Energy subsidies: ready for a reduction?

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July 9th, 2015

This year a lot of emerging countries are facing the difficult task of balancing their economies within a relatively adverse environment. In general, growth is slowing down in the main developing countries and financial conditions are also likely to get tougher in the coming quarters when the Federal Reserve starts to normalise its monetary policy. Given this situation, the fall in oil prices and those of many other energy commodities is paving the way for a reduction in energy subsidies. Granting energy subsidies is widespread practice in emerging economies and it has a significant effect on public finances, to such an extent that its direct fiscal cost amounts to 0.7% of the world's GDP and exceeds 5% of GDP in some countries. Below we analyse its rationale and importance from a geographical point of view.1

Governments tend to justify implementing energy subsidies with two reasons. Firstly, to ensure poorer people have access to basic services such as electricity and heating. Secondly, to support local industry by paying the public sector part of its energy costs. Hence, it should come as no surprise that this is a core policy in emerging economies. However, although there may be good intentions behind the initial motivation for energy subsidies, in many cases these lead to inefficiencies and, paradoxically, social injustice. From an environmental point of view, energy produced by local industry tends to be promoted even when this may be highly polluting. At a social level, as subsidies are normally applied to the price of a good and not focused on any particular group in society, they are highly inefficient: a very high fiscal cost is normally incurred relative to the advantage gained by those who really need such support and, in fact, in many cases subsidies do not benefit the poorest and most vulnerable consumers. By way of example, a study by the United Nations of India's subsidy for liquefied petroleum gas (used primarily to cook and heat homes) found that less than 25% is allocated to rural areas, which not only hold most of the country's population (70%) but also the largest number of poor people.2

Most emerging countries devote a lot of resources to energy subsidies in spite of them being relatively ineffective. In fact, the fiscal cost is particularly high if we also take into account the environmental cost generated.3 According to a recent study by the IMF, if subsidies on the price of energy were removed, the savings for public treasuries would amount to 4% of the world's GDP. By region, emerging Asia and MENAP are two of the zones were the fiscal benefit would be greatest, at around 10% of GDP.4

In the last few years some of the main emerging economies have started to cut back on their energy subsidies. The best-known case is that of India which, in 2013, started a programme of slow but progressive reductions in this kind of assistance. This Asian country has been followed by other large economies such as Indonesia, Egypt and Malaysia. Given the potential savings for public spending in eliminating such subsidies, this change in trend is encouraging. The challenge now is to invest these savings in public resources to protect the most vulnerable people more efficiently, consolidate the change in energy policy once the energy price normalises and maintain a more balanced macroeconomic situation.


1. See IMF (2015), «How Large are Global Energy Subsidies?», WP/15/105.

2. See United Nations (2008), «Reforming Energy Subsidies. Opportunities to Contribute to the Climate Change Agenda».

3. For example, promoting heavily polluting sources of energy leads
to higher expenditure on healthcare in many emerging countries.

4. MENAP is made up of countries in the Middle East, North Africa, Pakistan and Afghanistan.