May 17, 2016
On May 15, International Monetary Fund (IMF) First Deputy Managing Director David Lipton arrived in Tehran to discuss economic developments and policy initiatives following the lifting of sanctions. He told Iranians that “your ultimate success depends on what you do at home” in a speech at the Central Bank on May 17. Lipton highlighted areas for improvement in the banking sector that could help attract more foreign investment. He also emphasized the need to build a strong and flexible economy that will be less dependent on the oil sector.
During the two day visit, Lipton met with senior government officials, private sector representatives, bankers, academics, and students. “With an improved economic outlook in prospect, there is a unique opportunity to begin implementing reforms to entrench macroeconomic stability and promote higher sustainable and inclusive growth,” he said at the end of his trip. The following are excerpts from his speech and concluding statement.
I speak here today at a pivotal moment for Iran’s economy. With important sanctions lifted, your country has a new opportunity to deepen its integration into the global economy. That process has the potential over time to support faster growth and rising living standards for Iranians.
But positive results depend on overcoming two major obstacles as well. The first is navigating a difficult global economic situation. And the second is building a competitive and flexible domestic economy that will serve as a suitably strong platform for growth. I want to talk about those challenges today.
But first, let me say a few words about the IMF and how we have been helping Iran for several decades. The Fund’s membership of 189 countries has given us the responsibility—among our many mandates—of analyzing and advising members on economic trends at the global, regional and country levels. This has placed the Fund in a unique position to assess and compare country experiences, and by sharing those assessments and experiences to help countries chart their strategies, particularly at times of momentous change and opportunity. We have used these experiences in our policy dialogue with Iran for many years and I believe our perspectives now, at a historic time for the country, could be especially helpful in thinking about future prospects.
The Global Outlook
First, the global growth outlook is for continued recovery, but one that is weak, and holds formidable economic and political downside risks. The bottom line for Iran is that in the near future the global economy is unlikely to be the driving force to lift up emerging economies that it was in the past.
Our most recent forecast has global growth remaining largely unchanged this year at a subdued 3.2 percent rate, with only a slight increase to 3.5 percent in 2017. Overall, the outlook has weakened a bit over the past half year.
Emerging and developing economies will still account for the lion’s share of world growth. But their prospects remain subdued, particularly for two reasons that are important to Iran: the sharp fall in commodity prices led by oil, and China’s economic rebalancing.
Meanwhile, the modest recovery in advanced economies is expected to continue. But unresolved crisis legacies continue to weigh on growth. In many parts of Europe, for instance, sovereign and private sector balance sheets remain highly leveraged, and some banks are facing high nonperforming loans.
We are also witnessing increasing downside risks:
• The global slowdown is hurting bank balance sheets, and financing conditions have tightened considerably.
• Emerging markets face excess capacity in some sectors, capital spending is declining, and private debt—often denominated in foreign currency—is rising.
• We have witnessed an increase in financial market volatility Emerging market currencies have weakened—and some equity markets have fallen sharply.
• There has been a retrenchment of global capital and trade flows. Emerging markets last year experienced about $200 billion in net capital outflows, compared with $125 billion in net inflows in 2014.
• Inflation has fallen to historical lows, too low in fact. With headline inflation in advanced economies last year at its lowest level since the financial crisis, emerging markets’ core inflation well below central bank targets, the world risks a debilitating disinflation.
The Outlook for the Iranian Economy
So, what does all this mean for Iran? I suggest that while Iran will gain from pursuing integration with the global economy, your ultimate success depends on what you do at home: strengthening macroeconomic policies in the short run and forging ahead now with deep structural reforms for the long run. It is time for a plan of action on the economy. Let me talk about the short run and long run components in turn.
Iran has already taken important measures to secure macroeconomic stability, including an important decline in the rate of inflation. That was done despite an episode of increased costs of trade and financial transactions, and limited access to foreign exchange assets that caused inflation to jump and the rial to depreciate significantly. That achievement will serve Iran well as its implementation the Joint Comprehensive Plan of Action continues.
With the oil sector regaining access to export markets, with businesses and banks facing lower transaction costs as they reintegrate into global trade and financial systems, both the oil and non-oil economy will gain.
But the global economy poses challenges that could eat into those gains.
• Like other oil exporters, Iran has to manage the transition to lower oil prices. Although the impact of lower prices will be partly mitigated by higher oil export volumes, there are limited prospects for a large increase in Iran’s oil revenue because of high global output and weak demand.
• Second, Iran’s non-oil exports also are feeling the effects of weak global demand—something that all exporting countries are experiencing. Some of that comes from slower growth in China.
• And third, global lenders and investors have become more exacting and cautious, differentiating among countries according to how sound and reliable their policies are and how stable their fiscal, monetary and financial systems are.
So this is a time for convincing macro policies and clear communications:
• To sustain the recent success in the battle against inflation, liquidity growth needs to be contained. This can anchor inflation in single digits, reduce potential pressure on the exchange rate, and help maintain the competitiveness of the non-oil sector. In addition, Iran’s commitment to exchange rate unification will be critical to entrenching economic stability.
• The banking system needs to be able to effectively channel credit to the private sector. This will require addressing the high levels of nonperforming loans, bolstering bank capital, restructuring weak institutions, dealing with unlicensed financial institutions, and strengthening risk management systems and bank supervision.
• And fiscal policy also has an important role to play. Iran’s fiscal policy would be most effective by focusing on a gradual reduction of the non-oil deficit. But instead of cutting spending, it might be better to mobilize more non-oil tax revenue. That would create space for increased public investment in infrastructure and human capital.
