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Struggling economy could be Iran's undoing

Upcoming subsidy cuts could lead to high inflation, price shocks, public unrest and instability.

Iranian woman
An Iranian woman carries traditional bread in the old part of Tehran. (Behrouz Mehri/AFP/Getty Images)

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TEHRAN, Iran — In the end, Iran’s breaking point might not be broad international sanctions or the country’s increasingly vocal opposition movement. Instead, it might be President Mahmoud Ahmadinejad’s own plan to slash long-standing, and enormous, government subsidies.

In January, after decades of debate within the government and throughout every contour of Iranian society, the country’s parliament finally agreed on a bill to roll back the government support. The law will take effect later this month amid growing concern that the sudden and dramatic cut in subsidies could lead to high rates of inflation, price shocks and public unrest — destabilizing the country.

“I think that getting rid of the subsidies … will result in more demonstrations, more internal political problems,” said Hossein Askari, professor of international business and finance at George Washington University. “In the long run it will be a total failure because I don’t think they really thought this out.”

Iranian subsidies, some of the largest and most widespread in the world, have long acted as an economic lifeline for the country’s poor and middle class. But they are also a significant drain on the economy, accounting for a quarter of the GDP, or about $100 billion. Gasoline, natural gas, electricity, water, bread, rice, cooking oil, milk, sugar, postal and transportation services and medicine are all made cheaper through government support.

In Iran, a gallon of gas now costs a mere 40 cents.

Although cutting subsidies is generally considered to be smart economic policy, economists urge accompanying them with safeguards to help shield, at least initially, those the subsidies were meant to help.

“Iran has done none of those things,” Askari said.

A cab driver in central Tehran, like many locals here, strongly opposes the president’s plan.

“Of course the government should keep the subsidies. Iran is an oil-rich country and has to give back to the people,” said the driver who did not want to give his name because of safety concerns.

The cuts are politically dangerous for the government of Ahmadinejad, who is already facing severe economic sanctions from a growing list of countries and a simmering opposition movement that proved capable of launching large-scale demonstrations during last year’s contested elections. Even among Iranian lawmakers, disagreement with the president over how to roll out the subsidy cuts forced the country’s supreme leader, Ayatollah Ali Khamenei, to intervene.

Under the new law, all subsidized items will move to free market prices by 2015. In the first phase, from September through March 2011, $20 billion of the annual $100 billion in subsidies will be cut. Fifty percent of that $20 billion will be used as cash handouts for poor families, 30 percent will go to companies in the form of loans and 20 percent will be used to build a social security safety net.

But the law gives the president discretion on how the cash payments will be distributed, a system analysts said invites corruption and leaves open the ability for the government to punish the country’s middle class, which largely opposed Ahmadinejad during the 2009 elections and demonstrations.

“Despite its helpful aspects, however, the statute leaves many questions regarding its coverage, overall impacts, effective execution and financial balance unanswered,” Jahangir Amuzegar, a former executive board member for the International Monetary Fund, told, a Middle East business website. “As a policy document, it is also a poorly worded and awkwardly constructed piece which some legal scholars regard as unconstitutional; most economists consider inequitable, ineffective and even counterproductive; and many social psychologists find morally flawed. And nearly everyone outside government circles thinks it would be unworkable.”