Economy, Domestic Economy

Iran’s New Era of Economic Expectations

Iran’s New Era of Economic ExpectationsIran’s New Era of Economic Expectations

While the lifting of sanctions gave rise to many potential benefits for Iran’s economy, the country’s leaders face new fiscal challenges.

An article recently published in UK news website Public Finance International surveys the Iranian economy, excerpts of which are as follows:

In January, as most of the world settled in to a new year, Iran was preparing for what could potentially mark a whole new era. Implementation Day, as it became known, was approaching, and with it the possible removal of some of the most painful parts of a 33-year regime of sanctions.

When 16 January did come around, the International Atomic Energy Agency confirmed, as expected, that Iran had adequately curbed its nuclear program.

A deal brokered between Tehran and five world powers, including the US, Germany and Russia, could now swing into action. A host of crippling sanctions was lifted; Iran could come in from the cold. Its exile from the international community was over–sort of.

It was a landmark moment for Iran. Sanctions had some serious consequences for the country’s economy and, in turn, its people. As a result of one 2012 sanction alone—an EU ban on the import of Iranian oil–inflation raged at more than 30%, the currency went into a tailspin and up to 40% were knocked off the volume of exports, leaving a serious dent in the public purse.

In 2013, Iran’s oil minister acknowledged just how much the country was losing—as much as $8 billion every month.

  Tangible Gains, Failed Expectations

Three years on, Martin Cerisola, the International Monetary Fund’s mission chief for Iran, estimates the country’s public accounts will be lucky to see $8 billion per year in oil revenues until 2019, even if it scales up production to pre-sanctions levels of 4 million barrels a day.

Tanking oil prices have dashed any hopes that free oil trade will return anywhere near as much to the economy, explains Djavad Salehi-Isfahani, a professor of economics at Virginia Tech University and an authority on Middle Eastern economics.

A few months on from Implementation Day, it has become clear that the removal of sanctions will not return the economic buoyancy that their imposition once took away. Iran’s leadership will have to accept much more far-reaching change if the full benefits of sanctions relief are ever to materialize.

That’s not to say there will not be some tangible gains. Before January 2016 was out, the Iranian state airline’s aging passenger plane fleet got a much-needed $25 billion upgrade.

The country regained access to more than $100 billion in frozen overseas assets, some $30 billion of that immediately.

While around half of this is already tied up in various debts and deals, the rest can be used to shore up the economy or finally complete a host of infrastructure projects, abandoned when sanctions took hold. The cost of trade and transactions will come down and foreign direct investment is already flooding into the economy, rekindling once-thriving industries such as car manufacturing–and industry means jobs.

But some benefits that were supposed to be realized immediately have fallen short of expectations—Iranian banks’ reconnection to the Swift system, which enables international transactions, for example. This should have paved the way for Iran’s financial sector–once a key driver of growth but now outdated and ailed by non-performing loans–to reap the benefits of reengagement with the international system.

However, in March this year, Iran’s Leader Ayatollah Seyyed Ali Khamenei, complained: “Our banking trade, our efforts to return wealth from various banks, various kinds of businesses that require financial services, all of these are facing problems.”

  Problems Within

One major source of problems is that most US sanctions remain in place.

The country is barred from using the American financial system or its dollars, and even the big, non-American banks that are permitted to do business with Iran still decline to do so for fear of falling foul of US sanctions.

Yet many difficulties in Iran stem from within, and not outside the country. Its economy is plagued by undercapitalized markets, a 13.7% inflation rate and, as World Bank chief economist, Eric Le Borgne, points out a “very weak” labor market for even the Middle East and North Africa region.

According to World Bank data, labor force participation stood at just 45% in 2014. The opportunity for some of Iran’s labor-intensive industries to rebuild is expected to alleviate widespread unemployment somewhat, but Le Borgne highlights that sanctions only added to this problem.

“The causes of Iran’s labor market issues are structural, just as they are in its product and credit markets,” adds Cerisola.

For example, rigid labor laws make it very difficult for private sector employers to lay off workers, preventing Iran’s burgeoning youth population from competing for jobs held by those already employed.

  Need for Reforms

“To maximize the full potential from the lifting of sanctions, Iran really needs to advance with reforms,” Cerisola said, one being greater operational independence for the central bank.

This has already improved since former president Mahmoud Ahmadinejad was replaced by Hassan Rouhani, Iran’s leading reformist figure, in 2013. Rouhani separated monetary and fiscal policy, leaving the former fully under central bank control. Inflation fell from the highs of 40% to 15% as a result. In contrast, under the Ahmadinejad government, intervention in credit allocation drove non-performing loans to 23% of all credit in 2010.

Similarly, Rouhani reestablished a number of critical economic and budget management bodies disbanded by Ahmadinejad and pursued much-needed tax increases and stronger administration despite tough economic conditions.

But the mismanagement of the Ahmadinejad years has left damaging legacies: an inability to implement countercyclical fiscal policy worsened the impact of sanctions and a bungled subsidy reform program remains a significant drain on Iran’s resources, to name a couple.

The private sector, too, presents problems. Since an addition to Iran’s Constitution in 2006, the government has been obliged to reduce the size of the bloated public sector by selling off state assets, in the hope of bringing about growth.

But, as Alireza Nader, a senior international policy analyst for the Rand Corporation who specializes in Iran, explains, it’s still “pretty hard to tell” the difference between the two spheres and most major companies still have ties to the public sector.

What has happened in the past decade, Nader says, is that public companies have been sold off to entities associated with powerful state bodies that have much political influence and a tight grip on the economy, controlling most major industries–meaning they are likely to be one of the biggest benefactors of the foreign cash now flooding the country.

Charitable trusts known as foundations also play a major role in the economy. For Nader, this is the greatest force working against Iran’s ability to capitalize on sanctions relief.

“There is potential but Iran’s political economy is really problematic.”

At the IMF, Cerisola agrees that strengthening the privatization process will be essential, as will easing the business environment, tackling unemployment and strengthening fiscal policy. He is hopeful this can be achieved, despite what he admits is a complex political economy.

Le Borgne agrees that there seems to be strong support for reform in the country, but notes implementing this will require “strong and sustained political will”.