Iran Feature: The Death of Ahmadinejad's Subsidy Cuts Programme (Amuzegar)

Economist Jahangir Amuzegar writes a lengthy study for the Middle East Economic Survey of the life and death of Mahmoud Ahmadinejad's subsidy cuts programme --- the opening and concluding sections of the article:

On 13 November 2012 the Islamic Republic’s Majlis (national assembly) voted to “suspend” the second phase of the Targeted Subsidies Reform Act of January 2010 --- thereby halting further price increases in public utilities (food, fuel, water, electricity) and further rises in monthly welfare cash payments to households during the current Persian year (March 2012-March 2013). Thus a program that had been announced with the greatest fanfare in December 2010 as the center-piece of President Mahmoud Ahmadinejad’s “Great Economic Surgery” (MEES, 24 November 2008) came to an inglorious end with hardly a whisper.

Furthermore, alarmed by the widespread rumors that the government intended to raise cash subsidies by manipulating exchange rates, the Majlis passed further restraining legislation. According to a new law coming into effect on 7 December 2012, “all money received from the sales of oil and gas proceeds at new higher exchange rates is part of the government’s general revenue, and no part of it could be used to raise monthly cash payments.”....

The Report Card

A balanced assessment of the subsidy reform program is virtually impossible due to: (1) the absence of a comprehensive official report regarding the program’s operations, its sources and use of funds and its achievements and failings; (2) a dearth of reliable independent data on the actual consumption and use of subsidized items before and after the reform; and (3) most significantly, the coincidence of the program with escalating international sanctions on Iran’s frail economy and a steep decline in the rial’s value, making  cause and effect on major economic indicators difficult if not impossible to determine. Complicating the assessment process further are the irreconcilable differences between highly positive claims by reform officials and equally strong denials by the program’s critics.

With these caveats in mind, a quick look at the available information leads to some provisional observations.  To begin with, it is interesting to note that the only piece of information regarding the program’s financial status is a televised statement by the Reform Organization’s official spokesman on 9 October 2012. Accordingly, from December 2010 to October 2012, the reform program spent a total of IR71,200 trillion, of which IR45,500 trillion was received from higher price adjustments, IR18,000 trillion from regular budgetary appropriations and the rest from a provisional loan from the CBI.

Information regarding the program’s operation and achievements is also provided by an article written by the finance minister in April 2012 in which he unequivocally claims that:

• The three principal objectives of the law—an improvement in consumption patterns, more equitable income distribution and the reduction of smuggling—have all been achieved. That is, despite a rising population, larger annual GDP and increased exports, the growth rates of gas, electricity, bread and water consumption were all stopped or became negative—resulting in savings of $15bn.

• The national consumption pattern shows that some 80% of the population had their welfare improved.

• Due to the reduced difference between domestic and foreign prices, flour and gasoline smuggling out of the country has nearly stopped. At the same time, contrary to dire predictions, the rise in the consumer price index resulting from higher price adjustments has been less than 10%

While no independently verifiable data in support of these statements were offered by the minister, it would not be implausible to assume that (1) there has been some reduction in waste and profligate consumption of bread, water, electricity and natural gas in response to higher prices; (2) the income status of perhaps the lowest two or three deciles of the population might have somewhat improved through monthly cash payments; and (3) smuggling  of some previously low-price items might have stopped. 

But this is far from being the whole story. A glaringly disappointing aspect of the reform exercise has been the nearly total absence of improvement in energy-saving industrial technology— the single most sought after goal of “the great economic surgery.” In fact, anecdotal evidence shows that higher energy prices, instead of inducing industrial enterprises to renovate, have resulted in bankruptcies and factory closures.

There have been lapses in other aspects of the claimed success. Recently published records, for example, show that between December 2010 and April 2012, higher prices of just 14 consumer items alone absorbed some IR1,620,000 of the IR1,820,000 received in monthly checks by a four-member family, leaving only IR200,000 for tens of other urgent needs. Other reports indicate that the smuggling of gasoil, which had never stopped altogether, has increased again due to new price differences caused by the devalued rial.  Gasoline consumption has also reportedly reverted to the old ways.  And despite repeated official denials, Central Bank data show that producer prices to have been on the rise since December 2010 and are visibly traceable to the consequences of subsidy reform.

Offsetting the scant benefits of the program to the Iranian economy are three thorny problems which the initiative now poses for the government.  First, since the scheme is admittedly not self-financing, continued monthly cash payments to nearly the entire population impose a considerable financial burden on the already deficit-ridden fiscal budget. Second, since monthly welfare checks rely on borrowings from the Central Bank, they stoke the already troublesome inflationary fire. The third, and by far the most formidable task, is how to wrap up the program.  Current regular monthly compensation checks are now regarded as a permanent “entitlement” whose cancellation or even reduction poses a frightening challenge to the government.

What Next?

The Majlis’ November 2012 act only “suspends” the program’s second phase and presumably does not terminate the reform initiative.  In fact, the head of the Subsidies Reform Headquarters has told the press that the government will shortly propose the resumption of the new phase in the context of the forthcoming (2012-2013) fiscal budget, and hopes to reach a satisfactory compromise with the legislature.

Yet under the current circumstances, the Subsidies Targeting scheme --- in its January 2010 form --- is to all intents and purposes dead. Given the current official inflation rate of nearly 25% (caused mainly by excess domestic liquidity as well as international sanctions), the banking system’s latest record of non-performing loans and the growing current budget deficit, no prudent legislature would dare allow further drastic increases in the price of basic consumer staples.

And given the rial’s dramatic devaluation, the original statute would be nearly impossible to carry out.  Under this act, the prices of gasoline and other subsidized items were to be gradually raised to international levels (ie no less than 90% of their fob prices on the Persian Gulf). With the dollar/rial rate at the time of the legislation hovering around $1=IR10,000, the five-year price adjustments required a four to five times increase in the price of most items. Now, with the exchange rate nearing $1=IR30,000, compliance with the act’s original provisions would require a further threefold increase, which would be well-nigh prohibitive. Any new subsidies reform initiative would therefore have to start from scratch.