Managing Partner, Eurasian Nexus Partners, Vienna, Austria
May 22, 2023
Reducing the current energy subsidies is the main remedy for the runaway budget deficit in Iran, but there will be major political obstacles. On the one side, the government is concerned about a new wave of social unrest, and on the other side, Majles deputies will oppose such a move, especially as they will stand for re-election in February 2024. Therefore, the government will be forced to structure, time and justify its decisions in a way that repercussions can be managed.
The Iranian government pays enormously high fuel subsidies.According to Massoud Mirkazemi, former vice president in charge of the Plan and Budget Organization, the subsidies cost more than $100 billion per annum.
Average daily consumption of gasoline has increased by about 8-10% per annum in the past decade. The only exceptions were 2020 and 2021, when Covid-related closures and restrictions reduced overall consumption. The hike in consumption in the current Iranian year (started on March 21) is estimated at about 9%.
A number of causes lead to a highly inefficient use of gasoline in transportation. These include: Lack of efficient public transportation, inadequate roads, fuel-inefficient domestic cars and the low quality of domestic gasoline.
According to Mostafa Nakhei, spokesperson of the Majles energy commission, in the current state budget, the government has allocated $1 billion to importing gasoline and fuel oil to make up for growing domestic demand. The higher-quality imported fuel is used in large cities to manage the environmental impact.
Currently, every car owner in Iran receives 30 liters of gasoline per month for as low as 15,000 rial. Any amount above that ration is 30,000 rial per liter — less than 6 US cents at the free-market exchange rate.
The high budget deficit is a main driver of excessive inflation in Iran, and the Raisi administration has declared the containment of inflation as one of its highest priorities.
Undoubtedly, one of the technocratic solutions to contain inflation would be to reform the energy subsidies in order to achieve two important goals: Reducing the budget deficit and also containing energy consumption.
A third important goal would be to reduce the growing phenomenon of fuel trafficking. About 8% of the country’s diesel production and a sizable quantity of gasoline are smuggled out, adding to the enormous economic cost of the current fuel subsidies.
A number of moves by the government, such as limiting the use of gasoline cards by car owners or a pilot project to distribute gasoline based on national ID cards, are leading to an assumption that another price adjustment is in the works. The last fuel price increase in November 2019 led to massive social protests.
Even though a reform of the subsidies would itself have an inflationary impact, a smart approach would allow the government to allocate more targeted subsidiesto lower incomes and address growing poverty levels.
However, there are two serious impediments to this idea: On the one side, the government cannot afford to risk another wave of social unrest which could lead to protests beyond fuel price hikes, and on the other side, Majles deputies would be hesitant to vote for an unpopular decision a few months prior to their re-election bid in February 2024.
Scenario 1: Lifting of subsidies after the elections
One scenario is for a price hike after the Majles elections in February 2024. The government may calculate that it won’t face political pushback from parliamentarians. Officials may also assume that social backlash could be managed by increasing cash and non-cash benefits to the lower-income classes who would be exposed to the inflationary consequences. Different approaches would probably be prepared based on the socio-political conditions leading up to the elections. If the polls themselves go smoothly and a more moderate Majles is voted into office, the social acceptance of such economic changes may be higher. But if the level of social protest remains high, the fuel price hikes would lead to new protests and make the policy shift costly and challenging.
Scenario 2: A three-tiered pricing system?
One path for the government is to continue the status quo while generating other petroleum-sector sources of income for the Treasury. In fact, there are suggestions to allocate some of the revenues generated through efficiency improvements in the sector to covering the cost of fuel subsidies. However, a continuation of the low fuel price would lead to continued growth of domestic consumption and deepen the crisis. Therefore, even in this scenario, some changes will be introduced, such as putting an upper limit on how much gasoline each car can receive at the higher existing price. The consequence could be a three-tiered pricing of gasoline and other fuels that will lead to additional operational challenges as well as new forms of black market in the sector.
Conclusion - Most Likely Scenario:
The most likely scenario is for the government to prepare for a smart rationing system based on identification cards rather than fuel cards. Allocating every citizen a gasoline ration will create a side market so that individuals who don’t have a car can transfer their ration to car owners. Experts reject this approach because it would create a secondary market for trading gasoline rations. Alternatively, the government can allocate a monetary value to every citizen and in return increase fuel prices in stages. More than 70% of Iranians are already receiving cash benefits, and a fuel allowance could be added to it. However, this shift would require major structural adjustments to prevent social backlash. This is why the public must be prepared for the policy announcement. The current burden of fuel subsidies on the economy is not sustainable, and a meaningful reform will have financial, economic and environmental advantages. The main obstacles will be political, hence some will argue to implement the shift after the Majles elections in February 2024. The risk of social unrest can be managed, if the direct allocations (cash or in kind) to citizens kick in before fuel prices are increased.
Bijan Khajehpour is the managing partner at Eurasian Nexus Partners - eunepa.com - a Vienna-based international consulting firm. He also sits on the board of the Europe Middle East Research Group. He is considered an expert on geopolitics of energy and the Iranian economy and energy sector.
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