Energy Subsidies Must Go, But How

EghtesadOnline: Fossil fuel subsidies paid by the Iranian government are 21 times more than its direct subsidy payments, Parliament Speaker Ali Larijani said last week.

News ID: ۷۴۶۴۰۳

01 January 2019

According to Larijani, 9,000 trillion rials ($84.11 billion) in subsidies are paid annually in the energy sector, which shows that over the past eight years, the government has given both cash subsidies and energy subsidies, while the key goal of Targeted Subsidies Law of 2010 was to reduce fossil fuel subsidies and cut it to zero in five years.

As per the Targeted Subsidies Law, subsidies on food and energy were reduced and instead 455,000 rials ($4.2) were paid to each and every Iranian on a monthly basis. The plan has been retained, such that nearly 76 million or 95.21% of Iranians currently receive the monthly cash subsidy.

Now, eight years into the law, not only have authorities failed to reduce these subsidies, but they have also increased the volume owing to the fact that in 2010, gasoline price was 5,000 rials (about four cents) per liter and the US dollar was exchanged for 10,000 rials, accounting for 85% of the Persian Gulf FOB prices, Financial Tribune reported.

Presently, gas prices have reached 10,000 rials (about nine cents) per liter while 1 US dollar is exchanged for around 80,000 rials in the Forex Deals Integrated System (known by its local acronym Nima), suggesting that the government pays 90% of gas costs in subsidies to consumers.

The Rich: Main Beneficiary of Energy Subsidies

What’s more, the Targeted Subsidies Law was introduced for supporting low-income households, although analytical reports show that the rich are the main beneficiaries of energy subsidies.

Journalists with the Persian daily Donya-e Eqtesad, Mehdi Naji and Pouya Nazeran, have published analytical reports proving that the share of people in the highest income decile (the richest in the country) from energy subsidy stands at 1,000 billion rials ($9.34 million) per day while that of households in the lowest income decile (the poorest) is 100 billion rials ($934,579) per day.

Over the past few years, the monthly cash subsidy program has grabbed the attention of the government, parliament and even economists. When it's time to negotiate the annual budget, the removal of high-income households from the list of direct subsidy receivers is debated heatedly to save a few trillion rials. However, calls to cut the sizable energy subsidies go unheeded, as if the government and parliament are unwilling to even discuss the issue of raising energy prices.

Elimination of fossil fuel subsidies, and not direct subsidies, should take the government’s higher priority, well-known Iranian economist Djavad Salehi-Isfahani told the Persian weekly Tejarat-e Farda.

Salehi-Isfahani received his PhD in economics from Harvard University and taught at the University of Pennsylvania (1977–84) before joining the Global Economy and Development Faculty at Virginia Tech, where he is currently serving as professor of economics. He is the writer of the book “Government Subsidies and Demand for Petroleum Products in Iran”.

Blame on Implementation

The economist believes the former administration’s misguided implementation of Targeted Subsidies Law does not give grounds for the rejection of premises on which it rests.

"The first thing to know is that there is a difference between an idea and the execution of that idea. Instead of criticizing the concept behind a plan, we need to weigh in on how it was carried out. Part of the blame for the failure of the Targeted Subsidies Law rests on its executor," he said.

"Giving away too much of the country’s funds to win over people's support, as practiced by President Ahmadinejad, even before the implementation of the Targeted Subsidies Law and the miscalculation of the plan’s revenues that forced the government to borrow from the Central Bank of Iran and print more money to pay for its spending led to an increase in money supply and inflation. These were the mistakes in the execution phase of the plan. We’d better detach setbacks in the execution of this plan from its core idea, if we are willing to figure out whether to keep or ditch it.”

Salehi-Isfahani believes that the real purchasing power of the 455,000 rials in direct subsidies of 2010 is now one-fourth its original value that is about 100,000 rials.

The program was inflation-inducing initially but currently has little to no negative effect on the economy. On the other hand, the total amount of monthly cash payments (420 trillion rials or $3.92 billion) is meager when compared with the substantial sum of energy subsidies paid by the government annually.

Major Flaws

Fossil fuel subsidies support industries that trigger negative health impacts, local environmental pollution and climate change impacts and costs, the economist said.

Salehi-Isfahani stressed that energy subsidies have destructive impacts on employment.

"A fierce competition exists between human workforce and automation in production. When you grant energy subsidies, it is obviously a signal for the producer to replace human workforce with machines. Automation eliminates the number of workers needed per unit of goods or services produced and that is a very wrong policy in a country with a vast number of jobless people," he said.

The economist noted that the third flaw concerning energy subsidies is that it deepens the wealth divide in the country, as the rich enjoys 10 times more energy subsidy benefits than the poor.

He stressed that the government is under pressure over the budget.

"It gives around 5 million barrels of oil and gas to people at very low prices. Compare about 420 trillion rials in direct subsidies the government pays annually with the staggering figure of 9,000 trillion rials mentioned by the parliament speaker, which it provides in energy subsidies,” he said

Asked about what policy changes and measures the government can undertake to improve the effectiveness of the Targeted Subsidies Law, Salehi-Isfahani said, “Undoubtedly, eliminating fossil fuel energy subsidies must take priority over cash subsidies. It is ill advised and politically incorrect to talk about removing energy subsidies without compensating the poor and the middle class for the higher energy prices they face by paying direct subsidies.

"Ahmadinejad made a sensible choice by timing the rise in energy prices with the start of paying monthly cash handouts. There was no social discontent in Iran on December 19, 2010, when the Targeted Subsidy Law took effect whereas in many countries, the rise in energy prices has led to street protests. The rise in energy prices must be in proportion to cash subsidies people receive,” he concluded.