful fuel subsidies in these and other emerging economies.
Fuel subsidies are poor policy. In short, providing cheap, subsidized fuel distorts local markets, reducing demand for potentially more efficient fuel substitutes and driving up demand for fossil fuels. This can have bad consequences for both consumers and the government.
First, subsidies must be paid for, and often this comes directly from the taxpayer. In Indonesia, for example, the government provides fiscal subsidies for fuel that amount to nearly $20 billion annually, or 13 percent of annual government spending. This makes it more difficult for governments to meet budget targets, and reduces funding for more productive initiatives, like infrastructure. According to the Energy Information Agency, fuel subsidies around the world reached over $410 billion in 2010.
Second, because most fuel is imported using hard currency, fuel subsidies can have deleterious effects on an economy’s (or a company’s) foreign balance sheet. Oil price shocks or currency fluctuations can deplete foreign reserves or exacerbate fiscal pressures and debt loads. Just ask Brazilian state-owned oil giant Petrobras. Government pressure to keep prices low and currency fluctuations over the past few years have cut into profits, threatened its credit rating, and prevented investment in more production.
The time for reform is now. Low oil prices reduce the shock of removing fuel subsidies and moving to market-based pricing. Proposed reforms by recently elected President Joko Widodo in Indonesia would increase prices by 50 percent. This would be much more difficult if prices were high. Reforms in other countries, like India and Brazil, can also be accomplished at a much smaller burden to consumers.
Stronger currencies add to the benefit of reforming now. Over the past six months, stronger local currencies in these countries have increased their purchasing power against the dollar. This means imported, dollar denominated oil is now cheaper than it was six months ago.
India is out in front on this issue and leaders in Brazil and Indonesia should follow its lead. Last week, Prime Minister Narendra Modi announced his intention to raise natural gas prices and deregulate diesel fuel price controls. While this is only a beginning, it’s certainly a good start. President Widodo and Brazilian President Dilma Rousseff should follow suit, regardless of the political complexities.
Collectively, Brazil, India, and Indonesia represent one-quarter of the world’s population. Ending subsidies now would go a long way to addressing fiscal uncertainties and reorienting government investments to more productive means. These countries should not overlook this once-in-a-generation opportunity.