Report: Iranian Economy at Crossroads

May 11, 2016
Iran’s political elite is divided on what direction to take Iran’s economy. One camp, consisting of President Hassan Rouhani and his centrist and reformist supporters, prioritize economic growth through greater cooperation with the outside world. “The second force, as represented the hardliners, the ruling clergy and the Islamic Revolutionary Guards Corps (IRGC), would prefer to retain the current economic structure, as these forces maintain a significant stake in the economy,” according to Zubair Iqbal, a scholar at the Middle East Institute. The following are excerpts from his new paper.
 
Iran’s Economy Post-Sanctions
 
The Iranian economy is at a crossroads. Hard choices will have to be made in the wake of changing international conditions and the global oil outlook. The lifting of sanctions following the nuclear agreement has the potential to reinvigorate growth. Steps taken over the past few years have helped contain inflation, reduce some subsidies, and achieve a degree of exchange rate stability with some growth. However, the economy remains weak.
 
Unemployment, especially among the younger generation, remains high. Prospects for the current year look better in light of the easing of financial constraints following the release of large official foreign exchange reserves, higher oil production, and improved market confidence leading to higher investment. Iran’s fiscal position will likely be consolidated further if planned revenue measures, including an increase in VAT and elimination of tax exemptions and a reduction in subsidies,  are implemented, which, combined with higher domestic production and imports, could further reduce inflation.
 
However, the Iranian economy is confronted with a dramatic fall in oil prices. It is compounded by the requirements of time-consuming and expensive investments in reviving output toward its pre-sanctions level of about 4 million barrels per day and rising domestic demand. While an increase in oil output and related investment would help increase GDP, lower export prices will likely further weaken the external position and the budget. With limited prospects, at present, of any meaningful supply restraint agreement among the major oil producers, oil revenues for the next 3-4 years could be up to 30 percent lower than those projected on the assumption of a strong recovery in 2016. Similarly, there would be little accumulation of foreign exchange reserves that have served as a cushion against future uncertainties. In this event, there would be little room for expansionary policies to reinvigorate growth. Thus, downside risks to growth have increased.
 
At the same time, the Iranian economy is saddled with significant structural distortions that continue to constrain its growth outlook. Critical prices, including exchange rate and interest rates, are still out of line; the financial sector is burdened with large nonperforming loans; the private sector faces weak demand and inadequate availability of credit; and government arrears have accumulated while subsidies remain large. Public sector entities control a significant share of the economy and access to bank credit. Governance of the private sector and the business environment is inadequate and nontransparent, undermining private investment. Increased regional instability as well as uncertainty with respect to the implementation of the nuclear agreement further compound downward risks.
 
Domestic Vs. Regional Priorities
 
Broadly, Iran aims to accelerate economic growth under the existing political structure while simultaneously strengthening its regional strategic position. Within the Iranian political elite, however, lies two competing strands. One, as represented by the reformists and the technocratic government of President Hassan Rouhani, prioritize economic growth. As such, they are more inclined to seek a regional strategic balance and greater cooperation with outside powers in order to serve their economic agenda. If the authorities choose to liberalize the economy through widespread economic reforms, and reduce the role of the inefficient public sector, domestic political power would likely shift in their favor.
The second force, as represented the hardliners, the ruling clergy and the Islamic Revolutionary Guards Corps (I.R.G.C.), would prefer to retain the current economic structure, as these forces maintain a significant stake in the economy. …

Iran’s Policy Options
 
Iranian authorities could pursue three broad strategies in the current circumstances: (a) maintain the status quo, (b) implement widespread and coordinated reforms, or (c) implement mild politically-neutral reforms. The third option would ease some constraints on private sector investment and fiscal consolidation in response to lower oil earnings, but leave the economic and political structure broadly unchanged. …

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