The Islamic Republic's ‘Targeting of Subsidies’ program has finished its first year of cautious and controversial operation. It is now approaching its second (and as yet uncertain) phase. In the meantime, public debates regarding its basic structure, its major accomplishments, and the wisdom of its continuity are the subject of heated public debates in and out of the Majlis (national assembly).

This brief review attempts to present an updated sketch of the results – based on official statements, newspaper stories, and scattered observations by private analysts at home and abroad. With no official reports on the program’s operation yet published, the most onerous task faced in preparing this analysis has been the difficulties of: (1) obtaining sufficient data on the program’s finances; (2) reconciling contradictory statements by government officials made on various aspects of the program (including its exact number of beneficiaries); and (3) closing the unbridgeable gaps between official claims, on the one hand, and observed realities on the other.

Background In A Nutshell

As a top priority in the ‘Great Economic Surgery’ scheme announced by President Mahmoud Ahmadinejad in 2008 (MEES, 24 November 2008) the Majlis passed the Subsidies Targeting Act on 5 January 2010, designed to raise domestic prices of some 16 subsidized consumer items to their international levels within five years (MEES, 31 May 2010). These subsidies – covering mostly gas and oil products, electricity, water, bread and milk had originated during the Iran/Iraq War of 1980-88 when most domestic prices were fixed in order to control inflation. With the gradual rise in world prices of raw materials, and particularly that of crude oil (pushing up the price of Iran’s oil from less than $10/B in mid-1986 to $128/B in mid-2008), the implicit or notional value of the subsidized items began to climb rapidly. By the time of the subsidy act’s passage, the implied worth of energy and other products sold at fixed prices by Iranian state agencies was variously put at $90bn to $120bn (depending on the daily crude oil price in the market). The actual budgetary (ie out of pocket) cost to the treasury, however, was less than $30bn.

The 2010 statute authorized the government to raise prices of subsidized items to world levels gradually, within five years. One half of the revenues received from upward price adjustments had to be given in cash or non-cash payments to targeted consuming public sectors facing higher prices. Some 30% of new revenues had to go to energy-intensive industries as an incentive to acquire new technologies and/or cover the higher costs of their no longer subsidized inputs. And the final 20% was the treasury’s share to cover the administrative costs of the program and other budgetary needs.

Disregarding the legislature’s recommendation for a gradual five-year approach, President Ahmadinejad in late December 2010 announced drastic increases in energy, water, power and bread prices to go into effect immediately (MEES, 20 June 2011). And unable to find a satisfactory formula to determine eligibility for receiving welfare assistance, it was decided to give some IR455,000 a month to all registered applicants – electronically deposited in the bank account of the family head.

Dissatisfied with the government’s haste in implementing the original statute, the Majlis, in the course of approving the March 2011 – March 2012 fiscal budget, made a number of specific changes in the initial act. First, the government was allowed to increase prices by no more than 20% during the course of the year. Second, the consumers’ share was increased to 80% from the previous 50% in order to maintain financing of the monthly cash payments. The share of production units was reduced to 20%. And, the 20% share of the Treasury was totally eliminated. The budget document projected some $54bn to be received from adjusted prices during the year, out of which some $40bn was earmarked as welfare payments to consumers; $4bn was appropriated as aid to state power companies; $6bn had to go to city transport means; and the rest to be used for administrative expenses.

Government’s Success Claims

On 19 December 2011 and the first anniversary of the program, President Ahmadinejad and some of his cabinet ministers celebrated the occasion by highlighting the scheme's “success” in a live television broadcast. The president called the program a “historic manifestation of successful government/people cooperation” that could serve as a “model” for “more than 100 countries that had already asked for our guidance.” The program’s achievements, he added, show that the Iranian people can conquer any heights and reach any summit – proving the skeptics who warned about the reform’s dire consequences clueless and wrong. He attributed the program’s success to three factors: diligence on the part of program officials; the people’s confidence in their government; and, above all, the Hidden Imam’s assistance.

