By Clemens Breisinger, Sikandra Kurdi, Rawan Hany and Mariam Raouf[1]
Energy costs are on the rise in Egypt and shortages of electricity have resulted in scheduled power outages since August 2023. Understanding the trade-offs inherent in the energy subsidy system can help policymakers to chart the best course in a difficult economic period.
In November 2023, the price gasoline increased 12% from EGP 10.25 to EGP 11.50 per liter. Electricity, gasoline and diesel prices in Egypt are highly subsidized, but these subsidies put a heavy strain on government budgets as world prices have risen due to the war in Gaza. Almost 4 percent of the government budget is projected to go to fuel and electricity subsidies. Imports of natural gas from Israel’s were also directly affected by the conflict.
At the same time, the government has acknowledged that cutting electricity consumption to support exports is a crucial source of hard currency during the debt crisis. An official from the Ministry of Electricity stated that cutting domestic consumption is motivated by the need to preserve gas for export and President Sisi mentioned savings on the order of 300 million dollars linked to the scheduled power cuts.
While Egypt has allowed fuel prices to climb, as shown in the figure below, subsidy rates remain high due to the global rise in prices.
[1] We have used Artificial Intelligence (ChatGPT) to summarize the content of the journal article: Breisinger, Clemens; Mukashov, Askar; Raouf, Mariam; Wiebelt, Manfred (2019) : Energy subsidy reform for growth and equity in Egypt: The approach matters, Energy Policy, ISSN 0301-4215, Elsevier, Amsterdam, Vol. 129, pp. 661-671, https://doi.org/10.1016/j.enpol.2019.02.059, https://www.sciencedirect.com/science/article/pii/S0301421519301491. We thank Jawoo Koo and MinAh Kim for their collaboration and support.
Source: GlobalPetrolPrices.com. Accessed January 30, 2024.
Past work from IFPRI researchers has highlighted the long-term distortionary impacts of the energy subsidy system in Egypt, while also showing that adjustments to this system will be painful in the short-term.
The recent paper “Energy subsidy reform for growth and equity in Egypt: The approach matters” delves into Egypt's journey of reforming these subsidies, highlighting the intricate balance between economic growth, equity, and the imperative of social protection. The subsidies, while initially designed as tools for wealth redistribution and protection against volatile energy prices, have inadvertently led to fiscal challenges and a disproportionate benefit to the more affluent.
To shed light on the intricate dynamics of this issue, the authors employed a dynamic, computable general equilibrium model to capture the interplay of energy-related activities and their ripple effects across sectors like agriculture, energy production, manufacturing, and services. The model-based findings suggest that the economic adjustments associated with energy subsidy reforms in Egypt present a multifaceted picture. In the immediate aftermath of higher energy prices, there's a noticeable dip in real GDP. However, as time progresses, the long-term outlook becomes positive, even as energy prices continue to rise until subsidies are completely phased out. This dynamic plays out differently across sectors: while the construction industry thrives, manufacturing faces challenges. Mining, especially sectors related to crude oil and natural gas, sees growth in the long run.
On the social protection front, our findings underscore the importance of continuing and scaling up measures, especially as energy subsidies are phased out. Notably, targeted cash transfers to the most vulnerable households emerged as a more effective strategy compared to broad food subsidies (Breisinger et al., 2023). Fuel subsidies still make up the large majority of social protection spending in Egypt, with spending on fuel subsidies approximately three times larger (120 billion EGP vs. 35 billion EGP) than for the national cash transfer system Takaful and Karama.
Share of fuel subsidies in government expenditure in Egypt
Source: Ministry of finance, The Financial Monthly Bulletin, various issues.
The journey of phasing out energy subsidies is not just about economic recalibration. It's about ensuring that as we stride towards sustainable development, no one is left behind. Here are some of the key policy recommendations emerging from our research:
- Gradual Phaseout is Key: Immediate abolishment of energy subsidies can be jarring for the economy. A gradual phaseout provides sectors and households the necessary time to adjust to rising energy prices. This approach not only cushions the immediate economic impact but also paves the way for long-term growth and stability.
- Strengthen the Business Environment: Provisions that serve the business environment are essential for raising productivity and competitiveness. Measures like the new investment law are steps in the right direction. Enhancing the business environment can accelerate the positive impacts of subsidy reforms.
- Labor Market Flexibility: Labor law reforms and technical and vocational training are crucial. These measures ensure labor mobility, especially for unskilled workers, allowing them to transition smoothly in a changing economic landscape.
- Social Protection Measures: As energy subsidies are phased out, it's vital to continue and scale up social protection measures. Our findings highlight the effectiveness of the expansion of the food subsidy program and the introduction of cash transfers. However, targeted cash transfers, especially to the poorest rural and urban households, are more efficient in safeguarding the most vulnerable.
- Re-evaluate Food Subsidies: While food subsidies have played a role in protecting households, they are not always well-targeted. Re-evaluating and refining these subsidies can ensure that assistance reaches those who truly need it.
Our exploration into Egypt's energy subsidy system highlights the delicate interplay between economic growth, equity, and social protection and the need for strategic policies and interventions. While Egypt is currently in a critical fiscal position that has focused attention on short-term solutions, the broader perspective in our research helps keep in view that long-term reforms are also needed for sustainable growth.
