Commodity price falls unappreciated boon for ASEAN policy makers

The extent and complexity of food and energy subsidies across South and Southeast Asia stand out as perhaps the clearest macroeconomic policy failing of recent years and one that creates far more distortions and opportunity costs than societal or equity benefits.

"The increase in the subsidy burden has been largely responsible for the deterioration in Asia’s fiscal position in recent years."

The extent of the distortion and its uniqueness to Asia is borne out in a few key figures.

Fossil fuel (coal, oil, and gas) subsidies are a prominent feature of many Asian economies:

• Of the 25 top subsidising countries in the world identified by the International Energy Agency for 2012, 10 were in Asia.
• Total known fossil fuel subsidies across Asian Development Bank member countries probably amounted to just under $US600 billion for 2011-2013.
• The cumulative cost of fuel and food subsidies during 2007 to 2014 would go a long way to funding South and Southeast Asia’s well-documented physical infrastructure deficits.

Fortunately, 2014 appears to be the year policy makers across ASEAN and certainly in India got serious about factor price reform. We are hopeful the current episode of commodity price disinflation will motivate policy makers to move domestic fuel prices more in line with international prices. A more efficient fiscal policy structure that can target public investment and infrastructure will dramatically improve the allocative efficiency of the South and Southeast Asian economies, automatically reducing budget deficits and therefore government borrowing requirements.

Asia’s subsidy burden tracked international commodity prices inexorably higher over the decade from 2002 onwards

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Subsidy distortion

The economies of Emerging Asia account for over 20 per cent of the global energy subsidy bill with petroleum and electricity accounting for 90 per cent of subsidies. The increase in the subsidy burden has been largely responsible for the deterioration in Asia’s fiscal position in recent years.

India and Indonesia stand out as the two economies with the most problematic subsidy structures but Thailand and Malaysia have also engineered significant subsidy burdens for themselves.

The size of subsidies across South and Southeast Asia

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New Indonesian President Jokowi has inherited an annual subsidy bill of more than $US20 billion that accounts for more than 20 per cent of total government spending. Fuel price hikes attracted protests and often violent riots in the past, despite their overwhelming skew to benefit the rich and middle-class, not the poor.

India stands outs as the economy with disproportionately higher food subsidies. Indeed, food subsidies rose fivefold under Prime Minister Singh. However new Prime Minister Modi failed to tackle India’s complex food subsidies in his first budget.

Subsidy burden and the budget position 

Total government expenditure

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Gasoline subsidies across most of Asia largely benefit the middle-class for whom first time car-ownership has become more of a novelty than a necessity. The great folly of the Asian subsidy decision of recent years is choosing policies that subsidise middle-class vehicle ownership and not fund public transport which would boost labour market mobility for the poor and very poor.

The existing subsidy structures across Asia are poorly targeted and the true welfare loss from unwinding them either by design or natural attrition (as international prices fall) should be minimal.

Most of Asia’s subsidy burden can be traced to the introduction or enhancement of subsidies during the dual food and energy inflation of 2007-08. South and Southeast Asia largely experienced a significantly negative terms of trade shock for over a decade from 2001 to mid- 2014.

Now Asia is experiencing a positive terms of trade shock.

As the ratio of trade to GDP is around 75 per cent to 80 per cent of GDP for ASEAN and over 400 per cent of GDP for Singapore, the impact of the positive terms of trade shock will probably be outsized.

The typical automatic stabiliser to a terms of trade shock is exchange rate appreciation. Asian currency depreciation is thus likely to ameliorate, not alleviate, this positive terms of trade shock.

Some degree of fiscal rectitude, via subsidy rationalisation, may prove to be the prudent policy choice.

This is an excerpt from the ‘South by Southeast Economic Insight – South and Southeast Asia’.