Iran’s
Emerging Economic Threats
By
Jahangir Amuzegar
The West’s inordinate preoccupation with the Islamic Republic’s
nuclear program in recent months has diverted world attention away
from two other issues that threaten the management of Iran’s
frail economic structure. These internal challenges are perhaps
of much greater potential impact on the economy than any unilateral
or selective external economic sanctions.
President Ahmadinejad’s faith-based, populist, and “justice-driven” administration
has come under fierce attacks by its critics (including ex-presidents
Mohammad Khatami and Hashemi Rafsanjani) for its ad hoc, arbitrary,
and whimsical economic policy decisions. The president’s
obstinate rejection of expert economic advice and stubborn resistance
to accepting economic realities, in the opinion of his growing
detractors, have exposed the Iranian economy to a double whammy
of what economists call “stagflation” (a mixture of
slow economic growth and high inflation) and the “Dutch Disease” (a
disequilibrium among domestic economic sectors caused by a sudden
foreign exchange windfall).
The Stagflation
The ninth post-revolution
Islamic government under the Ahmadinejad presidency – promising to “put the oil money on everyone’s
table” – has, in the opinion of foreign and domestic
analysts, embarked on a hazardous expansionary monetary and free-wheeling
fiscal policy conducive to dire consequences. Accused of
ignoring both the guidelines of “Iran’s 20-year
Perspective” (ratified by the Expediency Council and endorsed
by the Supreme Leader) and the mandates of the Fourth Five-Year
Economic Development Plan (2005-10), the Ahmadinejad government
is taken to task for adopting such ill-advised economic policy
measures as sudden increases in workers’ wages and retirees’ benefits,
raising subsidies to more than 20% of GDP, doubling the perennially
deficit-ridden national budget, reducing bank lending rates arbitrarily
below prevailing inflation, promoting sub-prime marriage and housing
loans to young and often unemployed couples, making credits available
to the so-called “quick-returns businesses,” appropriating
funds on the spot to hundreds of unplanned and questionable local
projects (eg, sport stadiums, covered swimming pools, libraries,
roads, etc) requested by people welcoming the president on his
nationwide tours.
More troubling
still, Mr. Ahmadinjad’s ill-concealed and
enigmatic suspicion of banks and bankers has not been shaken, despite
the failure of mandated lower bank lending rates and other cheap
credits to unaffordable borrowers to: increase domestic investments;
help GDP growth; reduce unemployment; and lower inflation, as the
president promised. And his genuine and yet bizarre obsession that “high” loan
rates are the cause of all domestic economic woes, led him to insist
on pursuing the same course. Rejecting experts’ advice and
disregarding what his detractors call the most elementary economic
principles, he countermanded the decision by the Council on Money
and Credit in mid-2007 to keep bank lending rates unchanged, and
ordered the Council to further lower the rate – despite a
near revolt by bankers.
The government’s largess through its expansionary monetary
and fiscal policies, despite ample warning from more than 50 private
economists, inevitably resulted in a spectacular and unprecedented
rise in liquidity. Thus, between June 2005 and June 2007, the broad
money supply (M2) registered a rise from IR730 trillion to IR1,400
trillion – an expansion which a critic claims was equal to
the entire money stock accumulated since 1890s. As a result of
injecting this increased liquidity into the market through the
banking system, the consumer price index (CPI) that had been kept
in check (partly through keeping prices of 10 major staples fixed
at the September 2004 level) began to creep up. According to Central
Bank data, the index climbed steadily from 11.7% in the second
quarter of 2005 to 15.8% in the third quarter of 2007, and is forecast
to reach 17.5% by March 2008 – or nearly twice as high as
the planned target. Other official agencies (eg, the Ministry of
Commerce and the Majlis Research Bureau) put the current inflation
figures at 20% and 22.4% respectively. Most private economists
at home and abroad also express doubts about the accuracy and reliability
of Central Bank figures.
