The State of the Nation: Electricity subsidy conundrum for the government

This article first appeared in The Edge Malaysia Weekly, on January 1, 2018 - January 07, 2018.
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THE government’s hand may have been forced by economic and financial circumstances but the successful implementation of the subsidy rationalisation plan over the past few years sits squarely on the list of the administration’s achievements.

After all, it is an exercise of sheer political will to wean a country off its dependence on artificially depressed costs, like in the case of petrol and sugar.

Thus, the government’s announcement last week that it would spend RM929.37 million on keeping electricity tariffs from rising in the first half of this year seems to be a backward step.

Obviously, the impending 14th general election cannot be ignored. A promise to maintain electricity tariffs certainly carries with it strong populist overtones. That said, in an environment of relatively high inflation and growing concerns over the rising cost of living, it could make sense to reintroduce subsidies.

“The government has had a shift in policy priorities of late, focusing on addressing the cost of living. While there is some merit for the government to disburse subsidies as long as it is within its fiscal capacity, this has to be targeted at the right groups to ensure the measure is effective,” says Dr Yeah Kim Leng, professor of economics and director of Economic Studies Programme at Jeffrey Cheah Institute on Southeast Asia at Sunway University.

The subsidy on electricity tariffs, however, is too broad-based to be effective, he points out.

“The low-income group that would need this subsidy the most would benefit the least from it,” he explains.

After all, low-income households would consume the least amount of electricity. Similar to other consumption subsidies, this group benefits the least.

 

Electricity subsidies, briefly

It is important to appreciate that electricity in Malaysia is already indirectly subsidised. This is because national oil and gas company Petronas forgoes revenue to supply natural gas to Tenaga Nasional Bhd at below market price. Currently, Petronas is committed to supply up to 1,000 MMSCFD of natural gas to TNB at only RM22.70 per MMBtu compared with the RM31.968 per MMBtu (based on indexed price) that TNB would have to pay if it were to procure liquefied natural gas (LNG) from the international market.

This translates into a 28.9% discount to market prices. Keep in mind that TNB currently consumes less than 1,000 MMSCFD of natural gas, thus, all its gas consumption is at below market cost. Also note that gas generates about 41% of the nation’s electricity needs.

This regulated natural gas also fell under the purview of the subsidy rationalisation plan. The price of the subsidised natural gas is currently scheduled to increase by RM1.50 per MMBtu every six months in order to achieve parity with LNG prices.

Just like Yeah, other economists argue that broad-based subsidies like this create inefficiencies in the economy and may not necessarily benefit the low-income group that needs them the most.

Separately, base electricity tariffs are reviewed every three years in what is known as the regulatory period. The first — RP1 — ran from January 2014 to December last year.

Thus, a decision was due to be made for the coming regulatory period, RP2, from January 2018 to December 2020.

According to last week’s announcement by the Ministry of Energy, Green Technology and Water, the government has opted to keep base tariffs unchanged in RP2. Strictly speaking, fixing the tariffs does not translate into a subsidy.

Base tariffs are determined by projected fuel prices as well as anticipated generation mix. They also take into account the amount of capital expenditure that TNB needs for its regulated assets — transmission and distribution.

In RP1, the government approved a 4.99 sen per kWh hike in base tariffs to 38.53 sen per kWh. This hike mainly accounted for higher fuel costs. Only 0.9 sen per kWh of the hike was allocated to TNB for capital expenditure.

So, where is the subsidy being applied?

Based on the ministry’s announcement, the government will be directly subsidising the imbalance cost pass-through (ICPT) mechanism that is designed to transfer fluctuations in fuel costs to consumers.

Currently, the ICPT is supposed to be charging consumers a surcharge of 0.28 sen per kWh. Instead, the government is maintaining the 1.58 sen per kWh rebate. The net difference — 1.8 sen per kWh — is the subsidy that will cost the government an estimated RM929.37 million in the coming six months.

 

An inefficient subsidy

Subsidising electricity tariffs has two effects. First, it transfers cash directly to households and businesses in the form of lower electricity bills. Second, it has a moderating effect on inflation.

Rising inflation is a major concern for the government. Up to November last year, the Consumer Price Index (CPI) averaged 3.9% year on year. In contrast, CPI growth averaged 2.29% from 2010 to 2016.

“Compared with historical averages — between 2.5% and 3% — and compared with the deflation we are seeing in some other economies, Malaysia’s inflation appears to be high,” says Yeah, although he stresses inflation is still below worrying levels.

Intuitively, managing the cost of electricity should temper inflation going forward.

The trouble is, electricity has a relatively small weightage in the CPI — only 2.7%. Furthermore, electricity has been one of the more stable components of the CPI, closing at 106.3 points in November. Since the CPI is based on 100 in 2010, that means electricity costs have only climbed 6.3% since 2010.

In contrast, the overall CPI stood at 120.8 points as at end-November. Meanwhile, more volatile components, like food and non-alcoholic beverages, came in at 129.9 points.

Yeah points out that the impact of the subsidy on inflation will be minute.

Without the subsidy, electricity tariffs would have risen 1.8 sen per kWh or 4.67%. Putting second-round effects aside, this roughly translates into a mild 0.12 percentage point increase in overall inflation.

Keep in mind that this assumes a full year of subsidies, which would cost only a little less than RM2 billion.

In contrast, the government is expected to spend RM26.54 billion on subsidies and social assistance this year, based on the latest Economic Report.

It is interesting to note that this year will see the first increase in the government’s subsidy bill since the rationalisation plan was implemented. In 2014, 2015 and 2016, subsidies cost the government RM39.7 billion, RM27.27 billion and RM24.69 billion respectively.

Subsidies as a share of operating expenditure had also fallen from 18.1% in 2014 to 10.5% last year. But this is expected to increase to 11.3% this year.

However, it is not the absolute amount of electricity subsidies that is the main concern.

“The negative aspect of this subsidy is the mixed message it sends. The government has been working on its subsidy rationalisation plan for years. Now, it seems to be sending a different signal. This can undermine the credibility and the consistency of government policy,” observes Yeah.

However, this effect can be mitigated if the subsidy were more transparent. For example, by implementing a cap — limiting the absolute amount of electricity tariff subsidy instead of fixing the tariffs regardless of the market price of fuels.

After all, fuel prices have proved to be incredibly volatile. As it stands, coal prices are almost 50% higher today compared with the beginning of RP1. Coal is the largest driver of the ICPT today.

“The trouble with such broad-based subsidies is that they promote inefficiencies in the economy. They encourage energy-intensive industries and reduce the incentive for companies to be more efficient in energy costs,” explains Yeah.

While it is good for the government to intervene to ensure relatively stable energy costs, a long-term subsidy regime can be costly with little benefit to the poorest in the country, he says. A better alternative, he adds, would be to spend the money on subsidising transport — possibly by building better infrastructure — education or healthcare.

 

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