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Saturday, July 26, 2014
- The transition team of Iran’s President-elect Hassan Rouhani was busy last week lowering expectations for a quick economic recovery, saying that things are far worse than they had thought.
At the same time, the outgoing economy minister was briefing Iran’s Supreme Leader Ali Khamenei with a rosy picture.
Politics aside, it is hard to exaggerate the difficulty Rouhani faces in turning Iran’s economy around, especially without some relief from the international sanctions.
The Mahmoud Ahmadinejad administration stopped publishing national income data in 2008 as part of the annual balance sheet of the Central Bank of Iran (CBI), placing in doubt the most important indicator – the rate of economic growth.
Its reporting on inflation and unemployment has been more regular but lacked credibility because the reports were often cryptic and framed in the most positive light.
Last week, the CBI announced a rate of inflation of 35.9 percent for the Iranian month that ended on Jun. 21, averaging the increase in the consumer price index over two 12-month periods.
In reality, the index had increased by 50 percent during the last 12 months.
Government reports have shown unemployment to be rather steady in the 11-12 percent range. This provided an image of a stable jobs situation while the government’s own survey data indicated rising unemployment.
Iran’s last two censuses of 2006 and 2011 show a substantial increase in the unemployment rate of prime-age (20-54) workers from 11.5 to 15.4 percent. For obvious reasons, these figures were not part of the economy minister’s report to the Supreme Leader.
Challenges and opportunities
Perhaps the biggest surprise for Rouhani’s team came from the government budget, which they will inherit in two weeks. Rouhani’s senior advisor and head of his transition team, Akbar Torkan, said that he was not able to find reliable sources of revenue for 38 percent of government expenditures.
This presents the incoming government with its most immediate challenge – how to control inflation with public finances in such a dire state.
While he inherits an economy in deep crisis, there are a few things that Rouhani can be thankful for from his predecessor.
The first is Iran’s subsidy reform. Three years ago, Iran was the least efficient user of energy because it had the lowest energy prices in the world. Roughly four million barrels of oil and gas equivalent per day (twice what it exported) were distributed to domestic consumers with huge subsidies, mostly benefiting the rich.
In January 2011, President Ahmadinejad embarked on a bold reform that sharply reduced energy subsidies and distributed the savings as equal cash transfers.
Despite the fact that prices have been frozen since 2011, the programme has curbed energy consumption and saved Iranians from queuing for gasoline despite international sanctions that prohibit such imports.
More importantly, the cash transfers, which cover 97 percent of the population, have been an important supplement to the country’s leaky safety net, softening the blow from the sanctions to the poor.
Rouhani can do well to remove the programme’s deficit and better target its transfers, but its bitter pill has been already swallowed.
Another painful adjustment came last September when the value of Iran’s currency, the rial, collapsed following the tightening of sanctions against Iranian oil exports. Just two weeks ago, the rial was officially devalued by more than 100 percent, making it easy for Rouhani to start his tenure with a more realistic exchange rate.
Before devaluation, cheap foreign currencies hurt Iranian production, which caused Iran’s dismal job growth.
Iranian producers are now in a better position to compete, but their limited access to the global economy, caused by sanctions, is a huge obstacle.
Rouhani’s promise to reduce sanctions will therefore be essential for Iran’s economic revival.
Relief for insolvent banks
Last year, the Ahmadinejad government quietly reversed itself on interest rates, letting banks charge rates above the earlier strict limits set by his own administration of 12-14 percent.
The low interest rates on deposits compared to inflation is the main reason why depositors have flocked to foreign currencies, gold and real estate to protect their savings.
As deposit rates increase, Iran’s liquidity-starved banks will attract more money and can begin to lend to liquidity-starved businesses.
Rouhani has promised a government of “experience and hope”, one that has “the keys to unlock closed doors”. There is reason to expect improvements in Iran’s economy during his first 100 days as president, but beyond that all bets are off.
Rouhani’s moderate posture has already paid off in terms of lower expectations of inflation, which has stabilised the foreign exchange markets and is gradually returning private savings to the banks, thus alleviating the liquidity crisis that has immobilised Iran’s businesses.
Rouhani’s economic team, to be announced in the next week or two, is expected to include experienced economists, which will further boost confidence among Iran’s economic actors.
But to restore hope, Rouhani needs to do more; he must create jobs.
Jobs can only come if Iran’s producers can export or invest in the production of goods that substitute for imports. However, their ability to do so is seriously hampered, if not made impossible, by international sanctions that have closed the gates to the global economy for Iranian producers.
The keys to these locks are, unfortunately, not in Rouhani’s hands.
They are with Western leaders and the Supreme Leader, who will decide if and when the nuclear agreement is resolved and sanctions can be removed.
Rouhani has a short window of less than two years to prove to the Iranian people that Iran’s moderates, who are willing to engage with the outside world, can run a better ship than the radical isolationists. He has a historic opportunity to deliver a lesson that is not just important for Iran but for the entire Middle East.
Pushing for stricter sanctions against Iran, as some in the West are doing, risks harming this historic opportunity.
*Djavad Salehi-Isfahani is a Professor of Economics at Virginia Tech and Non-resident Senior Fellow at the Brookings Institution. Find more of his IPS work here.