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Can Iran finally pass subsidy reform?

Past reform efforts have been hindered by inefficiency and corruption, and the challenge of implementation remains.
EDITORS' NOTE: Reuters and other foreign media are subject to Iranian restrictions on leaving the office to report, film or take pictures in Tehran.

A vendor hangs vegetables in front of a shop in a bazaar in northern Tehran February 29, 2012. For months now, Iranians have endured economic hardship, political repression and international isolation as the authorities refuse to halt sensitive nuclear work as demanded by the U.N. Security Council. REUTERS/Morteza Nikoubazl (IRAN - Tags: POLITICS ELECTIONS SOC

Iran is preparing to implement the second phase of its subsidy reforms, generating anxiety among politicians, businesspeople and society at large. 

The Iranian government has approved the executive bylaws that determine the implementation of the second phase of removing the blanket subsidies on energy and foodstuffs in return for cash handouts to the vulnerable social classes. The first phase of the reforms was introduced in December 2010 by the previous government and caused major inflation over the past three years. Critics of former President Mahmoud Ahmadinejad accused his administration of neglecting legal provisions such as the allocation of only 50% of the new revenues from price increases for cash handouts to society. Consequently, the administration of President Hassan Rouhani has committed to structuring the new phase of price adjustments more in line with the original law and with less inflationary impact. The government also made preparations to discontinue payments to a large segment of the middle and higher-income Iranian families.

The government decree that determines the approach to the second phase of subsidy reforms includes the following provisions:

  • The cash payment in the current Iranian month of Farvardin will be the last one of the old system, after which a new system will be devised with a reduced number of recipients.
  • Families who qualify to receive cash handouts will have to register with the Ministry of Cooperatives, Labor and Social Welfare. The government has stated that it will fully verify the information that families submit in their applications. Evidently, only those households considered low income will qualify. The support will come in cash as well as in material goods (probably through the so-called “goods baskets” that the government introduced last year). Families that are already recipients of state support through the Social Welfare Organization and the so-called “Imam Committee” will automatically receive cash handouts, but other applicants would have to be verified by the ministry. Failure to registrater equals agreement not to be included in the handout program. The government has also indicated that it will cross-verify information with banks, especially with regard to owning properties that may have been used as collateral with banking facilities. The new decree has also promised severe penalties for citizens who base their application on fraudulent data about their family’s finances. In addition to the much stronger drive to verify information, the government has also tapped celebrities to encourage the middle and high income classes not to enlist for cash handouts.
  • A new parameter in the reformed approach is for all families supported by the program to also be covered by health insurance affiliated with the Ministry of Cooperatives, Labor and Social Welfare. If implemented properly, this will be a significant step toward social justice, as the well-being of low-income families has always been undermined by their inability to pay for health services and medicine.
  • The decree also outlines the mechanism by which the government will allocate shares (30% of the total new revenues) with a focus on supporting industries that are hit by the new fuel-price structure as well as on improving energy efficiency and investing in the country’s transportation sector.
  • In order to keep the financial data of the subsidy reforms transparent, the government has instructed the Treasury to initiate a new account to accept payments from the organizations involved, including the National Iranian Oil Products Refining and Distribution Company as the main player in the fuel sector, the National Iranian Gas Company from the gas sector and the Ministry of Energy for the electricity and water sectors. This way, the administration will have a clear picture of the funds that are available for the various programs that need to be financed through subsidy reforms. In some cases, it is even clear which portions of the payments from these organizations will be used for what. For example, 62 rials per every kilowatt of electricity sold by the Ministry of Energy will be used to support power and water companies in their effort to increase efficiency. As the mismanagement and opaqueness of the financial aspects of the reform were the key problem with the previous administration, creating transparency in the financial flows will facilitate assessing the actual success of the reforms.
  • While some of the new prices have already been applied (such as a 20% increase in water prices, 23% in the base price for electricity consumption and 20% on residential natural gas use), the key indicator — the price of gasoline — has yet to be finalized. There are different views on what approach to apply. Some argue that the price should remain two-tiered, with a lower price for a monthly ration and a higher price for any consumption above that level. Others argue that the price should be uniform in order to prevent corruption in the usage of the lower price. The core problem is that the devaluation of the rial has undermined the original pricing strategy. When the so-called free-market price of 7,000 rials per liter was introduced in 2011, it corresponded to about $0.70. However, the new proposed price of 10,000 rials would only represent $0.40 and have little effect on overall consumption behavior. Moving to a higher price for gasoline would yet again lead to a major inflationary impact that the government would not be able to contain, especially as Iranian society is prone to an “imagined inflation,” usually based on benchmarks such as the gasoline price. In other words, prices for goods and services will increase as soon as a new price for gasoline is announced by the government.

Economists are divided on the inflationary impact of the new phase of subsidy reforms. For example, university professor Mohsen Ranani proposes not to implement the second phase. He argues that the inflationary impact cannot be prevented and that the government is wrong in believing it can contain the explosion of liquidity. Other experts, such as economist Shahin Shayan Arani, believe that the government’s contractionary fiscal policies will prevent major inflationary pressures.

For now, the government seems resolved to implement the new phase as planned in the original law on reforming subsidies. If implemented well, the new phase could have an overall positive macroeconomic impact on the country, especially as it should contain runaway energy and fuel consumption. However, the problem in a country like Iran is not how intelligently laws and regulations are designed, but how efficiently they are implemented. Unfortunately, the system is prone to corruption and abuse and the government will have to be careful of how it implements the new decree and what mechanisms it will adopt in preventing corruption. For example, corruption was the main cause for the fact that in the old system of cash handouts, the number of recipients recorded in the system was higher than the Iranian population. Clearly, a successful implementation of this new phase will have to be accompanied by intelligent reforms in the administration of such laws, not just inside the implementing ministry, but also in all organizations directly or indirectly involved in the process.