Fueling Risk

• Author: David Coady, Valentina Flamini, and Matias Antonio
• Position: a Deputy Division Chief, is an Economist, and is a Research Assistant, all in the IMF's Fiscal Affairs Department.

The sharp rebound in international petroleum prices since the end of 2008 has again exposed the fiscal risk to many low- and middle-income countries that subsidize fuel prices. Two years ago, an article in F&D projected an escalation of fuel price subsidies if countries continued to restrict the pass-through of international price increases to domestic consumers (see “Oil Subsidies: Costly and Rising,” in the June 2010 issue of F&D).

Those risks are now a reality.

After peaking in mid-2008, international prices plummeted over the following six months. But much of that decline has now been reversed. Sustained price increases over the past three years left international prices at the end of 2011 at about 80 percent of their mid-2008 peak. Since the second quarter of 2012, prices have moved up and down.

As during the sharp international price increases up to mid-2008, many low- and middle-income countries have struggled to pass recent price increases through to domestic consumers, with most of them allowing less than 70 percent pass-through over the past three years (see Chart 1). Pass-through levels were especially low in oil-exporting countries, half of which—many in the Middle East and central Asia—passed through less than 55 percent of international price increases. By contrast, advanced and emerging European countries passed through much more of the increases.

Large fiscal costs

The cost of incomplete pass-through is a sizable fiscal risk for many countries (see Chart 2). For example, in half the countries in the Middle East and central Asia, the cost exceeded 2.3 percent of GDP at the end of 2011, while half the countries in sub-Saharan Africa had costs exceeding 1.3 percent of GDP.

A key difference with the low pass-through during the most recent price increase is that it was partly attributable to the relatively high fuel tax levels in many countries at the end of 2008. As prices began to fall in the second half of 2008, many countries passed through very little of the decline to consumers in an attempt to recoup past revenue losses—over this period, pass-through fell below 30 percent in most low- and middle-income countries. As prices rebounded, countries with tax levels above historical norms lowered them to prevent sharp increases in domestic prices.

For many countries with low pass-through over the past three years, tax levels are still sizable and can be maintained as long as future international price changes are fully passed...