Fuel Subsidy Removal and Cash Transfers
A West African government spends 3.2 billion dollars a year keeping petrol at 500 per litre when the landed cost is 850. Daily consumption is 40 million litres, and fuel is smuggled to two neighbours where the pump price is above 900. The budget is 24 billion dollars; debt service is 6 billion, education 2.4 billion, and subsidy arrears are 1.1 billion. Inflation is 18% and the currency has depreciated from 450 to 750 per dollar in two years. The government proposes to remove the subsidy and pay 8 dollars a month to 5 million households, costing 480 million dollars a year. A minister argues that the subsidy protects the poor; an adviser argues that it mostly protects the rich and smugglers.
1. Using the figures, assess who actually benefits from the subsidy.
Read the worked answer
Who benefits from the price gap? The subsidy keeps the pump price 350 per litre below landed cost. Every litre bought at the controlled price carries that benefit to the buyer. Households with cars, generators, and large fuel purchases capture most of it; a poor household that buys a few litres for a lamp or travel captures little. The rich also tend to own the vehicles and businesses that consume petrol and diesel in bulk.
Smuggling leaks the benefit abroad. With neighbours above 900 per litre, a trader can buy at 500 and sell across the border. The 40 million litres/day figure is therefore likely to overstate domestic use; part of the 3.2 billion dollars is financing exports and arbitrage, not protecting the poor.
The arrears matter. 1.1 billion dollars of unpaid subsidy claims is a contingent liability. If paid, it competes directly with education (2.4 billion) and debt service (6 billion).
Conclusion: The subsidy is broadly regressive. It is not targeted, it is leaky, and it is fiscally expensive. The minister's claim that it protects the poor is only true in the weak sense that poor households also buy some fuel; most of the money does not reach them.
2. Evaluate the proposed removal-plus-transfer package against removal alone, considering inflation, fiscal space, and poverty.
Read the worked answer
Removal alone: The pump price would rise toward 850, a 70% increase. Fuel has a weight in the CPI and feeds transport, food, and power costs. A rough first-round effect could add several percentage points to 18% inflation, with second-round effects depending on transport fares and wages. Fiscal saving is large: 3.2 billion, less any remaining costs. Poverty would rise in the short run because transport and food costs climb, and the poor spend a larger share of income on these.
Removal plus transfer: The 480 million dollar transfer is only 15% of the subsidy's cost. At 8 dollars per month for 5 million households, it is unlikely to offset the full cost of higher fuel for a typical poor household. But it is better than nothing and can be targeted through a social registry. The net fiscal saving is about 2.72 billion dollars. If part of that is used for public transport, health, and education, the package can be made more progressive than the subsidy.
Judgement: The transfer as designed is too small to protect the poor fully, but removal alone is worse. The package should be judged on the net saving and on whether the transfer reaches the intended households, not on the pump price alone.
3. Recommend a sequencing plan and two complementary measures, with one risk.
Read the worked answer
Sequencing:
- Build and verify the beneficiary register before removal; publish the eligibility rules.
- Announce a phased price adjustment over six months rather than a single shock, so households and firms can adjust.
- Remove the subsidy on industrial and large-volume users first, then on retail petrol.
- Pay transfers monthly and publish the payment rate and coverage.
- Use part of the saving for mass transit and rural transport, which lowers the cost of the price increase for the poor.
Complementary measures:
- Strengthen border monitoring and publish fuel volumes to reduce smuggling.
- Expand the social registry and link transfers to school attendance or health visits, but avoid excluding informal workers.
Risk: The transfer may be captured by better-off households or delayed by payment systems. A credible audit and a grievance mechanism are needed. If removal happens before the register is ready, the poor bear the adjustment cost and the reform loses public support.