Domestic Economy

One Plan, 20 Points

One Plan, 20 Points One Plan, 20 Points

The recent plan of action published by the government to help stop and reverse the economic recession and create conditions for decent levels of growth is still being debated in the parliament. The 18-month plan, which was to be implemented as of Mehr 1 (Sept. 23), was sent to the legislature last month.

Earlier this week one lawmaker said the 20-point stimulus package proposed by the Rouhani administration would soon reach the floor for a final vote, though most parts of the plan do not need parliamentary approval.

What follows are some views and analysis regarding recent economic developments and future prospects.

1- Unprecedented stagflation. Galloping inflation coupled with a serious recession during the past two years (2012 and 2013), is unprecedented over the past three decades if the first few years after the 1979 Islamic Revolution are not taken into consideration. Based on data from the Central Bank of Iran on national accounts since the 1950, such massive decline in the GDP, saddled with 30% inflation was never witnessed for two consecutive years even during the 1980-88 Iraqi-imposed war.

2- Complexity of the recession compared to inflation. In what is known as stagflation, the stagnation factor is indeed more complex and predominant than the inflation segment, simply because it could be the outcome of variations from both the supply and/or demand side. Hence, depending upon which of the two sides is heavier, the exit strategy from stagflation would vary accordingly.  Identification and classification of the causes influencing the 'scale and period of recession' is obviously of importance.  

3- Rising oil revenues and the emboldened government. In the years 2006-2011, the high price of oil in international markets filled the government offers as never before.  As a result the government embarked on a variety of ambitious projects.  These included lending (loans) for the so-called small-scale quick-return businesses, the multi-billion-dollar Mehr housing project (low cost housing for the poor), and the highly controversial subsidy reform program (cash handouts to almost the entire 75 million population) despite huge deficits in the annual budgets.    

4- Dissolution of the powerful Management and Planning Organization (MPO) and poor policymaking. From the mid-2000s (Ahmadinejad presidency 2005-2013) the organizational structure of some key state economic institutions, in particular the MPO, were subject to major upheavals and eventually disbanded. Access to past records and valuable experience which had been treasured in these organization(s) over the years was almost impossible.

5- Stabilizing (fixing) forex rates at the expense of the production sector. For all practical purposes 'stabilizing' the exchange rates of hard currencies despite high inflation and the increasing cost of manufactured products during the eight years was a political decision which bankrupted local manufactures unable to compete with their overseas counterparts.   Although imports with artificially low foreign exchange rates brought windfalls for a selected few, it significantly raised the cost of domestically produced goods. Consequently, locally manufactured products became more expensive than foreign goods.

This resulted in unfair advantage for importers as opposed to local manufactures because of their inability to compete with the cheaper imports.  The outcome was the slow but steady decline and closure of large numbers of factories across the country.  In late 2000, based on the new polices there was a sudden surge in imports because of the 'subsidized foreign exchange rates' to which a selected few  had access. As a result, consumption of households plus production in small-scale industries, which could survive the deadly body blows, became more dependent on imports.

6- Banking system plagued by widespread misappropriation and corruption. The striking disclosure of the one-billion-dollar corruption scandal in the state banking system in the summer of 2010 coincided with the setting of a ceiling for interest rates. One outcome of this was that the banks took a backseat and plunged into further contraction refusing to lend to industries and businesses.  

7- Decline in oil value-added. Oil exports fell to new lows in 2011. As a result, oil production had to be brought down to barely 1.13mbpd -- a substantial fall compared to the 2mbpd a year earlier. The immediate and natural impact of this was a sharp drop in value added revenues reaching a massive 37.4% in 2012.    

8- Declining oil revenues took its toll also on the service sector. Decline in the hard currency income for the government translated into a deficit in the 2012 national budget. The service sector had to take a bigger share of the loss. The 2012 development budget of the government was in the red by 47%, almost half of the 2011 budget.  

9- Decline in industrial sector output due to falling oil production and exports.  Substantial decrease in oil export earnings since 2011, affected the import of raw materials, subsequently reducing the value-added of manufacturing sector and mining industries.

**Rampant Liquidity

10- Factors contributing to the forex crisis. Uncertainty due to the newly-imposed international economic and banking sanctions, decline in foreign exchange supply and the general macroeconomic instability jointly contributed to rampant liquidity. This paved the way for turbulence in the overall economic performance in general and the already fragile forex market in particular.

