Why a spaghetti ball makes subsidy reform in Egypt hard

Egypt is in deep troubles – its fuel subsidy bill is unsustainable reaching almost 30 percent of government expenditure, its foreign reserves have reached a critical level ($13,5bn), negotiations with the IMF are not running well, and there is, literally, no money left to finance its consumption of subsidised fuel, particular diesel which is already rationed. Egypt has to act, now, or it falls apart. But why government officials are so hesitant to reform an unsustainable subsidy system, although the country really hasn´t got another choice?

The first intuitive answer to this question is, of course, that the government doesn´t want to risk any popular opposition, a legacy that has been faced by many countries who have tried to reduce fuel subsidies in the recent past, including Nigeria, Jordan and Bangladesh only in 2012. But even more importantly, any serious reform attempts within the next months would bring the current government into troubles as parliamentary elections are about to be held once the current election law is reviewed. It is therefore not surprising that in its latest reform model, a reduction of fuel subsidies for private car owners is only to take hold from July. This lastest reform model, the so-called “smart-card system”, should ensure that owners of vehicles with smaller engines (up to 1,600 cc) will only consume 1800 litres annually of subsidised fuel. On the other hand, cars with larger engines won´t get access to any subsidised fuel. (The system will be implemented for government vehicles from May while industrial companies have already faced an increase in the price for mazut, by 130 per cent.)

At first glance, this might all sound convincing, but there are still a great number of outstanding questions which lead us to the core of the hesitance to reform. What will be the final market price? What is the next step after the “smart-card” system? And, how exactly, does the government want to implement this reform, considering the logistical and institutional side of things including the identification of all car owners, making sure that no car owner gets access to several smart-cards and mechanisms to avoid leakages of subsidised fuel to the black market? And finally, in the interim period, how is Egypt going to finance its energy bill?  Subsidy savings will only take place once consumers cross the magic 1800 litres line?

The shocking reality is that, having tried to get my head around these questions, I can´t really imagine that the government knows how to answer them. This is because, the whole problem of implementing subsidy reforms in Egypt, as well as other countries, goes much deeper than the fear of popular unrest. It is also an institutional problem or a problem that hinges on the “supply side” of energy subsidies (as Victor would phrase it).

I first realized this properly when listening to last week’s  Cairo Climate Change Talk where Dr. Radwan, Egypt´s former minister of finance, said that the government does not even have a clue about how high the bill on fuel subsidies is and how to calculate them, or as he put it: “One of the main problems is that we are running a spaghetti ball – going around and around in circles with different ministries and we cannot get out of this unless we separate the debts of the different ministries.” (This also links to another blog of mine on the methodological problem of how to calculate fuel subsidies).

Now, you might agree that this makes it much more difficult to believe that the smart-card system will work, especially, when imagining that ministries would have to carefully coordinate their actions for such a reform. For instance, the ministries responsible for i.e. welfare measures would have to ensure that smart-cards are distributed at the right time to the right people and in the right way. On the other hand, ministries entangled in the in the subsidy system would have to ensure that  fuel will be priced accordingly to a pricing mechanism that has not been agreed upon yet.

My conclusion to this is, that the only solution  to get a subsidy reform that works, is that it automatically has to come with an institutional reform and which includes more transparent welfare measures. Moreover, a much easier way to avoid any leeway for corruption or leakages would be a universal welfare measure to offset negative impacts of rising prices on the population (not a discretionary one like distributing cards arbitrarily measuring fuel consumption by individual car owners). In short, the solution would be a dividend-subsidy swap as we suggest.

But, even if a smart-card reform would work practically, it does not yield enough, if any, of the savings which are crucial for Egypt’s survival. So far, it is actually difficult to expect any mentionable savings, considering that per capita petroleum consumption accounts for not even 1000 liters a year (this takes into account an annual petroleum consumption of 787.000 bbl/d and an estimated adult population of 54 million) – remember the magic line is 1800 per capita/year. No wonder that the IMF has shown reservations over this and other current economic plans by the government and hesitates to give Egypt the much needed $4.8 billion loan. A dividend-subsidy swap, however, could yield savings  already after 9 months of its implementation, or even earlier depending on its design. So why not!

Looking at political and insititutional realities, any reform won´t happen or, at least not soon, if it is not tailored to the political and institutional reality of Egypt. As it looks now, Egypt will have to wait longer for its reform and a loan from the IMF, if that is possible any longer. But, just to keep in mind, there are workable and real solutions out there.

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