IMF: Iran Economy Improving Substantially

The International Monetary Fund is forecasting an improvement in sustainability for Iran in 2016-17 as better economic conditions herald more robust growth prospects for the country. According to the concluding statement describing preliminary findings of a recent IMF mission to Iran released on Monday, Iran's real GDP rebounded strongly over the first half of the year as sanctions eased post-JCPOA implementation.

The report confirms that oil production and exports have rebounded quickly to pre-sanction levels, helping cushion the impact of low global oil prices. Increased activity in agriculture, auto production, trade and transport services has led the recovery in growth in the non-oil sector.

 "Real GDP is projected to grow by at least 4.5 % in 2016-17," the report says adding that "prudent monetary and fiscal policies" adopted in recent years, along with favorable international food prices, allowed CPI inflation to decline to a low of 6.8% y/y in June 2016. Although point-to-point inflation has risen to 9.5% in September, IMF staff estimates inflation is expected to average 9.2% in 2016-17.

The Iranian government is implementing far-reaching, ambitious, reforms to support a sustained acceleration in growth, says the IMF.  "To anchor inflation over the medium-term, the authorities have proposed a fundamental overhaul of the monetary policy framework and plan to gradually reduce the non-oil fiscal deficit." They plan to clear government arrears, recapitalize banks and strengthen supervisory powers.

According to the Washington-based lender, new CFT laws have been passed and the government is committed to enhancing safeguards in the financial system to secure better access to the global financial system. The staff sees these reforms as critical if Iran is to harness its re-integration into the global economy to spur growth and become a more market-based, diversified economy.

Raise Revenue, Contain Spending

The mission has also offered some recommendations to support the government’s reform efforts, warning the officials that vulnerabilities are emerging that could erode Iran’s economic achievements.

Among other things, staff estimate that the non-oil fiscal deficit in 2016-17 will increase by 0.5 % of non-oil GDP to reach 8.9 % of non-oil GDP (or 7.7 %of total GDP). Oil receipts to the budget are falling short because of the need to repay to the NDFI (the national wealth fund) the funds that were borrowed last year. As a result, the overall fiscal deficit is expected to deteriorate to 2.7 % of GDP in 2016-17 from 1.7 % of GDP 2015-16.

With economic activity recovering briskly, the IMF notes that recalibrating monetary and fiscal policies at the margins will help keep inflation in single digits. Safeguarding the reduction in inflation will be essential to preserve the credibility of Iran’s reform efforts and ensure the planned unification of the exchange rate is durable. Adjustments in administered prices should be compatible with the objective of single-digit inflation.

Steps to manage credit growth, for example, by slowing or halting the pace of expansion in directed credit schemes or implementing differentiated loan-loss provisions, would help stem the build-up of additional liquidity pressure. The Central Bank of Iran should also assess what additional steps it can take to absorb excess liquidity. Fiscal policy also needs to help by avoiding excessive pro-cyclical stimulus. Every effort should be made to step up revenue collections and contain spending, including by removing high income households from the subsidy beneficiaries list.

The Fund also emphasizes enhancing the ability of the central bank to safeguard price stability. The proposed Central Bank Bill correctly places price stability as the core objective of monetary policy. However, the proposed governance structure of the CBI is complex and decision-making committees are dominated by representatives of other government agencies. To enhance the ability of the CBI to pursue its inflation objective independently, IMF staff recommend that the number of governing bodies be streamlined and membership limited to senior CBI officials and/or independent experts.

"The central bank will also require instruments to intervene and manage liquidity to guide interest rates. The authorities should start issuing appropriate instruments, for example government bonds or central bank paper, for this purpose and allow for the possibility of an emergency liquidity facility at the CBI."

The Fund recommends the 2017-18 budget be guided by the need to gradually reduce the non-oil deficit in line with the permanent income norm not only to support low inflation but also to adjust to lower oil prices and higher debt service costs. "The government appropriately intends to increase non-oil revenues to secure this adjustment and provide non-inflationary resources to fund higher public investment spending."

Provisional estimates by IMF staff suggest public debt could be as high as 40% of GDP once government arrears to the private sector are recognized. The Debt Management Office has adopted a prudent and phased approach to securitize part of these obligations. Going forward, the cost of securitization of the remaining stock of arrears is best borne by the government given its fiscal origin. Securitization with new debt issuance would deepen local debt markets and could provide the CBI with an instrument to manage liquidity. It will be important to ensure the interest costs associated with new debt are adequately budgeted for.

Reforms

According to the Fund, fundamental overhaul of the banking system is needed to help unleash higher growth in the private sector. Capital is low and the stock of non-performing loans remains high despite the securitization of government arrears and steps taken by the supervisor to require higher provisions. Policies of interest rate controls and directed credit constrain banks’ profitability and capacity to build capital.

The financial sector reform strategy must ensure that the problems in the banking sector are fully addressed to lift financing constraints to growth. Staff suggest banks undertake forward looking tests of their commercial viability as part of an asset quality review. Where such tests identify shortfalls in capital or risk management practices, banks should be required to present and implement time-bound plans to remedy these shortfalls.

Any bank that is not viable after such a process should be resolved. To enhance the commercial orientation of the state-owned banks, the burden of government-mandated credit policies should be moved to the budget and their recapitalization needs met via new long-term government bonds.

The Fund takes note of the fact that the CBI has taken important steps over the past year to restructure and bring unlicensed financial institutions under its supervision, helping address an important source of financial instability. Finally, the Fund says implementation of the FATF plan will bolster Iran’s AML/CFT framework and facilitate re-integration of domestic banks into the global financial system.