Artificial stability of the foreign exchange rates and ordering rates lower than their actual value for several years before the crippling sanctions came into effect transformed the currency problem into a crisis.    

11- Difficulty in diagnosing economic ills. The suffocating economy up until 2013 overshadowed the relationship between state agencies and the banks. This problem was so acute that all conventional diagnosis practically ceased to be effective. The banks in dealing with monetary restrictions set aside the compulsions of transparency and barely showed any symptom of the compounding disease. On the other hand, in such environment businesses seldom filed for bankruptcy because they got all the financial backing they wanted.   

12- Two channels transferred the recession to the future. Negative economic growth itself caused and/or intensified the elements that contributed to the stagflation process in two ways.

First, low profitability of businesses resulted in their inability to repay outstanding debts. That increased the non-current (outstanding debts) and financial constraints.

Secondly, reduction in dispensable income of households and by extension their savings prevented them from contributing to any productive investment.  Similarly reduction in consumption of durable goods led to further stagflation (namely in the key real estate sector). Last but not the least, due to the declining purchasing power the preference was to consume less with inferior quality.   

13- Controlling inflation and the forex market.  Since September 2013 up to the present, visible cracks are seen in the huge wall of sanctions as nuclear talks between Tehran and the P5+1 continue on a relatively positive note.  Oil exports picked up during the second half of that year. The concurrence of other positive developments such as restructuring the oil and gas sector resulted in an increase in foreign exchange revenues. The declining inflation patterns commenced at a noticeable pace and relative stability returned to the foreign exchange market. These positive signs became possible by, inter alia, controlling the monetary base and restoring a semblance of economic stability.

**First Priority

14- After President Hassan Rouhani took office in the middle of last year, priority was accorded to curbing inflation. In comprehending the causes contributing to stagflation that had almost paralyzed the economy in 2012 and 2013, the first priority of the government was to arrest the rising inflation.  

The first major move was to implement a free and fair pricing mechanism without government interference or decree by its affiliates and keeping away from stopgap solutions. Instead the government focused on viable solutions to resolve issues contributing to the inflation for which it adopted a monetary base strategy.       

15- Disorganized distribution of cash subsidies in 2010.  what happened in 2010 was unique and unusual to support households at the lower end of the economic ladder grappling with almost daily price rises. It was an unprecedented experience and unique in every sense. The intention behind such social support mechanism was to help the most vulnerable segments of the society. Cash handouts to the general public without targeting the genuinely needy and vulnerable groups, absence of a specific plan to extricate them from relative poverty, lack of proper conditions to improve their quality of life… was and is not inconsistence with known welfare paradigms.

16- Prevention from shock therapies in managing the subsidies was the first cautious step taken by the incoming government. Avoiding triggering uncertainties in the market while efficiently managing the multi-billion-dollar cash handouts demanded professional traits. Because market stability and decline in the pace/extension of stagflation over time could be harmed and hindered with new and unwanted shocks.

17- Effectiveness of attracting investments for 201-14. Increase in investments will emerge beyond 2014-15. Therefore to help arrest the current levels of stagflation, close attention must be paid on four major bottlenecks: sanctions, fall in effective demand, financial constraints, and market uncertainties which could undermine much-needed economic growth.     

18- Preventing the spread of the Dutch disease: Spending foreign exchange earned from oil exports with the aim of creating prosperity and using forex rates as a means to tame inflation are methods which have been tried and tested in the past. One of the outcomes of this process is said to be the Dutch disease. In short, such policies have, among other things, resulted in more stagflation in the industrial and trade sectors.

19- Focus on small and medium size businesses. Ways to address stagflation must be designed in a way that expansion and growth of small and medium size businesses are enshrined in its ultimate goals. True, big business could be a source of great support and help lead the way out of stagflation, but this departure will do little if anything to create the much needed jobs for the army of unemployed.

20- Ineffectiveness of growth in cash flows on real income. Stimulating  demand in a situation where the supply side of the economy is suffering from visible constraints, namely poor finances, imported raw material and capital goods, will further aggravate the situation and lead to higher prices in the volatile market.  This will not help boost growth of domestic production but to the contrary give rise to higher inflation, which in turn will undermine the wellbeing of the masses.