How to manage fuel subsidies

The years 2020 and 2021 will be remembered both due to the deadly pandemic and the vast fluctuations in global energy demand and its prices. In 2020, global demand for crude oil dropped the most since the Second World War. On April 20, 2020 the future oil contracts for May 2020 dropped 306 percent to settle at a negative $37.63 a barrel.

However, the price of a basket of oil, coal, and gas had doubled in October 2021 compared to the prices in May 2021: the earlier-than-expected recovery from Covid-19 in 2021 had surged the global energy demand.

The trend continued in the year 2022 – this time because of the Russia-Ukraine war. Due to Western sanctions (and potential sanctions) on Russian fuel supplies, energy prices in March 2022 were double their level in March 2021. This was the largest price increase for natural gas and coal. The steepest rise in energy prices in nearly 50 years caused the biggest shock to commodity markets since 1973.

According to the World Bank’s latest report on commodity price outlook, the price of Brent Crude oil is expected to average $100 per barrel in the year 2022, the highest annual level since 2013. These trends have put tremendous inflationary pressure on consumers worldwide, compelling their respective governments to provide some relief.

In this context, some governments are providing subsidized fuel, others are managing energy consumption through rationing, and yet others are using a mix and match of policy measures to minimize the pain of fuel inflation. However, the sustainability of their efforts becomes questionable as, according to industry experts, the oil and other energy prices are expected to remain elevated for years. The Russia-Ukraine war is changing energy trade flows, consumption, and production.

In Pakistan, the PTI government too came up with an energy relief package. On February 28, 2022 it reduced general sales tax (GST) on petrol and petroleum development levy to zero percent, slashed the prices of petrol and diesel by Rs10 per liter, and announced to fix those prices till June 30, 2022. The claim of the then finance minister to finance the relief package through enhanced revenue collection is supported by the Federal Board of Revenue’s (FBR) historic tax collection of Rs4858 billion during the first ten months of FY 2021-22. The FBR exceeded its collection target for the period by Rs239 billion. It is pertinent to mention that GST on petrol has been the single biggest source of FBR collection in the past, accounting for 35 percent of total GST collection in 2021.

Even before the relief package, former prime minister Imran Khan rejected Ogra’s fortnightly recommendations to increase the fuel prices on more than one occasion. These measures did contain fuel inflation and provided relief to the consumers. But they also led to a large current account deficit (CAD) as the import and consumption of fuel in Pakistan remained unaffected by the global price hike.

The FBR’s record collection of ‘rupees’ does not compensate for ‘dollar reserves’, which are rapidly depleting due to expensive energy imports. Rising current account deficit and piling energy circular debts are two of the major reasons the IMF opposes the energy relief package.

Initially, the coalition government termed the PTI government’s energy relief package as landmines for its successors. However, contrary to Miftah Ismail’s assurance to the IMF that this package would be rolled back, Prime Minister Shahbaz Sharif has followed his predecessor's decision and decided to continue (at least till May 16) with across-the-board subsidies on fuel through the energy relief package.

Here, one needs to keep in mind that the CAD accruing due to the relief package will turn unmanageable without the help of the IMF. Currently, petrol in Pakistan is subsidized by Rs21 per liter and diesel by Rs51 per liter. For macroeconomic stability and to contain the energy circular debt, the government would have to withdraw energy subsidies.

One can argue that a major chunk of petrol subsidies is being enjoyed by the owners of big vehicles, who consume 5-6 times more petrol per kilometer than motorcycles and rickshaws. They consume 60-65 percent of petrol in the country, and many of them may afford to pay its full price if the subsidy is withdrawn. The biggest sufferers of the no-subsidy scenario will be the owners of 15 million motorcycles (and rickshaws), who consume around 35-40 percent of petrol in the country and require government support to cope with the fuel inflation.

There is no easy answer to the question on how the government can roll back the energy relief package without hurting the lower-middle and middle-income earners. I endorse the suggestion forwarded by different quarters to cross-subsidize the diesel owing to its secondary inflationary impact (public transport, goods transport, agricultural machinery, etc). The proposal is that instead of increasing the price of petrol by Rs21 per liter and diesel by Rs51 per liter, their respective prices should be increased by Rs30-35 per liter, thus cross-subsidizing the price of diesel.

However, an increase in petrol price would have an immediate inflationary impact, especially on motorcycles or rickshaw owners. Targeted subsidy on petrol for these consumers, selling them petrol at a subsidized rate, is practically impossible. An alternative is to provide them relief through direct cash transfers whenever the average monthly price of petrol exceeds a certain threshold (to be determined by the Ministry of Petroleum). Let me explain how this system may work.

All two and three-wheeler owners (including government officials) earning below a certain amount per month (the threshold may be determined by the Ministry of Poverty Alleviation and Social Safety in consultation with the Ministry of Petroleum) may be eligible for this direct cash transfer programme. Their vehicles are registered against their CNICs. This record is available at vehicle registration departments and with the owner in the form of a vehicle registration document. This record could be triangulated with the National Socio-economic Registry (NSER) maintained at the Benazir Income Support Program (BISP).

The triangulation would enable motorcycle/rickshaw owners to check their wellbeing score (eligibility for cash subsidy) from the NSER database by texting their CNIC number at 8171. If eligible, they can then be provided direct cash transfer following the mechanisms established for cash transfer for different ‘Ehsaas’ initiatives. Those who are not registered with the NSER may get themselves registered at any walk-in registration centers. Only one vehicle per CNIC may be entertained for petrol subsidy.

The ministries of finance, petroleum, and planning can jointly devise the subsidy calculation formula. The full price of petrol may be passed on to the consumers. At the same time, the amount of subsidy gets directly transferred to the bank account or mobile vaults of the targeted beneficiaries. Such targeted subsidies would be acceptable to the IMF. The government would still have the option not to pass on the full Ogra recommended fuel rates to consumers so that the owners of vehicles below 1000cc may be protected against a fuel price hike.

I proposed the above plan to the macroeconomic advisory group of the previous government. The current government may like to tweak this plan or develop other methods to provide targeted fuel subsidies. The objective is to remain engaged with the IMF to achieve macroeconomic stability without quashing the lower-middle-income earners under this unprecedented fuel inflation.

The writer heads the Sustainable Development Policy Institute.

Twitter: @abidsuleri