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Five Key Lessons from Malaysia’s 2014 Subsidy Reform Experience
By Jihane Bergaoui

In September of 2013, Malaysia’s Prime Minister, Datuk Seri Najib Razak, announced an overnight increase of diesel and RON951 petrol prices by 10%. To mitigate the impact of the increase on low-income groups, the Government of Malaysia announced an expansion of cash transfers and other social services. The reform plan dedicated half of the savings from reducing fuel subsidies to direct cash assistance for low-income groups, while the other half would be used to finance development projects. A total of MYR 4.6 billion (US$1.5 billion) was allocated to implement an extended Malaysia People’s Aid (BR1M) program, benefiting 7.3 million recipients in 2016.

The Malaysian Experience

Energy subsidies have existed in Malaysia since the 1980s. From 1983 to 2014, the retail price of any energy product was set by the Automatic Price Mechanism (APM). Under the APM, if the market price was greater than the retail price, then the price differential would be subsidized by the government. This regulation made any change in the retail price of energy products extremely difficult. Largely due to a lack of political will and a reluctance to allow the price of energy products to increase according to the APM, the Government incurred a high subsidy bill. In 2008, spending on subsidies peaked at a level equivalent to 22% of revenue from total oil exports, exceeding spending on supplies and services.

The global financial crisis and accompanying hike in oil prices led to a worsening in Malaysia’s fiscal balance. In 2009, Malaysia’s economy contracted by 1.5% and the fiscal deficit ballooned to its highest level since 1982 due to the release of two stimulus packages worth RM67 billion2 aimed at boosting the economy during the crisis, as well as an increase in subsidies.

The subsidies led to economic distortions—they encouraged overconsumption and a waste of subsidized products, as well as leakages across Malaysia’s border spurred by fuel smuggling. Untargeted subsidies intended for low-income households largely benefited industries and higher-income households. For every RM1 billion spent on subsidies, 5 hospitals, 20 schools, or 50 km of roads could have been constructed3.

In September of 2013, Malaysia’s Government announced a subsidy reform plan, accompanied by an expansion in social protection programs to mitigate the negative impact on the country’s most vulnerable communities.

Lessons Learned

Looking back during an inter-regional ESROC4 webinar organized by ESMAP, Datuk Yogeesvaran, Deputy Director General for Macroeconomics at the Economic Planning Unit (EPU), provided five key takeaways from Malaysia’s experience:

1. The gradual implementation of subsidy reform can reduce political resistance.

In January 2014, as the Government began to implement its planned energy subsidy reform, an Incentive-Based Regulation (IBR) mechanism for electricity tariff fixing was introduced along with a reduction in natural gas subsidies which would be periodically adjusted every six months. This replaced the existing APM. At the end of the year, the subsidy component was eliminated for RON95 and diesel, and the retail price for petrol and diesel is now determined monthly using a managed float system. This mechanism uses the costs from the previous month as the reference price to set the fuel prices every month. In September 2015, the price of CNG for transportation was reviewed.

2. Subsidy reform must be complemented by mitigation measures for the lower-income groups.

The Government and authorities acknowledged the potential impact of price reforms and higher costs on households and businesses, especially among vulnerable groups such as low-income consumers, middle-income urban households, young working adults and senior citizens. As such, in addition to cash transfers to these vulnerable groups, the government enacted the Price Control and Anti-Profiteering Act 2011 to reduce profiteering by businesses and firms. Savings from the subsidy reform process have been redirected to cash transfer programs intended to alleviate the potential negative impact of energy price increases on the poorest households and individuals. The preliminary economic report for FY 2015/2016 estimates these savings for that period to amount to RM 26.2 billion (US$ 6.4 billion) 23.7% of which (MYR 5.341 billion, US$ 1.3 billion) has been allocated to be used specifically to finance the expansion of the BR1M program. In 2016, the cash transfer program benefitted 7.3 million recipients5—approximately 7% of the year’s savings will be transferred to finance education programs and 9% will be channeled to other social sector projects.

3. Effective stakeholder engagement and communication with political backing is important.

In the reform process, the government of Malaysia engaged with vulnerable communities at risk of being negatively impacted by the increase in energy prices by monitoring possible economic distortions and communicating the overall purpose of the reforms. Even so, it would have been even better for relevant information to have been communicated prior to the beginning of the reforms. It is important that a clear communication plan be in place prior to the start of the reform process.

4. Transparency and clarity around the price adjustment is crucial to reducing information asymmetry.

The Malaysian Government continued to inform citizens of what the energy prices would be in relation to global market prices, thereby creating transparency and public trust, and assisting people in preparing for potential price shocks. The Government also made it clear that the money saved from subsidy spending would be used to benefit the Malaysian people.

5. Timing of the reform is crucial to effectively mitigate the impact on the economy.

Malaysia was able to capitalize on the opportunity created by low global oil prices to implement subsidy reform without it resulting in a drastic economic shock. In addition, every six months the Government would compare the actual price of fuel with the projected assumed price and adjust the subsidies accordingly as it continued to implement its planned reform to decrease the risk of economic shocks.

1 Research Octane Number (RON) is the most common type of octane rating worldwide. Fuels with a higher octane rating are used in high performance gasoline engines.

3 Economic Planning Unit in Prime Minister’s Department (2016): “Mitigating the Impact of Energy Subsidy Reform: Malaysia’s Experience”

4 The ESROC platform, supported by the World Bank’s Energy Sector Management Assistance Program (ESMAP), brings together government officials from around the world and experts from the World Bank Group and international organizations to share their insights and experiences on reforming energy subsidies. For membership requests and general inquiries, please contact us at esroc@worldbank.org

5 Preliminary data for 2016 as of 30 June 2016