Iran’s Economy Facing a Challenging Year

Published on Monday, 08 Apr 07:00 am

By Jahangir Amuzegar

On 23 February some 20mn Iranian families, comprising 73mn individuals, were informed by their banks that a sum of IR850,000 (approximately $70 at the official exchange rate) had been deposited in their account as a bonus to help them celebrate Nowruz (the Persian New Year on 21 March). Twelve million ‘poor people’ covered by the Imam Assistance Committee, or the National Welfare Organization, received a total of IR1,000,000. A day later, the Majlis (national assembly) voted a comprehensive food stamp program (comprising rice, butter, sugar and red meat) to help some 7mn poorest. A special IR4mn bonus was later given to mass media reporters—presumably to propagate the good news.

The money for the bonuses was provided from an unlikely source. With the national budget already in deficit, and a legal ban on government borrowing from the Central Bank of Iran (CBI) in place, a rare amicable accord was reached between the Majlis and the administration to ‘borrow’ some $2.7bn from the (dollar-funded) National Development Fund (NDF), convert it into rials, and pay the bonuses. Appropriation for the repayment of the borrowed funds was to be made in the coming year’s fiscal budget. Although the use of the NDF for such a purpose was clearly alien to its objectives, charter and practices, there was no objection on anyone’s part.

The Fly In The Ointment
Coinciding with the bonus payday, and totally unrelated to it, some 43 Iranian academic economists sent a long, open letter to President Ahmadinejad, warning him about the gravity of the country’s current economic crisis, and asking him to reconsider his ongoing socio-economic policies in order to forestall national upheavals. The letter noted that, given the unprecedented large oil export receipts during 2005-12, the economy was expected to experience faster growth, lower inflation, reduced unemployment and improved welfare. Yet, due to the administration’s misconceived idealism and its non-professional and ad hoc approach to economic realities, the nation was suffering from the double scourges of both high prices and massive unemployment.

This warning letter closely echoed a similar missive addressed to the president six years earlier by some 60 like-minded Iranian economists alarmed by the corrosive effects of Iran’s ongoing ‘stagflation’ – a combination of high inflation and protracted unemployment called the ‘Dutch disease.’ In both letters, the groups called attention to the country’s major economic woes in detail, analyzed their causes and made a number of professional recommendations.  There was neither an acknowledgment nor any reaction to the letters by the chief executive.

Thorough and well-reasoned as the economists’ last letter is, its references to the broad-based and far-reaching economic sanctions by the UN, EU and US are peripheral and non-focused. Iran’s current grave economic crisis seems to be almost exclusively blamed on the government’s incompetence and mismanagement, while the crippling effects of sanctions on the country’s international trade and payments are not sufficiently emphasized.  No amount of incompetence and mismanagement would have resulted in the current malaise if the oil export embargo and payment restrictions had not been in place.

Troubling Signs
The economists’ letter seems to hint that after the Nowruz celebrations and the exhaustion of the cash bonus, the country might be in for a rough ride. Current visible signs indeed seem to indicate that the new Persian year (March 2013-March 2014) is likely to witness—apart from unforeseen political crises related to the June 2013 presidential election or other events - a combination of anemic growth, double-digit inflation, near record unemployment, multiple exchange rates, a banking system in trouble and the fate of the fiscal budget (including the second phase of the Subsidies Reform Program) in limbo. By some pessimistic estimates, the coming year promises to be the most worrisome twelve months since 1994. The one faintly bright spot on the horizon is the possibility of a compromise with the P5+1 group (the five permanent members of the UN Security Council – China, France, Russia, UK and US – plus Germany) on the nuclear issue—leading to the relaxation of economic sanctions, and new opportunities for investment and growth. An improvement in the non-oil trade might be another blessing.

A brief look at the anticipated behavior of these basic indicators shows the gravity of the country’s economic problems in the remaining months of the current administration and the first months of the new government to be elected in June 2013.

The new year’s GDP growth is variously estimated to be in  low single digits due to a combination of factors: (a) a drastic 50% fall in oil export earnings; (b) considerably reduced domestic and foreign investments; (c) deteriorating business climate caused by open quarrels among top political leaders; (d) lower volumes of capital goods imports due to foreign exchange shortages; (e) increasing bankruptcies and factory closings as the legacy of  poorly managed subsidy reforms; (f) difficulties in conducting international business because of escalating sanctions; and (g) reduced appropriation of development funds in the proposed 2013-14 fiscal budget — the sharpest in the last eight years.  The lowest growth projection is by the IMF at a mere 0.8%.  The highest figure, forecast by private analysts, is in the low single digits.

