June 14, 2008
JUNE 14 ? Asian governments fear reducing politically hard-to-cut fuel subsidies, but record-high oil prices are forcing them to do so in increasing number.
Last month it was Indonesia, Sri Lanka and Taiwan. Now India and Malaysia have joined the growing cohort of Asian governments forced to hike fuel prices in order to reduce the ruinous cost of subsidies or price controls amid record-high global oil prices. Other countries in the region, China included, look set to follow suit soon.
In many ? though not all ? of these cases, such price hikes risk a substantial political backlash. They will add to inflationary pressures that are unusually strong in most of the region amid high food as well as oil prices.
On June 4 India and Malaysia announced increases in retail fuel prices. India raised petrol prices by 11%, diesel prices by 9% and cooking gas prices by 17%, while also eliminating the import tax on crude oil and lowering import duties on refined fuels. Malaysia, meanwhile, announced whopping 41% and 63% rises in the prices of petrol and diesel respectively. The government also unveiled plans to allow domestic fuel prices to track global price movements (though remaining partially subsidised).
In announcing these measures, the two governments have become the latest to bow to the inevitable and accept that maintaining previous subsidy regimes was impossible with global oil prices at over US$130 a barrel. The actual mechanics of fuel-price adjustments around the region vary according to the structure of the price regime in each country; for example, some governments directly subsidise fuel, while others mandate price caps and then partly compensate refiners and retailers for losses incurred from buying at international prices and being forced to sell at capped domestic ones. In some cases, raising administered prices directly saves the government money, and in others it has a greater impact on the profitability of state-run oil companies.
Either way, there is little doubt that the latest round of price hikes is long overdue. In principle, such adjustments are sound economic policy, as they reduce market distortions and relieve pressure on national budgets or the finances of public-sector companies. However, such measures require careful handling, both because of their potential to spur social unrest and because of their inflationary impact. (The problem comes at a particularly bad time, with inflationary pressures also increasing because of high food prices.) As a result of subsidy adjustments, combined with the continuing record-breaking upward movement in global oil prices, the Economist Intelligence Unit will raise its inflation forecast for the region. We expect average inflation in Asia and Australasia (excluding Japan) to exceed 7% this year, up from our previous forecast of 6.6%. We have also recently raised our world oil forecast, to US$106.5 a barrel (dated Brent crude) in both 2008 and 2009, from US$91.25 in 2008 and US$85 in 2009 previously.
Although more market-driven fuel pricing is ultimately necessary, Asia is ill equipped to absorb sudden shocks, particularly as many countries in the region rely heavily on fuel imports and as consumers have been insulated for so long from market forces. Large one-off price adjustments will not only aggravate inflationary pressures, but will also undermine the price stability that many businesses have come to rely on in their planning.
In this context, the latest price hikes are less a sign of prudent policy ? that is, of governments biting the proverbial bullet in the name of fiscal responsibility ? and more an indication of how desperate the situation has become as global oil prices have soared. Supporting this view are the latest actions by the Indian and Malaysian governments (one of which faces a general election next year, the other of which is reeling from heavy election losses); neither government would probably do something so unpopular unless there were no other choice. Indeed, one could argue that a truly “responsible??? government would have acted far sooner to reduce market distortions. That governments are now doing so all at once may, instead, be an indication of how much damage previous policies have caused. This leaves no attractive options for many governments, which essentially now have to choose between drastic price hikes (as in Malaysia and Indonesia) or smaller and therefore ineffective ones (as in India).
China
China’s main mechanism for controlling the prices consumers pay for fuel is to control the price retailers can charge for fuel. The large state-owned oil refiners take a heavy financial hit as a result of this, and they are only partly reimbursed by the government (oil producers must also pay taxes on the “windfall??? they gain from higher crude oil prices, partly offsetting the cost of the reimbursement). Sinopec, China’s largest refiner, for instance, announced in April that its net profits had slumped by 66% year on year in the first quarter. The pricing system discourages domestic refiners and distributors from selling fuel when international oil prices are high, and this tension is sometimes reflected in shortages as the oil companies try to resist government pressure to sell higher volumes of fuel at a loss. Recent reports of the re-emergence of fuel shortages at petrol stations across the country suggest that the companies are once again becoming more reluctant to meet demand. This could in turn suggest that a price hike is on the way, perhaps in July or August.
