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June 2018, No. 87


Economy

IRAN in 1400


Warning against 13.5% Inflation, 16.3% Unemployment Rate



Tax is considered the most stable income and Islamic securities are regarded a smoothing factor in the final stage.


Dr. Hassan Dargahi, Economist

The results of a credible scientific study show that continued pursuit of existing policies will cause the Iranian economy to suffer from low growth.

The study, presented by Dr. Hassan Dargahi, a member of the Economics and Political Sciences Faculty at Shahid Beheshti University, at the 2nd Iran Economic Conference, substantiates that the downward trend of long-term production, which is the result of the continuing inefficiency of the economy, indicates a gradual decrease in effective human, physical, financial and natural resources capacities in the country. Therefore, implementation of a set of corrective policies with the two goals of promoting endogeneity and developing exogeneity is imperative.

Based on this research, implementation of economic reforms under conditions that the country faces a serious problem of productivity crisis requires its own scientific principles and rules in economic management. The question, however, is why the realized policies are often different from optimal policies? Given the current political and economic climate, there is no luck in implementing economic reforms. Therefore, in order to adopt a decisive economic agenda and to place Iran on the path of development and progress, the economic decision-making system of the country should be designed for a transitional phase in a centralized manner, based on the support and trust of the establishment, so that by relying on consultation of the elite it could take effective economic decisions and powerfully monitor them.    

Economic Status Quo

Associate Professor of the Economics and Political Sciences Faculty of Shahid Beheshti University, emphasizes in this research: ďIf the current state of affairs does not change the economy of Iran and if we assume conditions in the future where no reforms in the field of macroeconomic policies have been implemented, then a picture of the economy can be imagined of the Iran economy projected for the year 1400 (2021/22), which will continue to be trapped by low growth.

By lack of reforms it is to assume conditions where the role of the banksí debts to the Central Bank is the determinant of the monetary base. Due to the dependence of the government budget on oil revenues, the administration faces limited resources and reduces its financial balance by cutting on its expenditures (particularly development expenses).

On the other hand, the curtailment of foreign exchange earnings from non-oil exports has continued due to the declining trend of the real exchange rate, and with the assumption of a symmetrical trade balance, the volume of imports decreases. This option can be assumed as a condition of the Iranian economy in post-sanctions era, the most important feature of which is only a different image of the amount of oil production and exports compared to the past. It must be noted that the prediction of the pattern is based on the assumptions and the specified structure of the pattern, so any change in sales and structure will result in a change in projection.


The implementation of macroeconomic reform policies will increase economic growth by 2% per annum compared to economic growth of 3% without reforms.


Based on this research, the main exogenous variables relate to the population and the oil sector. The average annual population growth, assuming a fertility rate of 2.1, is equivalent to one percent. The age group population of men and women, which is an effective factor in estimating work force supply, has been extracted from the International Labor Organization website. The oil price (dollar per barrel for the years 1376 {1997/98} to 1400 {2021/22}) is based on the average of various international forecasts, in a gradual process of $50-60.

It is assumed that the daily production and export of oil and gas condensates will increase from about 2160 thousand barrels in 1395 (2016/17) to 2500 thousand barrels per year in 1400, respectively. It can be argued that if the bank deposit interest rates as of the current year drops to 14% by 1400, the share of the state budget, the National Development Fund and the National Oil Company from the oil revenues in 1395 would be 65.5%, 20% and 14.5% respectively, and for the years 1396 (2017/18) to 1400, it is equivalent to 55.5%, 30% and 14.5% respectively. The average official exchange rate and the open market rate in 1396 were equal to 33,000 (for one USD) and 37,500 rials respectively, and for the years 1397 (2018/19) to 1400 they would be 35,000 and 40,000 rials; the uncertainty in the economy would be maintained for investors and economic activists and no attempt would be made to eliminate it; the resources would be allocated in the same wrong way, and the expectations of the private sector from the government to facilitate business and invest in the necessary infrastructure would not be met. 

