International Herald Tribune
Bowring: Asia's oil subsidies
Friday, May 30, 2008

HONG KONG: Asia's oil subsidies

Developing Asia sees itself as a victim of high oil prices. But it seldom stops to consider how much it is to blame for the escalation of prices in a market always highly sensitive to supply and demand.

In the past week, several countries have announced a cut or the intention to cut oil subsidies to their consumers. Indonesia is raising prices by 30 percent; Malaysia is contemplating similar action. India may do the same, but its government fears the political consequences. China may do likewise when broader inflationary pressures ease and the trauma of the Sichuan earthquake is behind it.

But all these countries - and some others too - are thinking largely in terms of the domestic consequences of oil subsidies. Last year alone, subsidies cost the Malaysian government around $12 billion, or 25 percent of its spending, exceeding development outlays. This year, oil subsidies could hit $15 billion, threatening the country's excellent credit rating.

Indonesia's subsidy is set to rise from $10 billion in 2007 to $15 billion this year if oil prices stay around current levels. India's budget deficit, including off the books oil subsidies via state oil companies, could hit 9 percent of GDP this year. The country's dependence on oil imports is also raising concerns about its growing trade deficit, which is weakening the rupee and spurring inflation.

China may in principle be able to afford its subsidies for oil and energy consumption, but they are distorting the economy and disrupting the finances of state-owned power, smelting and energy companies.

All this is widely known. What is not talked about is the impact that these subsidies are having on demand for oil. As it is, developing Asia accounts for only about 20 percent of global oil consumption. But the more important statistic is that Asian countries account for about two thirds of the annual increase in global oil demand and an even higher percentage of the increase in imports. Most of the rest of the increase comes from oil exporters like Russia and the Middle East, where prices are low and economies booming. Oil consumption in the developed world is declining slowly.

With developing Asia now consuming about 17 million barrels a day - and that figure rising by about 1 million ever year - the key question is: How much additional demand has been created by these oil subsidies?

There is no accurate way to measure how sensitive demand is to rising oil prices across this diverse group of countries. But the difference between oil at $65 a barrel and oil at $130 a barrel could well limit demand by at least 1.5 million barrels a day.

Sudden rises in oil prices could depress consumption in countries like China and Malaysia, where additional domestic demand may be needed to compensate for slowing export growth. There is merit in some subsidies, at least in the short term. Many lower income people cook with kerosene or get to work on motor bikes. Related fertilizer subsidies may also be necessary to sustain food output.

But subsidies for oil and other energy sources mainly benefit higher income groups and capital intensive industries at a time when rising income differentials and job creation are bigger concerns than overall economic growth.

Subsidies also must take at least some of the direct blame for the pollution which shrouds Jakarta, Beijing, Delhi and Kuala Lumpur, and indirect blame for shifting resources away from investment in schools and public health. Subsidized oil, for example, has shifted focus from public transportation to highway construction, with the automobile seen as a mainspring of industrial growth. In Malaysia car ownership is far above the norm for the country's national income level, and in China the average engine size of new cars is rising.

Mobility and vehicle ownership are natural expectations as societies get richer. But there is scant justification for oil subsidies. Ending subsidies now would be politically unpalatable, but concerted action by all the leading Asian nations would dramatically benefit both consumers and governments, not to mention the world trading and financial systems.

For sure, the West is mainly responsible for overall oil demand. But no other region subsidizes its use like developing Asia. No wonder the region's demand is growing so fast - and causing such grief. It is past time for Asian countries to look beyond their budgets to the global impact of their behavior.