asdasdasdasdasdasdasdasdasdasd

Is Iran's 'Bread' Subsidy Reform a Half-Baked Idea?

Is Iran's 'Bread' Subsidy Reform a Half-Baked Idea?

A new round of protests has begun in Iran. People are taking to the streets following a controversial subsidy cut perceived as an increase in the price of bread. These protests were inevitable in a country in which there are so many economic and political grievances and in which civil society and labour groups, demoralised about their ability to influence policymaking through the ballot box, have turned to mobilisations to get their voices heard and their anger registered.

The policy that has triggered the protests has been widely reported as a cut to a “bread subsidy” that has suddenly increased the cost of bread and cereal-based products. This is inaccurate. The subsidy that has been eliminated was an exchange rate subsidy. The government had been providing Iranian importers allocations of hard currency below market prices. This policy indirectly subsidised the purchase of wheat and a few other foodstuffs by the importers. It did not directly subsidise the purchase of bread by ordinary people.

Importers could apply for foreign exchange allocations from the Central Bank of Iran to import wheat. In theory, this would allow them to bring wheat to the Iranian market at a lower price. But in practice, the subsidy had long ago stopped working. Several distortionary effects of the policy were likely generating inflationary pressure across the economy.

First, the exchange rate subsidy was poorly targeted. To put it simply, the Iranian government was intervening to make foreign money cheaper, not bread prices themselves. The subsidy was therefore ill-suited to stabilise prices when Iran’s import needs rose, a periodic occurrence when the domestic harvest falls short of targets. It was also unable to counteract the effects of global increases in the price of wheat. Breads and cereals prices have risen steadily in Iran for years, quadrupling since 2018. 

Second, providing foreign exchange at a subsidised rate was exacerbating Iran’s fiscal deficit. Financing this deficit is a major driver of inflation in Iran. The official subsidised exchange rate diverged from the exchange rate on which Iran’s government budget is balanced in 2015. Since then, the spread between the two rates has increased dramatically. The subsidised exchange rate has been fixed at IRR 42,000 since 2019. The exchange rate in the Iranian government budget for the year beginning March 2022 is IRR 230,000. As this spread widened, the Central Bank of Iran faced increasing difficulty in meeting demand among importers for subsidised foreign exchange, creating a foreign exchange liquidity crunch that made it harder to stabilise Iran’s currency outright. In recent years, the Iranian government was spending around $12 billion in hard currency on a subsidised basis.

Third, this additional exchange rate volatility has increased the pass-through effects related to Iran’s dependence on imports more broadly. The Central Bank of Iran has had partial success in stabilising the exchange rate by introducing a centralised foreign exchange market for importers and exporters called NIMA. But Iran’s economic policymakers were tying their own hands in the stabilisation of this exchange rate, which is far more critical for Iran’s economic performance, by diverting precious foreign exchange resources towards essential goods importers. When it comes to inflation generally, the government ought to focus on intermediate goods on which “made in Iran” products depend. The exchange rate subsidy for essential goods was making it harder to stabilise the exchange rate for all other goods.

Fourth, the exchange rate subsidy was always subject to abuse. Particularly in the early years, importers were known to seek and receive allocations of subsidised foreign exchange and either pocket those allocations or turn around and sell on the hard currency to other firms at the market rate. This kind of profiteering was difficult to police. As more scrutiny came upon the allocations, importers with political connections were most likely to continue receiving allocations from the Central Bank of Iran, making enforcement politically fraught.

The evidence that the exchange rate subsidy had failed can be seen in consumer price index data. Bread and cereals inflation has outpaced general inflation since last summer. This is a likely reflection that, in practice, a diminishing volume of wheat imports were being conducted using the subsidised exchange rate—the reform was already being priced-in by the newly elected Raisi government. The sudden price increases were are seeing now are more likely the result of price gouging. Firms across the food supply chain are using the policy reform as an opportunity to raise prices, knowing the blame will be cast on the government.