The minister of economy and finance, in turn, chided those who were predicting “70-500%” inflation resulting from price adjustments by claiming an additional cost of living increase of only 7.3% in the 12-month period, part of which was also due to higher import costs. He reproached those who were predicting a recession by stating that the annual GDP growth rate had been higher than that of the year before, and that the Tehran Stock Exchange had experienced a rise of 6,000 points instead of a predicted decline. As a matter of public welfare, too, he continued, the government expected only 60% of the population to become better off, while actually 80% have been the true beneficiaries.

The minister of industry and commerce, in his turn, talked about successful protection of industrial units after the reforms. The minister of agriculture boasted that the reforms had shortened a 20-year perspective for optimum farm efficiency down to merely three-four years and added that agricultural imports had declined by 18%. The secretary general of the Subsidies Reform Headquarters bragged about the uniform monthly cash payments resulting in 56% welfare improvement for low-income families, but only 5% gain for the wealthy He also predicted that, in the absence of any unpredictable shock, inflation would top no more than 21.6% by the end of the year (March 2012). Finally, a top government consultant cited some (undocumented) figures showing that: the highest 5% of income earners had their cost burden increased by 39% while the burden for the poor was only 5%, and for the “middle class” 12%.

Left untold were the eagerly awaited information regarding the program’s financial budget, specific data on consumption of higher priced energy and other items; the magnitude and nature of assistance to production units; steps taken by productive units to improve their efficiency in order to make up for their higher input costs; and the impact of higher prices on the international competitiveness of Iran’s energy-intensive exports.

The accuracy of the positive claims made is also impossible to ascertain due to: (1) the absence of independent, non-governmental research organizations to offer corroborating evidence; (2) refusal by reporting officials to offer any further information or elaboration on the reform operation beyond their brief and scripted announcements; and (3) failure of the figures provided by various sources to add up. A highly critical Majlis report and widespread complaints by the private business community thus seem to cast much doubt on these claims.

The Majlis Report

Shortly after the ministerial television broadcast, the Majlis Select Committee on Economic Restructuring in mid-December 2011 issued a report on the implementation of the subsidies reform. The Majlis report, avowedly based on information collected from the Subsidies Reform Organization, the Supreme Audit Court, Iran’s Chamber of Commerce and Industry, private economic analysts, and ordinary citizens – begins by pointing to certain positive aspects of the program (such as possible improvement in the Gini coefficient, reduced consumption of certain energy products, and lower than expected inflation). It then focuses on the reform’s glaringly negative aspects. The report’s detailed charges point to: (a) various violations of the original statute’s spirit and letters such as undue haste in its implementation; (b) neglect of the mandated fiscal discipline; (c) failure to send periodic reports to the Majlis; (d) delay in repayment of funds borrowed from the Central Bank of Iran (CBI); (e) commitment to pay IR455,000 a month to millions of recipients without having a clear and secure source of income; (f) inability to deliver the share of producers; and (g) facing the prospects of a $15bn deficit – thus complicating the already thorny treasury problems. The report suggested that the government should revamp the current cash-back system in both the amount and its number of recipients, calibrate monthly payments to family incomes, and put an end to uniform cash distribution.

Lingering Questions

Persistent refusals by the Subsidies Reform Organization to provide a full report of its operation have led to many unanswered questions regarding the exact number of welfare recipients, its sources of finance, and its compliance with the Majlis statute.

On the question of recipients, in late December 2011, President Ahmadinejad, in a ‘face to face’ meeting with an eastside Tehran audience, claimed that “75mn people” in Iran were actually receiving the monthly stipend. Now, since the Iran Statistical Center’s ‘population clock’ put the country’s total residents in March 2011 at 75,161,018, then nearly every man, woman and child in Iran must have been on the government’s dole. Yet, apart from untold number of families or individuals who, for one reason or another, initially did not wish to be included – and still do so – there must be substantial other subtractions from the total. There are probably more than 2mn additional subjects—prisoners, shanty town ‘carton dwellers,’ homeless drug addicts, runaway children, and others in remote localities (beyond mere 161,018) – who are obviously without any bank account to which monthly pay is to be electronically deposited! And there are numerous small and forgotten villages, like the one near Kermanshah in Western Iran (detailed on the Mehr website) with totally illiterate residents without a birth certificate, marriage license, or identity card – and with no water, power, telephone, or banking services. The total official number thus can in no way be verified.

