Public Information Notice No. 08/135

Public Information Notice: The Executive Directors of the IMF Hold Seminar on Fuel and Food Price Subsidies-Issues and Reform Options

October 10, 2008

On October 1, 2008, the Executive Board of the International Monetary Fund (IMF) held a seminar on Fuel and Food Price Subsidies: Issues and Reform Options. The staff paper on which the discussions were based is posted on the IMF's website at http://www.imf.org.

Discussion by Executive Directors

Executive Directors stressed that the rapid growth of fuel and food price subsidies following the recent surge in fuel and food prices can have important consequences for domestic resource allocation, economic growth, and the government budget. They noted also that price subsidies can have significant transnational spillovers through their impact on global warming, international prices, smuggling, and regional pollution.

Directors therefore welcomed the opportunity to discuss the reform of fuel and food price subsidies to improve their effectiveness, reduce their distortionary effects on the economy, and lessen their fiscal costs, while protecting vulnerable groups. They found the analytical framework discussed in the paper, and the cross-country evidence presented on the prevalence and size of fuel and food price subsidies, to be useful for understanding the policy issues involved, and encouraged a wide distribution of results. A number of Directors would have liked to see a more comprehensive discussion of subsidies, including agricultural subsidies and biofuels production by developed countries, which they considered to be distortionary. A few Directors cautioned that staff discussions of environmental externalities, including those associated with taxes and subsidies, should not stray from the IMF's core mandate. While a number of Directors noted that international coordination of subsidy policies may be needed to tackle global and regional spillovers, some were not convinced of the proposals for global coordination of subsidy policies.

Directors recognized the difficulties involved in identifying and quantifying subsidies, particularly tax subsidies. A number of Directors had reservations about whether the concept of optimal taxation provides an operational basis for the estimation of subsidies. Directors called for transparent and accurate reporting of subsidies to facilitate a better public understanding of their costs and benefits, and supported Fund technical advice and assistance for this purpose. They concurred that Fund bilateral and multilateral surveillance would naturally cover food and fuel price subsidies when these command significant resources or when there are significant transnational spillovers. Some Directors stressed the importance of a case-by-case approach in the Fund's technical advice.

Directors noted that the immediate policy response in a number of countries involved a combination of partial pass-through of international price increases together with higher subsidies and/or lower taxes, while more permanent solutions were being considered. A number of Directors considered that this was an appropriate response under these circumstances. Directors supported the full pass-through of fuel and food price increases to consumers to promote efficiency and contain negative external effects. Full pass-through would also reduce pressures on the budget and the balance of payments in oil-importing countries, and it would free resources for public investment and poverty alleviation in both oil-importing and oil-exporting countries. Directors stressed that full pass-through must be accompanied by the implementation of compensatory measures to protect vulnerable groups, although they recognized that such implementation presents practical and political challenges in many countries.

Directors agreed that, to the extent possible, price-setting mechanisms should be depoliticized to ensure the pass-through of international price increases. This goal is best achieved through price liberalization, which ensures continuous and full pass-through. When liberalization is not possible, or when markets are imperfect or governments are concerned about excessive price volatility, Directors recommended that an automatic price adjustment mechanism be implemented to adjust prices periodically in light of changes in international prices. An effective automatic price adjustment scheme can avoid protracted deliberations each time international prices increase, thereby smoothing the increase in domestic prices. Directors observed, however, that pricing formulas have often been suspended or abandoned, and so the challenge is to design mechanisms that are sufficiently resilient.

Directors noted that many low-income and emerging market countries lack the capacity to implement well-targeted safety nets, and consequently have difficulty in passing through prices increases. They concurred that, in such countries, universal subsidies or tax reductions, which benefit higher income households disproportionately, might have to be phased out gradually while more effective safety nets are put in place. Directors noted, however, that in many countries imperfectly targeted compensatory measures are more cost effective than universal subsidies, and would be a superior alternative to universal subsidies until better-targeted safety nets are in place. Directors encouraged countries to work with the World Bank and other development partners to set up effective social safety nets.

Directors emphasized that another key element of a successful subsidy reform strategy is the implementation of information campaigns to mobilize public support for reform. To be effective, such campaigns should clearly identify the cost of subsidies, the beneficiaries, and how the authorities plan to utilize the savings arising from reforms.

Directors stressed the importance of collaboration with the World Bank, UN agencies, OECD and regional development banks on subsidy reform. They observed that the Fund, consistent with its mandate, should focus on the macrofiscal impact of subsidies and subsidy-reform options, while the Bank can more effectively assist countries in the design and implementation of subsidy reform.