By Jahangir Amuzegar
This is the first of a two-part article.
By Jahangir Amuzegar
The Islamic Republic’s five-year-old subsidy program, designed to compensate consumers for increased prices of energy and public utilities, has now become a fiscal albatross around the government’s neck: it cannot be continued as it is; and it cannot be terminated outright. It symbolizes the Persian adage: “a fool may throw a rock into a well where a hundred wise men won’t be able to retrieve it.”
The misconceived, misconstrued, and mismanaged scheme, launched in late 2010 during the administration of former president Mahmoud Ahmadinejad has so far cost more than $60bn with huge losses for the treasury, and questionable tangible benefits to the recipients. The program’s cost so far has been equal to nine years of the annual economic development budget.
THE BACKGROUND
From the post-1979 revolution period until 2010, the Islamic Republic, proud of being a welfare state, has provided its citizens with various goods and services (food, fuel, power and water) at highly subsidized prices – often below costs. According to an International Monetary Fund (IMF) report in May 2015, the Islamic Republic is paying the highest energy subsidies in the Middle East – North Africa region – estimated to be equal to 5% of its gross domestic product. Along with Venezuela, Iran has the lowest energy prices in the world – and eight times higher energy consumption per capita than in European countries.
This generosity has produced two thorny problems: one of efficiency, and another of equity. Dirt cheap prices of some subsidized items gave rise to profligate waste – with people feeding their animals with cheap bread, rural people using natural gas to heat up their shacks with windows open, and industries replacing labor with cheap energy, using natural gas. Equity problem rose as the well-to-do, with larger houses and bigger cars, had more use of subsidized items, and enjoyed disproportionately larger shares of the subsidies.
Misunderstanding and misinterpreting Western economists’ dictum that public subsidies are more efficient if paid in cash rather than through price discounts, the Ahmadinejad government decided in December 2010 to raise prices of government supplied energy and utilities, and compensate the users with monthly cash pay.
The “Subsidies Targeting” bill submitted to the Iranian parliament (Majlis) in early 2010 proposed to raise prices of energy and utilities gradually to their world level in five years. Increased revenues from higher prices were to be shared by the needy consumers, energy-intensive industries, and the treasury. While the bill passed by the Majlis authorized the government to raise prices of subsidized items to their international levels gradually in five years, the government ignored the mandate and increased prices of gasoline, gasoil, natural gas, electricity and water by four to eight times.
THE FIRST PHASE
The program’s “first phase” of operation (2010-13) proved highly disappointing, due to its basic structural flaws. Underestimating the size of potential monthly cash recipients, and overestimating the magnitude of revenues from higher energy and utilities prices, the government faced a fiscal deficit almost from the beginning.
In the first three years of the subsidies program some IR14 trillion deficit of the monthly cash programs was financed by borrowing from the Central Bank of Iran (CBI) and using the treasury’s borrowing account – giving rise to enhanced liquidity and higher inflation.
Monthly cash payments that were supposed to absorb only 50% of the revenues from higher energy prices ended gobbling up 200% – with the shortfalls covered by borrowing. The shares of the industry and the treasury were totally neglected. Furthermore, while higher energy costs had to pay by energy intensive industries, they were not allowed to raise their prices. By failing to give the industrial enterprises their shares of revenues as prescribed by law, the government caused drastic fall in industrial output – leading to the worst recession in Iran’s post-revolution history.
THE SECOND PHASE
The program’s continued fiscal deficit and its growing burden on the treasury, along with reports about misuse of the scheme, and a rising chorus of criticism regarding the inequity and inefficiency of the uniform and universal cash payments to all, called for urgent reform.
All eyes were on the newly-elected President Hassan Rohani in June 2013, and his group of economic advisors to come up with a plan to salvage the deficit-ridden program, and create a sustainable basis for a solution. Yet, for the first nine months of the new administration, nothing was changed and the program continued as before.
Pressured by various forces, the Rohani team finally came up with a new plan. The subsidies “second phase” promised to start from the third month of Iran’s New Year (May 2014). Monthly cash payments were now to be given to the head of each family after (1) he or she answered a questionnaire regarding family income and wealth, and (2) eligibility for aid was confirmed after the questionnaire’s review by the authorities. Applications were distributed in mid-April 2014.
Public response to the government’s initiative was highly disappointing. While it was widely expected that some 7 or 8 million well-to-do families out of an estimated 76 million would respond to the government plea, no more than 2.4 million individuals (or only 3% of the total population) volunteered to forego the monthly subsidy. Altogether, some 73 million inhabitants continued to demand the bounty. Matched against other available data, it was also evident that the respondents were not always truthful in their applications.
Failing to find enough wealthy volunteer families to forego monthly cash receipts, the government was back to square one to find and eliminate well-to-do recipients. Yet, while it was generally expected that the government’s 2014-15 budget would delineate a new second phase of the subsidy program, the draft submitted to the Majlis lacked any new proposals or guidance, and left the decision to the assembly – the first sign that the “wise men” had no clue as to how to approach the subject.
The Majlis, in its part, reversing its unwise 2010 decision that no one should be left out of monthly cash payments, ordered the government to eliminate the top 30% of income earners from the bounty. Accordingly, every household receiving a monthly check was asked to fill out a form stating their income and assets. Payments of cash subsidies in the New Year (20 March 2014- 20 March 2015) were thus contingent upon the completion of the application form and income eligibility. False information on the forms would result in imposition of three times the subsidies received as a penalty.
But the task once again proved to be as difficult as ever. In the first month of the new Iranian year, 2015-16, the fiftieth tranche of the monthly cash subsidies was routinely paid out without mention of any changes. Private newspaper investigators, however, claimed that payments to some five major groups – recipients living abroad, owners of luxury automobiles, foreign-exchange dealers, board members of banks and private corporations, and high-income physicians – had been quietly eliminated.
A strong immediate denial of the reported cuts by the government spokesman showed how apprehensive the authorities were of a public backlash. While the government spokesman finally acknowledged that monthly cash payments to some 250,000 recipients had been stopped in the last two months of the 2014-15 Iranian year, the authorities still did not announce or mention the base criteria for such suspension.
In passing the 2015-16 budget, the Majlis, facing falling oil prices and other rising expenditures, finally cut the administration’s subsidy appropriation by IR30 trillion (from proposed IR420 trillion to IR390 trillion) requiring the government to eliminate 6 million wealthy recipients from the monthly dole.
Four criteria for the elimination were suggested: number of individuals in the family; city of residence, ownership of property, and the type of automobile owned. Excluded recipients had a chance to protest the government’s decision and ask for a review within a month. The government was also given three months to come up with concrete indicators for cutting the number of recipients.
Dr Amuzegar is a distinguished economist and former member of the IMF Executive Board.This article first published in the Middle East Economic Survey (MEES).