Global Experiences: How to Build a Strong and Flexible Economy
The second topic I promised to address is building a competitive and flexible domestic economy that will serve as a suitably strong platform for future growth.
Future sustainable growth will depend increasingly on the performance of the non-oil sector, which is where almost all job creation will have to come. That, in turn, points to the need for a reorientation of the Iranian economy—both to take advantage of the opening to international trade and investment and to unleash entrepreneurial forces that can spur investment, lift productivity, provide jobs, and raise living standards.
I spoke earlier about the perspective on economic trends that the IMF brings to bear across countries and regions. I would add that we also can draw upon decades of experience with economic transformations. This global and historical frame of reference is very useful in assessing where Iran now stands and where it might go in the coming years.
There are several important examples in recent years of economies that have emerged into the global economy after periods of relative isolation—or even closed doors. We have witnessed Latin America successfully abandon years of import substitution policies after experiencing hyperinflation and a debt crisis that brought their economies to a standstill.
China opened its doors beginning in the 1970s to emerge a generation later as one of the two largest economies in the world. In Eastern Europe, the collapse of the Soviet Union sparked a profound restructuring of many economies that today have largely integrated into both the European Union and the global economy. And Korea dismantled close connections between companies, their banks and government that had led to a lack of competition as well as a borrowing binge that was disconnected from enduring profit prospects.
I am not suggesting that Iran is the same as these other countries. Far from it. The point is simply to say these are experiences that policymakers in this country can study and draw upon.
Let me list a few lessons that emerge from other countries’ experiences:
• One that has been heeded here, though it is important continually to bear in mind, is that a loss of monetary stability can undermine structural reforms and set back growth for a long time. Well intentioned reform plans have been undermined by attempts to use liquidity to address real and structural problems, ending in inflation and exchange rate depreciation.
• Another is that a lack of competition both limits growth and can breed corruption by sustaining economic rents to be fought over. Protection from global competition, through import tariffs and other restrictions, and domestic monopoly rights, created by law and regulation, deprive consumers of the benefits of better quality products at low prices. And they prevent the job growth that would come from vibrant competition among new enterprises, and which is badly needed in countries with a large and growing youth demographic.
• Ownership links between companies and banks eventually lead to conflicts of interest, excessive and irresponsible borrowing and lending and debt problems. When such relations involve state owned enterprises and banks, the debt problems often end up weakening or even crippling public finances with dire growth consequences. Reforms to privatize state enterprises, and to separate companies and banks lead to improvements in governance and more responsible decision making as each has to face a hard budget constraint.
We have seen these problems play out in many of our member countries. And we have seen how countries—from Peru to Poland, China to the Czech Republic—that have managed to stabilize, liberalize, privatize, and open up have seen those actions pay off over time in investment, productivity and trade. Through the process of liberalization, competition leads to more efficiency, less corruption, and higher productivity. Privatization and governance reforms prevent the misallocation of credit and thus allow the private sector to grow and create jobs for young people and room for the middle class to thrive.
The Challenges in Iran
How does this fit with the current situation facing Iran? If there is a consensus that Iran needs to become a more open and integrated economy, then this is a key moment to take a broad perspective and make the most of the opportunity.
In our advice to the Fund’s membership at last month’s IMF Spring Meetings, we highlighted structural reforms for all countries as a crucial element in the quest to boost growth and create jobs. Some of these structural reforms would likely benefit Iran. They are, in essence, built around the principles of liberalization and privatization,
• Opening up product and services markets can be particularly effective because they bring short-term gains. They can spur more competition, and increase integration with the world economy. They can help create high-quality jobs for the younger generation of Iranians.
• Labor market reforms can be particularly effective in drawing people into the workforce. This approach could be considered in Iran, where unemployment remains high, and demographic pressures will continue to bring large numbers of new entrants to the labor market in the coming years. But it is important that some measures—tax cuts and training programs—that have fiscal implications are able to fit within the broad fiscal framework.
• Another area of structural reform is the policy mix that can help to foster innovation. This can be achieved by removing barriers to competition and foreign investment, reducing the hold of monopolies and special interests, cutting red tape, and increasing investment in education and research. Countries are finding that increased openness to foreign investment can facilitate technology transfers and enhance access to foreign markets. They are trying to reduce the cost of doing business, address vulnerabilities in the corporate and banking sectors, advance privatization, and foster financial transparency and a level playing field for all investors and entrepreneurs.
Iran faces a unique set of issues related to the reintegration of its banks to the international financial system. The Iranian authorities have made recent progress in the establishing a framework aimed at combating money laundering and the financing of terrorism. This is a critical element for reconnecting with the international financial system. The IMF will continue to support the Iranian authorities’ efforts in this area.
Let me conclude with the big picture. The opportunity for Iran to deepen integration into global economy is coming. Development that builds on the economic stabilization already achieved, combined with new reforms, can unleash creativity and entrepreneurship that hold great promise. By continuing to strengthen its economy, Iran can change the lives of its own people, particularly the younger generation, and build a legacy for the future. That is a challenge befitting a country with a heritage like Iran’s.
The experience of countries going through similar challenges shows that successful reforms require leadership and popular support. There inevitably will be costs and dislocations, but they ultimately will be outweighed by the long-term benefits.
A more prosperous Iran also can help to put the global economy on a sounder footing. The process of reintegrating with the global economy will not be without its challenges, but the potential rewards are worth the effort.
Iran has been a respected voice of economic cooperation at the IMF for many years. Its voice can only be enhanced by taking the steps now to build strong, sustainable and inclusive growth. The IMF looks forward to working with Iran on this endeavor.
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