 
 

Whether or not the reform is half-baked, the idea has been cooking in the oven for a long time. The subsidy cut was years in the making and the preferential exchange rate was nearly nixed in 2019, as the Iranian economy underwent a painful adjustment following the reimposition of U.S. secondary sanctions. At the time, the Iran Chamber of Commerce, the voice of the country’s private sector, issued a strong statement calling for the elimination of the subsidy. But the reform was eventually shelved—the Rouhani administration had been cowered by the 2017 and 2018 economic protests, which were instrumentalised by their political rivals.  

In the end, the Central Bank of Iran took a different tack. They kept the exchange rate in place but began to eliminate the range of imports eligible for the rate. Initially, importers could apply for subsidised foreign exchange allocations for the purchase of 25 essential goods and commodities. As of September 2021, that list was cut down to just seven goods—wheat, corn, barley, oilseeds, edible oil, soybeans and certain medical goods.

These were preparatory steps for the elimination of the subsidy. In practice, many Iranian grain importers had stopped using the subsidised exchange rate, both in anticipation of its elimination and because it was impractical. One of the fundamental problems facing Iran’s food supply chain is that even when Iranian importers can identify buyers and arrange logistics—difficult things to do when under sanctions—the payments that need to be made for those purchases are often delayed. Importers that were applying to the Central Bank of Iran for allocations of subsidised foreign exchange might wait weeks before the money hit their accounts. Cargo ships would sit idle off Iran’s shores, unable to deliver the grain until the seller received their funds. These delays added costs. The Iranian importers were on the hook for huge fees as the ships they chartered remained out of service. Importers that opted to use the NIMA rate have been able to make payments to their suppliers more quickly and reliably. This is because there is far more liquidity in the NIMA market, in which foreign exchange is supplied by Iranian exporters who are repatriating their export revenues as required by law.

Overall, there is a sound economic argument for eliminating the subsidised exchange rate. But that does not mean that there will not be pain for ordinary people in the short term and the protests are motivated in part by an expectation of further pain. The abject failure to communicate a plan around the subsidy reform will lead to its own distortionary effects, including predatory pricing. Failing to communicate directly and clearly with the Iranian public about this major reform is its own kind of contempt, even if the reform itself is not contemptuous.

 In that vein, the elimination of the subsidised exchange rate has been criticised as “neoliberal” and in many respects, it is. As part of the continuity in economic policy, the Raisi administration appears to be continuing the Rouhani administration’s commitment to austerity, seeking relief from inflation through fiscal tightening. The national protests in 2017 and 2018 were triggered by the same anxieties around the government’s perceived failure to protect economic welfare within the Islamic Republic’s social contract.

But on the other hand, this is not a simple economic reform. Iranian officials have likened it to “economic surgery” necessary to repair an economy weakened by sanctions. The reform also does not preclude other redistributive policies. The subsidised exchange rate was a poorly designed and inefficient policy that did more for a small number of elites than it did for Iran’s poor.

The Raisi administration has promised to soften the blow of the reform by providing targeted cash transfers (for two months) to the most vulnerable in Iranian society. Electronic coupons are also being provided. Iran has a good track record with cash transfers, which do something the exchange rate subsidy did not. Such transfers directly boost the consumption of ordinary people in the face of rising prices. If the government can use the fiscal savings from the elimination of an inefficient and poorly targeted policy to shore the economic welfare of Iran’s poor more directly, while also addressing long-running distortions in the foreign exchange markets, this reform may succeed yet. But if the government fails to communicate clearly about its implementation of the reform, the Iranian public will continue to only see failure.

Photo: IRNA

EU Embargo of Russian Oil Spells Trouble for Iran

EU Embargo of Russian Oil Spells Trouble for Iran

SIPRI Has Overstated Iran's Military Spending For Years

SIPRI Has Overstated Iran's Military Spending For Years