With respect to the program’s finances, the head of the government’s General Inspectorate, the chief of the Supreme Audit Court, the president of the Iran Chamber of Commerce and Industry, and the semi-independent press have all questioned: (1) the true sources of financing monthly cash payments; (2) the fate of production units’ share; and (3) the reasons for the shortfalls in the budgets of public utility companies. There have been no explanations on the part of the Subsidies Reform Organization regarding the charges that it has used parts of the annual development budget, most of the producers’ share, and portions of the revenues from oil and electricity exports to finance its cash payments. According to these charges, the reform agency has drawn some $12bn from three sources – $5bn from the CBI, $2bn from the ministry of energy’s budget, and $5bn from oil export receipts – to supplement its revenues.

The third and equally troublesome question points to the contradictions between reform officials’ claims of payments to production units, and nearly total rejection of these claims not only by eligible recipients, but also by the head of the Supreme Audit Court. The failure to protect business units against higher energy and other input costs, it is held, has resulted in: (a) large scale bankruptcies and reduced capacity utilization; (b) a decline in industrial and agricultural investment; and (c) a shift of enormous accumulated liquidity to the gold and foreign exchange markets.

Finally, there has been no answer to the charges that the funds received from higher prices of water, power, and gas have not be fully disbursed to their producing companies. As a result, the enterprises engaged in these utilities have been unable to pay their contractors, and even their employees – a charge about which the Majlis has passed a formal “inquiry” from the government.

An Informal Report Card

The stubborn and unabashed refusal by officials to reveal the program’s pertinent data continues to leave unanswered many pertinent questions regarding the program’s performance, as well as those previously raised regarding its objectives and operation (MEES, 20 June 2011). With no official reports available, however, some scattered data from public and private sources may be drawn upon to provide a few tentative conclusions regarding the program’s first phase of operation and its current status.

The most difficult puzzle to unravel is the program’s fiscal budget. President Ahmadinejad and the spokesman for the Subsidies Reform Organization have both rejected the Majlis charges of fiscal deficit. In fact, the president told an enthusiastic conference of the Islamic Workers’ Society in early September 2011 that due the country’s improving finances, monthly cash payments to households could be tripled! Thus, the program’s true income and outgo are a matter of pure conjuncture.

Based on the reported number of registered recipients – officially claimed to have been 64mn at first, and gradually rising to variously reported 72-75mn by the end of the first year – each being paid IR455,000 a month, with the last installment paid out in December 2011 – the program must have cost some $27-32bn at the official exchange rate of $1=IR11,000. At the same time, apparently no more than $17bn is estimated to have been collected from phasing out subsidies, resulting in a $10-15bn deficit.

The effects of subsidy phase-out on consumption, cost of living indices, and production efficiency are equally murky. According to some perfunctory (and un-corroborated) official statements, fuel oil consumption has declined by 27%; kerosene by 10%; gasoline by 6%, bread by 36%; and dairy products by an unspecified amount.

The most feared consequence of the reform, ie high inflation, has according to official statistics been fairly subdued. The projected cost of living increase, announced by the CBI at the start of the program, was a maximum of 15% in 12 months. Other credible projections ranged from 32% to 60%. Ridiculing these projections, President Ahmadinejad promised an actual decline after March 2011 (ie three months after the program’s initial price adjustment). The official cost of living index for December 2011 is reported to be 19.6% higher than the figure for December 2010. Private estimates give much higher figures. Part of the reason for the relatively moderate official figure must have been the government’s order preventing private and public sector enterprises from raising their prices in the first three months of the program’s operation. After April 2011, however, prices were allowed to rise by only 10%. And, shortly after, prices started to climb up by 1-1.5% per month.

