Proposed government subsidy cuts face three obstacles

Analysts warn that poverty, regulatory issues, and macroeconomic concerns could complicate the readjustment of energy prices

Energy tariffs under the spotlight. Credit: Pexels

Energy subsidies will be reduced to a third during 2024, an amount equivalent to 0.7% of GDP, some U$S2,5 billion. The government seeks to eliminate all of them in the next 3 years.

Economy Minister Luis Caputo announced this in a TV interview, adding that there will be a change in the way subsidies are handled, shifting from the supply side (energy generation) to the demand side (users). In any case, sector sources said that key details are still missing.

Juan José Carbajales, former Hydrocarbons Deputy Secretary, says the decree declaring the energy emergency published this Monday in the Official Bulletin kicks off a process of comprehensive tariff review, with a new tariff scheme set for the end of 2024, but leaves two fundamental questions about segmentation. 

“Will there be a single subsidy for electric energy for lower income households? Will power and gas bills for medium-income households come without subsidies?,” Carbajales, head of Paspartú consulting firm, asked in the firm’s latest report.

Caputo said that the subsidy cut for 2024 will be 0.7% of the GDP. Of that total, 0.5% was destined for energy tariffs, while the rest was for transport. This means the state will save U$S 2,5 billion, and an additional U$S1 million in transportation. 

Given that subsidies currently amount to 2% of GDP, he said that subsidy correction will be “gradual, at a rate of approximately one third per year” until December, 2026.

The announced “change of approach” aims to stop destining the bulk of subsidies to companies and give them to users in order to be able to differentiate them based on their income and wealth.

Limitations to subsidy removal

Julián Rojo, an economist at IAE Mosconi and investigator at IIEP-UBA, added that there are very noted limitations when it comes to readjusting energy prices. As of November, 7 out of 10 residential users currently pay “only 16% of energy costs, while the remaining 84% is paid for by the state.”

According to Rojo, the first limitant is socioeconomic fragility: “Considering that more than 45% of households are below the poverty line, it would be very difficult to eliminate subsidies to this segment as well as to some of their close neighbors, meaning people who are just barely above this socioeconomic level.”

The second constraint is macroeconomic due to the impact on prices. “History tells us that it is not a good idea to devalue at the same time that tariffs are raised, and even less so if wages are used as anchors, because its impact on the inflation rate is enhanced. This suggests that the coordination between energy and economy in the context of a stabilization plan must run like clockwork,” Rojo said. 

Rojo added that in an exchange rate appreciation process, there may be pressure for a new devaluation, which implies higher energy costs and therefore higher subsidies. All this could lead to “efforts having been in vain.”

The third item, Rojo added, is regulatory “The energy sector has a very weak institutional framework. At the same time, there is legal precedent on tariff increases that makes it very clear that there are difficult decisions to be made. This is important to try to solve the tariff arrears because middle-income and low-income users pay only 18% and 15% of energy costs, respectively. In order to eliminate energy subsidies, as of February 2024, their tariffs should increase by a factor of 6 and 8, respectively.”

The middle class under the spotlight

Without details on how subsidies will be removed and what the future of segmentation will look like, all eyes are on the middle class segment that continues to receive subsidies and only pays 18% of energy costs.

Rojo places this sector under the spotlight. “Middle-income users are in a particular situation. Income for those on the lower end is close to that of people in low-income sectors, while those in the upper end share income levels with the wealthiest households. This is relevant because, in the process of transitioning from the current segmentation to a rational regulatory criterion of targeted subsidies, it is not so much the level of household wealth, which is one of the decision variables for assigning segments, that matters, but income level as well. This suggests that there is a portion of middle-income users that are among the 15% to 20% of the country’s wealthiest population and are paying only 18% of the cost of energy. On the other extreme, this segment also contains households with similar characteristics to those with low incomes. In other words, we need to have a more rigorous treatment when trying to solve the tariff arrears for these users,” he explained.

Originally published in Ámbito


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