CALM DURING THE STORM

Iran 2011 | ECONOMY | REVIEW: ECONOMY

Over the past decade Iran's economic growth has been robust and its external position has strengthened thanks to a favorable oil price and pro-cyclical economic policymaking.


The performance of the Iranian economy has been buoyant in recent years, benefitting from a strong oil price and expansionary fiscal and monetary policies. Nominal GDP was estimated by the IMF to be $333.1 billion for 2008/9, with projections for 2010/11 of $353.7 billion. Real GDP growth was estimated to have averaged 5.6% over 2Q 2005-1Q 2009, tapering off down to around 2-2.5% during 2008/9 in response to fluctuations in the international crude oil price. Gross official reserves reached $80.5 billion, sufficient to cover 12 months of imports by September 2009. The Central Bank of Iran (CBI) has used this opportunity to calm inflation, with estimates for the end of 1388 (corresponding to the end of 1Q 2010) of 10.8% for consumer price inflation (CPI). Despite the drop in the oil price, the current account (CA) surplus ended 2008/9 strongly, reflecting the increasing strength of non-oil exports and the increasingly diverse export basket of the country. The government was able to rely on support from the Oil Stabilization Fund (OSF), which helped cover the projected fiscal deficit that occurred as a result of oil price fluctuations. At the same time, the state budget for 2009/10 was one that sought to rein in government spending and prepare Iran for a new bout of pro-cyclical spending from 2010 on.

ECONOMIC PLANNING

In Iranian economic policy-making, socio-economic development plays an important part. Ever since 1990, the Iranian government has outlined its economic decision-making through a series of Five-Year Development Plans (FYDPs). Prepared and formulated by the Presidential Office, the plans follow the guidelines of the Supreme Leader and are closely scrutinized by the Parliament prior to their implementation. The first development plan covered the years 1990-1995. Subsequent plans focused on reconstruction and later the development of Iran's economy and industrial base, with an emphasis on becoming self-sufficient in producing strategic industrial and agricultural goods, while aiming for an improvement in the living conditions of the people and the social development of the country as a whole.

In 2005, a higher level economic strategic plan, called “Vision 2025", was developed that would help guide the ongoing Five-Year Development Plan (FYDP) process. From an economic point of view, Vision 2025 set the goals of “gaining economically, scientifically and technologically the first position in the Southwest Asia region (including Central Asia, the Caucasus, Middle East and the neighboring countries), by putting emphasis on the production of scientific knowledge and the transition to a knowledge economy". The plan has set a target of $3.7 trillion of investment in all fields of the Iranian economy by 2025, according to Iran Daily.

FOURTH PLAN'S PERFORMANCE

The Fourth FYDP (1384-1389) covered roughly the period from the second quarter of 2005 to the first quarter of 2010. For this period, and in order to achieve the goals set in Vision 2025, the plan foresaw annualized growth of 8%. After realizing 5% and 6% growth in the first two years of the plan, the country reached the target of 8% in 2007. However, as a result of the global economic downturn, the growth rate fell to 2.5% and 2.1% in 2008 and 2009, respectively, according to the CBI's own figures. Although negatively affected by the downturn, Iran was among the few emerging countries that were only affected mildly by the global recession and it managed to sustain its uninterrupted growth pattern by maintaining growth above 2%.

The effect of the global economic downturn reached Iran mainly through decreased revenues from crude oil. As the average sale price of Iranian crude oil decreased from $94 per barrel in 2008 to $64 in 2009, revenues from the sale of crude oil declined by 29% and stood at $55 billion, although Iran's average crude oil production did not change and stood at 4 million barrels per day; 62% of the crude oil was exported in 2009.

The decrease in oil prices is closely related to the government budget, as generally 40% of central government revenues come from oil and gas sales. In the first nine months of 1388 (2Q 2009-4Q 2009), government revenues reached $45.3 billion, some 0.5% lower than the same period in 2008. Government expenditures, on the other hand, reached $61.2 billion, down 1.6% on 2008 figures. Thus, the government budget showed a deficit of $15.9 billion, 8% lower than the deficit for the same period in the previous year. The fact that the Iranian government managed to shrink the deficit in a period when revenues coming from oil and gas were also lower is explained by the 14% increase in tax revenues. This is mainly due to a 16% increase in direct taxes, which make up 73% of tax revenues in the Iranian system. Revenues from both public and non-public corporation taxes recorded growth of 68% and 49%, respectively. The introduction of a value-added tax (VAT) in September 2008 has improved revenue collection means significantly. The VAT is levied at a universal 3% rate, though with exceptions for tobacco (15%) and fuel products (30%), according to the IMF. Revenues derived from VAT are to be equally shared between the central government and the municipalities. VAT has been initially applied to all importers, exporters, and incorporated businesses with an annual turnover in excess of IR3 billion.

