Sanctions Forced Iran to Slash Bloated Energy Subsidies

Inter Press Service

Touring Iran's Arab rivals this week, U.S. Secretary of State Hillary Rodham Clinton sounded almost triumphant as she asserted that economic sanctions have helped slow Tehran's nuclear progress.

But U.S. and international efforts to isolate Iran have, ironically, pushed the Islamic government do something it has needed to do for years: phase out costly consumer subsidies that promoted waste and depressed export earnings for oil and gas.

At the end of last year, the government of President Mahmoud Ahmadinejad almost doubled the price of petrol to 70 U.S. cents a litre and reduced subsidies on electricity, water, wheat flour and other staples that cost the regime between 70 and 100 billion dollars a year. Despite dire predictions from critics inside and outside Iran, there have been only isolated protests and Iranians appear to be doing what the reforms intended: reducing consumption.

The government cushioned the blow with initial lump sum cash payments of about 80 dollars to 70 percent of Iranian households. Also, most Iranians have not yet received new higher utility bills and many have stockpiled consumer goods.

While it will take time for the shock of higher prices to work through the system, so far "it looks like the plan is proceeding smoothly, which surprised some outside of Iran who see rebellion under every rock," said Kevan Harris, a sociologist at Johns Hopkins University who travels frequently to Iran.

It is noteworthy that Iran is proceeding with the reforms at a time when price hikes have triggered riots in Tunisia. Pakistan, fearing similar unrest and a government collapse, has backtracked on increasing fuel prices in defiance of the International Monetary Fund.

IMF officials, writing recently in an online publication, the IMF Survey Online, said that ending subsidies "should remove distortions and restore efficiency in the economy" and allow Iran "to export more oil and thus generate more revenue".

Iranians have learned over the past three decades to adjust to sanctions and pride themselves on their independence. Rationing was introduced during the 1980-88 Iran-Iraq war – when most of the world sided with Iraq – and oil production collapsed.

Afterwards, the government kept prices for staples and energy low "to appease a war-weary society", wrote Semira Nikou of the U.S. Institute for Peace (USIP) in "The Iran Primer", a recent joint publication of USIP and the Woodrow Wilson International Center for Scholars.

But the burden on the budget became unsupportable as Iran's population more than doubled after the 1979 revolution. Subsidies in 2009 – about 4,000 dollars for a family of four – cost about a third of Iran's 335-billion-dollar GDP. Petrol was cheaper than bottled water – a fact reflected in Tehran's hideous traffic and pollution-choked air.

Recent reports from Tehran suggest a drop of six to 10 percent in traffic volume and similar reductions in the use of electricity and water. The air is more breathable in the capital, although that may reflect recent rain and snow more than subsidy reform.

Middle class Iranians say the cuts are largely directed against them since the wealthy can afford the hikes and the poor consume relatively little. One Tehrani who spoke to IPS on condition of anonymity said potential protesters among the lower classes might be intimidated by fear of losing future cash payments if they are arrested.

If the price hikes reduce consumption without stirring social unrest, that could bolster Ahmadinejad, whose popularity has sunk following fraud-tainted elections in 2009, a vicious crackdown on civil society and disputes with parliament and other government bodies. In recent days, Ahmadinejad and his top advisers have noted smugly that his more liberal predecessors – Mohammad Khatami and Akbar Hashemi Rafsanjani – sought to cut subsidies but faltered in the face of domestic political opposition.

Still, Ahmadinejad is blamed for initial economic illiteracy – giving cash handouts to the poor and forcing banks to loan money at artificially low rates – which pushed inflation up to 30 percent during his first term as president.

His rhetoric about the Holocaust and Israel encouraged the imposition of severe foreign economic sanctions – ostensibly directed at Iran's nuclear program. Separate U.S. legislation has chased away much-needed investment in Iran's energy sector, putting future production and prosperity at risk. Unemployment is in double digits and the brain drain of educated professionals, particularly young people, is rising.

Still, Djavad Salehi-Isfahani, a professor of economics at Virginia Tech and an expert on the Iranian economy, said the subsidy phase-out "will ultimately strengthen the Iranian economy for the simple reason that the economy was heading the wrong way bingeing on very cheap energy. What does a person do, who needs to lose weight but has access to free dessert? Lose the free dessert first!"

With the world's 17th largest economy, minimal foreign debt and underground oil resources estimated by the IMF at 10 trillion dollars and natural gas reserves at four trillion dollars, Iran has enormous potential, especially if it can resolve its quarrels with the international community. (The next round of talks on Iran's nuclear program is scheduled to take place Jan. 21-22 in Istanbul.)

Salehi-Isfahani, who recently returned from a visit to Iran, predicted that inflation – which had dropped to around 10 percent – would rise to 20 percent in the short term. However, that "does not necessarily mean unrest because of the rather clever way the poor have been compensated in advance," he said.

"I just came back from Iran and from what I saw and heard most people agreed that this had to be done, but many doubted the government's ability to implement it well," he said. "If the government has been able to convince most people that living in an oil-rich country does not entitle them to cheap energy, it has taken a huge step."

Farideh Farhi, an Iran expert at the University of Hawaii, said the streets remain calm in part because of heavy security and because "people are tired" after months of political tension.

She added, however, that criticism has also been muted because "the announced price increases were way more than expected and there is a very clear sense that if it doesn't work it will be a disaster for everyone. So everyone is holding their breath, hoping for the best."