If we must go the fuel subsidy way, here's how we should get it right

Residents queue to fill their jerricans at a petrol station in Nyeri. [Kibata Kihu, Standard]

I do not remember any moment in recent history when consumers had to be turned away at the pump stations for lack of the precious commodity. Yet, this past week the whole nation had been sent into a panic mode as the retail units run out of supplies. While many consumers seemed to be caught by surprise, the warning signs have been all over for a keen observer.

For instance, a simple google search about fuel and gas in Kenya gives several diverse sets of articles on the same over the past two years on both mainstream and social media. If it is not about a new tax, it is about the new pump prices or a tussle between the Government and the oil marketers on something. Questions about the nature and clarity of the tax subsidy that the Government has been running from around April 2021 to cushion consumers against high pump prices have been with us since the inception of the programme.

At some point, there was news that the relevant ministry, its agencies and Treasury had been running the programme without proper appropriation of the funds from the National Assembly. Arguably, the funds are drawn from the Fuel Development Levy Fund whose charge was increased to Sh5.40 per litre for 0.4 cents in 2020.

Under the Constitution and the Public Financial Management frameworks, no public resources can be expended without the express approval of the National Assembly. The exceptions are in cases of emergency where the Treasury CS is mandated to authorise expenditures first before seeking ratification from Parliament within 60 days. But emergency clauses must meet stringent criteria defined by law before they can be invoked.

However, now that we are in it, it may not add value to start crying over spilled milk. The questions relevant for us now are: One, how did an economy that prides itself as the regional super power lead itself into such an embarrassing situation? Two, why is there so much opaqueness on the subsidy programme and a seemingly obvious policy incoherence? Three, is there a better way to execute the fuel subsidy programme if we must go that route?

Subsidies are debatable

The supreme law in financial economics is the absence of arbitrage opportunities in a market-based economy. This simply means that the market forces of supply and demand are able to wipe out any abnormal profits in any industry to assure that only true price of commodities and services prevail at any given point in time. The net outcome is to appropriate the correct price for the consumer and allocate decent profits for the entrepreneurs and/or investors as a return for their investment and risks taken.

These were the revolutionary thoughts of Scottish Philosopher Adam Smith from 1759 through 1776 and adopted in modern economics from the 1900s. While there is a lot of empirical literature on the benefits of subsidies to the economy, there still exist questions as to their net impacts. For instance, Investopedia.com identifies the three primary advantages of subsidies as control of inflation, moderation of supply and demand forces and reduction of prices for consumers.

On the contra, the disadvantages include a potential distortion in the supply side since low prices may push the demand up; difficulties to quantify or measure the actual impact of subsidies in the economy; and subsidies ultimately will have to be financed from somewhere that means increase in taxes elsewhere. In strict economic jargon, subsidies are considered as pareto inefficient as they interfere with the cardinal rule of economics that at an equilibrium state, it is impossible to make somebody better off without making another person worse off.

Therefore, government interventions constitute an interference with the forces of the invisible hand advocated by Adam Smith. These distortions create arbitrage opportunities for abnormal profits and/or corruption. Subsidies affect the market by reducing the price paid by buyers and increasing the quantity sold. Thus, the subsidies will cost more than they deliver in form of benefits. Important lessons can be learned from the populist Nigerian and Venezuelan fuel subsidies that have become a huge exchequer burden in these countries.

To contextualize our current predicament, the country abolished price controls from the late 1980s in favour of a market based economy. However, at the policy level the Government has never left off critical sectors of the economy. For example, while the oil sector has maintained large private sector drivers, the government hand has remained all over through various controls and regulatory interventions. In fact, the genesis of the current retail supply crisis can largely be attributed to the Government regulatory actions. For private sector investors, their life blood is adequate working capital/cashflows to sustain operations and assure investors of their return on investment.

It is unthinkable how a government can force oil dealers to dispense fuel in their pumps at cost plus government taxes and then hoard their profit margins for days leave alone a whole month. While the consumers get fuel in cash, the Government bureaucratic processes enshrined in law make it literally impossible to ever get this compensation process right and on time. A good case in point is the Sh13b that was at the center of this crisis.

For the money to be released to oil marketers, as long as the funds were initially collected by the Government, it must first be appropriated in parliament and approved through the Controller of Budget for disbursements to happen. That would explain why some white smoke appeared only after the president assented to the supplementary budget estimates that have been with parliament since January 2022. A scrutiny of the estimates indicates the Ministry of Petroleum and Mining got the lions’ share of the re-allocation with its recurrent budget increased by at least Sh25b.

This outlier allocation can only be attributable to the fuel subsidy, meaning an additional budgetary allocation to supplement the petroleum development Levy collections being to compensate the oil marketers of their foregone profit margins.

Chequered History

As a country, subsidies do not evoke great memories, especially when initiated around election periods. There seem to be a strange coincidence between election cycles and a crisis in one or two of the high volume consumer goods in the country. Often, this has been around maize, sugar, fertilizer, cooking oil, wheat, medical supplies and now fuel. From the era of the Goldenberg in the early 1990s, there are traceable associations between astronomical corruption scandals and either one or more of these commodity crises.

Thinking ahead, however, it is plausible for us to wonder why the Government would collect taxes only to refund the same days later in form of subsidies. Yes, these are hard economic times for ordinary folks across the nation, but why create such a complex tax reimbursement scheme? Aren’t policies supposed to be simple, clear, unambiguous, administratively feasible and with vouchable accountability frameworks?

How does the Government verify and vouche for the base supplies used to reimburse oil marketers? How are their point of sale data harmonized with government payment systems to assure only authentic claims are processed?