Market economy proponents are finally getting some traction in Iran.
At present, all Iranian politicians from across the national spectrum agree that the country needs to open its doors if it wants a prosperous future.
Sanctions were removed five months ago, opening the way for doing business with the international community. The country is emerging from sanctions and recession after weathering multiple crises.
Some, however, are still brewing, like the mounting overdue debt in the banking system, which threatens their solvency.
Economic output and productivity have been hit hard by recession and state coffers have been squeezed by falling oil prices. So the administration of President Hassan Rouhani has had a lot to address in its three-year life. Its grades are mixed, according to Britain-based Iranian economist Mohammad Hashem Pesaran who was recently interviewed by the Persian weekly Tejarat-e Farda.
Rouhani has been quite successful in curbing inflation, aided greatly by falling commodity prices and weak consumer sentiment. The administration has brought it down from over 40% in 2013 to the single-digit neighborhood this year.
While doing so, the government has contained the overdue debt crisis for now and stabilized the Iranian rial. The rial lost 60% of its value during the prior administration, as a result of its inefficient fiscal policies and after sanctions caught up with Iran.
President Rouhani inherited a mess, it comes as a great surprise he did not sink in it. However, the incumbent president was elected on the promise of swift reforms and sound decision-making. And here Pesaran is left dissatisfied.
Iran’s main hindrance for business is its multitude of bureaucratic regulations, which was in some cases “calibrated to help evade sanctions”. Now that those sanctions are gone, directives made to manage them should follow suit.
“In a situation where an economy is isolated, it will create permits to protect it from liberalization and interaction with other economies,” he says.
Furthermore, nationwide cash handouts, a multiple foreign exchange rate regime, efforts to prop up the rial’s value and fixing and subsidizing energy prices weigh heavily on the state’s shoulders and threaten the fragile stability Rouhani has achieved.
Petrol Prices “Politicized”
Fuel prices in Iran have been heavily subsidized for decades. It has been so with all Middle Eastern oil producers. But these subsidies bring heavy costs both in dollar terms and in opportunity cost.
Attempts have been made to move prices closer to international levels. The drop in oil prices provides a great opportunity for liberalizing fuel prices. Its cost and the shock to the economy is far weaker when oil is $50 a barrel rather than $100.
But as Pesaran acknowledges, “the price of gasoline is highly politicized”. This has actually weakened the resolve to liberalize fuel prices, as cheaper oil means less subsidy costs.
The University of Cambridge professor also pointed out another brewing problem: the foreign exchange policy. As with most economists, he is in favor of unifying the foreign exchange rates. The Central Bank of Iran has promised to adopt a managed float policy, in which exchange rates are allowed to fluctuate under close watch of the bank.
“I definitely believe in unified exchange mechanism but the issue is real exchange rates,” said the professor.
The rial kept steady throughout last year, while the difference between Iran’s inflation and that of the dollar or the euro is over 10%. Normally, this should cause the rial to depreciate. But a combination of limiting imports and trading by the central bank has stopped the rial’s weakening.
If this situation continues, a sharp devaluation awaits the rial, unless the central bank, as in the past, wastes its reserves on defending the currency.
“Considering the difference between inflation in Iran and the world, currency stabilization actually means postponing depreciation and laying the groundwork for a possible crisis in the future,” he said.
These said, Pesaran acknowledges that Rouhani was all caught up in negotiating a deal with the West for half of his term.
“The Rouhani administration spent two years trying to remove economic sanctions and did not have the opportunity for reforms. They did not have a choice in this. Without resolving the sanctions issue, it was difficult to decide on the prospective direction of the Iranian economy,” he said.
Shying Away From the Necessary
The real problem in carrying out economic reforms is the political aspect of things. Some political groups stand to lose in a market economy, as they lost profits when sanctions were lifted.
Also, misrepresentation of politically charged subjects like fuel prices and exchange rates can swing votes from one party to another easily. This cost makes any party shy away from doing the necessary.
“The common point about business regulations, foreign exchange, subsidies and fuel pricing is their political aspect and thus I believe a consensus needs to be reached among various groups to move the economy forward,” he said.
“Populist policies are a relic of the past and should be reformed and replaced. Iran’s economy needs deep changes and the only way is to carry out structural changes to increase its competitiveness.”
These reforms are needed, if Iran is to reap the benefits of sanctions relief. Connection with the international community is key, but Iranian banks are struggling to reconnect with their global peers.
Iranian banks say Europeans are reluctant because they fear being penalized by the US for running afoul of remaining sanctions. Europeans banks contend that the risk of doing business with Iran is too high and that Iranian bank structures are opaque, falling short of international standards. Both arguments have merit.
Way to Go: Teaming Up With IMF
In all, there is a lot to do. However, governments become conservative in their final year, hence no drastic changes are likely in the coming months.
Pesaran hopes the next government continues the path of reason. He is concerned about how oil income is used in the future.
“We should be very careful when we spend petrodollars in Iran. Oil revenues should only be used to build infrastructure,” he said.
“Iran cannot forget petroleum. Oil, gas and petrochemicals are Iran’s competitive advantage, but Iran’s sovereign wealth fund should be boosted to expand manufacturing and non-oil exports.”
