Economy, Business And Markets

Time to Free Fuel Prices

Time to Free Fuel PricesTime to Free Fuel Prices

The 66% plunge in oil since June 2014 poses a tremendous challenge to the Iranian economy.

The government’s main source of revenue has shrunk to a third of the level it had been for years. An emptier pocket has made steering through current choppy economic times difficult.

Also, life has been sucked out of Iranian equities, 40% of which have something to do with oil. But, there is an opportunity in every threat. Low commodity prices, especially that of crude oil, provide a once-in-a-generation opportunity to rationalize energy policy.

This could be a momentous shift for the Iranian economy, like Deng Xiaoping’s Chinese market opening in 1978 and Poland’s adoption of “shock therapy” proposed by Leszek Balcerowicz in 1990. These bold politicians seized propitious circumstances to push through reforms that transformed their countries.

The plummeting price of crude, coupled with advances in clean energy and conservation, offers the government a chance to cut subsidies for dirty fuels altogether. The government can get rid of billions of dollars of distorting subsidies, while shifting taxes toward carbon use.

A cheaper, greener and more reliable energy future could be within reach. Major cities need fresh air. The coffers could use the cash.

The most obvious reason for optimism is the plunge in energy costs. There are growing signs that low prices are here to stay. Floating the price of fuel would give far less of a shock to the economy today, than it would a year ago.

Gasoline costs 27 cents a liter in Iran today, seventh cheapest in the world. By comparison Germans pay $1.38. Our Turkish neighbors pay over $2.03, according to World Bank data.

Raising the price of fuel will curb unnecessary motoring, decrease demand for inefficient cars and force Iranian automakers to up their game. It would also reduce pollution. It would change the dynamics of business in Iran to a more competitive and energy efficient one. The increased cost of transport is well worth it.

It would reduce pressure on government finances as well. The Iranian government has subsidized the price of fuel along with many other essential goods for over half a century. Attempts to reduce them have mostly failed or were blocked for fear of harming the poor. Yet the most fervent energy users are companies and the well off.

  Failed Attempt

The conservative parliament voted to scrap plans to raise fuel prices by 10% annually until they reached 90% of the cost of fuel ready on tankers in the Persian Gulf in 2004 to support the poor.

Former president Mahmoud Ahmadinejad offered a plan to swap subsidies with cash handouts to the poor in 2009. The government was supposed to pay half the money raised from increasing energy prices in cash handouts to the poor, use 30% of the money to support industries and save 20% for its own expenses. It went into effect in December 2010.

Energy prices rose an average 400%. Gasoline went from 10 cents to 70 cents per liter though the government went ahead and gave each car a 720-liter ration of 40-cent gasoline.

Diesel prices had a steeper increase, but working vehicles got generous rations of cheaper fuel. Heating gas went up 30 times.

As for handouts to the poor, every Iranian was paid $45 each month. This racked up the costs and no money was used to support industries or fuel fiscal spending. The plan has actually cost more. The Iranian government has made 950 trillion rials ($25.9 billion at current market exchange rate) from the plan while paying 1.35 quadrillion rials ($36.8 billion) from the plan’s botched execution by 2013, according to IRNA.

The difference was paid through capital expenditure costs and printing out 57 trillion rials.

Ultimately, runaway inflation and devaluation of the rial brought down the value of the handouts and fuel price increases. When the administration was passed on to President Hassan Rouhani, the second phase of the plan was carried out. The government tried to limit the number of recipients but 73 million, 91.2% of the population, applied.

Today, a year after the second phase, gasoline costs 27 cents a liter and diesel costs 13 cents. Cash handouts are now worth $12.43 and the government’s cost for paying cash handouts will outstrip what it raises by 70 trillion rials ($1.9 billion) this year.

  Time Is Now

This senseless trend must end. Low energy prices make ending it much easier.

The Central Bank of Iran has promised to adopt a managed float for the rial and abandon the multiple exchange rate regime it currently employs. Removing subsidies should be done in tandem with abolishing the current corruption breeding forex regime.

These two moves would eventually make Iran a more competitive and efficient economy and leave Iran a better place to breathe in.

However, no shift this size will be without consequences—though belittled by recent crises—and populists would use it as ammo against whoever is brave enough to make this radical move.

Current political costs may seem inhibitive, but gratitude will come from future generations.