IMF First Deputy: Iran Economic Recovery Extending Beyond Oil Sector - EXCLUSIVE

The fact that Iran’s economy is facing major challenges is well acknowledged.  Its heavy reliance on oil export revenues and the dominant role of the state in the economy combined with the dire straits of many of its banks are more than enough to raise alarms.

However, there is widespread consensus among international observers that the country also has bright prospects if it taps into its potentials, including natural wealth and human resources.

IMF, as an international institution privy to Iran’s workings, has projected real GDP to grow by at least 4.5 % in fiscal 2016/17 – thanks largely to ramped-up oil exports as the sanctions fade.

The Fund’s First Deputy Managing Director David Lipton says with inflation being anchored in single-digits, Iran’s economy is growing well beyond its familiar petroleum sector.

What follows is the second and final part of Lipton’s interview with the Financial Tribune which took place on the sidelines of the joint annual meeting of the IMF and the World Bank held last month in Washington D.C.

Financial Tribune: Iranian banks we have a lot of problems; NPL ratio is around 12%, and the central bank wants to bring it down to a healthy level. However, the point is that in the end, policymakers do not want to see a run on the banks. Lenders apparently do not have enough motivation to clean up their balance sheets and we have the problem of how policymakers can motivate banks to do so.

David Lipton: It is an important issue. As you know I visited Tehran in May and what I know about this issue is what I learned there in discussions. Firstly, and I think most importantly, the problems of Iran’s banks really have to be tackled. If there is an attempt to use liquidity creation to make sure banks are always in a situation where they do not have to deal with their problems, it will undermine the key objective of bringing inflation down and keeping growth going. That is the first priority to deal with the actual problem rather than to try to postpone dealing with the problem.

Secondly, I think our conclusion has been that it will be very important for the central bank to have sufficient authority and legal power to conduct the needed restructuring in the banking system. That is best done by the passage of the new Central Bank Law and separate Banking Law that are under consideration, depending of course on the nature of the legislation. But if the legislation is successful, it would be giving the central bank the authority to require the banks to meet certain capital standards by certain times, and it will permit the central bank as a supervisor to have a stronger say in how the banks manage themselves as they meet the new capital standards. There are a range of powers the central bank will have that will allow it to have a restructuring process including dealing with NPLs among other subjects.

In the last published IMF report on Iran, your colleagues did not indicate  that the exchange rate was not competitive, and did not ask the central bank to consider eliminating exchange rate controls to create the conditions for sustainable growth. Why?

Let me just talk about the future: growth has been restored in Iran and the fact is that it is now estimated to be rising even a bit faster than we thought when I was there in May.

But the growth is not broad-based, and it is mainly due to higher oil production.

I understand. The other important accomplishment is that inflation has been reduced and keeping it down is the key to maintaining the kind of macro-stability that will give the country competitiveness beyond the oil sector. You are right that one needs to have a competitive exchange rate, but at this point and given the exchange rate system you have, the main determinant of whether there will be an environment where there can be competitiveness beyond the oil sector and job creation especially for young people, is to be successful in keeping the inflation rate appropriately low and stable. There is plenty of time to consider whether the exchange regime remains appropriate for the country. That is a big question that every country can ask itself from time to time.

Moreover, monetary policy has to be managed in a way that is consistent with the choices that have been made about exchange rate policy and the system has to have an anchor. The anchor that has been chosen, the exchange rate, may have been changed here and there, but at any given point in time, if you intend to maintain the exchange rate as the anchor, you then have to live with managing monetary policy in a way that keeps inflation under control and maintains competitiveness. In addition, we have observed that industrial production has picked up rapidly over the last year and reached almost pre-sanction levels suggesting the recovery is extending beyond the oil sector aided by low inflation and more stable exchange rate.

Maybe what I want to ask you is not related to our conversation. Recently LSE said that some of the academics, who work there, are not allowed to recommend anything about Brexit to the UK Foreign Office. This kind of nationalism is very new. Do you think that this kind of nationalism is a problem for the future of the world economy and could lead to trade barriers and undermine global welfare?

The IMF’s view is that openness, interconnectedness and free trade have been of huge benefit and should continue. There should be an effort to maintain connections and to take advantage of all the opportunities that the international economy has to offer, whether it is in trade, services or the know-how.

After the JCPOA, we thought that something big had happened, but since the implementation day, we have problems to reintegrate with the international banking system and even now big banks do not want to do business with Iran. How can we convince them and how long will it take to make sure the big banks work with Iran?

As you know, there are two categories. Certain international sanctions were removed, and the US sanctions that remain, still prevent US banks from doing business with Iran. So, we are talking about other banks. In that case, both while I was in Iran and in conversations and examinations since then, it is clear that the international banks have a great interest in coming into Iran. They see great promise and great profit opportunity.

However, they still remain concerned about the risks of doing business in Iran not because they are restrained by sanctions, but because they think if they engage in business with Iran and one way or another end up with financing activities that lead to a penalty, because there are many activities where they could be penalized, that would make all their efforts unprofitable. This is what we are talking about here.  Iran has passed legislations, the so-called AML and CFT legislations that give the central bank a legal basis for developing regulations that will allow them to prevent and monitor anti-money laundering and counter financing of terrorism activities in banks. This is not a quick or easy process. Iran’s central bank has asked the IMF to help assess the subject which is going to take place in the next year or year and a half. It has asked for technical assistance from the World Bank and elsewhere.

This important work has to be done to make international banks comfortable. There are many other countries where international banks similarly make a decision of “we can go in, we cannot go in” based on the quality of AML and CFT regimes and the implementation of those regimes in individual institutions. I think there is every promise that if Iran is patient and diligent about the implementation of AML and CFT regimes, this can work out.

International banks are eager to establish banking links with Iran to help companies around the world and their customers do business in Iran. Iran has quite impressive economic prospects if it pursues the kinds of reforms that will allow the non-oil sector, a diversified non-oil sector, to become an engine of growth.