India
The fuel-price hikes in India highlight a perennial policy dilemma: how to begin to cure the country’s chronic fiscal problems while also meeting demands for populist policies (such as heavy spending on poverty relief) that are a political fact of life. The Congress-led coalition is hoping for re-election next year, but the fuel-price hikes have angered the left-wing parties on which the coalition relies on for support in parliament. Strikes have already been called in a few states. India’s heavy reliance on imported fuel makes it vulnerable to changes in global oil prices. But given the scale of global oil price rises, the latest price hikes won’t have a huge effect. In fact, because the rises were combined with duty cuts, which will mean less tax revenue, the net impact on government coffers could be negative. The impact of rising prices on the poor will remain a politically sensitive issue, especially with headline inflation continuing to pick up. We are revising our consumer price inflation forecast for India, to an average of 6.9% in 2008 from 6% previously.
Indonesia
As Business Asia reported in its last issue, the government raised the price of subsidised fuel by an average of 28.7% on May 24, provoking widespread protests. The price hike was essential because high fuel subsidies were putting an unbearable strain on the national budget (partly because the government underestimated the price of oil in its original assumptions, but also because subsidies mean that Indonesians enjoy some of the lowest fuel prices in the region). The scale of the problem is evident in the fact that President Susilo Bambang Yudhoyono has had to put his popularity on the line several times since taking power in 2004. Most notably, in late 2005 his administration raised fuel prices by 127%. Despite Indonesia’s unnerving history of fuel-price protests and political unrest, Yudhoyono’s prospects of re-election next year are helped by the failure of a credible opponent to emerge so far. Inflation will remain a worry, however. We expect inflation to average 9.9% in 2008 and 7.2% in 2009. It should run at more than 11% in the next three months, so Yudhoyono can expect an especially rough ride for a while.
Malaysia
It seems extraordinary that the beleaguered government of Abdullah Ahmad Badawi, Malaysia’s prime minister, should be prepared to make itself even more unpopular by raising fuel prices. Abdullah’s Barisan Nasional (BN) coalition retained power in the March general election but humiliatingly lost its two-thirds majority. Abdullah has been under siege ever since as calls for his resignation have mounted. Unsurprisingly, the emboldened opposition has lost no time in trying to make political capital from criticising the fuel-price hike, which proves only that Malaysian consumers have been sheltered from market forces for too long. This is reflected, perhaps, in the fact that consumer price inflation has remained moderate ? at only 3% year on year in April ? while in other countries it has picked up much more sharply. The situation also reflects the fact that in 2007 the government did not want to adjust subsidies, despite rising international prices, because of the approach of the election. It is ironic, therefore, that voters’ dissatisfaction about rising prices was an important factor behind the BN’s poor electoral performance in March this year. In the light of the latest fuel-price hike, we will be revising up our inflation forecast for 2008, from 2.8% to around 4.5%.
Sri Lanka
The Sri Lankan government reacted sooner to high oil prices than many other governments in the region. It has relaxed controls on fuel prices a number of times since last year. Most recently it lifted prices for petrol, kerosene and diesel by 14-47% on May 25. This does not make the Sri Lankan government a model for policymakers elsewhere, however. The country is firmly in the camp of “desperate cases???; it has been obliged to raise prices in large part because of the weak fiscal position created by its policy excesses, most notably defence spending related to the conflict with the Tamil Tiger rebels. As a result of previous subsidy cuts and high food prices, inflation is alarmingly high, at 26% in May. The latest price hike will add to these pressures; we forecast average inflation of around 21% in 2008. Rising living costs ignited public anger that contributed to the downfall of the United National Front government in 2004.
Taiwan
From May 28, prices of unleaded petrol and diesel have been raised by 13% and 16% respectively. Further rises have not been ruled out. Despite this, as Business Asia noted in its last issue, the political fall-out for the new government should be limited. The government of Ma Ying-jeou, the new president, is insulated, to an extent, from criticism of the price hike because it flagged the move well in advance and is simply reinstating a policy of the previous Democratic Progressive Party (DPP) government. The DPP shelved the policy because of the approach of the parliamentary and presidential elections in early 2008, but that was not enough to keep it in power and the DPP suffered heavy losses. With no national elections scheduled until 2012, Ma’s government is in a relatively strong position to raise fuel prices without worrying unduly about public opinion. It is helped, too, by the fact that fuels and lubricants have a weighting of only 3.3% in the consumer price index. Inflation is likely to average just 3% this year. ? Business Asia