x Abu Dhabi, UAEThursday 27 July 2017

Pressure starts to bite over subsidies

A desire to keep consumers happy means cheap fuel and food are unlikely to disappear from the Middle East's petrol stations and supermarkets any time soon.

Beverage prices rose 5 per cent in the UAE during April last year. Jeffrey E. Biteng / The National
Beverage prices rose 5 per cent in the UAE during April last year. Jeffrey E. Biteng / The National

Surging prices of oil and food are putting Middle East governments in a fix.

For decades, they have used subsidies and price controls to help to keep inflation in check and protect citizens from volatility in global markets.

So tightly woven into the fabric of society have the measures become that nobody questioned the approach for many years. Instead, many consumers enjoyed the benefits of cheap electricity in their homes and offices, petrol in their cars and bread on their tables.

But now, as oil and food prices nudge close to record peaks, pressure is growing on the finances of governments and market retailers who have to absorb the costs.

The potential scale of the problem was illustrated in the UAE in recent weeks by petrol shortages in the Northern Emirates.

Fixed prices for petrol but insufficient compensation to fuel suppliers for higher global prices were believed to be behind the queues snaking out of petrol station forecourts. The stations' owners were simply unwilling to pay market prices any more for a product they could only sell at much lower government-set rates.

Across the region, governments are coming under fire from the IMF and other global bodies that argue subsidies are not the best way of appeasing their populations or helping society's poorest.

But the backdrop of social unrest raging across parts of the Arab world has made the idea of exposing consumers to higher prices unappetising.

Concern about instability means subsidised fuel and food should remain part of the region's landscape in the immediate future, say economists.

"Subsidies have to do with the way governments perceive themselves, and it's difficult for them to know what to do after the Arab Spring," says John Sfakianakis, the chief economist at Banque Saudi Fransi. "Subsidies can distort prices and can create capital inefficiencies, but when you put them in, it's difficult to take them out."

Anger at the rising cost of living helped to fuel the social disorder in Egypt and Tunisia, which led to the overthrow of the presidents in those countries.

Prices of many commodities - from corn to oil and wheat - have surged this year. Corn prices have risen more than 10 per cent so far compared with last year, according to the Standard & Poor's GSCI index. Prices of North Sea Brent crude are up by more than 20 per cent during the same period.

Supply pressures caused by the combination of bad harvests in the case of food and production capacity worries in the case of oil have contributed to market volatility.

In response, many governments have shown a willingness to help consumers. Egypt's temporary government has promised to keep existing subsidies, while Bahrain in February ordered an increase in food subsidies. Kuwait's rulers agreed this year to the distribution of US$4 billion (Dh14.6bn) of free food to citizens. Morocco, Yemen, Syria and Jordan have also taken similar action.

Of those nations, it is the non-oil exporters that are most vulnerable to higher prices. While GCC countries can use oil windfalls to pay for their expenditure rises, the financial positions of other nations is more precarious. Egypt's budget deficit is expected to widen to 10.9 per cent of GDP this year as official spending rises.

"Subsidies are more of a problem for oil-importing governments where the pressure on budgets is greater," says Marios Maratheftis, a research executive at Standard Chartered.

In the UAE, the Government has also been spurred to respond. Although inflation in April slowed to 1.1 per cent, food and beverage costs rose 5 per cent during the month compared with April last year.

Last month, the Ministry of Economy agreed with food retailers to fix the price of 400 commodities at 70 retail outlets across the country.

Officials also appear to have stalled plans to gradually liberalise fixed petrol prices. In an effort to reduce pressure on retailers and to slow rapid consumption growth, the Government lifted prices at the pump twice last year.

Despite the double rise - a total of up to 27 per cent, depending on the grade of fuel - petrol retailers say they are still losing money.