Other countries have succeeded in reducing sting of price rise by adopting cash transfers, PR blitz to educate populace

PUTRAJAYA recently backtracked on subsidy removals because of the public backlash. The prime minister and the cabinet were accused of being out of touch with realities on the ground.

Subsidies or their removal is a touchy subject, but the country must find a way to educate the populace on their financial unsustainability in the long run.

According to economists, the projected amount of RM77.3 billion in subsidies in 2022 equals 9% of our gross domestic product. This is because of the country’s small tax base – Malaysia collected only RM63.3 billion in the first seven months of 2021, barely covering the government’s operating expenditures.

The cost of maintaining subsidies will compound the national debt situation, which stands at RM1.006 trillion or 61.4% of GDP. If not addressed, it could breach the 65% threshold by year-end. If this happens, economic growth becomes increasingly difficult. Malaysia will also be vulnerable to future economic shocks and debt default.

There exist strong economic rationales for subsidy removals. Despite being widely perceived as an “equaliser”, subsidies benefit the wealthy, as they consume and accrue more of the subsidised goods over time. Subsidies distort the market, as producers are not penalised for inefficiency. They divert funds that could be allocated to education, healthcare, etc. They also promote smuggling to neighbouring countries, where such goods are not subsidised.

Educating consumers

Take, for example, the subsidy for cooking oil in 2kg, 3kg and 5kg bottles, which costs RM55 million per month. It was removed because the subsidy was abused by commercial and industrial parties, and smugglers – bottled cooking oil from Malaysia is widely sold in southern Philippines and Thailand. Hence, only the 1kg cooking oil subsidy remains, at a cost of RM4 billion a year, as Malaysian B40 households rely on the polybags.

The government failed to explain the true financial cost of maintaining such subsidies and had it embarked on such a move, Malaysians would have had a crash course on finance and their reaction to subsidy removals might not have been so negative. Malaysians need to be made aware of the negative impacts of subsidies and distinguish between those needing help and “free riders”.

Cash transfers

The global best practice is to replace a subsidy with targeted cash transfers. However, people naturally dislike losses more than they like similar gains. This is referred to as loss aversion, a real or potential loss perceived as psychologically or emotionally more severe than an equivalent gain. This appears to be true even when the cash transfer is far more useful, as people can use it to purchase the previously subsidised commodity, buy other goods, invest or even save it.

To limit the effects of loss aversion, according to a 2012 report by former World Bank global director of trade, investment and competitiveness, Caroline Freund, is to provide a cash transfer before removing a subsidy, while at the same time endorsing it as a “subsidy replacement transfer”.  By doing so, the transfer is internalised by people as something they own.

Iran’s fuel subsidy replacement

Some countries which have successfully implemented cash transfers are Iran and India.

Freund highlighted Iran’s subsidy reform plan of 2010. At one point, the country had one of the largest subsidies of energy and food in the world, amounting to nearly 20% of GDP. By depositing into the bank accounts of low-income earners before fuel prices rose, Iranians could see the money in their balance but could not withdraw it until the fuel subsidy was abolished.

Despite prices rising after the subsidy removal, the news was met with surprising calm by the public. This innovative approach of early cash transfers led the people to focus on how to spend the cash rather than on the subsidy loss. Officials were also worried about runs on Iranian banks as soon as the cash became available, but this did not happen either. Instead, those who had failed to register for the cash subsidy clamoured to apply.

More importantly, the price adjustment had the desired result, with the use of fuels falling by up to 36% and income equality grew. The Iranian Central Bank also reported in 2012 that the Gini coefficient, which measures the inequality among values of a frequency distribution fell to 0.3813 in 2010 compared with 0.4023 in 2005.

The Iranian example shows the importance of educating the public on the rationale of subsidy removal and then gradually slashing subsidies on certain goods over time, with vulnerable low-income families being compensated with direct targeted cash handouts.

India’s cooking gas subsidy

As for India’s success in subsidy removal, the country imports nearly 80% of its crude oil and to lessen the financial burden of subsidising end products like petrol, diesel, liquefied petroleum gas, and kerosene, New Delhi implemented economic reforms over a 10-year period to deregulate prices.

The cash transfer aspect of India’s subsidy reform plan, launched in 2013, is the direct benefit transfer for LPG or the Pratyaksha Hastaantarit Laabh (PAHAL), which ended in June 2020.

The government had subsidised LPG cylinders (cooking gas) for households while imposing taxes on commercial users. This created a black market in which fraudulent household beneficiaries diverted cylinders to the commercial market. To end this, LPG was sold at market rates but PAHAL softened the impact by providing subsidies directly to households in the form of cash transfers.

By June 2019, there were 247 million PAHAL recipients at a cost of about US$7.74 billion. To manage the scaling up process, it utilised Aadhaar, India’s biometric ID number system and a financial inclusion drive helped open 200 million new bank accounts, especially for women and the poorer segments of the population. This was further complemented by a repetitive, multilingual and multimodal outreach campaign, leveraging on a mobile platform that allowed PAHAL to educate Indian households.

Ultimately, the Indian government estimated that it had saved US$8.8 billion between 2013 and 2019. The scheme also helped direct subsidies to Indian women, which increased their financial inclusion and access to clean cooking fuel – as opposed to burning firewood and other biomass fuels.

If Putrajaya adopts a similar combined approach like that of Iran and India, it can minimise the backlash when the time comes to remove another Malaysian subsidy.

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