Burning Oil

Bill Spindle, The Wall Street Journal:

Iran's new president, Mahmoud Ahmadinejad, has grabbed the world's attention with his bombast over Tehran's nuclear program and saber rattling against Israel. At home, however, the president's popularity is soaring thanks to another reason: his enthusiastic embrace of economic populism.

In recent weeks, he has proposed a $4 billion national school-renovation program and has raised not only salaries for workers in Iran's vast, government-controlled industrial sector but also the minimum wage for everyone else. He doubled government grants for newlyweds and forced banks to lower interest rates by several percentage points.

Mr. Ahmadinejad is emerging as an Iranian version of Venezuela's Hugo Chávez: a pugnacious politician, buoyed by oil money, whose anti-elite message and defiance of the West is causing his popularity to soar. Mr. Ahmadinejad isn't nearly as powerful as Iran's Supreme Leader, Ayatollah Ali Khamenei. But his policies, which interrupt Iran's tentative stabs at economic liberalization, have helped him wield more influence than many thought possible for an Iranian president.

The president's rapidly rising spending also poses a serious threat to the Iranian economy. Many people in the country fear in particular that Mr. Ahmadinejad could be stoking runaway inflation. Moreover, he has created soaring expectations, particularly among Iran's agricultural and working poor, that could be hard to meet. READ MORE

"It's dangerous," says Ali Naghi Khamoushi, president of the Iran Chamber of Commerce, Industries and Mines. "There's a lot of money coming in, and if it isn't managed well, we'll face a lot of problems."

In the late 1990s, under a series of reform-minded governments, Iran tried to emerge from the economic and political isolation that followed the Islamic revolution and eight years of war with Iraq. In 2001, the government adopted a 20-year plan to boost imports and exports by lowering trade barriers. The ultimate goal was to join the World Trade Organization.

One key to that plan was diversifying an economy heavily dependent on oil revenues. That means implementing a long list of free-market recommendations, including freeing up labor markets and phasing out subsidies.

Mr. Ahmadinejad's policies are rapidly reversing that tentative economic liberalization. In addition to his spending plans, his government has spurned foreign investment and recently raised tariffs on mobile-phone handsets by 60%. Another plan: doling out shares -- he calls them "Justice Shares" -- of government-controlled companies to the poor.

In Ghavart, a conservative, working-class town of 9,000 near the Jey industrial center, Mr. Ahmadinejad's pay raises and subsidies have provided relief -- for some. Hamid Kachoui, a grocer, says he's noticed customers buying extra chicken or meat recently.

"It's much better. People don't have to scrape by," said Mr. Kachoui, 18 years old, standing by a storefront stall packed with rice, bread and other staples. Many food basics are heavily subsidized by Iran's government, using oil money to bridge the gap with international market prices.

Mr. Kachoui credits the improvement to Mr. Ahmadinejad, whom he says nearly everyone in the village supported in last year's election. "With President Ahmadinejad, things will get much better," he says.

Down the road in Jey's industrial center, private biscuit maker Esfahan Farkhondeh Co. has been thrown into a crisis. Last year, the 14-year-old company produced 6,500 tons of biscuits, the kind served with tea and coffee at almost every social gathering in Iran. A few months ago, new laws pushed up the minimum salary for most of the industrial bakery's workers by nearly 50%. The others got 22% raises, according to Mohammed Reza Vaez Shoushtari, an owner and manager.

Meanwhile, the government lowered subsidies on sugar and flour bought by industrial bakers, a nod to Iran's designs on joining the WTO. "Biscuits are not a necessity for people," says Mr. Shoushtari, suggesting a reason why his industry was singled out. The government left subsidies for retail consumers unchanged.

The decision pushed up the price of the two main ingredients in the company's biscuits. The company's bank tightened loan requirements after government-mandated interest-rate cuts and now won't extend additional money to keep the company operating.

Pinched, the biscuit concern informed buyers it would raise prices by 15%. They immediately cancelled about 80% of their orders, Mr. Shoushtari says. He figured most were delaying purchases to see if the government will reverse its decision on the subsidies. Without the ability to fire workers, he plans to wait, hoping the business climate stabilizes.

"When the president changes, the country always becomes a bit chaotic," he says.

For the year that ended March, 2006, Iran is projected to have earned about $49 billion selling oil and natural gas, more than double its take of four years ago, primarily because of rising prices. Much of the president's spending is coming from Iran's Oil Stabilization Fund, which is supposed to pay for long-term infrastructure projects or to buoy the country if oil revenues falter. Iran has dipped into the fund almost every year to fill holes in the government budget. Last year, it spent $7.7 billion from the fund, much of it for government subsidies on basic products, from wheat to gasoline.

All these steps carry the same basic risk: Even with oil revenues running at record levels, the government probably can't afford to pay for all of its initiatives. And Iran's economy may not be able to handle all this oil cash without pushing the country's double-digit inflation even higher.

"He's making a lot of promises that are going to be difficult for him to keep," says Siamak Namazi, a Tehran business consultant. Still, he says, Mr. Ahmadinejad is "getting a cushion. A lot of his plans that would be disastrous are being patched over with the oil money."

