The Subsidies Conundrum
- Iran has subsidized petroleum products, basic foodstuffs, medical goods and utilities since 1980, first to manage hardships during the eight-year war with Iraq, and then to prevent political and economic challenges after the war.
- Since the 1990s, three presidents have tried to cut back subsidies that are now estimated to cost Iran between $70 billion and $100 billion annually. President Mahmoud Ahmadinejad won parliamentary approval for a controversial plan to phase out subsides by 2015.
- Under the plan, universal price controls are to be replaced with small cash payments to families and direct support of industries. Some economists are concerned that lifting price controls will trigger dramatic rises in inflation and unemployment.
- The cutbacks come at a time the government already faces serious economic troubles and tougher international sanctions. For the public, the change is likely to produce the most economic disruption since the revolution. Economic reforms have triggered unrest in the past.
- If reform succeeds, however, the program could help reduce waste, shrink state outlays and enhance efficiency and productivity.
- Subsidies will be phased out over five years, ending in 2015.
- The government can cut back up to $20 billion of subsidies within the first year. In subsequent years, parliament will have to approve additional amounts through the annual budget process.
- Immediate cutbacks affect the price of petroleum products, wheat, rice, cooking oil, milk, sugar, postal services, as well as airline and railway services. The government has discretion on which subsidies to cut first.
- Medical services and products are not affected by the plan.
- In lieu of subsidies, the government will distribute small sums of cash to individuals.
- A new government body—a subsidy reform organization—will hold most of the funds that were once allocated for subsidies. It will plan and supervise the distribution of cash payments as a substitute for subsidies. Parliament insisted on making the organization subject to audit.
- The funds accrued from subsidy cuts will be divided:
- Iran is cutting back subsidies at one of the most precarious moments, politically and economically, since the 1979 revolution. To avoid a backlash,Tehran must avoid a further drop in employment, a slowdown in the economic growth rate and a significant increase in inflation. The growth rate of Iran's gross domestic product is already at its lowest point since 1989, after the war with Iraq ended.
- Ahmadinejad’s poor economic track record has spawned concern about his administration’s ability to implement such extensive reform in ways that are not politically disruptive and economically harsh, particularly on urban middle and working classes.
- The controversy over Iran’s nuclear program could produce future setbacks. The Islamic Republic faces the danger of additional sanctions if there is no agreement with the international community to resolve growing tensions.
- Subsidy reform alone may not solve Iran’s chronic economic problems. To improve Iran's overall fiscal health, the government also needs to pursue structural changes and other free market reforms to reduce inefficiencies plaguing state-owned or state-affiliated industries. The government otherwise may still be forced to support key sectors that depend on the state's protection or business.
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