Continuing double-digit inflation is the second challenge. Endemic to Iran’s post-revolution economy, inflation has been generally caused by: (a) a steady increase in production costs on the part of mushrooming and highly inefficient state enterprises; (b) stagnant productivity of labor, capital, and management; and (c) steady increases in government expenditure, accompanied by perpetual budget deficits. In the 34 years since the revolution, Iran has had only four years of officially balanced budgets. The more recent price hikes, however, are rooted in the Ahmadinejad administration’s monetary and welfare policies, ie: (a) massive monetary assistance to the so-called ‘quick returns’ enterprises (absorbing some IR430 trillion in bank loans) with disastrous results (50% closed down within two years); (b) profligate investments in the low-cost housing project (Maskan-e-Mehr) with no palpable effects on urban housing prices; (c)  spot allocation of funds to ad hoc local ‘development’ ventures demanded by the welcoming crowds during the president’s nationwide tours; and (d) selection of non-professional contractors to undertake gigantic construction  projects. As a result, total liquidity has increased from IR1,640 trillion in 2007 to IR4,780 trillion in 2013—or nearly 300%. Ironically enough, both rising and falling world prices of crude oil (as the lifeblood of the Iranian economy) have contributed to rising inflation, either through undertaking expansive fiscal measures or resulting from budget deficits financed by the CBI’s printing press.

The most recent and sudden surge in consumer prices, however, is clearly attributable to the drastic plunge in the free market value of the rial—from about $1=IR12,000 in December 2011 to about $1=IR34,000 in recent days. The national currency, which had been distinctly  overvalued for years and in desperate need of adjustment, lost its exchange parity overnight once the fresh embargo on Iran’s oil exports and restrictions on the CBI’s operations were announced by the EU and Washington in late 2011 (MEES, 6 August, 2012).

Due to the continued tightening of economic sanctions, the increase in the consumer price index (CPI) is now officially expected to surpass 31% by April 2013—the highest in the region, the fourth highest in the world, and  Iran’s own highest in the last 17 years.  Private estimates go as far as 50%.  A maverick US economist puts it at over 100%. In the months to come, the expenditure of the Nowruz bonus, and continued budget shortfalls, are expected to add at least 6-7% to the current official number.

Unemployment, particularly among educated youth, will continue to be a vexing problem for the government in the coming year – due in part to the anemic GDP growth, and increased entrants to the labor market. Despite President Ahmadinejad’s repeated promises during his tours in 2006, 2008, and 2010 to end unemployment within a year, the total number is currently estimated to surpass 3mn —even with the practice of considering two-hours of work during a week as employment. The latest official numbers show a national jobless rate of 13.5% – with those for 15-24 years old reaching 25.5%. For women, the rate has gone even higher. By private estimates, the national jobless rate is currently no less than 20%—the highest in the last 30 years and among 17 similarly ranked countries. The government’s repeated claims to have created more than a million jobs each year in the past five years have been summarily dismissed by private analysts as incompatible with anemic (or even negative) GDP growth during the period. The combination of inflation and unemployment figures - the so-called ‘misery index’—is now 43.7% – up from 23.6% in 2005. Ironically enough, a factor contributing to higher unemployment has been a phenomenon called multi-jobs occupation. According to official labor statistics, some 25-35% of workers under the Labor Law are ‘double-job’ employees. Similarly some 60% of the public sector ‘managers’ reportedly, have two or more jobs.

The current national exchange rate system is in chaos, and in need of a clear policy. Currently, there are three rates in place – an official ‘reference’ rate of $1=IR12,260 applying to the foreign currency supplied by the CBI for imports of ‘essential’ goods and services. Then there is the ‘free market’ rate, ranging from $1=IR30,000-IR40,000 with no restrictions or regulation for purchase and sales. And then there is an officially administered ‘transaction’ rate that is determined daily, some 20% below each day’s free market rate –  appropriated for ‘semi-essential’ items. With the list of ‘essential’ items frequently changed by the Transaction Center, the perils of perpetual uncertainty and the opportunities for rent-seeking activities abound. Thus, while doctors, nurses, and health officials loudly complain about the dearth of life-saving drugs due to the exchange shortage, fleets of imported luxury cars roam the streets of Tehran.

Although nearly all responsible officials talk about the desirability of a return to a single rate, the goal has so far proven elusive. There is no agreement among senior officials regarding the single ‘equilibrium’ rate. While President Ahmadinejad believes that the current ‘reference’ rate of $1=IR12,260 is the right one, and should be adopted as such, the Minister of Trade and Industry asks the public to “forget about the US dollar at 10,000 rials, and get used to 40,000.”