Contributing
to the CPI rise have been several factors in addition to the
government’s expansionary policies: commercial banks’ heavy
borrowings from the Central Bank for their own lending, high denomination
cashiers’ checks issued by banks without corresponding reserves,
increases in the prices of some public services, higher import
tariffs to protect troubled domestic industries, larger exports
of domestic consumer goods to take advantage of government’s
non-oil export prizes, considerable hoardings of popular items
in anticipation of higher prices, and rising popular inflationary
expectations. Curiously enough, price controls on major staples,
while countering the immediate effects of the inflationary trend,
eventually have worsened the situation as the Treasury has been
forced to raise subsidies to producers of controlled items – thus
adding to budget deficits, more liquidity, and still higher inflation.
But surprisingly,
despite all the fiscal and monetary stimuli, gross domestic product
(GDP) has remained somewhat sluggish, and
went up by only 5.1% a year in real terms – far below the
targeted 8%, and less than the actual 5.4% a year during the Fourth
Plan (2005-10). A number of related elements – low total
factor productivity, unprofitable public development projects,
inadequate private investments, lingering private sector doubts
about the government’s ultimate intentions, the slow and
unpromising process of privatization, the depressed Tehran Stock
Exchange, increased UN and US economic sanctions, and rumored flight
of capital – have been identified as major causes for the
slow growth. The outcome of faster price inflation combined with
sluggish growth has been the current stagflation.
The Dutch Disease
Under the Third
Development Plan (2000-05), the Iranian economy experienced an
average annual real GDP growth of 5.4% (close to
the 6.2% target), and an average yearly inflation rate of 14.1%
(lower than the anticipated 15.9%). The average price of Iranian
crude fluctuated between $21 and $44/B during the five-year period.
The average oil export receipts were $26bn a year. For these and
other country-specific factors, Iran was on an upward growth path,
and thus relatively immune to both stagflation and the Dutch Disease.
By contrast, in the first 2.5 years of Ahmadinejad’s rule,
according to official data, the oil price of Iranian crude ranged
between $51/B and $85/B – the highest in Iran’s 100-year
oil history. The oil receipt rose to $46bn in 2005, $51bn in 2006,
and is expected to reach $60bn in 2007. According to a high-ranking
Majlis deputy, the more than $120bn receipts from oil exports during
the 2.5 years of Ahmadinejad’s presidency have been equal
to the total oil income during six years of the Khatami and eight
years of the Rafsanjani administrations.
In market-based
economies with no exchange controls, any such windfall in foreign
currency earnings would tend to increase the
exchange value of the local currency and alter relative prices
of the so-called “tradable goods” (ie, imports and
exports). Foreign products would become cheaper and more attractive,
and locally produced wares lose their relative international competitiveness.
Domestic capital and investment would thus be attracted to the “non-tradable” sector
(eg, land, housing, and local services), raising their relative
prices. In countries like Iran, where the foreign exchange rate
is not floating but “managed” by the central bank,
the process would be somewhat different, but the results would
be the same. Conversion of petrodollars into rials by the central
bank would increase domestic liquidity, raise aggregate demand,
and lead to rapid inflation. But again, price rises in the “tradable
goods sector” would be much higher than those of imports
and import substitutes. And higher inflation at home compared with
those of the country’s main trading partners would make “the
real effective value” of the rial higher in terms of foreign
currencies, thus fulfilling the same task, ie, making imports cheaper
and exports more expensive. In Iran’s case, according to
the IMF estimate, “the real effective exchange rate” of
the rial in the 18 months ending in September 2006 appreciated
by 11%. Since the nominal exchange rate of the rial since then
has been kept between $1=IR9,200-9,300, while inflation has been
in rapid rise compared to those of major trading partners, the
real effective rate has appreciated correspondingly further. And
the Dutch Disease symptoms have become more transparent.
