How to remove subsidies and not hurt the poor — Iran offers lessons

India is beginning to experience the pains of removal of subsidies on oil and gas. However, unknown to many, Iran has begun doing that even more forcefully, four months ago, and appears set to do a much better job of it.

Going by Ali Mohammadi, consul general of the Islamic Republic of Iran, prior to February 2011, a litre of petrol would cost the equivalent of Rs4, while diesel would cost around 60 paise. Electricity was pegged at around 6 paise a unit (kWh). This made Iran one of the cheapest countries in the world by the cost of fuel and energy. All thanks to subsidies.

Today, a portion of the subsidies is gone and even subsidies on bread are being sought to be removed. Any subsidy eventually leads to aberrations in the marketplace. It also encourages smuggling out of cheap fuel, to be sold at a profit to neighbouring countries. And lower prices always encourage people to use more, or even waste, the precious energy source.

Obviously, removing subsidies isn’t easy. But unlike India, Iran has a roadmap for itself. It has decided to phase out all subsidies over a five-year period. To minimise any shock on account of the increase in oil, gas, electricity and bread prices, the first reduction of subsidies would have to be 20% at the very minimum. However, Iran has managed to reduce subsidies by almost 50% and with practically no protest from its teeming millions.

How did it do this?
First, by announcing the rollout of the subsidy removal, they did away with ad-hoc decision making. A planned approach is always better than one based on opportunism and whim.

Next, the government asked every individual to fill in forms listing the names of the members in each household, how many cars the household had, details of assets — especially apartments and land, wealth and other sources of income. This data was then cross-checked with existing databases from banks, car registration databanks and property records. Once the list was verified, all the identified persons were asked to open accounts — something that the Unique ID project hopes to do in India in the years to come.

As of February this year, a subsidy compensation of $45 per head per month was credited into each person’s account, irrespective of whether the person was rich or poor. This way, all people are treated alike, rather than attempt to divide populations into economically backward, caste reservation, or specially targeted groups.

“The logic is simple. The rich man may get $45 per month from the government, but will end up paying a few hundred dollars more for the unsubsidised oil and electricity that he now purchases. For the poor man, the $45 per month allows him to decide whether he will opt for bread, or fuel,” said Mohammadi.

To soften the blow for marginal users, each car owner now gets 60 litres of semi-subsidised petrol at Rs15 (equivalent) a litre against an electronic smart card (as against Rs4 a litre during the pre-February 2011 period). The rest he must purchase at the unsubsidised rate of Rs28 per litre. Diesel, which was earlier sold at 60 paise a litre, is now pegged at a non-subsidised rate of Rs7.40 a litre.

To soften the blow for transporters, the government allows for special loans at lower rates of interest for a limited period. For electricity, it follows the practice of telescopic tariffs, commonly followed in India as well, where the price keeps increasing as consumption goes up.

But more interesting is the way it plans to encourage its young to raise a family in ‘decent’ surroundings. “We had a major housing shortage,” says Mohammadi. “And the government saw in that shortage an opportunity to create jobs, carve out a future and to make life easier and better for its people.”

The government decided to give to each child (irrespective of gender), as soon as it is born, a sum of around $950 paid as a trust fund into the child’s account. To that, the parents of the child must add another $20. The amount may not be withdrawn or mortgaged till the child reaches the age of 20. Every year, the government tops up this amount by around $200, with the parents adding another one-third of this amount. With the passage of time, and with the accrual of interest, each child could end up with $60,000-75,000 by the time it reaches the age of 20.

“At that point of time, a boy and girl, should they decide to get married, will have a corpus of around $120,000 which they could use either to purchase a house, or to invest in a business of their own, or in both,” says Mohammadi.

To ensure that there is no shortage of houses, the government has already launched a massive house building exercise where land is given free to developers on a 99-year lease for building houses on the outskirts of cities as extension towns, using pre-approved designs and plans. Developers are also given a subsidised loan of $15,000 per apartment to meet working capital costs. Connectivity is assured with train and bus services planned right at the outset.

“The strategy is good,” says a developer. “Unlike India, where the government charges for land and registration, thereby making houses more expensive and unaffordable, the Iranian government wants to make housing affordable. The flats are built in abundance (currently 1.6 million apartments are under construction, with 600,000 in the final stage of completion) to prevent black-marketeering. What the government ‘loses’ as income from the sale of land, it makes up from taxes later. The idea is to give people a decent start, not to make them paupers at the very start of their family life.”

“Our plan was strategic,” explains Mohammadi. “With sanctions crippling several economic activities, housing was a good way to create jobs. The land was ours, the cement ours, the labour ours. All were free from sanctions. The activity created jobs. And it gave a better future to our young people.”

Mohammadi also laughs away the popular impression that people have about Iran being a fundamentalist society. “Go to our universities. Almost 60% of the students are girls. Go and see the teachers in our Universities. Almost 30% of them are women. In fact, the increasing numbers of working women has given them a lot more authority in society than ever before. We focus on good quality education, which is why most of our scientists in chemical, petrochemical, missile and nuclear plants are our own people, not imported from overseas. That is our way of coping with sanctions. We build our inner strength and capabilities.”

Today, Iran has 83% literacy (unlike in India where literacy means just writing one’s name, Iran considers literacy to mean completing school education). Its government knows that when it has young people, without education or jobs, turmoil is round the corner.

That is what happened when the erstwhile Shah allowed illiteracy and unemployment rates to soar, and did not ensure that quality electricity was available to villages as well.

To encourage employment, Iran has introduced a social safety net which allows old people to retire as early as they want. If a man retires after 25 years of service, he is eligible to receive 30 days of his monthly income regularly even after retirement.

If he retires after 20 years of service, he gets a monthly retirement package equal to 25 days of his last drawn salary. “We encourage early retirement, because it allows younger people to get jobs and become responsible,” says Mohammadi.

That is why we welcome investments in road and transportation, mining, housing and a host of other industries. The most proactive have been China. Iran-China trade has gone up to over $7 billion per month compared with just around $2 billion with India (of which around $1 billion is oil).

“Many big Indian businesses are still worried about the effect of sanctions on their activities. But smaller business houses have begun investing in Iran, though not with the same zest as the Chinese, and we welcome all of them as investors,” says Mohammadi with a wistful smile.