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Iran’s "Major Economic Surgery" Now a Reality
Iran, as a country between globalization and isolation, tradition and modernity, has had a major importance on the international scene. Televisions, newspapers, magazines, columnists, journalists, reporters, almost all media have tried to understand, follow and interpret the developments since the Islamic revolution of 1979. Recently, this growing attention has focused on almost the same issues such as Iran’s nuclear program, UN sanctions, diplomatic efforts, President Mahmoud Ahmadinejad as a highly controversial figure in Iran. Nevertheless, Iran’s economic performance with its cautious approach to globalization has attracted less international media attention respectively. In this performance, long-lasting subsidies granted by the Iranian government to energy, food and certain services have an important role in terms of effects on the budget, monetary policy, development plans and the social well-being of the country.
Iran’s economic achievement has mostly been dominated by its energy reserves. With its 73.6 million inhabitants, 828 billion dollars of GDP (PPP), 1.6% real GDP growth, 154 billion dollars of trade volume, 66.2 billion dollars of exports of oil and gas (75.6% of its total exports), Iran was the world’s 18th largest economy in 2009. .
Iran, as a member of OPEC, has the world’s third largest proven oil reserves and the second largest natural gas reserves. It is also OPEC’s second largest oil producer and the world’s fourth largest crude oil exporter. With all its enormous potential, Iran, according to the International Energy Agency’s (IEA) World Energy Outlook, spent $66 billion in 2009 on subsidizing fossil fuels, ranking it number one in the world . This subsidy has been a huge burden on the shoulders of the economy, which creates inefficiencies in the energy sector. In total, the subsidies, including those for food and various services, are estimated to cost Iran up to $100 billion a year. Considering Iran’s GDP, which was $331 billion in current prices in 2009, one could imagine that the magnitude of the subsidies saved would reach 30% of GDP, which has a significant impact on Iran’s GDP. .
The history of subsidies in Iran dates back to the 1970s, when high inflation rates and price instability, especially in fossil fuel-based products, prompted the government to set up a consumer support fund in to control prices and distribute subsidies. This was replaced by the Organization for the Protection of Consumers and Producers in 1977. The government believed that subsidies were the best way to distribute the national wealth. During the Islamic Revolution of 1979, the government had to increase subsidies due to declining oil production, continued high inflation and the growth of the black market. In fact, while Iran was among the most energy-efficient countries in the 1980s, it is now one of the most wasteful. However, with regard to food and medical subsidies, the situation was reversed. These have played an important role in improving child nutrition and reducing infant mortality. During the first and second presidencies of Mohammad Khatami, between 1997 and 2005, although the government was tasked with preparing the necessary subsidy reform through economic development plans, attempts failed due to the risk economic, social and political consequences arising from sudden price increases.
The problem in Iran, even recognized by President Ahmadinejad, is the imbalance between high-income people and low-income people due to government subsidies. Although the richest 20% of Iranians pay only one-tenth of total income tax, they benefit from 70% of public subsidies. The poor using less energy receive very few subsidies compared to the rich. The motives for lifting subsidies are to manage consumption, promote productivity, create justice, eradicate social gap and increase national production. Energy consumption in the country is extraordinarily higher than international standards.
Finally, in December 2008, the government submitted the “Subsidy Targeting Act” to Parliament for the gradual reduction of subsidies on fuel, electricity and certain goods in five years. On this date, the so-called “Major Economic Surgery” began in Iran. In accordance with the law, the government provides cash grants to compensate low-income families against the adverse effects of possible inflation. In short, the plan is to move from a subsidy policy to market-based energy pricing in five years with assistance for low-income groups. The government intends to distribute 50% of the budgetary savings resulting from the reduction in subsidies through direct cash or non-cash compensation.
In the end, it took a year for Parliament to pass this law and in December 2009 it was passed by Parliament and then approved by the Guardian Council. Thus, since the beginning of 2010, the Government has been working on the strategy for implementing this law. At the end of December 18, 2010, the law entered into force. As stated in the law, the government must adjust the domestic prices of gasoline, gasoline and liquid petroleum by the end of the 5th economic development plan (2010-2015) so that the price of these products does not not less than 90% of international prices. (FoB Persian Gulf). For electricity, all subsidies will be lifted until the end of the 5th Plan and the price must be 100% consistent with the final product price. Apart from energy products, the law also covers water, wheat, rice, edible oil, sugar, milk, postal services, air services, rail services, flowers, bread.
In fact, in Iran, the 30-year-old habit of living with artificially low prices has made it harder for governments to implement a substantial reform program so far. Thanks to 15 years of long debates, this time a consensus has emerged on the need for this reform in public opinion. It is widely recognized that this reform program will bring, among others, the following results:
– Additional revenues will be available for infrastructure investments.
– Producers will have to give priority to energy efficiency in their production processes.
– Cash transfers lead people to be more efficient in allocating their resources.
– Demand for fossil fuels will decrease due to high prices, so domestic prices will be adjusted to world prices and smuggling of these products out of Iran will be discouraged.
– Lower demand will leave more energy resources for export.
– Iran’s domestic automotive industry, producing 1.5 million cars per year, will need to modernize with the aim of increasing energy efficiency and becoming more competitive in the export market.
– Demand reduction will also make people more resilient to UN sanctions. The government has also accelerated the reform program due to United Nations sanctions against refined petroleum products to reduce their domestic demand.
But concerns have arisen over the transparency and adequacy of the measures to avoid or mitigate the negative impacts of the program for low- and middle-income people. Therefore, the speed of raising subsidies and the methodology to compensate different population groups are general concerns to which the following could also be added:
– There are doubts about the level and frequency of annual price adjustments.
– The definition of eligibility for compensation as well as the amount and duration of these payments are ambiguous. This could lead again to an injustice in the distribution of income.
– The program will most likely trigger inflation depending on the speed of price increases.
– Strategies aimed at minimizing inflation are not enough.
– Uncertainties in the expenditure of the income saved.
In accordance with the provisions of the law, an independent organization has been created to manage cash transfers which must be approved by Parliament. This body has already started its work a long time ago and has collected statistics from households to verify their income for money transfers, registered their bank accounts. In accordance with the mentioned law, 50% of the additional income generated by the reduction of subsidies will be used for cash payments, investments in housing, medical services, social security and increased employment. In addition, 30% of revenues will be allocated to companies to invest in energy-efficient technologies, improving public transport and supporting agricultural and industrial projects.
Now everyone is looking at the first results of the implementation and trying to make estimates about its immediate impacts on the economy. As required by law, the government sent thousands of inspectors to check prices to avoid any sudden increases in producers and people started withdrawing cash transfers. Although the first impression shows that there is no unusual reaction from people, the change has been calmly absorbed and business is going on as usual, it is reported that some producers have started to slow down the process. introduction of products on the market due to expected price increases. Obviously, it is too early to draw a conclusion from this great economic transformation.
Last but not least, Iran is on the verge of carrying out one of the “major economic surgeries” in its long history. Most people are worried about the difficult results of the implementation process, possible protests, mismanagement of additional revenue, corruption, adverse social consequences. However, with more transparency and good cooperation between the government and the parliament, some concerns could be lifted. Clearly, the political, social and economic risks are enormous for the Iranian people, especially under the threat of sanctions resulting from a stubborn and intransigent foreign policy. Although the goal is to end the maintenance of energy prices at a tenth of their global level and to stop the massive waste of energy, inflation, sanctions, corruption and their most serious could be Iran’s inevitable future.
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