/

Burden of subsidies grows

by Michael Richardson

SINGAPORE — As the price of oil has surged ever higher in recent weeks, Asian countries that subsidize energy prices have been hit hard. India, Indonesia, Malaysia, Sri Lanka, Pakistan and Taiwan have been forced to raise fuel prices by cutting their subsidies, despite concerns about stoking inflation, public discontent and political instability.

Will China, which in 2002 surpassed Japan as the world’s second-largest oil-consuming nation after the United States, follow? The answer is of global significance. The government in Tokyo will be keen to know because it will affect the high prices of gasoline, diesel and other refined oil products in Japan, where fuel prices are not subsidized.

If Asia’s two emerging economic giants, China and India, keep guzzling oil at current rates, the International Energy Agency reckons their net oil imports will almost quadruple to 19.1 million barrels a day by 2030, more than the combined imports of the United States and Japan today. By then, China would be the biggest oil user.

However, eliminating subsidies and raising domestic oil product prices to market levels would rein in demand and encourage energy efficiency, thus relieving a significant amount of upward pressure on the international oil price.

Meeting in Japan last weekend, finance ministers from the Group of Eight powers warned that runaway oil prices could imperil global economic growth. Ministers from Britain, Canada, France, Germany, Italy, Japan, Russia and the United States called for an urgent boost to world oil production and an end to fuel subsidies blamed for helping push the crude oil price to a recent record level of over $138 a barrel.

A week earlier, also in Japan, G8 energy ministers plus their counterparts from China, India and South Korea had diverged over this issue. China and India signed a statement acknowledging the need to phase out subsidies eventually. However, they argued that removing them quickly could trigger economic and political instability.

Malaysia became the latest convert to subsidy cuts earlier this month when it raised the price of gasoline by 41 percent and diesel by 63 percent. Without the cuts, the government would have had to spend a third of its budget on fuel subsidies. Malaysia was in danger of allocating $15 billion on subsidies this year, just over 7 percent of GDP.

Indonesia also faced severe pressure on its public finances. Without raising pump prices, its subsidies would have amounted to almost 3 percent of GDP in 2008.

By contrast, the subsidy bill India faced before it lifted gasoline and diesel prices by around 10 percent would have been well under 1 percent of GDP. China, too, has leeway to proceed more cautiously than either Malaysia or Indonesia. China’s fuel subsidy amounts to around 0.25 percent of GDP.

Still, HSBC estimates that if oil prices remain at $120 a barrel this year, the effective subsidy paid by China to maintain lower domestic prices could reach $27 billion, or 4 percent of the annual budget.

China is in a bind. It wants to improve energy efficiency and ease dependence on imported oil, which now comprises almost half of total oil consumption. However, an even higher priority is to stop consumer price inflation from rising above the 8.2 percent annual rate recorded for the first four months of this year. The effect of the inflationary surge since the first half of 2007, the steepest in over a decade, has been to drive up the price of food, prompting strong complaints from Chinese workers and their families.

Meanwhile, the government wants stability so it can stage a successful Olympics in August. Yet in China’s main cities, including Beijing where most Olympic events will be held, public discontent is rising over oil product shortages, especially diesel.

These are caused because the government keeps gasoline and diesel prices artificially low to protect consumers. However, refiners have to pay world market prices for the crude oil they turn into products. They sell at a loss and look to the state for reimbursement.

This is also what happens in India. Neither country can hope to have a modern and efficient refining industry while subsidies continue.

Last November, the Chinese government raised prices by 10 percent amid fears that fuel rationing was threatening social stability. The big question is when it will do so again, by how much, and how long it will take to eliminate subsidies altogether.

Michael Richardson, a former Asia editor of the International Herald Tribune, is an energy and security specialist at the Institute of South East Asian Studies in Singapore.