The banking system is also expected to experience a rough ride in the coming months. All state and private banks - while technically modern, electronically equipped, and functioning normally well—present several problems of their own. Apart from being under universal economic sanctions and badly constrained in their routine international transactions, they suffer from massive debt to the CBI, enormous non-performing loans and a troubling number of bounced checks. The banking system debt to the CBI now stands at IR540 trillion—up 42% in one year. The system’s non-performing assets are estimated to have reached IR800 trillion—up 36% in one year—and an alarming 18% of total system assets. The number of bounced checks has been steadily rising every year in the last five years and now exceeds IR370 trillion—or nearly 5% of all checks issued.

Finally, in the coming year Iran is expected to face a difficult and painful fiscal situation. The proposed budget for 1392 (2013-14), recently presented to the Majlis for ratification, faces an uncertain fate in the coming weeks. The budget proposal calls for expenditure to rise by nearly IR7,300 trillion ($590bn at the official rate) or some 29% over the previous year. Current expenditures are to rise by some 20%, while development outlays are to decline by 4%. While the draft budget’s assumptions regarding Iran’s reduced daily oil export volume, the average price of Iranian crude and total foreign exchange available to the treasury are fairly realistically estimated, there are no guarantees that they will materialize as projected.

A controversial and troubling aspect of the proposed budget is the section dealing with the resumption of the second phase of the Subsidies Reform Program (MEES 14 December, 2012). Irrespective of the acceptability of the proposed figures to the Majlis once it begins to discuss the budget in the next few weeks, the fate of the second phase seems in peril at this juncture. A majority of the Majlis deputies (including the powerful speaker), backed by the Iran Chamber of Commerce and Industry and most private economists, are against an early resumption of the program’s second phase. Given high and rising inflation, the harsh and escalating economic sanctions and the forthcoming presidential elections in June 2013, they believe that the second phase should be postponed until 2014. Private analysts, concerned economists and many legislators also believe that, given the program’s less than satisfactory performance in the first phase, its time horizon, scope of operation, sources of finance and methods of welfare compensation should be totally reexamined, and adjusted.

The president, rejecting the negative evaluation of the program and its alleged negative impact on liquidity and inflation, has adamantly opposed any postponement proposal, arguing that some 30% of the program’s objectives have been fully achieved in the first phase and the rest could be accomplished through a ‘shock therapy’ operation in a final second phase. At the second anniversary of the program in December 2012, he said he wished the naysayers (read: Majlis deputies) would have let him implement the whole program in a single year (instead of five) because the ‘high-minded’ people of Iran were ready for such ‘shock therapy.’ And now, he again asks the Majlis to let him finish the whole price adjustments during the last few months of his administration.

Meanwhile, the president continues to claim that the immediate total energy price adjustment is the “key to curing Iran’s current economic malaise” – without saying how.  In a series of statements during a long speech in the Majlis in January 2013 and a televised dialogue with viewers later, he expanded on his unorthodox and somewhat mystifying salvation theory. Ignoring all evidence to the contrary, he said the early resumption of the second phase was “the only way to bypass and surmount the nefarious aspects of the universal economic sanctions” – without elaborating on the causative links. In yet another perplexing statement during the late February 2013 TV program, he claimed that the resumption of the second phase would be “the best way to reduce the share of oil export receipts in the national budget and the national economy” – again without elaborating on the process involved.

Given the short period left of his lame-duck administration, and the rial’s recent plunge making domestic energy price adjustments to the Persian Gulf levels several times more difficult, it does not look like he will have the chance to prove his points.

Self-Inflicted Wounds
Of the thorny economic problems which Iran is going to face in the coming year, independent of sanctions, almost all are self-induced. They are rooted in a wrong-headed populist strategy of combating endemic inflation by hoodoo remedies. Faced with protracted double-digit price rises caused by perennial budget deficits and excess spending, President Ahmadinejad decided early in his administration to combat this demand-caused economic disequilibrium by focusing on the supply side. Thus, instead of trying to raise revenues or reduce wasteful expenditures, he chose a crowd-pleasing, short-term economic policy of controlling costs - with scant regard for its harmful long-term implications. To keep household and business expenses in check, the government proceeded to hold three vital cost factors -- the exchange rate, interest rates and the basic energy prices— in check through government diktats. The outcome has been a near disaster in all three areas.

The short-sighted policy of keeping the exchange rate artificially overvalued in order to hold import costs down led to a number of troublesome consequences such as: (a) reducing domestic producers’ ability to compete with foreign suppliers; (b) bringing down domestic production capacity of import-competing industries by some 30-40%; (c) idling thousands of workers with each additional billion dollar of imports; (d) worsening Iran’s non-oil trade balance; and (d) giving a hefty subsidy to foreign farmers and manufacturers  The over-valued exchange rate also resulted in increased national dependence on the world economy (even for essential food items). Thus, with the imposition of new tough sanctions on Iran’s oil exports and its central bank operations announced in late 2011, the long dormant pressure on the rial blew up and the current era of exchange instability ensued.

