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An Oil-Price Test for MENA Governments

In recent years, Middle Eastern and North African countries have been weaning consumers off domestic energy subsidies, while modernizing and diversifying their economies. With oil prices recovering, however, there is a risk that these countries will revert to their old wasteful spending habits.

WASHINGTON, DC – Since January 2016, when oil prices ended a sharp two-year slide, the price of crude has more than doubled. As a rule, higher prices are bad for oil-importing countries and good for oil producers. But, in the Middle East and North Africa (MENA), the recent price rebound presents a critical test for importers and producers alike. The outcome will determine the region’s future economic trajectory.

MENA countries – both energy importers and producers – have long depended on energy subsidies to provide social protection and, in the case of producers, to spread the benefits of resource wealth. According to the International Monetary Fund, the region’s total pre-tax energy subsidies amounted to nearly $240 billion in 2011 – equivalent to 22% of government revenue, and nearly half of all global energy subsidies.

Yet, in recent years – and especially since oil prices began to slide in 2014 – MENA countries have been working to wean consumers and businesses off subsidized energy, while modernizing and diversifying their economies. With oil prices having climbed to higher levels, however, there is a risk that these countries will revert to wasteful spending, raising the likelihood of spiraling debt.

A reversion to old habits is particularly risky, because there is no guarantee that oil prices will continue to climb, or even remain stable at their current levels.

To be sure, vigorous global growth in oil demand, reinstatement of sanctions on Iran by the United States, and lower production in Venezuela and Angola will put upward pressure on prices. But the rapid response of US shale producers to changes in the market is likely to have strong moderating effect on global prices, meaning that the triple-digit peak prices reached in 2014 are unlikely to return.

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Moreover, while the price rally that began in 2015 accelerated considerably in late 2016, when the members of the Organization of the Petroleum Exporting Countries (OPEC), Russia, and a few other producers agreed to cut output, it is unclear whether these restrictions will be extended further. Indeed, as the price rises, OPEC members, in particular, will not feel the urge to comply with the restrictions and will boost output, which in turn will bring the price down.

All of this means that the near-term outlook for oil prices is uncertain, at best. MENA governments that took advantage of falling oil prices to reduce budget-busting fuel subsidies should thus tread carefully. The long-term consequences of abandoning critical and difficult reforms could far outweigh any short-term benefits.

For now, rising global oil prices will cause domestic prices to rise as well, unless governments use subsidies to limit the pass-through to local consumers. But while that approach might prevent demand from falling in the short run, it would also increase public-debt levels and leave fewer resources to invest in private-sector development and broader economic transformation.

Even if governments relied on spending cuts elsewhere to pay for the subsidies, the net result would be negative. For example, if they reduce transfers to low-income households, they would impose further hardship on some of their most vulnerable citizens. Given the high propensity of poor households to consume, such cuts would also weaken aggregate domestic demand. That would translate into slower economic growth and job creation in countries struggling to generate employment opportunities for large numbers of young people.

In short, the more governments attempt to protect consumers from the effect of higher oil prices, the more they (or, in some cases, distributors) stand to lose. Instead of taking this path, therefore, MENA governments should, first and foremost, continue working to increase the efficiency of public investment, including by completing the elimination of fuel subsidies.

Those governments should then use their savings to expand and strengthen social safety nets, thereby protecting the poor while enabling the economic dynamism needed to give the poor a chance to escape poverty. Meanwhile, governments should invest in structural reforms to support a renewed and more competitive private sector and develop smart regulations that crowd in private investment. In some countries, this would mean removing the hurdles impeding the adoption of modern digital infrastructure and payment systems.

The combination of thriving private sectors and strong social safety nets would encourage risk-taking and entrepreneurship – both of which amount to powerful engines of long-term growth. That, not more budget-busting energy subsidies, is what the MENA countries need.

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