With respect to the producers’ mandated share, the data are again highly controversial. While reform officials claim that $7.7bn has been paid to producers out of the receipts from adjusted prices, spokesmen for industry, agriculture, transportation, and energy services deny having received any such payments. Similarly, the chief of the Supreme Audit Court stated in mid-September 2011 that the share of industry in the first eight months of operation had not been paid. And the president of Iran Chamber of Commerce and Industry confirmed that aid to the production sector has been only in the form of low cost loans and not direct cash – ie a fixed amount of $130,000 at 4% interest – regardless of the borrowing enterprise’s energy use.

Probable Impacts

While it is too soon to gauge the impact of the program on either social welfare or productive efficiency, certain available data and observations may show the trend. A special weekly report by Radio Farda – specifically designed to gauge the impact of the subsidies reform on the lives of some 7.5mn Iranian working families (comprising 30mn people) during 2010-11 – shows that President Ahmadinejad’s promise of eradicating poverty in the first year of subsidies reform has been far from being materialized. According to individual callers to the radio station, while government officials claim that the workers’ lot has improved, the opposite has been the case.

In the same vein, a Gallup measurement of global wellbeing, conducted in September 2011, has found that “suffering” in Iran had doubled to 26% in 2011 from 14% in 2008 – and registering in the highest range worldwide. Classifying the respondents as “thriving”, “struggling” or “suffering”, the poll found 55% of Iranians to be “struggling” and only 20% “thriving.” Unemployment at 15% and underemployment at more than 35% has been found to be the main causes. Although obviously not accusing the welfare reform of being the culprit, the poll seems to indicate that the latter has not been of much help.

Countering the finance minister’s claim that 80% of the population has become better off after the reform, a former member of the National Council on Money and Credit told ILNA news agency in late December 2011 that the “working class” has so far lost 50% of its purchasing power due to inflation and that monthly cash payments could compensate the higher costs of only water and power for working families – with the result that they have been worse off after the subsidies reform. According to a confirmed report, some 1.6mn households have failed to pay their monthly gas bills.

Similar sentiments seem to have been felt by the business community as well. In a poll regarding the climate for trade and business in Iran involving nearly 250 enterprises in the country’s 31 ostans (provinces) conducted in the spring of 2011, more than 65% of participants reported that the subsidies’ reform had raised their production costs much or very much; and 79% complained that their higher output costs had not been made up by the government. Only 9% reported that their higher expenses had been partially offset by the state. According to the president of the Tehran Chamber of Commerce, a large number of industrial enterprises are now operating at no more than 30% of their capacity due to higher, non-compensated, energy costs. A former Islamic Republic’s finance minister also claims that the reform has resulted in recession, further unemployment, and higher prices.

The Program’s Second Phase

Claiming that 70% of subsidies still remain to be reformed, President Ahmadinejad told the press corps in early January 2012 that the second phase of the program would start before the end of the Iranian year – 20 March 2012. Responding to widespread complaints by the Iran Chamber of Commerce and Industry, and many Majlis deputies, regarding the neglect of the production sector, government officials further promised to remedy the situation through direct financial assistance, low-cost loans, and price rise allowances.

According to a statement in late December 2011 by the secretary general of the Reform Headquarters, some 3mn households comprising 10mn well-to-do individuals in the top 20% of the population – those with monthly incomes 10-20 times the current monthly cash receipts (ie individuals earning $445-890 a month) – shall be excluded in the second phase. Wealthy families would first be asked to forego monthly cash receipts voluntarily so that the rest could get more. And if they did not, “more precise methods” would be employed – according to the head of the Subsidies Reform Organization.

However, the start of a new phase seems fraught with untold problems. To begin with, due to a steady rise in consumer prices, wide gyrations in the foreign exchange market, and mounting bank loans defaults, the head of Iran Chamber of Commerce and Industry, the chief of the Supreme Audit Court, the mayor of Tehran, and others believe that the second phase should be postponed. Furthermore, the change in the roster of the recipients would seem be neither easy nor lawful. Given the fact that after months of studies and preparations in early 2010, the government was still unable to identify different income receivers – and thus decided to include everyone on the roster – it is not certain that a universally satisfactory formula could easily be found this time. Finally, since depriving anyone from the bounty is a violation of the original statute, the new decision requires an amendment, or a new law – as the Majlis speaker has already indicated.

