On February 1, 2023, the Cameroonian government announced an increase in fuel prices. Petrol and diesel prices rose by 15.87% and 25.2%, respectively. This forced the government to increase public sector salaries by 5.2%. The increase in fuel prices followed an agreement reached between the IMF and the Cameroonian authorities between January 19 and 27, 2023, as part of the third review of the program supported by the Extended Credit Facility (ECF) and the Extended Fund Facility (EFF).
In this agreement, the Cameroonian government committed itself to reducing subsidies on petroleum products in order to create a budgetary reserve to finance productive investments and social expenditure (IMF, 2023). However, the increase in fuel prices could not be without consequences on the general price level, estimated at 6.3% at the end of 2022, i.e., 3.2% above the 3% standard (INS, 2022).
Curiously, there was no reaction from the Central Bank – whose primary objective is to stabilize prices – in the aftermath of this fuel price increase. This once again raises the question on the effectiveness of the coordination of economic stabilization policies in the CEMAC zone.
This paper analyses the implications of the reduction of subsidies of petroleum products on macroeconomic stability in Cameroon. Such an analysis will help to highlight the relevance of economic policies coordination for strengthening the resilience of the economy’s towards internal and external shocks.
Overview of the Economic Situation
For several years, the Cameroonian economy has been facing numerous crises that affect its macroeconomic stability both internally and externally. Internally, economic growth has been seriously affected by the socio-political crisis in the northwest and southwest regions, but also by other important factors such as drought in the North and growing insecurity, particularly in the far North and Eastern regions of the country, which have led to massive migration.
Externally, the economy, like all economies open to the rest of the world, has suffered the effects of the COVID-19 pandemic, and more recently, has had to cope with the economic shock caused by the war in Ukraine. The specificity of these different events is that they led to a significant slowdown of the production process, which in turn led to a rise in strong inflationary pressures.
According to the National Institute of Statistics of Cameroon (INS), the inflation rate in Cameroon hit a peak of 7.69% in September 2022, i.e., 4.69% above the community norm. This general rise in prices in the country is essentially due to an increase in food prices caused by the rise in importation costs and the pressure on domestic supply.
The Cameroonian economy remains open to the rest of the world and highly dependent on manufactured exports. Consequently, the disruption of supply chains since the beginning of the crisis and the conflict between Russia and Ukraine have led to a tightening of global financial conditions, resulting in prolonged shortages and increases in the prices of fertilizers and several raw materials.
While the economic forecast for 2023 looks favorable, the country remains dependent on terms of trade and thus exposed to many exogenous shocks. According to the International Monetary Fund (IMF, 2023), economic growth is expected to increase to 4.3% in 2023, while inflation is expected to remain at about 6% by the end of 2023. However, Cameroon’s budget will remain in overall deficit and is expected to be at 2.2% of GDP by the end of 2023 to limit public debt to 43% of GDP (far below the EU norm of 70%).
In January 2023, the Cameroonian government took several measures to strengthen the resilience of the economy to various shocks. Among other things, the government recognized the need to reduce subsidies on petroleum products, which represent six times the budget allocated to agriculture, four times that of health, and more than three times that of energy and water (IMF, 2023).
Consequences of Reducing Fuel Subsidies on Macroeconomic Stability
Macroeconomic stability boils down to the stability of the general price level (Abdelmalki, 2012). By deciding to reduce subsidies on petroleum products and increasing fuel prices, the Cameroonian government is convinced that the improvement in the budget balance will encourage the recovery of economic activity.
According to the IMF, part of the subsidies could be used to develop the private sector, in particular by creating space for productive investments in order to broaden the tax base. However, the issue of counter-cyclical manipulation of government budget balances in order to significantly and sustainably influence the level of economic activity remains a controversial topic among economists (Sheikh et al, 1980).
An orientation of the order in which subsidies are reduced will provide greater visibility. While budgetary economists – based on the Keynesian theory of national income – believe that fiscal policy is an effective instrument of stabilization, monetarists believe that money supply is the most important factor in determining national income. The latter argue that purely fiscal intervention by the government, i.e., unaccompanied by an accommodating monetary policy, can only have a short-lived and negligible effect on national output.
In line with the Keynesian theory (1936), increase in public spending would therefore have a positive effect on national income, and on the propensity of agents to spend and import. Economic activity would expand but, at the same time, the foreign trade deficit could further increase. There will also be a rise in real interest rates, which will lead to a fall in investment.
