Reducing subsidies for gasoline can lead to severe inflation in Iran

Reducing subsidies for gasoline can lead to severe inflation in Iran

Azerbaijan, Baku, Dec. 23 /Trend, T.Konyayeva/

The experts consider necessary the recent decision by the Iranian government to reduce government subsidies to the population, but a belated decision that should be implemented in conjunction with other strategies.

"Subsidies for many items including gasoline, gas oil, electricity, and food items have been a burden on the Iranian economy, Kamran Dadkhah, a Professor at Northeastern University, USA, wrote in e-mail to Trend. For long, the governments have talked about removing or modifying them, but have failed to act despite for the long run health of the economy, their removal is imperative".

The announcement to reduce state subsidies for the Iranian public was made on Dec. 19, implying that there will be a fourfold increase in petrol costs and cuts in the discounts on food prices.

Roughly 60 liters of gasoline at a subsidized price equivalent to 40 U.S. cents per liter will be allocated for every car in Iran monthly in the coming year, with the fuel cost about 1,000 riyals (10 cents) per liter in the previous years. This price was maintained for the first 60 liters purchased per month and then witnessed an increase

According to the website of the Iranian Oil Ministry, gasoline consumption declined by 16.6 percent on the first day after the prices increased. On Sunday, gasoline consumption amounted to 53.3 million liters, which was 10.6 million liters less than the previous figure.

According to Dadkhah, the government policy is a correct one, but there are a number of factors that have made the decision troublesome.

"First, the subsidies have been in place for too long. They could have been removed much easier during previous administrations of Hashemi Rafsanjani and Khatami. As time has passed the gaps between official (subsidized) prices and market (or international) prices have widened. Thus, the adjustment has become harder," he said.

Dadkhah described international sanctions against Iran as the second reason.

"These sanctions have increased the cost of doing business for Iranian government, businesses, and producers by up to 30 percent," he said.

In early June, the UN Security Council (SC) has adopted a resolution enacting new sanctions against Iran because of its refusal to stop enriching uranium. Later, the U.S. Congress adopted unilateral sanctions against Iran, and in July, the meeting of the EU foreign ministers in Luxembourg also endorsed the imposition of additional sanctions, aimed primarily against the banking, financial and energy sectors of Iran. 

Restrictions imposed by the EU include the ban on the sale of equipment, technologies and services to Iran's energy sector. The same measures also fall on oil refining industries. Also new investment in Iran's energy sector was prohibited.

Dadkhah believes that the government has been cognizant of the difficulties and fearful of social unrest, and that is why the onset of the policy has been delayed.

"Now the government has taken certain precautions: it has built stockpiles of items it is predicting that people will try to hoard; has warned the suppliers not to raise their prices precipitously; and has ordered extra security forces to the streets," he said.

These precautions, in the short run, would forestall sharp rise in the prices and prevent any rioting, Dadkhah said. "But sooner or later there will be increase in prices of all goods and services, he said. - Since fuel, energy, and transport are essential in the production and distribution of goods and services, the rise in prices would be widespread and severe."

Energy consumption in Iran over the past 10 years has almost doubled. According to data provided by BP, in 1998 the daily oil consumption in Iran amounted to 1.194 million barrels, while in 2008 this figure had risen almost 45 percent - to 1.730 million barrels per day.
At the same time, gas consumption in 2008 reached 117.6 billion cubic meters (per year) compared with 51.8 billion cubic meters in 1998.

The American expert believes that if the government does nothing, the result will be a severe recession and unemployment.

"To counter this, the government has deposited sums of money in people's bank accounts. This money is supposed to alleviate hardship of the vulnerable families with low levels of income," said Dadkhah.

But government has to do more and indeed has to increase the demand to counter the price increase, he said.

"The result would be severe inflation in the coming years, Dadkhah said. Another side effect would be that Iranian goods could not compete internationally. The result would be further increase in imports, reduction of exports, and bankruptcy of some Iranian factories."

The main economic problem of Iran today is the inflation, the rate of which is the highest for the country in the current decade, which led to a significant drop in the value of Iranian rial over the past few years.

Inflation rate in Iran in July this year amounted to 21.5 percent compared to 22.5 percent in June, IRNA state news agency reported. In 2009 the inflation in the country reached 17.1 percent compared to 8.9 percent two years earlier.
Some economists believe that the high inflation in Iran is caused by the wrong economic policies of current President Mahmoud Ahmadinejad, who provides loans to SMEs at low rates, subsidized people, overly investing public funds in the industrial sector. Revenues from oil exports are also distributed wrongly, the experts say.

"At present the exchange rate of the rial for the dollar is too low. That is, the rial is overvalued, Dadkhah said. The best the government can do is to float the rial. An increase in the value of the dollar, yuan, and other currencies in terms of the rial would give Iranian producers a breathing space. Of course, there will be more hardship for the people."

According to him, the removal of subsidies could be a good beginning for the economy if it is combined with other policies including floating of the exchange rate, reduction of the role of the government in the economy, reduction of tension with the West over nuclear activities, and other structural changes.

Dadkhah's opinion is also supported by a professor at Tehran University Jamshid Pejuan, who considers implementation of a plan to reduce subsidies a perspective step in improving the economic situation in Iran, but at the same time, a belated decision.

"This project had to be carried out several years ago, said a member of the economic commission of the former parliament Pejuan.- Daily delay could harm the economy of Iran, so it should be implemented as soon as possible."

However, according to him, the higher prices caused by the decision, should not cause inflation, bankruptcies in some production areas and other negative consequences.

"Rise in prices after the implementation of this plan is a completely natural case, said Pejuan. - The main goal of this plan is to raise some prices and improve the situation with disparate relative prices in Iran, existing for a long time. "

He stressed that the price increase was expected, but along with it, the prices for some products are expected to lower.
"For example, the price will reduce for vehicles that consume large volume of gasoline, but the prices for subcompact will rise, he said. - Or after a rise in prices of any equipment that consumes large volume of energy, the prices of equipment, which consumes even more energy, will lower."
Regarding the potential closure of some production sites, Pejuan believes that due to the subsidies in this area so far, some production areas in the country have profited by using them,.

"The new project will prevent the subsequent opportunity to earn in such a way and there will be likelihood of their closure, he said. - This is also a natural process, and basically the project is intended to serve precisely this purpose."
"Still there is a price to be paid. In the absence of all other changes, we may expect modest long run benefits, but still a short run price in terms of inflation, hardship, and worsening non-oil balance of trade," said Dadkhah.             

T.Jafarov contributed to article.

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