Iran Economic Monitor for Fall: Weathering the Triple-Shock

The Iranian economy entered a third consecutive year of recession following the triple-shock of sanctions, oil market collapse and Covid-19. 
Gross domestic product contracted by 6.8% in the fiscal 2019-20 as a result of expiration of US sanctions waivers on Iran’s oil exports. The spread of Covid-19 and the subsequent collapse in oil markets also impacted the last quarter of the year’s GDP (ending March 2020) as oil production reached a three-decade low of 2 mbpd (million barrels per day). 
Despite the expansion of US sanctions to other key industries, non-oil GDP grew by 1.1% in 2019-20, driven by agriculture and manufacturing sectors. Price competitiveness of products in these sectors increased following the currency depreciation. 
On the demand side, GDP contraction was broad-based as all sectors contracted. GDP shrank at a slower annual rate (2.8%) in the first quarter of 2020-21 (April-June 2020), as Covid-19 health measures were limited and then relaxed in mid-April. The recent weak growth performance adds to a decade-long stagnation. 
During 2011-20, GDP grew at an annualized rate of –0.1% and Iran’s per capita GDP fell below regional and income group averages, reads a new World Bank report titled “Iran Economic Monitor, Fall 2020: Weathering the Triple-Shock”. Below is the full text of the report’s executive summary:
High inflation placed additional economic stress on lower income households following a sharp depreciation of the currency. In April-November 2020, inflationary expectations and geopolitical and economic uncertainties sharply increased demand for safer assets, leading the rial to lose 43% of its value against the dollar year-on-year. Iran’s ability to buttress the exchange rate pressures was hampered by limited reserves and restricted access to exports proceeds abroad. 
The currency depreciation impacted consumers as imported goods became more expensive and domestic production prices, especially for tradable goods, increased. Consumer price inflation reached 30.6% (YOY) during April-November 2020 and climbed to a 16-month high of 46.4% (YOY) in November 2020. Similar to 2019-20, inflation was led by sharp price increases in food and housing which disproportionately affected lower income deciles.

Tightened Fiscal Space

The decline in revenues led the government of Iran to meet its financing needs through extensive debt issuance and sales of assets on the stock market. The fiscal deficit-to-GDP ratio is estimated to have more than doubled to 3.7% in 2019-20 as oil revenues halved and their share in budget revenues fell to a historic low. 
Oil revenues deteriorated further in 2020-21 following the global oil market collapse leading to only a fraction of budgeted oil revenues (6%) in April–July 2020 being realized. Tax revenues performed better in part due to improved collection and price effects. 
Expenditures grew faster in 2020-21 due to wage bill and pension payment adjustments as well as new transfers to households to counter the negative impact of high inflation and recession. This limited fiscal space led the government to heavily rely on bond issuance and sales of assets in the stock exchange as well as withdrawals from the sovereign wealth fund for emergency expenditures.
Multiple years of recession and high inflation have strained household livelihoods and stalled poverty reduction. In 2018-19, the national poverty rate measured at the international poverty line of USD5.5 purchasing power parity was 12.3%, up 1.5 percentage points from the previous year. Inequality (measured by the Gini index) was 35.6 points and continued to increase after 2016-17. Rising living costs eroded the value of cash transfers and labor incomes in real terms. 
Poverty mitigation measures, including cash transfers, helped partly mitigate pressures on the poor but also placed additional pressure on fiscal balances due to lack of adequate targeting.
As Covid-19 cases surged, stricter measures were enforced in fall 2020 and new social transfers were announced. In November 2020, stricter health containment measures were introduced after Iran registered over 1 million Covid-19 cases and the death toll climbed above 49,000 deaths. 
The economic shock of the Covid-19 pandemic pushed more households into poverty. In response, the authorities unveiled new rounds of cash transfers and consumption loans for lower income deciles and households without a permanent source of income.

Uncertain Outlook

Iran’s economic outlook remains highly uncertain, especially given the Covid-19 evolution and the continuation of US sanctions. 
Iran’s GDP in 2020-21 is estimated to contract by 3.7% due to a dual contraction of the non-oil and oil sectors. The projected contraction remains moderate compared to other countries due to a shorter initial period of domestic containment measures and neighboring countries’ move toward more growth-focused mitigation strategies. It also reflects the fact that the economy was already operating well below capacity prior to the pandemic. 
Oil production is projected to remain close to the first quarter level of 2 mbpd. Overall economic contraction is projected to increase in the second half of 2020-21 (October 2020–March 2021) as stricter health measures are enforced due to a resurgence of cases in the colder season. In the absence of a vaccine widely adopted in the country until end-2021, recovery in 2021–22 is projected to be weak and be primarily driven by the non-oil sector.
Fiscal pressures are forecast to increase due to lower revenue growth and higher financing costs. Government revenues are projected to reach a trough in 2020-21 as economic activity contracts before improving in the outer years with the moderate economic recovery and gradual pickup in oil revenues. 
Covid-19 healthcare cost and social assistance transfers are forecast to add to government expenditure growth that will be dominated by subsidies and labor compensation in 2020-21 and beyond. 
Extensive bond issuance in 2020-21 is forecast to continue and higher interest payment is projected to lead to a growing overall fiscal deficit in the medium term while the primary fiscal deficit-to-GDP ratio marginally improves.

Microsimulation Analysis

A microsimulation analysis based on shock scenarios shows that poverty could substantially increase, by up to 21 percentage points, as a combined result of the fall in household incomes and high inflation through the pandemic. 
Iranians in the bottom half of the welfare distribution, working in services and high-contact economic sectors, and those in rural areas are disproportionately affected.
Risks to Iran’s economic outlook relate to the evolution of the Covid-19 pandemic and geopolitical developments. The economic outlook is subject to significant risks if large resurgences of Covid-19 outbreak force stringent lockdown measures or a reliable vaccine is not widely distributed in 2021. 
Higher government reliance on debt issuance and stock market sales of assets increase financial contagion risks and could place additional stress on the undercapitalized banking sector. External balances could worsen if further trade restrictions are imposed or demand in China and other main export partners do not recover in the medium term. Upside risks to Iran’s economic prospects include a stronger recovery in the oil market. 
The lifting of US sanctions would have a large positive impact, as it did following the Joint Comprehensive Plan of Action in 2015. With the economy operating at a lower base and below potential output, recovery in the outer years could be stronger.
The scope of challenges facing Iran’s economy raises the urgency of implementing deeper economic reforms complemented with more targeted social protection mitigation strategies. 
Multiple years of recession has severely undermined the welfare of Iranians and put unprecedented strain on the most vulnerable strata, which raises the urgency of reforms. Mitigation measures have partly offset these pressures in the past but remain insufficient due to lack of accurate targeting mechanisms and fiscal constraints. 
The newly piloted Welfare Information Platform of Iranians could be a crucial tool in the implementation of future interventions and social protection strategies. Cash transfers alone would be insufficient to protect the most vulnerable, if high inflation continues to reduce the real value of distributed cash transfers. 
The sustainability of such measures and overall economic recovery will ultimately depend on a package of deeper economic reforms that addresses the economy’s structural challenges.