November 19, 2015 | Business Insider

How the Iranian President’s Populist Economic Policies Could Be His Undoing

Detractors of former Iranian president Mahmoud Ahmadinejad used to say that he distributed potatoes to buy votes, a derisive reference to government subsidies which contributed to Iran’s spiraling inflation throughout his time in office.

By contrast, Ahmadinejad’s successor, current Iranian president Hassan Rouhani, has spent his two years in office embracing austerity measures designed to reign in government spending and turn around an ailing economy. But now, three months before parliamentary elections, Rouhani has completely changed course and is ready to inject billions into Iran’s economy in order to defeat his opponents in the February 2016 polls.

This is a risky strategy. Replacing austerity with a robust cash injection into the pockets of ordinary Iranians may spare him an electoral defeat. But big-spending economic populism jeopardizes the fragile foundations of economic recovery that Rouhani’s administration has built since 2013.

Rouhani came to power in August 2013 facing high inflation, a high unemployment rate, and negative economic growth. He wisely chose to curb inflation to reassure investors and ordinary Iranians.

Within two years, Rouhani successfully reduced inflation from 40 to 13.3%. Thanks in part to sanctions relief he also took the economy from negative growth to a modest recovery. Low oil prices — the key export and source of revenue for Iran’s economy — have hampered the economic rebound.

For decades, Iran’s oil exports spurred economic growth but also tainted the country’s economy and political culture. High oil prices traditionally buttressed Iran’s corrupt bureaucracy and its inefficient banking system, ensuring that cheap oil money financed public projects often driven more by patronage than sound economics.

Rouhani vowed to break this cycle. He was initially successful since he compared favorably to his predecessor’s mismanagement and the effects of international sanctions. With little money in the state coffers, Rouhani easily persuaded the public and the system that austerity was the best way forward.

But Rouhani’s success may be his undoing.

With sanctions about to be lifted as a result of the nuclear deal with the US and five other world powers, Iran aims to dramatically increase its oil production again. Even with low oil prices, its oil revenue will increase.

Moreover, with oil sanctions now set to be removed Iran will get instant access to foreign currency, allowing it to easily replenish its depleted reserves. And with Western and Asian businesses rushing to Tehran to sign deals for investment and trade, Iranians are growing impatient about the country’s austerity policies.

The proposed budget outline for next year, published in September, indicated that Rouhani’s austerity measures, which are aimed at lowering inflation, would remain in place. But within weeks, opposition mounted.

On October 4, four of Rouhani’s ministers, including his economy and finance ministers, issued an open letter criticizing his economic policy and warning that austerity compounded Iran’s economic woes.

Facing mounting domestic criticism over the nuclear deal, along with an orchestrated campaign to undermine his authority in advance of the February 2016 parliamentary elections, Rouhani has suddenly chosen his predecessor’s populist path. He’s proposing an anti-recession package to inject money into the economy and perhaps regain enough popularity for his political allies to win the upcoming vote.

But his stimulus package is not designed to spur economic growth: it only aims to stimulate consumer demand.

It includes loosening bank lending criteria, a measure that will inject cash into the economy but which might make the banking system more fragile. Rouhani’s stimulus also allocates $2 billion to short-term projects, providing individuals with easy credit for consumer goods at low rates.

Inevitably, this will lead to higher inflation — in a country where inflation is already above 10 percent. The reforms may also compound Iran’s economic culture of inefficiency and corruption.

The car industry consumer loans offered under Rouhani’s plan epitomizes everything that is wrong with Iran’s economic policies: it is effectively a stimulus package for Iran’s automotive sector, which is itself a poster child of Iran’s corporate cronyism.

Iran’s car industry is protected by high tariffs that enable the continuing sale of overpriced, substandard vehicles. Because of its notoriously poor quality, Iran’s car industry faces a strong grassroots boycott campaign.

Instead of reforming the auto industry, cutting costs and demanding efficiency, Rouhani is bribing consumers to buy overpriced ‘lemons.’

It’s not just the auto sector. Rouhani’s stimulus package will finance other bankrupt and inefficient sectors of the economy and gives a green light to Iran’s crippled banking system to initiate more soon-to-be nonperforming loans.

Rouhani’s reversal of his responsible monetary policies may buy him some seats in the next parliament.

It will also damage Iran’s long-term structural economic recovery and could prove Rouhani’s ultimate undoing.

Saeed Ghasseminejad is an Associate Fellow at Foundation for Defense of Democracies, where Emanuele Ottolenghi is a Senior Fellow