IRAN: AHMADINEJAD GETS HALF OF WHAT HE WANTS ON SUBSIDY

C O N F I D E N T I A L SECTION 01 OF 04 RPO DUBAI 000468

SIPDIS

E.O. 12958: DECL: 10/29/2019
TAGS: ECON IR PGOV PHUM PREL
SUBJECT: IRAN: AHMADINEJAD GETS HALF OF WHAT HE WANTS ON SUBSIDY

REFORM

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CLASSIFIED BY: Alan Eyre, Director, Iran Regional Presence
Office, DoS.
REASON: 1.4 (b),(d)

1. (C) SUMMARY: Iran's Majlis has vigorously debated and
ultimately approved the first part of President's Ahmadinejad's
proposed subsidy reform bill. The bill is a two-part program
intended to end state subsidies on energy, utilities and basic
food items and channel the savings as cash payments to
low-income groups. Despite criticism that the proposal could
add to Iran's inflation, lawmakers overwhelmingly passed five of
the 14 articles with only one change: to lengthen the period
over which the subsidies should be gradually eliminated. The
Majlis will take up the second half of the bill when it
reconvenes November 1, and there are indications that possible
changes to the cash payments provisions will be contentious. In
getting the first part of the bill passed, Ahmadinejad has
rebounded from a pre-election legislative defeat and is on the
verge of a victory that could have a major impact on the Iranian
economy. The vote to end the politically popular subsidies
suggests that there is an increasing awareness in the IRIG that
subsidies are no longer financially sustainable. A dditionally,
given the Supreme Leader's earlier general endorsement of
subsidy reform, it seems probable that a subsidy reform bill in
some form will be enacted. END SUMMARY.



Subsidy Reform: Majlis 1, Ahmadinejad 1




2. (C) On October 11, the Majlis approved the first part of
President Ahmadinejad's subsidy reform bill by a vote of 116 in
favor, 42 against and 12 abstentions. In the face of strong
criticism over the potential to further increase inflation,
effective government lobbying and broad-based agreement that the
IRIG will be unable to afford subsidies in the future pushed
Majlis to approve the first five articles of the bill,
liberalizing prices for a substantial number of items over five
years as follows:



-- Article 1: General framework for targeted subsidies.

-- Article 2: Gasoline imports.

-- Article 3: Other energy imports and utilities (electricity
and water).

-- Article 4: Wheat, rice, oil, milk, and sugar as well as
postal and transportation services. MPs did not approve subsidy
removal for pharmaceutical products.

-- Article 5: Bread and flour.



(NOTE: While the legislation does not dictate how the government
should implement the cuts, the expectation is that it will
increase prices annually, 20 percent at a time, to make up the
difference between current subsidized prices and a liberalized
price determined by a good's price in the region. END NOTE. )




3. (C) During the debate, numerous MPs took the floor to
criticize the bill, arguing it would create higher inflation,
one predicting a 20 percent increase and another 60 percent. MP
Hasan Vana'i, who led opposition to the bill, said subsidy
reform should wait until after other reforms are enacted. "We
must first tackle the country's economic infrastructure. We
must ensure that we have the capacity to produce and
distribute~otherwise, the implementation of this bill will lead
to a rise in prices."




4. (C) The comments of MPs opposed to the bill echoed the
comments of some experts. One Iran-trained economist who
describes himself as a free-market proponent shared his concern
with EconOff, arguing "You cannot have a free domestic market
without free trade and without privatized distribution networks.
In Iran, with government and public companies still controlling
exports and imports (after subsidies are removed),the free
market will fail to re-distribute...causing dramatic changes in
CPI and prices." Editorials making similar arguments were

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published in a number of economic-oriented newspapers and
online. Debate over the bill continued to intensify as MPs
considered individual articles of the bill.




5. (C) President Ahmadinejad dedicated large amounts of time in
supporting this bill, linking those who were against the program
as being opposed to its ideological underpinnings rather than
the need for economic reform. Ahmadinejad effectively
countered criticism of the bill by his unrelenting focus on the
current subsidy program's inequities and references to
'over-consumption' by wealthier Iranians. On October 11, he
participated in a one-hour discussion on state television with
two economists to debate the bill's specifics. Ahmadinejad
described in detail four goals for removing subsidies: (1)
providing justice so people enjoy public resources equally, (2)
optimizing resources so people allocate goods for themselves
most efficiently, (3) preventing waste of resources so people
consume more realistically, and (4) a first step in a broader
effort to reform the country's economic infrastructure.
Ahmadinejad rebuffed technical questions about how the subsidies
would be removed and cash payments would be made, instead
focusing on the necessity for reform and justice while
expressing disdain for those who "benefit from the chaotic
distribution of subsidies, and are now economically at a higher
level than others." A Tehran-based university professor who
knows the two economists who participated in the debate told
EconOff that they told her afterwards that they were not
allotted any time to express concerns, that "the discussion was
one-way," and that the way "Ahmadinejad portrayed the issue
about justice made it difficult to disagree."



