To pass (or not to pass) through international fuel price changes to domestic fuel prices in developing countries: What are the drivers?

Highlights: • various factors shape the pass-through from world fuel price changes to domestic prices. • Pass-through is higher when world fuel price changes are moderate and less volatile. • Flexible fuel pricing mechanism and narrow price gap with neighboring countries help. • Low inflation, limited fiscal space, and subdued exchange rate depreciation matters. • These macro conditions can be conducive to successful fuel subsidy reforms. This paper attempts to shed light on the drivers causing international fuel prices to be passed through to domestic retail fuel prices. While many developing countries limit the international fuel price pass through to domestic fuel prices, others do not. In the former, large fuel subsidies can emerge, thereby threatening fiscal sustainability, worsening income distribution and setting back efforts to fight climate change. Against this backdrop, we examine the factors that determine whether governments allow international fuel price changes to be passed through to domestic prices in developing countries using a dataset spanning 109 developing countries from 2000 to 2014. The paper finds that the pass-through is higher when changes in international prices are moderate and less volatile. In addition, the flexibility of the pricing mechanism allows for higher pass-through while exchange rate depreciation and lower retail fuel prices in neighboring countries inhibit it. The econometric results also underscore the fact that countries with inflation tend to experience lower pass-through, whereas those with high public debt exhibit larger pass-through. Finally, no evidence is found that political variables or environmental policies matter with regard to fuel price dynamics in the short-term. These findings, which are consistent across fuel products (gasoline, diesel and kerosene), allow us to draw important policy lessons for fuel subsidy reforms.