Iran's economy has grown by more than 5% in each of past three years, mostly on the back of the rising oil revenues. But Iran's official unemployment rate, which was 10% in 2005, remains unchanged as hundreds of thousands of young people flood the labor market every year. Its total population is almost 70 million. Some economists believe the actual unemployment rate could be more than 20%.

Inflation has also been a persistent problem, running at 15% last year, according to the government. With construction booming across the Persian Gulf, supplies of nearly everything needed for building are short and prices are soaring.

It's far from clear that Iran's tiny private sector can direct enough of the oil cash into productive investments to avoid a burst of inflation. The economy is struggling with competition from low-wage countries such as China, and the looming threat of organized international sanctions is taking a toll, particularly on businesses outside the petroleum sector.

Mr. Ahmadinejad, the former mayor of Tehran, came out of nowhere to win Iran's tightly controlled presidential elections last June. He parlayed a reputation for humble piety and hard work into a stunning runoff victory over a better-known candidate, former president and longtime power broker Hashemi Rafsanjani.

Mr. Ahmadinejad positioned himself as the candidate of the people against a rich and corrupt elite. One campaign ad featured a tour of the opulent mansion belonging to the previous mayor of Tehran, followed by a view of Mr. Ahmadinejad's modest home in a middle-class suburb. Asked whether they have a pool, Mr. Ahmadinejad's son simply points to a backyard too small for one. "See for yourself," he says. "Where's the sauna?" the interviewer asks. The son just shrugs.

Few things appealed more to Iranian voters, especially the working poor, than Mr. Ahmadinejad's promise to "put the oil revenue on the dinner table of every Iranian." Since being elected, he's made frequent trips to Iranian provinces -- political barnstorming previously unheard of in Iran's aloof theocracy. He encourages supporters to write with their requests and has promised funds for thousands of local projects.

His message is giving the Iranian government a boost of desperately needed popularity during a critical period of international tensions, in particular over the country's commitment to developing its nuclear capabilities. In a recent speech to the nation, Iran's Supreme Leader, Ayatollah Khamenei, compared Mr. Ahmadinejad's popularity to President Bush's low poll numbers.

Indeed, Mr. Ahmadinejad's standing among the poor and working class has allowed him to challenge domestic foes, including many in the clerical establishment, throwing Iran's political establishment off balance in ways few expected. With 17-hour workdays and a reputation for rectitude, Mr. Ahmadinejad has refashioned a post with few formal powers. The parliament, more representative of Iran's conservative establishment, has tried to parry Mr. Ahmadinejad's activism, rejecting three of his candidates for oil minister as well as nominees for other important economic portfolios.

But he's stunned Tehran's political elite by winning many battles. He has replaced several senior clergymen in the Ministry of Culture with non-clerical allies, apparently with the blessing of the Ayatollah Khamenei, a senior cleric himself. While less important than the Supreme Leader, Iran's president holds considerable influence over economic and social policies through his ability to nominate the heads of government ministries. He also appoints the head of the central bank.

To outsiders trying to penetrate Iran's opaque political system, it's still unclear whether the president remains under the control of the clerical establishment or whether this is a genuine bid for power.

"Everybody's too busy just trying to catch up with him," says Nasser Hadian, a political science professor at Tehran University and childhood schoolmate of Mr. Ahmadinejad. Although he disagrees with many of the president's policies, he grudgingly admires the way he has shaken up Iran's political culture. "He's challenging the entire spectrum of society, from the super-secular to the super-religious."

Thanks to generous subsidies, Iranian consumers pay some of the lowest prices in the world for gasoline, filling up for about 40 cents a gallon. Despite being the world's fourth-largest producer of crude oil, the country lacks enough oil refineries to supply itself with fuel, forcing it to import almost half its gasoline. When prices rose last year, the government withdrew $2.9 billion from the oil fund to cover the increased cost.

A looming battle over those subsidies typifies Mr. Ahmadinejad's coming dilemma. In the fall, as part of its WTO obligations, the government plans to limit the amount of subsidized gasoline consumers can buy. Above that level, consumers will have to pay higher prices. That will raise the cost of living for Mr. Ahmadinejad's constituents by pushing up prices of nearly everything else in Iran's gas-guzzling economy. The government is already talking about dipping into the oil fund to continue financing the subsidies.

The president hasn't taken a clear public stand on the subsidy-reduction plan, which would be a blow to Iranians such as Jamshid Gerami, 47, who was recently filling his tank at a Tehran gas station while 50 other cars waited in line behind him. "We're already paying more than we should have to," he said.

In Jey, an industrial zone in central Iran, Isfandiar Arab Jafaari, a 32-year-old truck driver, says he's hopeful about the future, even though he hasn't yet benefited from the president's plans. Mr. Ahmadinejad is the first leader "who's really concerned about the poor and about families in Iran," says Mr. Jafaari, who was on his way to deliver a shipment of biscuits.

Meanwhile, Mr. Jafaari's economic indicators are going in the wrong direction. The driver says he was a shepherd until seven years ago, when rising feed costs forced him to sell his 500 sheep. Now he supports his wife and two children driving goods, although he can't afford to insure his truck.

Earlier this year, he paid the equivalent of a month's income to buy two new tires. Last year, he replaced the other two at the cost of just half a month's income.

Write to Bill Spindle at bill.spindle@wsj.com