Cablegate: Government of Ethiopia Lifts Fuel Subsidy

VZCZCXRO4785
PP RUEHROV
DE RUEHDS #2816/01 2880452
ZNR UUUUU ZZH
P 140452Z OCT 08
FM AMEMBASSY ADDIS ABABA
TO RUEHC/SECSTATE WASHDC 2349
INFO RUEPADJ/CJTF HOA PRIORITY
RUEAIIA/CIA WASHINGTON DC PRIORITY
RUEKDIA/DIA WASHINGTON DC PRIORITY
RHMFIUU/HQ USCENTCOM MACDILL AFB FL PRIORITY
RUEKJCS/JOINT STAFF WASHINGTON DC PRIORITY
RUCNIAD/IGAD COLLECTIVE

UNCLAS SECTION 01 OF 02 ADDIS ABABA 002816

SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD EINV EAGR ET
SUBJECT: GOVERNMENT OF ETHIOPIA LIFTS FUEL SUBSIDY

REF: ADDIS 2800

SUMMARY
-------

1. (U) The government of Ethiopia's (GoE) Council of Ministers
lifted subsides on domestic fuel prices effective October 4. The
move came after the International Monetary Fund (IMF) objected to
the fuel subsidy before considering a balance of payments loan
(reftel). The Council also authorized the Ministry of Trade and
Industry (MoTI) to revise domestic retail fuel prices monthly, based
upon international prices. Accordingly, on October 4 MOTI increased
domestic kerosene prices by 50.4 percent and diesel prices by 39.4
percent. The latest domestic fuel price increases represent one of
the single largest fuel price increases in the country's history.
While the move to reduce government interventions in this major
market is positive, its impact will undoubtedly exacerbate
inflationary concerns. End Summary.

BACKGROUND
----------

2. (U) In the past several years, MoTI has set Ethiopia's domestic
fuel prices quarterly, and utilized a Fuel Stabilization Fund to
absorb the shocks of the frequent spikes in world oil prices.
However, in spite of the modest adjustments that have occurred, the
GoE has spent nearly USD 800 million subsidizing fuel over the last
three years. Before the recent drop in fuel prices over the last 3
weeks, an economist at the National Bank of Ethiopia (NBE,
Ethiopia's Central Bank) informed EconOff that the GoE was paying as
much as USD 50 million every month for a fuel subsidy in order to
cushion the local market from the record global rise in fuel costs.
On October 3, the Council of Ministers, surprisingly, approved a
study on the removal of subsidies on petroleum products. The
Council's statement suggested that declining trends in world fuel
prices justified a decrease in the national fuel subsidy. The
Council also authorized MoTI unilaterally to make monthly revisions
of domestic retail fuel prices in order to synchronize more closely
with international prices. Effective October 4, MOTI increased
domestic retail fuel prices, pushing the retail price of regular
petrol (benzene) up by 5.6 percent, kerosene by 50.4 percent, diesel
by 39.4 percent, light fuel oil by 31.7 percent and black fuel oil
by 26.5 percent. In line with the fuel price increases, the
Ministry of Transportation and Communication simultaneously revised
taxi and cross country bus fares.

EXPECTED IMPACTS OF THE ADJUSTMENT
----------------------------------

3. (U) The latest fuel price adjustments are the largest ever made
in Ethiopia at any one time. Kerosene, heavily used by the urban
poor for cooking has risen in price by 50.4 percent. The 39.4
percent increase in diesel will impact the growing urban working
class of Ethiopia who rely on mass transit on a daily basis not to
mention the increased transportation costs which will be passed
through to consumers broadly. One minor opposition party called for
a reversal of the price hike fearing the move's impact on cost of
living and inflation. The Amharic language Reporter newspaper also
criticized the move in an October 8 editorial in which it asserted
that given Ethiopia is an agrarian economy, the country should have
been food self sufficient and should have been exporting wheat to
continue subsidizing fuel instead of transferring the subsidy from
fuel to wheat. In addition, the GoE's fuel subsidy was contributing
to increasing budget deficits, inefficient markets and moreover
hampering much-needed poverty reduction spending. The Daily
Monitor, a local Addis Ababa newspaper, cited residents' concerns
that fuel price hikes would soon be followed by other goods and
services increases, thus further compounding the already heightened
expectations of future inflation.

FUEL SUBSIDY LIFTED AS GOE TIGHTENS FISCAL BELT
--------------------------------------------- --

4. (U) The GoE has been forced to cut the fuel subsidy in part
because of the IMF's guidance to tighten its fiscal policy in order
to rein in inflation and mop up excess liquidity. In addition,
soaring current account deficits and the acute lack of foreign
exchange in the GoE's coffers has made it increasingly difficult to
maintain the current level of fuel imports. Reports from the
Ethiopian Petroleum Enterprise indicated that Ethiopia imported 1.88
million tons of fuel last fiscal year (ending July 7, 2008) at a
cost of USD 1.6 billion, representing a 17 percent annual increase.
The value of merchandise exports during that same period was USD 1.5
billion, falling short of covering fuel bill costs. It remains to
be seen whether the move to cut fuel subsidies will restrain fuel
imports and change the demands of a booming transport sector that
has become very reliant on subsidized fuel. On the other hand, some

ADDIS ABAB 00002816 002 OF 002

experts argue that the price hikes will more than likely affect
consumption patterns among urban poor as most cannot afford to buy
kerosene at the newly adjusted prices. It is likely that there will
be a demand dampening effect for kerosene due to the new policy.
The urban poor will likely either be more cautious in using kerosene
or move to alternatives like charcoal, fire wood or a combination of
both -- each bearing its own environmental impacts. Car owners may
stop driving their cars or limit their demand and use public
transportation. The question is how significant the change in
demand will be and how long will it last. In a July 2008 report,
the IMF Executive Board advised the GoE to follow a gradual and
cautious removal of fuel price subsidies to abate inflation and
address dwindling foreign exchange reserves.

COMMENT
-------

5. (U) The reduction of fuel subsidies is expected to impact
severely the urban poor and, increasingly, the urban working class.
A gradual and selective lifting of the subsidies over a longer
period of time would have softened the blow of the recent and
dramatic adjustments in fuel prices, but may have also prevented
positive IMF consideration of balance of payments support. By
making this move now, when oil is selling at $90/barrel, the GoE did
buffer the public from bearing the brunt of $150/barrel prices a few
weeks ago. It also establishes a mechanism to adjust prices more
often now to pass on world price increases to consumers as they
occur, rather than imposing another large shock later. It remains
to be seen how the urban poor react to this price shock,
particularly on kerosene. As the country prepares for the main
harvest in December, which is generally energy and fuel intensive,
the pressure on domestic fuel costs will only compound already
galloping inflation, further deteriorating the cost of living. In
addition, the soaring current account deficits and fast depleting
foreign exchange reserves will no doubt force the GoE to continue to
pass on any future fuel price increase to consumers or to reduce
dramatically fuel imports. Post will continue to follow closely
these developments. End Comment.

YAMAMOTO

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