Interestingly enough, eliminating the richest 10mn individuals from the dole would probably save no more than $5bn a year. And, even if this entire amount were to be distributed among the rest of the recipients, it could still not preserve the original value of welfare receipts set in December 2010 – since the economy has experienced more than 20% inflation in the meantime.

From Economic Rationality To Political Populism

Less than a year since the passage of a long-awaited and positive economic reform legislature, the initial intent of the new law can hardly be recognized. The original intents were: (1) to rationalize hydrocarbon consumption through “opportunity cost” pricing; (2) enhance output efficiency through the adoption of new technologies; and (3) reduce income inequalities (caused by unfair distribution of price subsidies) through the establishment of a safety net for the poor.

Now, while energy and other subsidized prices have been raised towards their real opportunity costs, there seems to have been no commensurate pressure on the households to alter their consumption pattern. Reported reductions in major items (eg gasoline, and natural gas), even if true, do not meet earlier rosy expectations. Nor has there been sufficient inducement for producers to make credible attempts to renovate old and inefficient equipment. Instead, heavy energy using enterprises, in both the private and public sectors, have clamored to obtain special input quotas, direct cash assistance, zero interest loans, and other government aid. And, instead of establishing a safety net for the poor, the old and unfair across-the-board pricesubsidy program has been simply turned into new and addictive cash grants to everyone. In short, a fundamentally rational economic initiative has been turned into an ad hoc political and populist venture – with less economic rationality, and far more political hazards.

In many analysts’ view, the major responsibility for this metamorphosis lies with President Ahmadinejad’s own changed position. Between the announcement of the ‘Great Economic Surgery’ in 2008 and his televised address in 2010, announcing the start of the subsidies reform, the president persistently talked about allocating part of the new revenues for investment in development projects. Abandoning this clearly rational position, however, on one of his country tours in late December 2011, while defending his much criticized uniform monthly cash-back policy, he said “in two to three further steps, all subsidies would be returned to people in cash.” And by further stating that people would soon find their “due share” in “their own pockets,” he introduced a novel (and a highly pernicious) idea that welfare cash-backs were actually an inherent individual “right.” More puzzling still, when he was told about the producers’ complaint of being left out of the public assistance, he said “cash-backs to individuals are the same as aid to producers” – with no further explanation as to the connection.

Looking Ahead

The president’s maverick and pernicious concept of the people’s entitlement to the whole proceeds of the reform is opposed to by the Majlis because: (1) it is contrary to the spirit of the law, ie establishment of only a safety net; (2) it imposes a heavy fiscal burden on the treasury, while depriving industry and agriculture from receiving their prescribed shares; and (3) it clearly violates Article 7 of the original statute requiring payments to families commensurate with their incomes. Interestingly enough, even the government’s top economic advisor, and one of the primary designers of the Subsidies Reform Program, has now come to the same conclusion that cash payments to individuals is not the proper way of dealing with subsidy reform. Echoing the alternative measures suggested to deal with basic causes of poverty and income inequality (MEES, 31 May 2010) he now advocates the replacement of the monthly welfare checks by the establishment of an effective social security system, enactment of a fair and balanced tax code, and promotion of new technologies through accelerated depreciation.

Due to these lingering circumstances, the future shape of the program can in no way be predicted at this juncture. And, with escalating disputes between President Ahmadinejad and the Majlis – on top of other grave national preoccupations (eg biting sanctions, wild exchange rate gyrations, pending next year budget, saber-rattling over the Hormuz straights, and looming Majlis elections in March 2012) – the shape of the second phase, if not the fate of the whole subsidy reform, appears now to be in limbo. While the program’s immediate termination would be politically explosive, and thus not in sight, a continuation of the status quo seems highly doubtful.