The spectacular
rise in oil export revenues has allowed the Ahmadinejad government
to go on a spending spree by converting dollar windfalls
into the rial, doubling domestic liquidity and fueling the inflationary
fire. The inflationary tide has been the subject of widespread
public complaints, critical Majlis debates, daily newspaper editorials,
and warnings from the Supreme Leader and even the president’s
own Islamic Revolution Devotees party. In order to stem the tide
the government has taken advantage of the oil windfalls, reduced
import tariffs on consumer products, and opened the import gates.
The average annual imports of some $28bn during the Third Plan
(mostly consisting of capital and semi-processed goods) have been
allowed to rise to $41bn in 2005, $46bn in 2006 and an estimated
$55bn in 2007 (including larger volumes of manufactured goods,
and even certain agricultural products for the first time on record).
Symptomatic
of the Dutch Disease, the tripling of imports from their 2002
level has resulted in altering the GDP components. While
the abundance of cheaper imported goods from low-inflation countries
has helped check domestic price rises to some extent, it has had
two pernicious side-effects. On the one hand, domestic producers
of “tradable goods”, ie, goods competing with imports
(or ready for exports) have lost their international competitive
power due to rising domestic production costs. On the other, abundant
domestic liquidity has been drawn towards “non-tradable” items
(eg, land, real estate, and non-competing services). Not unexpectedly,
property values and house rents have reportedly doubled in some
parts of Tehran and other large cities within a short time. Unable
to compete with relatively cheaper imports, many domestic manufacturing
enterprises (eg, textiles, clothing, shoes, furniture and others)
and even some agricultural businesses (eg, tea, sugar, and fruit)
have, according to the Minister of Social Affairs, faced losses
and even bankruptcy. By some private estimates, each $1bn of additional
imports into Iran has resulted in 20,000 job losses. “Unlawful” strikes
by workers who have been laid off or not paid for months because
of their companies’ financial troubles are now regularly
reported even by the self-censored newspapers. Interestingly enough,
even the ministers of Labor and Commerce have openly complained
about excessive imports.
The Outlook
Apart from
unforeseen calamities – a drastic decline in
oil prices, effective new UN or US economic sanctions, or possible
military entanglements – the remaining 20 months of Ahmadinejad’s
lame duck administration will have to face the increasingly difficult
challenges of harnessing inflation and creating new jobs. These
problems cannot be solved by the methods adopted thus far. Inflation
can no longer be denied or explained away by calling it “imaginary,
inherited from the past, exaggerated by the opposition, or a natural
phenomenon experienced by all countries”, as the president
and senior government officials have so far maintained. Nor would
price controls, rationing, and other administrative measures be
of any major help as they would create new black markets, and encourage
further smuggling. Neither can high youth unemployment be effectively
and enduringly reduced by making low-cost credits available to
the so-called “quick-returns” businesses. The outcome
of this policy thus far, acknowledged by senior government officials,
has been rising non-performing loans, a growing number of jobless
debtors, intensification of rent-based activities, and other abuses.
An effective
and enduring solution to both inflation and unemployment seems
to require (1) a change in the government’s ideological
mindset, and (2) a political determination to deal with causes
rather than addressing the symptoms. President Ahmadinejad and
his government must accept the fact that private gain is not always
the enemy of social good. They ought to create a level playing
field where the private sector can thrive, free from government
intervention and unfair competition. They also must be convinced
that those who disagree with them are not always their enemies
but their adversaries. Politically, too, there is a need to realize
that due to the country’s limited productive capacity, low
factor productivity, and the precarious nature of imports, the
problems cannot be tackled by increasing supply alone. The ever
growing aggregate demand, fueled by high government spending, a
budget deficit and subsidized low prices, has to be contained.
Delivering the contractionary budget promised for 2007-08, and
replenishing the over-drawn Oil Stabilization Fund (OSF), might
be a good start.
Jahangir
Amuzegar is a distinguished economist and former member of the
IMF Executive Board. Petroleumworld
not necessarily share these views.
Editor's note: This
commentary was originally published by Middle
East Economic Survey MEES, VOL. LI, No 1, 7-January-2008.Petroleumworld
reprint this article in the interest of our readers.
