Malaysians Saying Goodbye To Subsidies

Subsidy is often viewed positively by the consumers but negatively by economists. However, the bottom line is, the population needs to adapt to real world prices and the country needs to boost its finances by cutting back on expenses such as subsidies.

In Malaysia, we have seen many subsidies such as the sugar subsidy, which was abolished in 2013, and the much talked about fuel subsidy, which has been reducing every year, with the recent reduction by RM0.20 last month.

The government has justified its unpopular move – which is to cut back on the spending to trim its fiscal deficit and ultimately achieve high-income nation status by 2020. On the other hand, Malaysians are not satisfied with the decision and are feeling the squeeze of the increasing cost of living.

Two sides of the coin

Supporters of subsidies often highlight the goods or services produced, or the job opportunities created. What usually isn’t highlighted is how the money could have benefited the society if it had been spent elsewhere, or left in the pockets of taxpayers.

On the flip side, subsidies works as financial assistance to the poor, increasing demand for certain things like education and healthcare, and also stabalising the economy in times of turmoil. These ultimately lead to a more productive nation.

However, on the other side of the coin, untargeted or blanket subsidies are unfair. In the government’s bid to help the poor, the high-income groups are also reaping the benefit of the subsidies, leading to over-consumption and wastage at times. Offering subsidies can also result in large fiscal deficits and realistically, it is financially unsustainable for a nation. Over time, the nation becomes over-dependent on subsidies and may be unable to adapt to real-world prices.

How efficient is Malaysia’s fuel subsidy?

Subsidy reduction is inevitable and it may not be the most horrible thing to happen to a country. To be globally competitive, Malaysians need to be realistic and be able to adapt to change.

Though the initial idea behind subsidies is to help the disadvantaged groups in the country, but more often than not, those who benefit from the subsidies the most are the richer people or companies.

According to the International Monetary Fund (IMF), 61% of the benefit of fuel subsidies goes to the richest 20% of citizens, who own cars, and in Malaysia’s case who own cars with high fuel consumption.

A lower income person driving a beat-up Perodua Myvi may only consume RM250-worth of petrol a month, but a person with higher income may be consuming about RM400-worth of petrol a month.

The fuel subsidy paid by the government for the Myvi driver every month is only RM29.35, while the higher income individual costs the government RM46.95 at the end of the month.

Can the RM46.95 be used more effectively to help the poor, or should the higher income group continue to enjoy this benefit?

The most effective way to remove subsidies

Even though the poor benefit the least from subsidies, they are hurt the most from the removal. In 2012, Nigeria’s proposal to remove its fuel subsidy entirely sent the citizens into the street in a week-long strike. Then, the government revised its plan and reduced the subsidy partially from 4.7% of GDP to 3.6%. The IMF cited this as a partial success in subsidy rationalisation.

Other recommended steps for a government to shed subsidy are to reveal the costs of subsidy to the citizens, and introducing ways to help the poor to transition.

Malaysia in that sense has been following these steps closely with gradual reduction in fuel subsidy and also increased BR1M for the underprivileged. However, this by no means lessens the friction for the rationalisation.

Given the various shortcomings of subsidies, why do governments keep resorting to them?

The most obvious reason is the power of subsidies can be attractive. It’s the best and most effective way to win voters. Targeted subsidy on the other hand may only win you certain segment of the popolution, while a blanket subsidy can be effective in a government’s campaign.

The more selfless and macro reason for governments to continue with subsidies is to avoid inflation and shield citizens from the pain of price increases in global energy markets.

We are not alone in subsidy rationalisation. Here are other countries that have gone through or are going through fuel subsidy removal as well:

1. Indonesia

On June 17, 2013, the government budget for 2014 was approved, with the proposed price of a litre of petrol will increase by 44% to 6,500 rupiah (RM1.80 a litre) and of diesel by 22% to 5,500 rupiah (RM1.50 a litre).

To cushion the hike for the lower income group, the budget also allocates 9.3 trillion rupiah (RM2.5 billion) in compensatory cash hand outs for 15.5 million households. The hand outs will be distributed in four instalments of 150,000 rupiah.

This month (November 2014), the current president, Joko Widodo “Jokowi”, raised subsidised fuel prices by more than 30%, a move that is expected to save the government of Southeast Asia’s biggest economy more than US$8 billion (RM26.7 billion) next year.

Indonesian fuel prices, among the cheapest in the world, were raised by 2,000 rupiah (RM0.55) per liter, with subsidised gasoline now costing 8,500 rupiah (RM2.34) a liter and diesel 7,500 rupiah (RM2.06).

2. India

India highlights another element of success: phasing out subsidies slowly. The new Indian Prime Minister Narendra Modi is closer to scrapping controls on diesel prices that led to US$66 billion (RM220.5 billion) of losses on sales of the fuel in the past decade.

Continuing the reforms of his predecessor, which began reducing the diesel subsidy (petrol is already deregulated) early last year; at the current pace it will disappear altogether by 2016.

Another goal is to narrow the budget deficit to a seven-year low of 4.1% of gross domestic product in the fiscal 12 months that began April 1 this year.

The latest half-rupee (RM0.027) rise came as planned, on June 1, 2014. The overall cost of subsidies should drop from about 1% of GDP in 2013 to less than 0.5% in 2016 (though much of that may be offset by the rising food subsidies).
Though the increase in kerosene prices will hurt the budget of villagers, this would be compensated by higher food subsidies of US$.8 billion (RM26.7 billion) through the Food Security Bill as proposed in the interim budget.

3. Ghana

Ghana partially removed fuel subsidies in July this year, just three months after reintroducing them, to cut spending and restore macro stability. The country is grappling with a persistent budget deficit and rising public debt, while the local cedi currency has slumped 30% in July since January.

The end of the subsidies in Ghana has caused premium petrol to rise 23% per litre to 3.36 cedis (RM3.49). The cost of diesel and liquefied petroleum gas (LPG) was raised by 22% and 15.7% respectively, according to a statement by the National Petroleum Authority.

Cutting energy subsidies is difficult. The obstacles one government has to go through to implement and stick to it are constant. However, the continuation of subsidies brings about huge drawbacks, such as the distortion of economy, fuel corruption, budget deficits, and to make matters worse, these subsidies benefit the rich more than the poor that they’re meant for.

The aim of subsidy rationalisation by our Malaysian government and also other governments who are going through the same process is not to remove the subsidy completely but to introduce a more efficient subsidy process, where the money directly supports growth and positive welfare of the people.

The most crucial issue to target, therefore, should be how to raise productivity so people can enjoy a better standard of living through higher incomes.

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