Iran stands at a crossroads

The prospects for the struggling economy are weak unless there is a permanent deal to fully lift the sanctions imposed on the country. Published in MEED, 22 June 2014

The Sunni Islamist insurgency that engulfed Iraq in June adds a significant new dimension to Tehran’s negotiations with the US over its nuclear programme and the lifting of economic sanctions.

It is an important opportunity for the Islamic Republic, which has been crippled by the penalties. As the only external state actor able to exert quick military strength on the ground in Iraq to resist the advances of the Islamic State in Iraq and Syria (Isis), Tehran suddenly finds its negotiating position strengthened at a key moment.

It has not been easy trying to run the Iranian economy lately. International sanctions have been biting ever deeper, cutting off the main source of government revenues and contributing to a sharp rise in the exchange rate. At the same time, much-needed reforms of the domestic subsidy system have helped lead to very high inflation, with annual price rises hitting 45 per cent in July last year.

According to the Washington-based IMF, the economy shrank by almost 6 per cent in the fiscal year to 20 March 2013 and is thought to have fallen by a further 1.7 per cent in the following 12 months.

Unemployment remains high at above 12 per cent, and twice that for young Iranians; it is expected to carry on rising in the coming years.

In February, the IMF sent a team to Tehran to conduct its first review of the Iranian economy since 2011. In a statement issued at the end of the visit, Martin Cerisola, assistant director for the IMF’s Middle East and Central Asia department, laid out some of the challenges facing the authorities in Iran.

“Large shocks and weak macroeconomic management over the past several years have had a significant impact on macroeconomic stability and growth,” he said. “A combination of shocks associated with the implementation of the first phase of the subsidy reform, ambitious social programmes inadequately funded, and a marked deterioration in the external environment stemming from the intensification of trade and financial sanctions, have weakened the economy.

Reforms required

“Iran now stands at a crossroads. With risks that the economy could continue to face a low-growth and high-inflation environment ahead, there is a need to begin advancing reforms to promote stability, investment and productivity.”

The authorities will have to proceed carefully, however, to ensure that any reforms they do bring in do not make the situation worse, not least with the next phase of subsidy reforms.

While this paints a fairly bleak picture of the economic environment, there have been recent signs of progress to offset at least some of the gloom. The election of Hassan Rouhani as president in June last year heralded a period of more astute economic policymaking and management. Inflation has been falling back, dropping below 30 per cent in December, partly as a result of tighter credit control by the Central Bank of Iran.

The government is also being more careful with its spending plans. The budget for the current fiscal year was set at $295.6bn, some 7.6 per cent higher than the previous year, but that increase is well below the rate of inflation, so in real terms the government is cutting back. According to Turquoise Partners, a Tehran-based investment firm, capital spending is up by 9.7 per cent to $221.8bn.

Rouhani’s election also marked the start of a cautious recalibration of Iran’s relations with the outside world, leading to a deal with the US and other international powers in Geneva in November to ease some of the sanctions on Tehran.

Economically, the most important aspect of the interim accord was a decision to allow Iran to resume oil sales to some international customers, notably in Asia. There was also some easing of restrictions on items such as aircraft spare parts.

Most sanctions remain firmly in place, however, and although there has been a steady stream of trade delegations arriving in Tehran from Europe, Asia and elsewhere, few international investors are in a position to sign any deals.

The interim deal expires on 20 July, although developments in Iraq look set to ensure a continuation of discussions irrespective of the nuclear talks.

Modest growth

Without any deal, the IMF expects the economy to return to growth in the coming years, helped by more sensible policy making in Tehran. But the rates it is predicting are very modest, with an anticipated 1.5 per cent expansion in the current financial year and 2.3 per cent next year.

A key factor is low oil revenues, which the IMF thinks will continue to fall in value, dropping below $50bn in 2015/16. That restricts the amount of money the government will be able to spend and, given the sanctions, there will not be any international private sector investors to fill the gap either. If Iran is to really recover and make up the ground it has lost in the recent past, it needs a deal to lift the sanctions on a permanent basis.