Countries should allow international prices to feed through to domestic prices while protecting households that need it most.
Governments face tough political choices as they try to protect their people from record food prices and soaring energy costs, pushed up by the war in Ukraine.
Countries have introduced a variety of policy measures in response to this unprecedented spike in the prices of the most crucial commodities. Our study of these measures announced by member countries shows that many governments have tried to limit the rise in domestic prices as international prices rise, either by reducing taxes or by providing direct price subsidies. But these support measures are in turn creating new pressures on budgets already strained by the pandemic.
Not all countries are able to follow the same path. Where subsidies exist, the pace of price adjustments and the extent to which social safety nets are used will differ from country to country. That’s why our note offers nuanced policy advice to countries based on each country’s situation, such as the strength of the social safety net, the level of existing food and fuel subsidies, and the availability of fiscal space.
The price spike
Russia’s invasion of Ukraine followed last year’s sharp rises in commodity markets, pushing food prices to record highs and natural gas to historic highs. Prices for wheat, a staple for which Russia and Ukraine together account for about a quarter of global exports, rose 54% from a year earlier. With food and energy imports from these sources disrupted, countries face high costs and supply uncertainty.
People in low-income countries are the most vulnerable to rising prices, as food accounts for 44% of consumption on average, compared to 28% in emerging market economies and 16% in advanced economies. Oil prices have also recorded significant gains, which impose different burdens on consumers. Higher-income households tend to use more fuel than lower-income households, and they consume more gasoline than poorer households, which in many developing countries tend to consume more kerosene. Government policies aimed at mitigating the social impact of rising prices must take these differences into account and ensure that the burden is not borne disproportionately by the poor.
The pass-through of international fuel prices to domestic consumers was weaker in the first four months of this year than last year. In addition, transmission was highest in advanced economies and lowest in oil-exporting emerging and developing countries. Fuel subsidies prevalent in many oil-exporting countries in the Middle East, North Africa, and Sub-Saharan Africa are a big reason why consumers in these regions may experience less pain at the pump, albeit in detriment of the increase in the tax burden. costs and therefore, in many cases, future cuts in other public services.
More than half of the 134 countries we surveyed had announced at least one measure in response to rising energy and food prices. Emerging and developing economies announced fewer new policy measures, likely because they continue to rely on existing energy and food subsidies and limit or avoid domestic price adjustments.
They might also have less fiscal space to react or more difficulty in quickly strengthening their social safety nets. In advanced economies, cash and semi-cash transfers (including vouchers and discounts on utility bills) were announced by the most countries. In emerging and developing economies, reductions in consumption taxes were the most frequently announced measures.
Social Safety Net Considerations
Although most countries limit the pass-through of international prices, this is not advised. Price signals are essential to allow demand and supply to adjust and to induce a demand response, in which high prices encourage people to be more energy efficient. On the other hand, subsidized prices encourage greater consumption, putting additional pressure on energy prices. At the same time, countries should provide temporary and targeted transfers to the most vulnerable households.
Demand response may be important for energy, but much less so for food, because people need to eat about the same amount. Nevertheless, countries should refrain from preventing domestic prices from adjusting because such measures, which result in subsidies, are not effective in protecting the most vulnerable. They are also costly, crowding out more productive spending, and reducing incentives for producers and distributors. We recommend allowing the pass-through of food prices, provided that vulnerable people are protected and food security is not threatened.
We also emphasize that countries need to consider the strength of social safety nets when designing policies:
- Countries with strong social safety nets could use targeted temporary cash transfers to mitigate the impact on vulnerable people. These countries can provide targeted transfers by building on existing social programs.
- Countries where safety nets are not strong enough to support the most vulnerable can expand their most effective existing programs by increasing benefit levels and coverage as needed. Digital tools can be used, for example, to register beneficiaries and pay benefits.
- Countries that already benefit from energy or food subsidies should gradually pass on international prices to consumers while committing to eliminate the subsidies in the coming years. The pace of transmission needs to be carefully calibrated based on the gap between retail and international prices, the available fiscal space, and the ability to implement measures to protect vulnerable people.
In countries where food security is a concern and all other options have been exhausted, governments may consider other temporary measures, such as price subsidies or import taxes with clear sunset clauses for staple foods. Governments should also try to increase food supply by supporting production, avoiding stockpiling and using food reserves when available. When food security is threatened, direct distribution of staple foods may be necessary.
Over the next two to three years, governments should focus on investing in social safety nets and reforming existing subsidies. These revisions will help countries improve their resilience and promote more productive spending to support inclusive growth.