Budget Deficit and Solutions

Budget Deficit and Solutions
Budget Deficit and Solutions

Attention is now shifting towards the potentially hot debate in parliament over the 2015-16 budget bill. Observers across the political-economic spectrum are keen to know how the government intends to address the newly emerging economic challenges in the list of proposals it will soon send to the 290-member legislature.

At the present juncture the crux of the matter for many is understanding the ability of policy tools to reduce the potential budget deficit and fill in the gaps. The most striking feature of what is, and lies ahead, is the plain truth that it is not only the sanctions that are exerting pressure on state coffers. The decline is international crude prices since summer resulting in deep cuts in Iran's oil earnings is exacerbating fiscal instability. So, the question is whether or not government tools are efficient enough to overcome the budget problems.

As things stand now, the sanctions will last until next June and oil revenues could remain depressed because of the pattern of decline in international prices. In short, the Rouhani administration cannot rely on any significant change in oil export revenues and must consider other workable venues to avoid red ink.

One could float the idea that the government should spend less and move within its means. But the reality is that capital expenditure is at the minimum level, and given the current expenditures related to wages of government personnel, it is a extremely difficult to reduce spending. Hence, declining in expenditures would be rather implausible.

There might be two other solutions. First, the government could issue bonds, which is currently under consideration by policymakers. Second, the official foreign exchange rate could rise. Presently the official forex rate is 25% lower than market rates. This gap is big enough to help reduce the budget deficit.                                      

This week’s reports on next year’s budget show the government has decided to raise the currency rates by only 5%. Officials say the greenback in the budget bill has been projected at 28500 rials. As the government needs Majlis approval on the budget, it is understandable for the executive branch to announce that it will not raise currency rates by more than 5%. However, the rate in the budget is different from the official rate. The Central Bank of Iran is the authority that decides the official rates and can raise the stakes if and when necessary. In other words, the budget rate is simply an ex ante rate.

To reduce the budget deficit, raising official exchange rates seems the best available choice that could have less adverse effects on inflation and macroeconomic stability. It is obvious that monetary policymakers are aware of this. Thus, it is highly likely that the rial would be depreciated in the not too distant future.