IMF urges Europe to pass on energy costs to consumers

The IMF has urged European governments to pass on rising energy costs to consumers to encourage “energy saving” and a shift towards greener power while protecting poorer households.

European governments, which have tried to shield households from soaring costs with price controls, tax cuts and subsidies “should allow the full increase in fuels costs to pass to end users to encourage energy saving and switching out of fossil fuels”, the assistant director in the IMF’s European department, said.

Writing in an IMF blog post on Wednesday, Oya Celasun added that at the same time governments should put relief measures in place to support low-income households — which are least able to cope with spiking energy prices — was “a priority”.

Energy consumer prices are rising at an annual rate of nearly 40 per cent in the eurozone and by 57 per cent in the UK, reflecting the surge in wholesale gas and oil prices after Russia’s invasion of Ukraine. This means that households are seeing their disposable income drastically reduced.

This is particularly true for poorer households, which spend a larger share of their money on electricity and gas.

As a result, the IMF urged policies to shift from broad-based support measures to targeted relief.

The existing measures include energy price caps in France, Spain and Portugal, electricity tax cuts in Germany and the Netherlands, energy subsidies in Italy and Greece and energy allowances in Germany and the UK.

However, “with fossil fuels likely to remain expensive for some time, governments should let retail prices rise to promote energy conservation while protecting poorer households,” said Celasun.

The existing broad-based support measures not only delay the needed adjustment to the energy shock, but they also keep global energy demand and prices higher than they would be otherwise, the IMF warned.

In many countries, the cost of combating the rising price of energy will exceed 1.5 per cent of economic output this year owing to broad price-suppressing measures, the IMF estimated.

This is more expensive than fully offsetting the increase in the cost of living for the poorest 20 per cent of households, which the IMF estimated at about 0.4 per cent of gross domestic product on average for 2022.

Andrew Kenningham, economist at Capital Economics, thinks that European governments will move towards more targeted support in the coming months “simply because the costs of universal energy subsidies will become prohibitive”.

The IMF singled out the UK along with Estonia, where living costs for the poorest 20 per cent of households are expected to rise about twice as much as the cost for the wealthiest.

Celasun also said that since prices were expected to remain high for several years, “the case for supporting businesses is generally weak”.

She explained that it was “appropriate” for governments to support companies amid a shortlived price surge as that could otherwise cause viable businesses to fail. This would particularly be the case if Europe faced a complete cut-off of gas flows and countries had to temporarily ration gas to industry.

However, she added that in most cases it was difficult to implement a well-targeted support scheme without introducing distortions and blunting the incentives for energy conservation.

Kenningham noted that the IMF offered only limited support for one-off windfall taxes on electricity producers but said he thought “the case is very strong where companies are making exceptional profits due to the marginal-pricing system”.