Complex Made Simple

Iran begins energy subsidy reform

After months of speculation and limited information regarding the timing or severity of the initial round of subsidy cuts, Iran increased the prices of energy products significantly last weekend.

By Alyssa Grzelak, Middle East economist, IHS Global Insight

As of Sunday (19 December), the prices of major energy products including gasoline, water, electricity and other fuels have surged-in some cases by up to five times the price seen on Saturday. According to Agence France-Presse, the price of heavily subsidised gasoline (for the first 60 litres purchased by each motorist per month) was increased to 4,000 rials (US$0.40) per litre on Sunday, from 1,000 rials per litre on Saturday. All gasoline purchased above the monthly quota will be priced at 7,000 rials per litre going forward.

The fourfold increase was just one of several price increases pushed through over the weekend in a long-awaited move by President Mahmoud Ahmadinejad’s conservative government. Originally set to roll out in September, the subsidy cuts enacted over the weekend are likely to have come as a shock to many Iranians who have been kept in the dark about the timing and severity of the initial cuts to take place under the government’s five-year plan to completely phase out energy subsidies.

Other rises included a reported three-fold increase in water and electricity prices and a five-fold increase in the price of cooking gas. Nonetheless, the government assured its citizens on Sunday that the price of public transportation in the country’s major urban areas would not go up following the sharp increase in fuel costs, but the price of taxis and other transportation methods are likely to increase dramatically.

Although not as large a drain on government resources, the price of bread also reportedly rose sharply on Sunday after the government cut its subsidising of some food products.

Increases to Affect Households and Industry

With the initial phase of subsidy cuts now in force, the most immediate impact will be on consumers, who saw the price of basic commodities rise dramatically over the weekend. With little warning, households will have to significantly adjust their spending patterns, with luxury and non-necessity items expected to take the biggest hit. The government has reportedly already begun to deposit transfer payments into the accounts of some 60 million Iranians who have signed up for government-mandated bank accounts and electronic transfers, in an effort to ease the burden of the price transition. Nonetheless, the transfer payments of around 810,000 rials every two weeks will do little to compensate for the sharp rise in consumer prices that are expected as a result of the subsidy cuts. The rural poor, who are a key support base for Ahmadinejad, are likely to be hit the hardest by the latest round of subsidy cuts, as little consideration regarding income levels was taken into account when deciding on the size of the transfer payments.

While households will feel the pinch more immediately, rising utility and transportation prices are also expected to squeeze domestic industry in Iran, which has already been hit hard by the rising cost of sanctions. Automotive, steel, and other manufacturing units, which had already struggled under widespread paternalistic support on the part of the government, are likely to find it hard to maintain profitability and compete internationally with the sharp rise in energy prices just enacted.

Outlook and Implications

Without major reform such as that enacted on Sunday, the soaring costs of Iran’s subsidies would prove unsustainable and inevitably lead to a major economic crisis for the country. However, the way that the subsidy-reform programme has been communicated and implemented so far raises serious questions about the timing and severity of future cuts, as well as the government’s capability to adequately administer transfer payments and distribute savings from the proposed cuts.

Although government officials would be loath to admit it, sanctions have undoubtedly played a major role in the government’s sudden push to enact austerity measures. Successive governments have publicly acknowledged the need to eventually overhaul the costly programme but none, until today, have succeeded in implementing such drastic measures. Ahmadinejad’s Economic Reform programme has come with its share of controversy; until Sunday conservative members of parliament had continued to be outspoken critics of the planned cuts, in spite of a resounding show of support from the country’s Supreme Leader Ayatollah Khamenei. The government remains fearful of the reforms’ potential to inflame political resistance and spark protests, as happened briefly when fuel rationing was initially enacted in 2007, and a stepped-up security presence is likely to be a feature in Iran’s major urban centres for some months.

Despite the costs, there is still significant opposition among conservative elements in parliament, who see the subsidy cuts as the nation reneging on its duty to spread oil wealth among its citizens. Economy-minded politicians also warn about the inflammatory effects such reforms could have on the country’s already problematic inflation. Over the coming months, IHS Global Insight will continue to monitor the subsidy-reform initiative carefully for its impact on economic growth, inflation, industry, consumer spending and policy direction.