Iran’s “Major Economic Surgery” Now a Reality

Iran, as a country between globalization and isolation, tradition and modernity has had an utmost importance at the international arena. TVs, newspapers, magazines, columnists, journalists, reporters almost all media have been trying to understand, monitor and interpret the developments since the 1979 Islamic Revolution. Recently, this increasing attention has focused almost on the same issues such as nuclear program of Iran, UN sanctions, diplomatic efforts, President Mahmoud Ahmadinejad as a highly controversial figure of Iran. Nevertheless, economic performance of Iran with its cautious approach to globalization has attracted respectively less attention of international media. In this performance, long-lasting subsidies given by the Government of Iran to energy, food and some services have an important role in terms of its effects to country’s budget, monetary policy, development plans and social welfare.

Economic realization of Iran has mostly been dominated by its energy reserves. With its 73.6 million population, $828 billion GDP (PPP), 1.6% real GDP growth, $154 billion trade volume, $66.2 billion oil & gas exports (75.6% of its total exports), Iran was the 18th largest economy in the world in 2009.

Iran, as an OPEC Member, holds the world’s third-largest proven oil reserves and second-largest natural gas reserves. It is also OPEC’s second-largest oil producer and the fourth-largest crude oil exporter in the world. With all its massive potential, Iran, according to the World Energy Outlook of International Energy Agency (IEA), spent $66 billion in 2009 to fossil-fuel subsidy, which ranks it first in the world. This subsidy has been a huge burden on the shoulders of economy which creates inefficiencies in energy sector. In total, it is estimated that subsidies including the ones for food and various services are thought to cost Iran up to $100 billion a year. Considering the GDP of Iran, which was $331 billion in current prices in 2009, one could imagine the magnitude of saved subsidies would run up to 30% of GDP, which has a significant impact on Iran’s GDP.

History of subsidies in Iran goes back to 1970s, when high inflation rates and price instability particularly in the fossil-fuel products caused Government to establish Consumers Support Fund with a view to controlling prices and distributing subsidies. This was replaced by Organization for Protection of Consumers and Producers in 1977. Government believed that subsidies were the best way to distribute national wealth. During Islamic Revolution in 1979, Government had to increase subsidies because of decline in oil production, continuing high inflation and growing black market. In fact, while Iran was among the most energy-efficient countries in 1980s, it is now one of the wasteful. However, with regard to food and medicine subsidies, the picture was vice versa. These ones have played an important role in increasing child nutrition and lowering child mortality. During the first and second presidency of Mohammad Khatami, between 1997 and 2005, although government was assigned to prepare the necessary subsidy reform through Economic Development Plans, attempts were unsuccessful owing to the economic, social and political risk of consequences arising from sudden price increases.

The problem in Iran, even recognized by President Ahmadinejad, is the imbalance between the high income and low-income people due to enjoying public subsidies. Although the wealthiest 20% of Iranian pay only one-tenth of the total income tax, they benefit 70% of public subsidies. The poor using less energy get very little subsidy compared to the rich. The motives of lifting subsidies are to manage consumption, promote productivity, create justice, eradicate the social gap and increase national production. The energy consumption in the country is extraordinarily higher than international standards.

At last, in December 2008, Government submitted the “Law on Targeting Subsidies”, to Parliament for cutting of subsidies on fuel, electricity and certain goods gradually in five years. By this date so called “Major Economic Surgery” has started in Iran. Pursuant to the Law, government pays cash subsidies to compensate low-income families against the adverse effects of possible inflation. In brief, the plan is to shift from subsidy policy to market-based energy pricing in five years with assistance to lower-income groups. Government intends to distribute 50% of fiscal savings resulting from the subsidy cuts through direct cash or non-cash compensation.

Ultimately, it took one year for Parliament to pass this Law and in December 2009, it was adopted by the Parliament and then approved by the Council of Guardian. Thus since the beginning of 2010, Government has been working on the implementation strategy of this Law. At the end as of December 18, 2010 the Law was entered into force. As stated in the Law, Government has to adjust the internal prices of petrol, gasoline, liquid oil by the end of 5th Economic Development Plan (2010-2015) so that the price of these products would not be less than 90% of international prices (FoB Persian Gulf). For electricity, all subsidies will be lifted up to the end of 5th Plan and price should be 100% consistent with the final produced price. The Law, in addition to energy products also covers water, wheat, rice, edible oil, sugar, milk, postal services, airline services, railroad services, flowers, bread.

As a matter of fact, in Iran, 30-year old habit to live with artificially low prices made harder for the Governments to implement a substantial reform program up to now. Thanks to 15-year extensive debates, this time a consensus has been reached on the necessity of this reform in the public opinion. It is widely recognized that this Reform program will bring, among others, following results:

– Extra revenue will be available for infrastructural investments.

– Producers will have to prioritize energy-efficiency in their production processes.

– Cash transfers lead people to be more effective in allocation of their resources.

– Demand for fossil-fuels will decline because of high prices so domestic prices will be adjusted to world prices and smuggling of these products out of Iran will be discouraged.

– Decline of demand will leave more energy resources for export.

– Domestic automobile industry of Iran, producing 1.5 million cars per year, will have to modernize itself with an aim to increasing energy-efficiency and will become more competitive in the export market.

– Reduction of demand will also make people more resilient against UN Sanctions. Government has also expedited the realization of Reform program due to the UN Sanctions against refined petroleum products with a view to decreasing their domestic demand.

But concerns have been emanating from the transparency and adequacy of measures to avoid or mitigate the negative repercussions of the program for both low-income and middle income people. Therefore, speed of lifting subsidies and methodology to compensate different groups of population are general concerns that following items could also be added to them:

– There are doubts about the level and frequency of yearly price adjustments.

– Definition of eligibility for compensation and the amount and duration of those payments are ambiguous. This might cause again unfairness in distribution of income.

– Program will most probably trigger inflation depend on the speed of raising prices.

– Strategies to minimize inflation are not sufficient.

– Uncertainties in the spending of saved revenues.

In line with the provisions of Law, an independent organization was established to manage the cash transfers which need to be approved by the Parliament. This organization has already started its works long ago and collected statistics from households in order to verify their income for cash transfers, recorded their bank accounts. In line with the mentioned law, 50% of additional revenues gained from cutting subsidies will be used for cash payments, investments in housing, medical services, social security, increasing employment. Moreover, 30% of revenues will be allocated to businesses for them to invest in energy-efficient technologies, improvement of public transportation, and support of agriculture and industry projects.

Now, everybody is watching the first results of implementation and trying to make estimations about its immediate impacts on the economy. As envisaged by the Law, Government has sent thousands of inspectors to check the prices in order to avoid any sudden increases by producers and people have started to withdraw cash transfers. Although the first impression shows that there is no unusual reaction by the people, the change has been calmly absorbed and business is going on its usual track, it is reported that some producers have started to slow down the introduction of products to the market because of expected price hike. Evidently, it is too early to reach a conclusion for this big economic transformation.

Last but not least, Iran is at the edge of realization of one of the “Major Economic Surgery” in its long history. Most of the people are worrying about the harsh results of implementation process, possible protests, mismanagement of additional revenues, corruption, adverse social consequences. However, with more transparency and good cooperation between the Government and Parliament, some worries could be eliminated. Evidently political, social and economic risks are huge for people of Iran, especially under the threat of sanctions as a result of stubborn and uncompromising foreign policies. Although the aim is to put an end to keeping energy prices at one-tenth of their world levels and to stop massive waste of energy, inflation, sanctions, corruption and their most probable severe social impacts could be the inevitable future of Iran.

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