It's painful, but removal of fuel subsidy is good for the country

Pump attendant prepares to fuel a car at the Rubis Petrol station along Koinange street, Nairobi. [Elvis Ogina, Standard]

The discussion regarding the intended removal of fuel subsidy in Kenya have left many Kenyans wondering how the cost of living will be. There is a consideration to adopting an automatic pricing mechanism based on global prices set by forces of demand and supply with built-in price smoothing to protect households while ensuring full pass-through in the medium term.

Fossil-fuel subsidies are one of the biggest financial barriers hampering the world's shift to renewable energy sources. Each year, governments around the world pour around half a trillion dollars into artificially lowering the price of fossil fuels - more than triple what renewables receive. This is despite repeated pledges by politicians to end this kind of support, including statements from the G7 and G20 groups of nations.

Fossil-fuel subsidies generally take two forms. Production subsidies are tax breaks or direct payments that reduce the cost of producing coal, oil or gas. These are common in Western countries and are often influential in locking in infrastructure such as oil pipelines and gas fields Consumption subsidies, meanwhile, cut fuel prices for the end user, such as by fixing the price at the petrol pump so that it is less than the market rate.

Fueling Inequalities

The negative economic and environmental effects of fuel subsidies are widely recognised. But these subsidies are also undesirable from an equity perspective since they exacerbate income inequalities and are not a cost-effective approach to protecting the poor. Their adverse impact on inequality arises through unproportioned distribution. The benefits of fuel subsidies are distributed in proportion to household energy consumption, and the consumption baskets of higher-income households are typically more energy intensive than those of lower-income households.

Public expenditures on energy subsidies can crowd out more redistributive public spending or require financing through regressive taxation. Yet governments in developing countries remain reluctant to remove subsidies because of the adverse impact of higher fuel prices on household real incomes, in particular of lower-income households who are least able to absorb the cost of higher fuel prices. Information on the magnitude of the income loss from fuel price increases, and its distribution across income groups, is therefore a key input into designing more cost effective policies to protect the most vulnerable social groups and gaining political and public support for reducing subsidies. Kenya spends close to 280billion annually on subsidies, which can be channeled to development projects targeting the ordinary citizens.

Depoliticize energy pricing

Successful and durable reforms require a depoliticized mechanism for setting energy prices. Establishing an automatic pricing formula for fuel products that links domestic energy prices to international energy prices can help distance the Government from the pricing of energy and make it clearer that domestic price changes reflect changes in international prices that are outside the government's control. Price-smoothing rules can help prevent large price increases. How much smoothing the Government chooses to implement will depend on its preference between lower price volatility and higher fiscal volatility.

Mitigating measures and reform plan

Well-targeted measures to mitigate the impact of energy price increases on the poor are critical for building public support for subsidy reforms. The degree to which compensation should be targeted is a strategic decision that involves trade-offs between fiscal savings, capacity to target, and the need to achieve broad acceptance of the reform.

The reform plan should have clear objectives. It should identify specific measures that will achieve these objectives, and include a timeline for implementing and assessing these measures. Revamping agriculture to spur production thus lowering the prices of agricultural products to consumers will help lower the cost of living thus compensating on the higher cost of fuel.

Effective communication strategy

An extensive public communication campaign can help generate broad political and public support, help prevent misinformation, and should be undertaken throughout the reform process. Transparency is a key component of a successful communication strategy. There is also need to improve on State corporations and revive oil refinery in Kenya. Corruption and wasteful government spending must be tamed to improve on service delivery to citizens. All citizens including MPs should pay taxes, this transparency will aid in sealing loopholes on tax evasion and tax avoidance by individuals and corporates. It will also help assure consumers that price increases are not simply being used to protect inefficient and poorly governed economy.