The government’s extensive interest rate regulation must take its share of the blame. Holding interest rates on saving deposits below the inflation rate and keeping bank charges on commercial and investment loans below free-market levels in the bazaar have inflicted immeasurable damage to the economy. Low (and negative) returns on deposits have discouraged savings and parsimony, stifled productive investments had led savers to move their funds from bank accounts to such other outlets as real estate, precious metals and US dollars.  Losing savings deposits has led the banks to steadily borrow from the CBI for their voluntary as well as state-mandated loans. Government dictated loans to favored, but money-losing, projects have been a main cause of the banks’ non-performing assets. Sizeable differences between mandated bank interest rates and the rates prevailing in the bazaar, combined with the small penalty for late repayments of loans, have induced some well-connected businessmen to borrow money from the state banks at rates in the low 20s, lend the borrowed sum in the bazaar at percent rates in the 30s, and postpone repayments of the loans for years at an annual penalty of only 6%! Poor and unprofessional assessments of borrowers’ proposed projects and the concentration of bank loans on a few selected mega borrowers have been other causes of the banking system’s problems. Nearly 80% of the total bank loans are now reportedly in the hands of less than 12% of active businessman.  In the absence of real banking system reforms in the coming year, the situation is likely to get worse - particularly if the sanctions are not removed.

Finally, keeping energy prices artificially down for years has resulted in profligate energy consumption, the continuation of energy inefficiencies, the rise of energy-intensive industries vulnerable to external shocks, a growing need for energy imports, intolerable air pollution and a clear rise in energy smuggling to neighboring countries.

Light At The End Of The Tunnel?
The past Persian year has been described by the CBI governor as “the most difficult” economic year since the 1979 revolution. Yet if the full effects of the harsh and tightening sanctions are allowed to continue or even worsen, the coming months will be just as difficult, if not more so. By everyone’s admission, the broad-based and crippling sanctions have so far failed to impact the Islamic Republic’s nuclear policy and programs. And they have not produced the popular unrest and street riots to force the government’s hand that those imposing the sanctions had hoped for. The Tehran government has not surrendered to the West’s demand and has continued the pursuit of its chosen path. But, continually escalating sanctions are beginning to bite hard, and have taken a very heavy toll on Iran’s middle and working classes, who have seen their purchasing power steadily reduced, their savings depleted and their jobs in jeopardy.  In a recent interview with German broadcaster Deutsche Welle, the Tehran Chamber of Commerce president openly admitted that the middle and lower strata in Iran now face great difficulties in meeting their five essential needs - food, housing, clothing, healthcare, and education.

Whether or not Tehran’s intransigence in the pursuit of its controversial nuclear program is worth so much pain and suffering for the Iranian people is an intriguing question. In the absence of a credible nationwide referendum, it would be hard to know the people’s true feelings about the policy. With the exception of the Islamic Republic’s leaders themselves, whose answer is accurately predictable, there can be only guesses regarding the feelings of others. In general, there is no doubt that the country’s politically conscious citizens must all be proud of their country’s advances in nuclear technology. There is also no doubt that a small but influential group of conservative and xenophobic hardliners continues to insist that Iran will never abandon its current defiant stance and continued hostility toward the West. Likewise, the scientists and engineers currently engaged in nuclear research might be thought to resent being denied their scientific right. Active smugglers and organized crime groups that now thrive on sanctions may also be found to support the status quo. In another perspective, a minority of upper class nouveaux riches—those who reportedly live in $10mn penthouses ‘above the clouds,’ enjoy their $250 dinners at the Milad Tower’s restaurant, purchase their $20,000 outfits at the Giorgio Armani boutique and drive their imported Porsches and Maseratis — may be found not to care one way or the other about the government’s inflexible position.

A secret poll conducted among the country’s middle and lower strata, however, might indeed show that an overwhelming majority of respondents would be willing to go easy on the nuclear issue, a phenomenon that has absolutely no effect on their daily life, in order to receive some relief, which has everything to do with it.

A Possible Respite
Iran’s fundamental economic woes are not all caused by sanctions, and they are not going to go away if sanctions are removed.  Yet no relief from the current economic malaise would be imaginable without some relaxation of these tightening restrictions. Optimism recently expressed by both parties to the Almaty negotiations, and the conciliatory remarks by Iran’s supreme leader in his Nowruz speech in Meshed, offer a glimmer of hope that there might indeed be some light at the end of the tunnel for Iran’s suffering population. The possibility of a new government - economically savvy, politically seasoned and diplomatically adept - being elected in the June 2013 presidential election can only add to this optimism.

*Dr Amuzegar is a distinguished economist and former member of the IMF Executive Board.

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