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Iran Considers Cutting Subsidies, But At What Cost?

The official price of one liter of gasoline in Iran is 10 U.S. cents.

The official price of one liter of gasoline in Iran is 10 U.S. cents.

A recent pronouncement by Iran's supreme leader, Ayatollah Ali Khamenei, appears to have settled a long-standing row between President Mahmud Ahmadinejad's government and parliament on how to reduce and gradually eliminate government subsidies of basic goods and services.

From gasoline and electricity to sugar and flour, total annual government subsidies amount to $90 billion to $100 billion, or around one-quarter of the $368 billion state budget for the Iranian calendar year 1389 that started on March 21.

Both the government and parliament agree the subsidies have to be gradually eliminated. The battle has been fought on how fast the cuts should be implemented. While Ahmadinejad had advocated a $40 billion cut in the first year, the parliament rejected the government's "excessive plan" and reduced it to $20 billion for this year.

Khamenei instructed both parties to honor the legislators' decision of $20 billion while "also respecting the government's concerns in carrying out the plan." That was widely understood and interpreted as approval of parliament's plan.

Why Is It An Important Issue?

Government subsidies started after the Islamic Revolution in 1979 to help the population cope with rising prices and stagnating incomes. Consistently expanding, the subsidies now eat up some 25 percent of the state budget. The official price for one liter of gasoline is 10 U.S. cents, because the government pays the remaining production and transport costs. This has led to overuse of fuel, electricity, water, and other commodities, and created an atmosphere of "unreal prices." The same applies to prices for basic foodstuffs such as bread and meat, or other products and services that depend on commodities, such as transport or pharmaceuticals.

Cutting subsidies will raise prices and inflation and lead to lower wages and higher unemployment. The research center of the Iranian parliament has calculated that an annual cut in government subsidies of $20 billion will lead to a 300 percent increase (to 40 U.S. cents) in gasoline prices and an annual inflation rate of 50 percent. To meet the increasing production costs, employers will have to pay lower wages or lay off workers. Pay increases will not be able to compensate for a 50 percent inflation rate. Iran's Supreme Council of Labor has agreed to raise the minimum wage by just 14 percent (from $260 to $300) for the coming year.

Further annual cuts in government subsidies in the next four years will create a dramatic picture of spiraling prices and inflation. Both Ahmadinejad's government and parliament have said that they are committed to eliminating all government subsidies in five years.

Last year, the officially announced inflation rate for the year was 11.5 percent, while unemployment rose to 11.3 percent.

Already isolated and struggling with economic sanctions, oil-rich Iran may face new and harsher sanctions over its nuclear program.

Political Implications

In the battle over slashing subsidies, the conservative majority within parliament argued that cutting subsidies too fast would lead to price hikes, drastic inflation, and exploding unemployment. Prominent conservative deputy Ahmad Tavakkoli asked, "What should we do if there is high inflation while we pay reduced subsidies to help people and we possibly have less income because of lower oil prices?"

But Ahmadinejad's supporters argued that cutting only $20 billion from government subsidies in the first year would not save enough money to compensate for the consequences of the subsidy cuts, including the inflation and unemployment.

The government plans to spend part of the money to be saved by reducing subsidies on handouts to the poor and low-interest loans. Ahmadinejad's critics, including the conservatives in parliament, fear the government will use the savings to enrich its political allies and supporters while risking social and political unrest.

Mir Hossein Musavi, one of the opposition Green Movement's leaders, has opposed the subsidy cut.

Referring to the Islamic Revolution, which was primarily driven by political rather than economic factors, some Iranian analysts believe the negative impact of subsidy cuts would not necessarily produce a radical showdown between the population and the government. They also believe the government would blame Western countries and international sanctions for the consequences of reduced subsidies.

Other analysts, however, argue that since the emergence of a strong opposition movement following the disputed presidential election last June, masses of lower-class people affected by the price hikes and unemployment that would follow cuts in subsidies would join the opposition movement that has so far been largely limited to Iran's middle and upper classes.