TEHRAN (Reuters) - Iran’s government is basking in rare IMF praise as the first major oil exporter to axe energy and food subsidies, but gains for the sanctions-hit economy could be jeopardized by costly cash handouts and the risk of runaway inflation.
With bread, electricity and gasoline prices soaring after President Mahmoud Ahmadinejad’s flagship economic policy slashed $60 billion of price supports, many experts say the IMF painted too rosy a picture of a country that will be among the hardest hit if oil prices plunge further as the global economy slows.
“Few people could dispute the need to reform Iran’s domestic energy prices,” the IMF said in its report, calling the $0.10 per liter subsidized gasoline price, at a time when global prices were around $2, “out of touch with reality, unsustainable and unjustifiable by any economic theory.”
For years, Iranian politicians agreed that the subsidies — a legacy of a statist revolutionary policy to spread the benefits of Iran’s vast oil wealth — were wasteful and perverse but it took the populist, West-baiting Ahmadinejad, already well into his second four-year term, to do something about it.
“On December 18, 2010, Iran increased domestic energy and agricultural prices by up to 20 times, making it the first major oil-exporting country to reduce substantially implicit energy subsidies,” the International Monetary Fund said in its July report “Iran - The Chronicles of the Subsidy Reform.”
Despite a sudden seven-fold rise in the cost of gasoline and bread prices doubling, the riots predicted by some analysts never occurred. Middle-class Iranians may grumble, but monthly payments of 455,000 rials (around $43) to every man, woman and child in Iran who applied, have softened the blow, particularly for lower-income families with many children.
“The successful implementation of the drastic price increases has created a unique opportunity for Iran to reform its economy and accelerate economic growth and development,” the report said.
But many economists say the subsidy reform risks causing devastating inflation and that the government may not be able to keep up the level of cash payments needed to maintain people’s spending power, especially if there is a drop in the oil price.
The IMF did not avoid the issue, saying in a separate report on the Iranian economy, inflation posed a “considerable” risk.
“... rampant inflation would result in a rapid erosion of domestic energy prices and of the targeted subsidies in real terms, and reduced incentives for enterprises to restructure, effectively reversing the early gains of the subsidy reform,” it said in its “Staff Report” on the Iranian economy published this month.
Iran’s inflation rose to 15.4 percent in the month to June 21, Central Bank Governor Mahmoud Bahmani said on July 27, showing a steady rise from a 25-year low of 8.8 percent in August 2010.
Iranians who have seen fuel bills and the cost of food soar after subsidies were slashed are skeptical.
“The statistics no longer serve any purpose because no one believes them,” Iranian economist Saeed Laylaz wrote in the reformist Roozegar newspaper on July 25.
Iran has told the IMF that it expects the subsidy cuts to cause inflation to spike to 22 percent and fall back to 7 percent “over the medium term.” The IMF says inflation will rise to 22.5 percent this year, from 12.4 in the Iranian year 2010/11 and fall back to 12 percent in 2012-13.
“I agree that rampant inflation is a serious risk. It will undo the subsidy reform and much more,” Djavad Salehi-Isfahani, an economics professor at Virginia Tech in the United States, told Reuters. But he added: “It is not a serious risk at this time because the government seems to understand it needs to lower inflationary expectations.”
Patrick Clawson, head of the Iran Security Initiative at U.S. think-tank the Washington Institute for Near East Policy, also said Tehran was acutely aware of the inflation risk and would make great efforts to keep it down, but with policies that would suffocate chances of economic growth.
“If oil prices remain high, then it will be quite possible to keep flooding the country with foreign goods which will be a powerful check on inflation in the prices of goods, but that will come at the expense of making Iranian products less competitive and therefore throwing people out of work,” Clawson told Reuters.
“My reading of the present government’s policies is that it is not particularly concerned about the productive economy, so perhaps it will actually bring inflation down.”
