Economy, Domestic Economy

Looming Budget Deficit Not Insurmountable

Looming Budget Deficit  Not Insurmountable
Looming Budget Deficit  Not Insurmountable

Iran is likely to record the largest budget deficit since the 1980-88 war with Iraq as last year's drop in oil prices proved too steep for the government to swallow. Although budget deficits are a common feature in countries financially dependent on volatile oil prices, the expected lifting of sanctions should mute most worries.

Mohammad Baqer Nobakht, president of the Management and Planning Organization, says the government will collect 22% less revenues than stipulated in this year's budget if business continues as usual. The expected deficit of 520 trillion rials ($15.8 billion) would be the largest since the Iraq-Iran war and constitute around 3.8 % of GDP.

> What Went Wrong?    

The 2014/15 budget was determined on an average oil price of $100, the highest price ever set in Iran's fiscal history. In theory, oil prices started dropping at an apt time - fall 2014, when government talks on the next budget kicked off. Despite official and independent analysis pointing out that the budget should be based on an oil price of around $60 per barrel, the government picked $72 per barrel as the farthest it could go. Brent crude has averaged $59 per barrel since the start of the Iranian year in March to date, a gap of 18.5% with the predetermined price; in contrast with last year's 14%.

The government has tried compensating the high oil price projected in the budget by stepping up tax collection and the sale of state-owned assets and enterprises. Together these two compose about half of the current budget (see graph). The budget depends for 31.5% on oil, which is low given that the share of oil averaged 45% over the past two decades.

Indeed, it seems the sale of assets in particular is giving President Hassan Rouhani’s administration a headache.  Two factors are in play here. One is the economy's shortage of credit, a direct result of banks' refusal to lend, but indirectly caused by sanctions relating to Iran's position in international financial markets. Another is the drop in profitability that many state-owned mining and industrial companies face at a time when global commodity prices have fallen sharply.

> Possible Solutions

Experts believe that the looming deficit should not be used as an argument for cutting back on infrastructure spending. Economist Said Lilaz calls for pushing through financial reforms and incentivizing the private sector to engage in profitable infrastructure investment, estimating that the government could attract at least 400 trillion rials in private investment, which is even higher than the current 300 trillion rials in infrastructure budget.  

Oil exports can also be boosted. In the current budget, the government foresaw average crude sales of 913,000 bpd – a number which could easily be boosted if Iran releases its large oil reserves. Sanctions are believed to be lifted in the coming winter, so that would leave the government three to four months to expand sales significantly. This should be done wisely as some analysts already point out that a flooding of the crude market will cause prices to implode.

One other solution, put forward by Mohammad Ali Kashefi, an economist at Sharif University, would be to let the rial depreciate, which will cause exports to strengthen and dollar-dominated oil revenues to increase. The problem with this proposal is that currency appreciation can only be a short-term and high-cost phenomenon, implying either allowing the CBI to flood the market with rials or for the government to sell its dollars. However experts believe the government should not drop its current contractionary policy and start borrowing from the CBI because this would run against its commitments to reduce inflation.

Significant holes can also be plugged by reforming unnecessary subsidies. The government has already enacted much-delayed legislation taking 2 million top-earners off the list of cash subsidy receivers. These steps will increase revenues significantly, while simultaneously putting a halt to inflationary pressures.  

Lastly, once sanctions are lifted, Iran can go the way of Saudi Arabia and other Persian Gulf countries by expanding lending from international bond markets. This would be beneficial to the development of the domestic financial market and should be relatively cheap for the low-debt country.