Kenya’s fuel subsidy is regressive and has a negative impact on economic efficiency, according to the International Monetary Fund.

They are typically poorly targeted and lead to inefficient allocation of resources because the main beneficiaries are the better off, said Tobias Rasmussen, the fund’s representative in Kenya.

“This happens as energy products have a higher share of the budget among high-income groups,” Rasmussen said in emailed response to queries. “The inefficient allocation of resources happens as the subsidies crowd out other more productive spending.”

Consumers in East Africa’s biggest economy pay 5.40 shillings ($0.05) per liter of gasoline and diesel toward a stabilization fund, which has been used to tame prices and keep inflation within the central bank’s targeted range of 2.5% to 7.5%.

Lawmakers plan to halve this subsidy to 2.90 shillings per liter, as well as reduce other taxes and retailers’ margins as part of efforts to lower the cost of fuel, according to proposed legislation in the National Assembly.

Authorities drew almost 25 billion shillings ($220 million) from the fund to stabilize prices between July and December, according to budget documents tabled in the National Assembly last week.

Inflation Driver

Fuel inflation was the key driver of overall consumer prices in Kenya in the past year, due to higher pump prices as oil rallied after muted demand in 2020. Global oil prices are at their highest since 2014, owing to depleting stockpiles and diplomatic tensions.

Without the cushion, gasoline prices would have jumped to 144.47 shillings per liter on Jan. 15, while diesel would be 128.44 shillings in the capital Nairobi, according to the Energy and Petroleum Regulatory Authority. However, the agency left prices unchanged at 129.72 shillings and 110.6 shillings respectively for the third consecutive time, after tapping the fund.

In the long-term, it will be difficult to retain a subsidy funded by a levy that’s been eroded in recent months, according to Renaldo D’Souza, head of research at Nairobi-based Sterling Capital Ltd.

“Inflation would therefore best be fought by monetary policy rather than subsidies, and allow a free economy,” he said in an email.

Kenya can also use other non-tariff measures such as boosting strategic fuel reserves and expanding Mombasa port to reduce demurrage costs, according to lobby group Consumers Federation of Kenya.

Kenya’s current storage capacity lasts 10 days, or a week on average, forcing it to pay about $12 million annually in demurrage for oil tankers, an amount that is passed on to consumers, according to EPRA.