The Costs of Subsidies




6. (C) Regardless of Ahmadinejad's ideological arguments, there
is a growing realization within the IRIG that the subsidy
program has become a drain on the Iranian economy, even if
advantageous for consumers who buy goods at below market prices
and for domestic producers who sell to the government at set
prices. As a result, the entire subsidy program costs the
government approximately USD 90 to 100 billion annually,
approximately one-third of national GDP. While one-third of the
annual budget is allocated for subsidy payments, the government
has often had to go outside of the budget process and dip into
the country's Oil Stabilization Fund (OSF) to fund the program.
As a result, the government in recent years has been accused of
'stealing' money by not following the budgetary process to make
large subsidy payments. (NOTE: While Iran does not publish the
OSF balance, numerous business analysts believe that it is close
to zero and is driving the government's call for reform. END
NOTE.)



The Example of Energy




7. (SBU) Energy subsidies are one such example of the
difficulties the government faces in trying to introduce reform
through eliminating politically popular subsidies.Energy
consumption has grown at twice the rate of GDP (today it is at
10 percent) over the last two decades and energy subsidies have
driven the high growth and disproportionately benefited the
affluent. They have also encouraged a large gasoline smuggling
operation. By the government's own admission, 10 to 12 million
liters of subsidized gasoline (one-sixth of daily consumption)
is smuggled out of the country daily. In attempt to reduce
gasoline consumption and liberalize pricing, the government
introduced gasoline rationing two years ago. Even though the
rationing program was considered to be a modest initiative, it
resulted in public protest and the torching of a dozen gas
stations in Tehran. After two years though the program has been
declared a success (gasoline consumption growth has slowed and
the amount spent on subsidies decreased) and helped pave they
way for further reform. (NOTE: Using smart cards, the
government limits subsidized gasoline (USD 0.11/liter) to 100
liters per vehicle per month after which consumers are required
to pay market prices (USD 0.40/liter). END NOTE.)

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Building Consensus on Subsidies




8. (C) President Ahmadinejad re-introduced comprehensive
subsidy reform in early 2009 as part of the annual budget but
the Majlis refused to approve it after Ahmadinejad refused to
entertain any changes to the bill and fearful Ahmadinejad was
spinning the cash component as a populist measure intended to
buy votes for his re-election (reftel). The bill was then
deferred to a special Majlis committee for further review.
There was no mention of the bill by the government again until
Ahmadinejad was inaugurated for his second term and declared
passage of the bill a top priority as well as "the most
important (economic legislation) in the past 50 years."




9. (SBU) At the President's urging, the bill emerged from
committee and the Majlis began debate on it in an open session
on October 11. Both the government and numerous Majlis members
made the case that the nine-month review had produced a more
robust bill that addressed numerous concerns raised earlier
about inflation and the process of providing payments to
lower-income Iranians. As one member of the committee explained
in an interview with the Iran Student News Agency, it met 53
times, with 136 hours of discussion among officials and outside
experts.




10. (SBU) The review resulted in three key changes to the bill.
First, in order to help avoid price shocks, the committee
recommended that the government remove subsidies over five
years, instead of three as originally proposed. Second, to keep
inflation in check, it recommended that the bottom 50 percent of
the population receive substitutes for subsidies, instead of the
original 70 percent the government proposed. As part of this
recommendation, the committee emphasized the increased use of
social safety net programs rather than strictly cash payments.
Lastly, to keep the power of the government in check, the
committee recommended the savings achieved by ending subsidies
be deposited in the Treasury and the government make requests to
spend the money through the budget process, instead of allowing
the government to spend the funds without oversight as
originally proposed.




11. (C) COMMENT: In the midst of political posturing between
Ahmadinejad and his critics in the Majlis, the government's
ability to marshal the support of MPs required to end subsidies
over the next five years is impressive. Beyond the legislative
victory, however, the larger question in what it portends for
the Iranian economy. Some IRPO contacts who follow the Iranian
economy closely insist that while price liberalization is a good
idea in theory, if the government fails to liberalize other
components of the economy that govern price, the result will be
hyper-inflation. Regardless, a consensus has formed that the
country can no longer afford to pay such large subsidies given
its precarious fiscal standing. Though it remains unclear to
what degree cash payments will affect inflation, ending
subsidies seems to be no longer a point of debate.




12. (C) COMMENT (Cont'd.): The larger controversy over the bill
though is yet to come. Doubts about the cash payment aspect of
the bill are starting to become more pronounced and more public.
There is a general concern that the government's actions to
classify different levels of economic strata have been haphazard
and incomplete. Other experts argue that cash payments are
economically inefficient and will only stoke inflation. Average
Iranians quoted in press reports are skeptical whether the
government will actually use the funds saved from subsidies to
improve the economy or will channel it to those with government
connections. Cash payment compensation and re-distribution of
wealth though is "what drives the Ahmadinejad administration's
zeal for this bill," according to an Iranian economist, who is
an expert on the Middle East and currently a visiting professor
at an Ivyleague university. As such, whether the targeted

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subsidy reform will pass depends heavily on how the debate over
cash payments plays out in the coming weeks, what changes the
Majlis agrees on, and if the government accepts them.
Additionally, once the Majlis approves the bill, the Guardian
Council will have to review it for ratify it before it becomes
law. In light of the Supreme Leader's endorsement of subsidy
reform earlier this year as well as his categorization that this
is 'the year of reforming consumption,' it seems probable that
some sort of subsidy reform will be enacted. END COMMENT.
EYREA