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The question of subsidies
Published in Daily News Egypt on 05 - 06 - 2006

CAIRO: As parliament continues to debate the state budget for the next fiscal year, booming oil prices have raised questions about how to deal with the rising cost of subsidizing energy.
Minister of Finance Youssef Boutros-Ghali warned the Shura Council last month of the danger of funding additional petroleum products and natural gas subsidies with debt.
This is an easy solution in the short term but in the long run it will be disastrous, since it also means a big rise in public debts, Boutros-Ghali told legislators, according to Al-Ahram Weekly.
Boutros-Ghali, along with Prime Minister Ahmed Nazif and Minister of Trade and Industry Rachid Mohamed Rachid, has advocated a complete reexamination of the subsidy system.
This began with the formation of the Ministry of Social Solidarity during the last cabinet reshuffle in December 2005. The new ministry is in the process of identifying the poorest segment of the population and the most appropriate method of subsidizing this segment with the objective of alleviating poverty.
But the current system of energy subsidies does little to alleviate poverty, according to Boutros-Ghali, because the majority of subsidies on petroleum products and natural gas go to the richest 2 percent of the population.
We decided as a government to make sure we involve society in this discussion, Rachid tells The Daily Star Egypt. There is a choice to be made: either we will continue to subsidize these products with the unlimited budget now relating to the increase in the cost of energy, which is going to impact how much we can spend on education, health, infrastructure, development and investment, or we can make a choice that some of the products are not relevant enough to the poor people of Egypt and that probably it s more important for them to get the other services.
The government is expected to spend a staggering LE 40 billion, or nearly 15 percent of the state budget, on energy subsidies next year, which is more than it currently spends on health and education combined.
Energy subsidies have two forms: explicit and implicit. Explicit subsidies involve direct payments by the government to support the import of certain petroleum and natural gas commodities. The bulk of explicit subsidies are spent on liquid petroleum gas (LPG), such as butane gas used for cooking.
We do not produce butane gas in Egypt; we import it mainly from Algeria, so the increase in the price of oil is immediately reflected in the amount of subsidy, says Samir Radwan, managing director of the Economic Research Forum.
The low price of LPG products also encourages intermediaries to benefit from mark-ups during the distribution process.
Most of the subsidy goes to the distributor rather than the consumers, says Hanaa Kheir El-Din, executive director and director of research at the Egyptian Center for Economic Studies.
Implicit subsidies are achieved through preferential pricing of energy products to local buyers. Such subsidies were not reflected in the state budget until the current fiscal year.
Previously, the government used to buy these products at a lower price from Egyptian General Petroleum Corporation, for instance, and the differential was born by the company, says Kheir El-Din. This was an implicit subsidy that no one realized how much it was. But now, since last year s budget, the implicit subsidy was depicted explicitly in the budget.
The magnitude of the government s support has hence become increasingly clear and is subject to parliamentary scrutiny during budget discussions.
Boutros-Ghali estimates that only 20 percent of energy subsidies benefit those who really need them. This implies that the government could redirect LE 32 billion (80 percent of the LE 40 billion to be spent on supporting the high price of petroleum and natural gas) toward other priorities if energy subsidies were better targeted.
These are broad-based subsidies based on reducing the price of distribution of the commodity, so they are not very well targeted to the poor, says Kheir El-Din. The liter of gasoline is LE 1. I think people riding Mercedes' and BMW's can pay much more than that.
Preferential pricing also benefits industrial producers and the low cost of energy is frequently cited as a key competitive advantage on a global level by manufacturers.
In the current age of globalization, however, the sustainability of this competitive advantage is questionable in the long-run.
If an industry is intensive in using fuel and is not competitive unless there is this fuel subsidy, we may reconsider shifting to another activity, says Kheir El-Din. We do not need to go on subsidizing inefficient industries forever.
Rachid adds that the advantage of low energy costs increases as oil prices rise further, implying that there is now room to increase the energy cost of domestic manufacturers.
We are maintaining an advantage to industry, and we will continue to maintain that, says Rachid. But that, again, will continue to be relative; the competitive advantage that we had when the oil price was $30 is becoming much more significant when it is now at $70. So the principle itself will be maintained, but how we are going to move in terms of matching the increase of prices, this is exactly what we are looking at, at the moment.
Radwan adds that the government s approach is to provide a broad range of services to support industry, thereby diminishing the importance of energy subsidies.
The Ministry of Trade and Industry is trying to look at how to support enterprises in a comprehensive way, says Radwan, through training, through giving advice, through the services of the Industrial Modernization Center, through making land available. If you are getting all this, you don t need an indirect subsidy.
The question of subsidies is arguably the toughest issue relating to the state budget, and reducing energy subsidies will be particularly contentious in light of its impact on business, a key constituency of a government focused on economic growth.
Whether the government can overcome resistance from manufacturers and persuade legislators to amend the current approach remains to be seen.

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