This rise in interest rates caused by government demand will make production less competitive, which will further encourage inflationary pressures. In the absence of an accommodating monetary policy defined and conducted independently by the Bank of Central African States (BEAC), this fiscal action could not produce significant positive results on the economy.
In general, the increase in fuel prices caused by the reduction of public subsidies on fuel products will have negative effects not only on the level of investment, but also on the level of national consumption and production. This increase will further affect the transport sector by increasing transport costs, which will be reflected in the prices of raw materials and other goods and services.
This could lead to significant economic disruptions, notably an increase in the cost of capital, resulting to a slowdown in domestic investment and the neutralization of fiscal stimulus measures. This will reduce productivity and aggregate demand, drive out many firms, reduce the competitiveness of domestic firms, weaken Cameroon’s competitive position, and maintain the dominance of the informal sector.
Macroeconomic Stabilization Challenge in the Context of Subsidy Reduction for Petroleum Products
Cameroon’s economy is the largest and most diversified in the Central African Economic and Monetary Community (CEMAC). According to the IMF, it accounts for almost 45% of the sub-regional GDP. Given its economic openness in the sub-region, any fiscal policy adopted by the Cameroonian public authorities is likely to produce negative externalities on the other CEMAC member countries in the form of asymmetric or idiosyncratic shocks. Therefore, any fiscal policy implemented in Cameroon should attract the attention of the BEAC, who is called upon to react if fiscal decisions have an impact on monetary stability.
As a general rule, while monetary policy focuses on restoring price stability, fiscal policy should focus on reducing cost-of-living pressures, while maintaining a sufficiently restrictive stance in line with monetary policy (IMF, 2023).
The effectiveness of fiscal policy as an instrument of macroeconomic stabilization is to a great extent determined by the role of inflationary anticipation of agents in determining wages and interest rates, on the one hand, and by the responsiveness of the central bank to the shaping of these anticipations, on the other (Sheikh et al, 1980).
By forming rational anticipations, economic agents correctly predict future inflation rates in their wage negotiations, an important condition for increasing employment and output in the short term. In this context, BEAC should therefore intervene to influence current and future inflation by better attaching agents’ expectations to the long-term inflation forecast (Cunningham et al, 2010).
This implies that BEAC must be able to control and stabilize the inflation anticipations of all economic agents. To achieve this, it can, for example, decide to define an inflation target by which it commits to maintaining inflation at a given level or within a given range over a certain period. This would send a signal to different economic agents about its priority as a central bank and would facilitate the anchoring of inflationary anticipations (Ambler, 2009).
According to Mishkin (2007), such a response from the central bank gives it a certain credibility, demonstrating its seriousness and commitment to guaranteeing monetary stability and its ability to make inflationary anticipations relatively insensitive to cyclical fluctuations.
By regularly, clearly and effectively communicating its objectives and methods, the central bank has the means to further anchor economic agents’ anticipations of the inflation rate, which would make fiscal policy an effective instrument to counter the effects of short-term internal and external economic shocks.
In most developing countries, fiscal policy tends to be pro-cyclical (Talvi and Végh, 2005) when it should be counter-cyclical (Keynes, 1936) or, alternatively, neutral (Barro, 1979). Indeed, without a coordinated action between fiscal and monetary policies, any public action aiming to boost economic activity or to respond to a particular economic crisis can only lead to mixed results on the economy.
Therefore, the increase in fuel prices in Cameroon, as in other countries of the CEMAC, obliges the Central Bank to communicate its position, which would contribute to further anchoring economic agents’ anticipation on future inflation rates. Only such an approach would give some degree of credibility to fiscal policy to counter the effects of exogenous and endogenous shocks on economic activity and prices in the short term.
Jean Cedric Kouam is the Senior Policy Analyst, Deputy Director-Economics Affairs Division and the Head of Fiscal and Monetary Policy Sub-section at the Nkafu policy Institute. He holds a doctorate in economic policy and analysis (monetary and financial macroeconomics) from the University of Dschang in Cameroon. Since obtaining the Diploma of Advanced Studies in Mathematical Economics and Econometrics at the University of Yaoundé II in 2012, he has provided courses in economics, finance, and macroeconomic modeling in several private higher schools in Cameroon.