Fuel subsidy spending this year may thus come in higher than in 2009 despite fiscal consolidation and subsidy rationalisation programmes undertaken since the 2008 Global Financial Crisis (GFC).
The government is now mulling a targeted fuel subsidy mechanism to replace the blanket subsidy approach to contain the fuel subsidy bill. To be clear, this idea is not new, but it never took off because of inherent weaknesses; to put it crudely, it cannot work.
Perhaps the government’s underlying idea is to lay the groundwork for the reintroduction of the managed float system – presumably, in hopes of reducing the fuel subsidy bill.
However, it makes little sense to “target” fuel subsidy while keeping retail oil prices at today’s rates because of the huge retail-market oil price differential.
There are two reasons why targeted fuel subsidy is unsound.
Firstly, the textbook explanation: subsidies, for all intents and purposes, distort market prices.
And this is by no means unethical in any way because subsidies, as well as taxes, can be the right solution to market imperfections.
With subsidies, it can lead to overall productivity gains and higher national output. However, subsidies can also reward inefficient industries and/or wasteful consumer behaviour. It is all relative, as they say it.
Considering that vehicles in Malaysia are subject to high taxes and duties (between 70% and 145%), fuel prices must be kept artificially low through subsidies. This is not to imply that fuel subsidy is justified, but rather to illustrate the dynamics between taxes and subsidies from the transportation sector standpoint.
Since low production cost is Malaysia’s competitive advantage, fuel subsidy plays an active role in controlling inflation.
At the very least, fuel subsidies help suppress the cost of car ownership and aid the mobility of most Malaysians since public transportation is not widely accessible/available.
The problem is that amid high global oil prices, the targeted fuel subsidy idea will only address the issue at the fuel consumption level, not at the production level.
The ongoing Ukraine-Russia military conflict has pushed global oil prices to a decade high when the supply chain is already severely disrupted amid worldwide lockdowns.
As a result, Malaysia’s producer price index (PPI) has surged to the highest level since the GFC at 13.2% in October 2021, then declining to 9.2% in January 2022 but rising again to 9.7% a month later.
Targeted fuel subsidy may help but not by much. Diesel, gas and electricity made up about 64.5% of Malaysia’s total final energy demand in 2019, so consumers will eventually feel the pinch from these channels – directly or indirectly.
Compare this with motor petrol which accounted for only 20.8% of the total final energy demand in the year.
And secondly, no one really knows how to target fuel subsidy correctly.
The subsidy distribution channel can never be foolproof, so the government may unintentionally over- or under-subsidise the targeted group.
Three ideas are being floated around so let us explore this further.
The first is the show-me-your-MyKad method, where the recipient enjoys fuel subsidy (via a lower retail oil price, presumably) when refuelling.
Herein lies the typical principal-agent problem where the agent(s) will behave in a manner that benefits them the most and not necessarily the principal. If one can use another person’s bank card to make a purchase, MyKad is no different.
Besides, what about a Malaysian taxpayer in a foreign country, say in Singapore, but refuels in Malaysia?
What about a foreign taxpayer in Malaysia? How can such a policy treat them fairly?
In sum, this method is costly and notoriously complex to administer.
The second one is the show-me-your-engine capacity method, where fuel subsidy is only given to motorcycles of 125cc capacity and below and cars of 1300cc and below.
The contentious point here is that, in this day and age, engine capacity does not necessarily determine the car price, and by extension, an individual’s income level. One could easily find a T20 with a 1300cc car (say, Mercedes-Benz A200) and a B40 with a bigger engine capacity car (say, an old boxy Volvo).
Should fuel subsidy benefit the rich with a new energy-efficient vehicle and not the poor with an old car? There are glaring ethical problems here, and one that is prone to abuse as much as the previous method.
The final one is the income supplementation method via universal cash transfers (UCT). Instead of giving the fuel subsidy at the transaction point, a determined sum of cash is given to the recipient to cushion price shocks.
Since a decade ago, Malaysia has had this system in place, so the real problem is whether we have the proper fiscal setup for higher UCTs.
For the record, this column had argued in the past that for UCTs to work, the goods and services tax (GST) must return.
We should not dismiss the targeted fuel subsidy idea despite its inherent weaknesses or imperfections. We must acknowledge that pro-poor policies are generally, by nature, inefficient and ineffective.
Since Malaysia is still reeling from the scarring effects of the pandemic-induced lockdowns, an immediate remedy to economic problems is very much needed.
To sum up, will fuel subsidy work? In its present form, and in the short term, yes, at least from the perspective of alleviating the financial pain of the vulnerable segments of society.
In the long term, no, because it will put pressure on the government’s fiscal position. Also, subsidies do not necessarily lead to positive behavioural change.
Will targeted fuel subsidy work? A resounding no. Will the government proceed with it anyway? Most probably yes, but with a managed float fuel pricing system and GST back in the game.
Instead of a targeted fuel subsidy, this article argues that UCTs provide a better buffer for the overall impact of rising prices.
After considering all possible scenarios, income supplementation is the goldilocks choice. Oh well, cash is king, after all. — FIRDAOS ROSLI
> Firdaos Rosli is chief economist at MARC Ratings Bhd. The views expressed here are the writer’s own. This article first appeared in StarBiz
