Economy, Domestic Economy

Balanced Budget Achievable Despite Falling Oil Prices

Balanced Budget Achievable Despite Falling Oil Prices
Balanced Budget Achievable Despite Falling Oil Prices

With the plunge in global oil prices by nearly 50 percent in the past six months which led to turbulences in Iran’s currency exchange market and dramatic drops in the equity market stock values, it is conceivable that the government would face a budget deficit if oil prices continue to fall or if the nuclear negotiations between Iran and the P5+1 (five permanent UN Security Council members and Germany) do not produce a positive outcome.

According to the figures released by the government, the overall state budget for the next Iranian year will be 8,379 trillion rials ($307.7 billion at the official exchange rate of 27,230 rials to the US dollar). This is while Iran is basing next year’s budget on an average oil price of $72 a barrel. However, global crude prices have already tumbled below $60 per barrel amid overproduction and slower demand growth. Oil experts say prices could continue to fall in 2015 to as low as $50 or even $40 a barrel.

In view of the above facts, the government will have no options but to look for other sources of income to compensate for the shortfall in the fiscal budget or to engage in major cost-cutting across many areas, as pointed out by expert on international affairs, Mohammadreza Hosseinpour in an article published by Persian economic weekly Tejarat-e-Farda.

  Higher Tax Revenues

One of the instruments available to the government for producing a balanced budget is to increase the tax revenues. If a recent statement made by the head of Iran’s tax organization, Ali Asgari is to be believed, “Iran could afford to run the entire country on tax revenues alone.” Increased tax revenues would help reduce the government’s reliance on oil exports, and is also in line with the ‘Resistance Economy’ policy – a set of guidelines by the Leader to lessen the impact of US-led sanctions on Iran’s economy.

Bearing in mind that tax revenue estimates are based on the amount of productive activities in the country, imposing higher taxes in the current less than favorable state of Iran’s economy might not be the best solution. Hence, boosting tax revenues would require fundamental reforms in the present tax regime to lower the current high rate of tax avoidance and tax evasion.

The next option to be considered by the government could be increasing the price of energy and some basic goods. But resorting to this option would most likely provoke negative reactions from the people, besides creating higher inflationary expectations which would by extension lead to increased inflation. Hence, this would not be a suitable solution for the government to resort to, especially considering that controlling inflations is on top of the Rouhani government’s agenda.

The government could also earn additional revenues through issuing Islamic treasury notes and fixed rate collaborative bonds or offering intangible and capital assets as collateral to raise funds, but a review of previous years’ yields from collaborative and treasury bonds reveals that these are unlikely to fill the gap in budget deficit.

  Proceeds From Privatization

According to Article 44 of the Constitution, the government could also increase proceeds from privatization by offering shares from the profitable state-owned companies in stock exchange market. The main objectives of Iran’s privatization program which were defined in various five-year development plans included a restructuring of the economy, especially reducing the government’s role and promoting the private sector; generating revenue for the government and reducing the financial burden of state companies on the budget; and increasing productivity levels in large enterprises.

Cutting the operating expenses is another measure by which the Iranian government could avoid a budget deficit. This is possible though cutting unnecessary government expenses and prioritizing the development projects to channel the funds to those projects that yield faster profits.

Furthermore, the government is given the right to fill the budget gap through loans from the Foreign Currency Reserves Account or the National Development Fund of Iran (NDFI). Both official reserves were established with the aim of transforming oil and gas revenues to productive investments for future generation. Accordingly, 20% of oil income is to be transferred to the National Development Fund and this percentage should increase by 3% annually until the end of Fifth Five-year Socio-Economic Development Plan.

But Note 2(N) of the budget bill allows the government to spend the extra revenues generated from export of oil and natural gas condensates (arising from increase beyond prediction of oil prices, volume of export or exchange rates) up to a maximum of 150,000 billion rial ($5.26 billion) in various areas as it deems necessary. This would leave negligible or no extra revenues from export of oil and gas condensates to be deposited in the Forex reserves accounts, let alone help the government in case of budget deficit.

  Foreign Currency Market

On the other hand, some exports believe the official exchange rate of 28,500 rials to the US dollar proposed in next year’s budget (starting March 21, 2015) – which is 2000 rial higher than the current official exchange rate — should be further increased to earn the government some extra cash during fluctuations in the exchange market. This is while the exchange markets in Iran have been unstable ever since the last round of talks between Iran and the P5+1 did not reach a comprehensive deal, leading to some turbulence in the market. The situation is worsened by a shrinking flow of foreign currency to the market arising from lower oil prices.

According to former managing director of Saderat Bank, Seyed Bahauddin Hosseini Hashemi, “around 70 percent of foreign currency flow to Iran’s market comes from oil revenues, with revenues from non-oil exports and other resources comprising only 30 percent of the hard currency market.”

The current economic sanctions imposed on Iran by the UN Secutity Council do not allow the government to borrow from the World Bank or to increase oil exports. The government borrowing more funds from the Central Bank of Iran would also lead to excess liquidity in the market due to high amounts of government debts to the CBI, which, by extension, would raise inflation.

Other plans would include cutting the government expenditures by dropping the cash subsidies to high-income earners, in addition to removing government subsidies on unnecessary goods and services. The controversial cash subsidies are currently paid to around 95% of Iranian population as part of the ‘subsidy reform plan’ passed under former president Mahmoud Ahmadinejad. The scheme removed subsidies on some basic goods and energy and instead paid cash to all Iranian households.

All in all, the author suggests that despite a major decline in oil export revenues, the Iranian government could still achieve its goal of producing a balanced budget by resorting to a combination of income generating and belt-tightening solutions.