Ahmadinejad’s economic surgery came just as the United States and the European Union were tightening sanctions on Iran over its nuclear program.
Tehran has consistently said the sanctions are having no impact, but they have deterred Western investment in Iran’s vital oil and gas fields and financial restrictions have caused problems for Iran to receive billion of dollars for its oil exports to major customers India and South Korea.
The IMF noted: “New international sanctions in 2010 have in practice increased the cost of doing business, limited FDI and technology transfer, and have affected international trade and financial transactions.”
In his comments at the end of the IMF staff report, Iran’s IMF Executive Director Jafar Mojarrad showed just how serious Tehran was taking the sanctions threat.
“Should these restrictions remain in place, Iran would have no choice but to cut oil and gas supplies to the interested parties, with possible spillovers to the energy markets,” he wrote.
Salehi-Isfahani said sanctions were only partly to blame for Iran’s economic ills.
“Sanctions have become a big part of the problem, but in the past government’s own policies were a bigger problem. Iran’s competitiveness has been seriously hurt by higher domestic inflation relative to the rest of the world. And now, (by) energy price increases.”
The IMF said the subsidy reforms would slow economic growth, to 2.5 percent this year, from 3.2 percent in 2010/11. But it said the cash handouts would help to keep the economy moving and that growth would rise steadily to 4.5 percent by 2014/15. Iran is sticking with its target of 8 percent annual growth during the five-year period 2010-15.
Salehi-Isfahani said the estimates were all over-optimistic, absent a big increase in the oil price which would allow massively more public spending.
“Since the government has stopped publishing GDP data it is hard to say what is going on. But 1-2 percent growth is possible given the government’s own investment activities.”
Many economists say Iran’s policy of pegging its currency close to the dollar was one of the biggest brakes on growth.
Despite an 11.5 percent devaluation on June 8 — an attempt to eliminate the gap between the official exchange rate and the price most Iranians actually have to pay to buy hard currency — Tehran’s stated policy is to keep the rial stable.
While that should help check inflation, economists said it was having a ruinous effect on Iranian industry, which struggles to compete with cheap imports and to sell Iranian goods abroad.
“The mass of imported goods reduces the competitiveness of domestic production by 10 to 12 percent per year,” Iranian economist Laylaz wrote in an article in reformist daily Arman on July 18.
According to Salehi-Isfahani, Iran’s exchange rate policy “is really using oil money to finance private consumption and then expecting people to compete with the Chinese.”
While the IMF praised the subsidy reform as a way to inject market economics into the Iranian economy, several politicians have voiced concern about the state of private enterprise.
Shahriyar Taherpour, a member of parliament’s industry committee, was quoted in the conservative Qods daily on August 8 as saying: “According to some information, some 50 percent of private sector industrial manufacturing capacity is idle.”
Under the subsidy reform, companies, like families, are meant to receive some government cash to help them cope with the sudden rise in costs, but it is not clear how widespread or effective the payments have been.
And many economists say there is a limit to the cash support Tehran can afford to hand out. Clawson has calculated that with 73 million Iranians receiving the 455,000 rials monthly payments, the new system costs an estimated $36 billion per year.
That is 35 percent of the $103 billion in oil and gas export revenues the IMF says Iran can expect this year — a proportion that will rise quickly if the oil price continues to drop amid a renewed global recession.
“I don’t think this universal payment can continue,” said Mousa Ghaninejad, an Iranian economist interviewed in the reformist Etemad daily on July 4.
“People are telling each other the payments are going to continue forever. That’s negative for our economy and impossible for the state.”
“What the government should be doing is to not allow oil revenues to directly finance consumption, as in handouts, but to spend it on infrastructure and education so Iranians are more competitive, not less, as a result of oil money.
“That would take a sea change in the mindset of Iranians, not just their government, that they are not entitled to have Dubai living standards just because they have oil. They have to become productive first.”
Editing by Stephen Nisbet