Breaking the cycle: Subsidies for transport fuels in Mexico
An interview with Leticia Armenta Fraire, Centre for Economic Analysis, Mexico
Recent volatility in petroleum prices has led to high energy subsidies in many countries. Mexico is one of them, with the transport fuel subsidy bill expected to reach 250 billion pesos (approx. US$ 20 billion) this year. To learn more about Mexico’s gasoline subsidies and the government's efforts towards reform, Subsidy Watch spoke to Mexican energy expert Leticia Armenta Fraire, Director of the Mexico City-based Centre for Economic Analysis, part of the renowned Tecnológico de Monterrey university system. The interview was conducted in Spanish, and has been translated into English.
SW: By its own estimation, the Mexican government will spend over 250 billion pesos subsidizing gasoline and diesel this year, an amount that a recent International Energy Agency report concluded was 8% of total world energy subsidization. This must be a tremendous burden on the Mexican budget.
LAR: Well, according to official numbers from the 2008 Mexican government’s budget, the subsidy to gasoline and diesel in 2008 amounts to 2.4% of the country’s Gross Domestic Product (GDP). Isolating gasoline for automobile use, the subsidy turns out to be 0.27% of GDP. While not a small sum, it is not an amount that can jeopardize the financial stability of the Mexican government.
SW: Mexican gasoline prices are as much as 25% below U.S. prices. Some argue that this price distortion sends wrong signals to economic agents in Mexico. Do you agree? And if so, what are the consequences for the Mexican economy?
LAR: Because gasoline, along with diesel, are used heavily in Mexico for the transport of basic materials and in industry, a distortion in their price can have major impacts on the economy. But for some time now the Mexican government has adopted a strict monetary policy, along with fiscal discipline, in order to keep inflation in check. As such, it is concerned about what a swift rise in gasoline prices would do to inflation. The government, therefore, has decided to eliminate the gasoline subsidy gradually, with the price of gasoline rising in monthly, and now weekly, increments.
So the problem is being corrected, while at the same time assuring that the impact on inflation is minimized. From June to September, for instance, the government raised prices so that the subsidy to gasoline dropped from 35% to 29% of the price.
SW: What is the Mexican government’s rationale for its gasoline subsidy policy?
LAR: The government did not establish these levels of subsidies intentionally. It is the result of the government’s price-fixing policy for gasoline. Most of the gasoline imported into Mexico is imported and sold by a state monopoly, Petróleos Mexicanos (PEMEX). Under the statute which governs PEMEX, the government is responsible for setting the price of gasoline.
The price of gasoline is set using a formula that only has as a variable the impact of inflation on prices. In other words, the government calculates the country’s inflation and then raises the price of gasoline in line with this inflation.
This formula had been working well in the past, but the high volatility in energy prices in the last few years has caused problems. The formula was not designed to absorb the impact of the unprecedented rise in petroleum prices we have seen the last few years. A spread has developed between Mexican and international gasoline prices, which in turn has resulted in the current levels of subsidies.
SW: So this would explain why in 2004 the price of gasoline in Mexico was more or less in line with international prices?
LAR: Yes, the problem has been caused by the volatility in the energy prices in the last few years. If you look at the historic figures you will see that in 2001 the price of gasoline in Mexico was actually 37% more expensive than in the United States. In 2004, this figure went down to 22%, then 4% in 2005 and around 1% in 2006. It was only with the unprecedented rise in oil prices in 2007 that Mexican gasoline prices began to be lower than in the U.S.
SW: Nobel Laureate Mario Molina recently said that gasoline subsidies are regressive measures in that they disproportionally benefit the wealthy. Do you agree?
LAR: I don’t think his analysis is complete. One has to look at the big picture. This issue isn’t black and white. What Dr. Molina is probably referring to is that people with higher incomes consume more gasoline because they have cars, or bigger cars, and utilize them more than people of lower means. Therefore, they benefit more from the subsidies.
But you cannot just look at automobile gasoline use. One has to also take into account other factors, such as the impact that the price of gasoline has on the price of public transit. Also, as I mentioned earlier, gasoline is used in the transport of basic inputs required by industry, as well as to transport food. As such, the price of gasoline affects prices for other goods that may have a bigger impact on people of lower means.
SW: The Mexican Minister of Finance, Agustin Carstens, has announced that the government aims to phase out gasoline subsidies by 2010. Is this realistic? What problems might the government encounter in trying to reach this goal?
LAR: The government has adopted a new formula this year to set the price of gasoline. Using this formula, they have moved quickly to raise the price, first at monthly, and now at weekly increments. The price of gasoline was raised 7 Mexican cents in August, 9 cents in September and in October the government moved to raise the price weekly by an average 3 cents a week. So I think it will be possible to reach this goal, especially now that the drop in petroleum prices has shrunk the gap between Mexican and international gasoline prices.
SW: What recommendations do you have to reform the gasoline subsidy policy?
LAR: I’m actually in agreement with the government’s current approach to lowering the subsidy because I think it is a requirement to having an open economy, and part of Mexico’s international trade commitments. The gasoline subsidy indirectly subsidizes the costs of other products in the economy, and may be in violation of treaties such as NAFTA.
The government should take advantage of the current drop in energy prices to quickly eliminate the gap between Mexican and international gasoline prices.
SW: But should the Mexican government be setting a price for gasoline? Why not let the price be set by the market?
LAR: In Mexico the issue of energy prices in general is very complex. Energy in the country is provided principally by two state companies: PEMEX in the area of hydrocarbons and CFE in electricity. For this reason the setting of prices is part of the economic policy, particularly given that the two companies provided 30% of the Mexican government’s revenue. For prices to be set by the market the federal government would have to have to reduce its dependence on this revenue. At the same time, these companies would have to be more efficient, to allow them to be competitive in the market, which they are currently not.