By Nader Uskowi
The rising oil prices in recent weeks have created heightened optimism on part of Ahmadinejad administration about their chances of pulling off their subsidy reforms despite misgivings by the Majlis and a growing public anger at rapidly rising prices, estimated at 15-20% for household necessities. The government economists expect the oil prices to continue its rise past the $90 mark achieved in recent days to settle at around $100 in 2011.
The massive and ambitious reforms target highly subsidized energy and food products. In removing those subsidies, the government has chosen a radical path, “a surgery,” as Ahmadinejad has put it. The gasoline prices were quadrupled and on average the prices of targeted products rose by 270%. The approach was necessitated by the government’s shrinking treasury unable to meet the financial burden of massive subsidies, estimated by the government at some $100 billion annually. (Although this figure could not be the real cost to the government, but probably the opportunity cost based on FOB prices of energy products in the Persian Gulf.)
To ease the hardship on ordinary people, the government began to handout $40 a month to 80% of the population, a figure less than the rise in prices, hence the public resentment of the reforms during its first week of implementation. The $100 oil will give the government the ability to continue its $40 monthly handouts (a total of $2.4 billion a month) and even raise it, or “double” it as recently mentioned by Ahmadinejad. The hope would be that after two years of maintaining these payouts the market forces and the ensuing economic growth would raise people’s income, no longer requiring the monthly handouts.
The strategy is of course risky. There is no consensus among economists that the oil prices would be on the rise. The $100 figure was first suggested by Goldman Sachs few weeks ago. There are contrarian views of declining oil prices in the coming years, for example, due to unexpectedly higher efficiencies achieved in transport sectors globally.
And as always there is the big elephant in the room, the economic sanctions against the country, a subject not dealt with in any serious manner during the current debate on subsidy reforms inside Iran. The removal of these sanctions would have the same effects as high oil prices. Right now the government is forced to pay premium on products and services due to sanctions, eating away good portions of the premiums of high-price oil. The decision facing the government here is purely political, something the economist planners of subsidy reforms could not plan for. The upcoming Istanbul talks between Iran and the major powers will give Ahmadinejad administration the best opportunity for a compromise, resulting in lowering or altogether removal of the sanctions.
Higher oil prices and/or removal of the sanctions are what's needed for the subsidy reforms to have a chance at success.