Iran is one of the few countries that do not need to resort to foreign borrowing in times of budget deficit. In 2009, the budget deficit was financed mainly through withdrawals from the OSF, in which surplus oil revenues from previous years are accumulated as well as revenues derived from the sell-off of state assets under the extensive privatization program. The share of privatization revenues in financing the budget deficit increased from 3% in 2007 to 15% in 2009, whereas withdrawals from the OSF decreased from 86% to 71% in the same period.

The slowdown in economic growth was also brought about by a tightening of monetary policy by the Central Bank in order to bring down inflation. This policy, accompanied by a cooling down of the economy as a result of the global downturn, was successful as the average annual CPI rate fell to 10.8% in March 2010 as opposed to 25.4% in March 2009. The month-on-month rate was down from 17.8% in March 2009 to 10.4% in March and 9.4% in July 2010. Thus, the economic planners were able to reach the target of bringing inflation down to 10%, as set out in the Fourth FYDP.

While inflation is on the decrease, unemployment in Iran continues to be a challenge. Hovering between 9% and 11% from the beginning of 2007 until the end of 2009, the rate surged up to 14.1% in the first quarter of 2010 and 14.6% in the second quarter. Although the Iranian economy was able to create 725,000 jobs per year during the course of the Fourth FYDP, the targeted 11% unemployment rate could not be achieved due to the large numbers of young people entering the labor force each year.

In 2Q 2009-4Q 2009, Iran's balance of payments registered a deficit for the first time in 12 years. The deficit stood at $4.3 billion as opposed to a surplus over the same period in the previous year, which stood at $20.6 billion. The turn from surplus to deficit in the balance of payments had two causes: First, as explained above, revenues from the export of oil and gas decreased by 33% over the period and stood at $48 billion. Secondly, the capital account deficit surged by 69% in the same period and registered a deficit of $12.6 billion as opposed to a $7.5 billion surplus in the 2Q 2008-4Q 2008 period.

While the decrease in revenues from oil and the deficit on the capital account negatively affected the balance of payments, other indicators showed strong signs of the economy beginning to diversify its export base. The export of non-oil products continued to increase and reached $15.1 billion in 2Q 2009-4Q 2009, registering an increase from $11.8 billion to $14.3 billion in the same period for 2007 and 2008, respectively. The top five importers of non-oil Iranian goods were Iraq, China, the UAE, India, and Afghanistan. Iran's main non-oil exports include chemicals and petrochemicals, dried fruit and nuts, and carpets.

The decrease in imports has also affected the balance of payments positively. In 2Q 2009-4Q 2009, goods worth $47.4 billion were imported, registering a decrease of 9% compared to the same period in 2008. The top five exporters to Iran were the UAE, China, Germany, South Korea, and Switzerland. The main imports included industrial raw materials and capital goods.

The data suggest that although the Iranian economy is still affected by fluctuations in the oil market, the government's policies aimed at diversifying the economy and increasing non-oil exports are beginning to show results. A broader economic base is something that Iran is looking to achieve, so as to maintain growth even during times of commodity price instability. The OSF has been a useful tool to maintain the government's pro-cyclical economic policy set, giving it a breathing space during years of lower oil and gas revenues, and maintaining more broad-based economic growth.

ON TO THE FIFTH PLAN

Policymakers are now preparing the outline for the second five-year period under Vision 2025. The Supreme Leader, Ayatollah Seyyed Ali Khamenei, outlined the general policies of Iran's Fifth FYDP (2010-2015) in a letter sent to President Mahmoud Ahmadinejad in 2009. In this letter, the Supreme Leader pointed out that the objectives of the new plan should include economic diversification to end the government's dependence on oil and gas revenues, the implementation of general policies for the privatization of state companies, and the promotion of competitive markets, so as to realize a sustained annual economic growth rate of 8%. Additional measures include boosting businesses in border regions, decreasing the gap between the rich and the poor, and redirecting government subsidies toward the lower strata of society.

Subsidy redirection has become a major issue for economic planners, and the Parliament has approved a bill that will see domestic energy prices increase, while subsidies on fuel and a broad range of other commodities will be phased out. As the Head of the Tehran Chamber of Commerce, Yahya Ale-es-hagh, told TBY, “On only the question of energy alone, the government is paying $100 billion to support energy subsidies." The Iranian economy has become overly reliant on subsidies, and the phasing out of the system and the re-directing of subsidies more toward the truly needy will reveal a number of efficiencies long hidden in the economy, as Dr. Behrouz Alishiri, the head of OIETAI explained to TBY. The reform bill sees a gradual increase in energy costs to users to Iran f.o.b. prices by 2015, though a substantial range of measures to help ease the country through this transformation is being implemented. Consumers are being educated in how to reduce the wasteful use of energy and in the value of installing insulation, while industry is being encouraged to improve energy efficiency and upgrade inefficient technology. By redirecting revenues away from the provision of subsidies, it is projected that the government will be able to play a greater role in increasing investment and development throughout the economy. So great would the effect of energy price reform and wider subsidy redirection be on the Iranian economy, that the IMF considers that over the medium term real GDP growth could be a full four percentage points higher, making the goal of achieving an 8% growth rate far more achievable.