Domestic Economy

Managing Post-Sanctions Era, Turning Tides

Business & Markets Desk
Managing Post-Sanctions Era,  Turning Tides
Managing Post-Sanctions Era,  Turning Tides

Iran is approaching a turning point in its economic fortunes. Mismanagement of gains from crude oil sales in the past administration, the 2012-13 economic stagflation and the drop in crude oil prices in the past year have made Iran's condition unique, to say the least.

On the one hand, Iran reached a deal with the world powers, promising to mothball much of its nuclear energy program in exchange for the removal of sanctions by the United Nations, the European Union and the United States.

The two main aspects of these sanctions include a cap on oil purchases from Iran and cutting off of all banking ties with Iran, including the expulsion of the Central Bank of Iran from the SWIFT interbank messaging network.

The sanctions are expected to be removed by early next year, as Iran fulfills its nuclear commitments.

On the other hand, given Iran's critical economic state, the removal of sanctions creates changes in many aspects of the Iranian economy, which has to be managed to produce the largest possible push for the economy. The crises in various sectors, the effect of sanctions removal and how it should be managed are the issues covered by a note recently written by top presidential advisor, Masoud Nili, titled "Iran's Dire Circumstances and the Need for Forming Post-Sanctions National Dialogue", Eghtesad Online reported.

As Nili puts it, there are 11 reasons slowing Iran's economic growth and jeopardizing its stability. First and foremost, productive activities are in dire need of financing, because a large part of assets held in the banking system is illiquid, crunching lending.

In Iran, where 90% of all funding goes through banks, the repercussions are far reaching.

"The current credit crunch is the number one threat to achieving an acceptable economic growth and single digit inflation," wrote the economist.

> The Fault in Our Work

The government's "weak fiscal position" due to a drop in oil revenues is adding to the slowdown. Government staff, especially in education and healthcare sectors, are also looking for salary increases in the post-sanctions era, which is unlikely to happen. Oil revenues this year are a fifth of 2011.

Government debt to the banking system, contractors and various pension funds is mounting. The default on these debt or rescheduling repayments has put these sectors under pressure.

Not to mention the economic isolation that draconian sanctions have forced Iran into, widening the technology gap between Iran and developed nations, increasing the cost of commerce and financing, and depriving Iran of export markets.

Furthermore, Iran is one of the least efficient energy users and a high per capita fossil fuel consumer. Cheap energy costs and countless policy experimentations have made efficiency a fantasy. The prospect of 4-5% growth for an economy that faced energy shortages during recession is not acceptable.

Add to those, an inefficient subsidies regime that squanders whatever little resource the government has, water shortage threatening both agriculture and industry, the multiple exchange rate regime where the central bank offers currency at around 20% discount to a select group—making the banking system a breeding ground for corruption—and weak consumer demand brought about by depressed wages and expectation of lower capital good prices in the post-sanctions era.

Moreover, years of central economic planning and state interference in every nook and cranny of the economy have ruined corporate governance practices and weakened the private sector by crushing their competition. Also, botched privatization efforts during the past decade gave control of government companies over to non-executive state organizations or swapped control from one part of the government to the other—as an example controlling interests in the petrochemical industry were handed over from the Oil Ministry to the Defense Ministry.

The privatizations left private companies in far worse conditions than when ownerships were straightforward.

According to Nili, this governance should be changed and a failure to do so will keep pressure on the private sector and scare off foreign investors.

To add insult to injury, countless illegal lenders have attracted a quarter of all the money in circulation with the promise of high returns. Connected to non-government state players, they answer to no regulator, pay no taxes and do as they wish. These credit institutions mushroomed during a period of lax oversight and abundant liquidity.

> Beam of Hope

To fix the situation, structural changes to increase productivity and heavy investment in energy and transport are crucial. But this need comes at a time where government coffers are empty.

The much-anticipated removal of sanctions will end Iran's economic isolation. In turn, crude export levels will recover though low prices will keep revenues depressed.

Also, Iran's frozen assets–$30 billion available for immediate use—will be released. Export costs will drop considerably; some economists think by as much as 30%.

Foreign financing will be available, along with direct investments from abroad. Access to new technologies will resume. Non-oil exports will also grow. Most importantly, banking ties with international players will resume.

But Iran has to manage the transition and avoid pitfalls like falling back into importing consumer goods using petrodollars, or giving away exclusive rights to foreigners.

It should also avoid racking up debt, especially foreign debt, as it could lead to a new currency crisis. The cycle of weakening the private sector and expanding government or state control over the economy must also be reversed.

> Change and its Management

What will be Iran's competitive advantage in the coming years? Not oil.

Though the oil industry will need heavy investment and new technologies in future, its growth will not be the main driver of growth like in the past, partly owing to low expected price levels.

Instead, Iran's cheap but educated workforce, investment in energy-saving solutions and increasing natural gas output along with its wide array of industries that can be made competitive will fuel economic expansion.

"The removal of sanctions will show in the wider economy sooner than affecting government budget," wrote Nili.

In this path, many aspects of the economy, including the banking system, foreign exchange rate regime, energy consumption, healthcare and education, should be overhauled.

Doing so will require unity in policymaking, consensus between the elites and management of public expectations.