By Joe Parkinson

Region's Leaders Gamble on Subsidies


Feb. 5, 2011

DUBAI—Spooked by a gathering popular revolt, Arab rulers across the Middle East are seeking to spend their way to safety—boosting subsidies, increasing wages and in some cases guaranteeing jobs for disaffected youth.

But with energy costs jumping and global food prices hitting record highs, economists and ratings agencies warn that Arab regimes' traditional economic weapons may be blunted. Bloated budget deficits and negative market sentiment have limited their room to maneuver.

The region's demonstrations have cited other broad frustrations—anger about high-level corruption, demands for political freedoms—but nervous Arab governments don't want rising food prices to add to the unrest. In the wake of Tunisia's regime-shifting upheaval last month, Arab states from Algeria to Yemen have moved to relieve economic pressure on their citizens.

The moves have been most pronounced in Egypt, where the government is battling to hold on to power, and in Jordan, which runs a large budget deficit and relies on external financing because it doesn't enjoy the rich natural resources of their oil-producing neighbors.

In the past two weeks, Jordan's government has announced a surprise pay raise for civil servants and a $125 million package of subsidies for fuel and staple products like sugar and rice. Algeria and Libya have moved to relax food taxes or cut prices of staple foods. Morocco's government, which heavily subsidizes food and gas, vowed to keep food prices at affordable levels "at any price." In Syria, the government of Bashar al-Assad reversed subsidy cuts on energy, lifting heating-oil allowances for public workers by 72%.

Oil-producing economies such as Saudi Arabia, Qatar and Bahrain face less pressure because they largely run fiscal surpluses and will see their spending power boosted by an increase in oil prices. But even in oil-rich Kuwait, the government has introduced a generous stipend and free food for its citizens until March 2012 to ease the burden of higher costs.

Economists say the region's regimes are fixated on survival and trying to spend their way out of trouble, but that could perpetuate the economic imbalances that helped fire protesters' disaffection. Elevated subsidies could further delay economic restructuring that would aid a peaceful transition to democracy, some economists say.

"For sure, an overreliance on subsidies or transfers of wealth to placate the population is a short-term fix that raises serious longer-term vulnerability—but for many countries it's about survival now," said Benoit Anne, head of emerging market strategy at Société Générale.

Ratings agencies say spending on subsidies could drive up Arab economies' budget deficits and ultimately leave them unable to finance their debt if investors pull back. Standard & Poor's drove that point home Wednesday when it downgraded the credit rating of Egypt, the world's largest wheat importer. Egypt, which heavily subsidizes bread for 14.2 million of its 80 million people, abandoned plans to phase out subsidies after protests swept the country.

"The [Egyptian] government will eventually take measures to alleviate poverty by increasing fuel and food subsidies....We believe this will have negative implications for the public-sector deficit, and it will likely be difficult to tackle the deterioration of public finances," S&P said in a statement Wednesday.

Many states in the region already run hefty deficits. Jordan is expected to post a deficit of more than 7% of gross domestic product this year, while Yemen and Morocco are expected to register deficits equivalent to 4.8% and 5.3% of GDP, respectively. Subsidy spending could magnify budgetary weakness, analysts warn, especially with food prices increasing rapidly.

High food-price inflation has cut spending power across the region, where populations spend a much larger share of their income on food than do residents of richer countries. The price of bread has shot up since last summer when a drought in Russia, one of the world's largest wheat suppliers, hit harvests and prompted an export ban.

—Joel Millman
and Caroline Henshaw
contributed to this article.


Copyright 2011 Wall Street Journal