THE ISLAMIC REPUBLIC OF IRAN TACKLES SUBSIDIES AS THE PRICE OF OIL DECLINES

 

Number 27 ● 11 January 2009

 

Brandon Friedman*

 

In the wake of the global economic crisis, Iran has found its economy facing pressure from the rapidly declining price of oil, which has plummeted to $46 per barrel in early January 2009 from a high of $147 per barrel in early July 2008. Mohammad Tabibian, an Iranian economist, noted that the impact of this crisis will be more serious for Iran than other oil-producing states (Hamshahri, November, 13, 2008). As a result of the new economic reality, Iranian president Mahmoud Ahmadinejad recently announced an ambitious new plan to eliminate expensive government subsidies that have kept consumer prices artificially low on critical goods and services, such as gasoline (petrol), electricity, and heating oil. Rising inflation and the sudden drop in the price of oil have forced Ahmadinejad to react to the government's potential cash crisis, but it is uncertain how the Iranian public will respond to the new plan to eliminate subsidies and raise taxes on goods and services that are considered daily necessities.

Iran is in the midst of its fourth five year economic plan (2005-2009), which under Ahmadinejad's leadership has adopted a policy of populist redistribution of national income. In 2006, Ahmadinejad established the $1.3 billion 'Imam Reza Mehr Fund' to assist young people with the cost of education, marriage, and housing. However, demand has far exceeded the fund’s supply, and young people are often unable to leverage a one time gift into a long-term solution. Throughout his term Ahmadinejad has used 'The Oil Stabilization Fund' (OSF), which was created by Iran’s Central Bank in 2001, to store surplus oil revenue and use in periods of price fluctuation, for populist cash handouts and ad hoc projects during his non-stop political tours throughout Iran, described in detail by Kasra Naji. The depletion of the OSF has left Iran's economy vulnerable now that the price of oil has precipitously fallen. Rising inflation suggests Ahmadinejad's government has not managed its oil revenues well and has had limited success implementing much needed structural reform. Inflation has doubled, from 10.2 percent in 2005/6 to approximately 24 percent in 2008, according to the Central Bank of Iran.

The government's subsidies for key consumer goods such as gasoline, heating oil, and foodstuffs have contributed to artificially high demand and inflation. Ahmadinejad, by continuing to use oil income to underwrite subsidies to consumers, has flooded the economy with cash instead of moderating spending and managing the expansion of domestic demand. For example, gasoline subsidies fuel public consumption which has forced Iran - one of the world's largest crude oil exporters - to import nearly one-third of its gasoline for domestic consumption.

A June 2008 'International Monetary Fund' (IMF) report - published on August 14, 2008 - noted that Iran's economy was "overheating" and in the “medium-term” was “very sensitive to the oil price assumptions.” It further elaborated that if prices for Iranian crude oil fell to $75 per barrel (the price was $140 per barrel in late June) Iran would suffer from a large budget deficit, "which would be unsustainable because of Iran's limited access to international financial markets.” In other words, the report suggests that if the price of oil dropped below $75 per barrel Iran's economy might face a serious liquidity or cash crisis.

In October 2008, when the price of a barrel of oil was $70, Iranian Central Bank governor Mahmud Bahmani warned, "If this rate continues until the end of the year, $54 billion of expected oil income won't materialize." (Washington Post, December 4, 2008). Following the implosion of several major U.S. financial institutions in September and October 2008, the global economy has dramatically slowed driving the price of oil down to a point where it now hovers well below the $75 per barrel price the IMF reported Iran would need to keep its economy sustainable.

On November 4, 2008, the Iranian daily Kargozaran addressed a column to president Ahmadinejad in response to the president's letter to more than 200 economic experts soliciting suggestions for confronting the global economic downturn. Kargozaran asked how, despite camp-aigning on slogans that promised to bring Iran's oil revenues to the tables of average people, Ahmadinejad's government had squandered $180 billion dollars oil revenues and caused a 60 percent reduction of the people's purchasing power during the past three years (Kargozaran was shut down by the authorities on December 31). Facing growing discontent with his populist economic policies, Ahmadinejad has recently used the plummeting price of oil and the global economic slowdown to reverse his course and push forward the badly needed structural economic reforms that Iranian technocrats have been demanding from Ahmadinejad throughout his presidency.

In an interview broadcast on Iranian television in early December 2008, Ahmadinejad tried to put a positive spin on recent events and gave the impression that Iran was insulated from the global economic downturn, “There is almost a zero percent possibility for our economy to be affected by this.” Later in the interview Ahmadinejad conceded the Iranian economy has indeed been affected by the global economic slowdown, “From one point, it may put us under pressure and that is the oil price. That is something which we have to manage." Ahmadinejad stated that he believed this was an opportunity, and reversing his populist economic policies of the previous three years, concluded that the current new situation “gives us the chance to implement reforms.”

On December 29th, the Iranian newspaper Javan published the details of Ahmadinejad's new targeted-subsidies bill, which is a first step toward reducing government subsidies. Some experts believe the Islamic Republic of Iran has used approximately half of its national revenues for this fiscal year to pay for subsidies on basic consumer goods and services. The proposed bill is designed to reduce inflation which is between approximately 24 and 29 percent, eliminate the nearly $90 billion in government subsidies on electricity, gasoline, heating oil, water, and other basic goods, and privatize these industries within three years. The bill will also implement taxes on energy consumption. At the same time, according to the Javan report, the bill promises to use 60 percent of net income from implementation of the law to provide “target social classes” with health and medical coverage and housing and job opportunities. The lowest strata of social classes are supposed to receive direct cash payments to assist them with purchasing basic goods and services in the absence of subsidies. The test for Ahmadinejad will be whether the average lower class Iranian citizen will receive enough from the proposed new social safety net the president is offering to survive in the absence of government subsidies of basic goods and utilities.

In addition to eliminating government subsidies on basic consumer goods and services, in October Ahmadinejad proposed a 3 percent VAT tax on all merchant sales. This proposal resulted in 10 days of protests and demonstrations in bazaars throughout Iran by merchants who argued that the tax would increase prices and reduce demand for their products. In response to the widespread protests Ahmadinejad said the bill may be delayed for a year. However, it appears to be moving forward in the Majlis despite the protests. Ahmadinejad's proposals are daring, some might even say desperate, political maneuvers, because they may undercut two of the pillars of conservative political base: the lower classes and the religious conservative Baazari-merchant community. Whether Ahmadinejad will be able to create the perception that he has succeeded in tackling Iran's economic challenges may determine his fate in the upcoming Iranian presidential elections scheduled for June 12th, 2009■

 


* Brandon Friedman is a research fellow of the Center for Iranian Studies at Tel Aviv University.


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Iran Pulse 27 ● January 11, 2009 © All rights reserved.

 

 

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