Economy 1400 Minus Reforms

Based on the results of this reliable study, the economy coming out of these conditions by 1400 can be drawn up as follows: Production in this case would not be in good shape at all. Despite production growth and an increase in oil exports, the situation would be very unfavorable so that the growth rate for 1396 would stand at 3.6% and an average growth of 2% would be predicted for the years 1397-1400. On the other hand, the growth of gross domestic product without oil is estimated to be 1.8 and 1.00 for 1396 and 1397-1400 respectively. Also, the study results indicate that about 200,000 jobs are expected to be created in the projected period.

Given the changes in the labor market, the number of unemployed will rise from 3.2 million in 1395 to 4.445 million in 1400. As a result, the unemployment rate would rise from 12.4% in 1395 to 16.3% in 1400. This unsuitable condition applies to the economic sectors, so that the value added of the tradable sector would not be favorable either. In other words, the growth of this sector would be equal to -1 for 1396 and about 0.2% for 1397-1400.

In non-tradable sector too, the value added growth in 1396 would be 3.5 percent and for the period 1397-1400 it is estimated at 2.2 percent. This behavior and these conditions should be studied and scrutinized in the study of productivity of the production factors. The average productivity growth depends on numerous factors each of which can greatly affect the growth of this factor: Factors such as government expenditures, imports, bank facilities, real exchange rates, and the degree of disruption of government policies. According to the studies conducted for the projected periods, the growth of productivity in tradable sector is negative and in non-tradable sector follows a declining trend.

Economic Growth by Increasing Oil Prices and Cutting Trade Costs

Economic growth, with the assumption of increasing oil exports and reducing commercial costs (such as transportation costs, insurance, financial and commercial transactions), could, in the circumstances cited before, secure a better situation for Iran than the proposed picture, because the trade cost that had been increased under the sanctions is gradually decreasing in the post-sanctions economic environment. On the other hand, the positive effect of Iranís global interactions in this period can have a positive effect on productivity. Therefore, by adding these two effects on economic growth projected by the model the economic growth for 1396 could be estimated at about 3.6%, and the average economic growth of the next five years in the base option at about 3% annually.

Therefore, the comparison of the base option forecast with the potential growth of the Iranian economy is a very important point. That is to say that in the post-sanctions economic environment, even with the increase of oil exports and reduction of transaction costs, if no improvement occurs in domestic macroeconomic policies and the investment and business environment aimed at promoting endogeneity and exogeneity, the economic growth will continue to grow below its lower potential growth. This means that a downward transition in the potential growth of Iranís economy will occur again.    

Reforms and Conditions of 1400

The results of this research illustrate another situation for the Iranian economy in the calendar year 1400 (2021/22). Based on these results, if the government makes reforms in its policies and does not repeat the past trend, the economic growth rate and other indicators can have a different situation than the above stated conditions. In general, correctional conditions can be expressed in several categories: 

Reforming Budget Policies

The first batch of reform policies are those directed at budget policies. The budget has two parts: Expenditures and revenues. In the income section, the government should be able to increase the share of tax revenues out of the gross domestic product by 8% to 10% by the calendar year 1400. Of course, other revenues should reach 4.5% of the GDP by the year 1400 from 3.2% in 1395. As for the expenditures, the government should increase its expenditure costs compared to the GDP from 18% to 22% by the calendar year 1400. To stabilize its budget, the government could use the share specified by Oil Stabilization Fund so that it could withdraw the deficit caused by the trade balance from the OSF. In fact, by using government facilities and leveraging these resources, the government can utilize the private sector participation in investment projects in the development sector. On the other hand, the government could grant facilities from the OSF to the private sector.

Of the total foreign exchange reserves from oil exports, 5% could go to the state budget, 47% to the National Iranian Oil Company and, ultimately, 37% to the National Development Fund. The financial rules governing the state budget aim to stabilize the government budget, make it predictable and eliminate the inflationary aspects of the budget. These policies can stop the disruptions caused by the government budget that spread to the economy. The focal point for implementing the financial rules is to reform the mechanism for allocating oil revenues so that the governmentís access to the oil revenues would not be subject to the conditions of the global oil market and the government could receive a specific amount of the oil revenues annually.

Furthermore, the reform of tax policies with an approach of deducting tax from the total income and improving tax coverage in order to create sustainable revenues for the government is recommended as another important stabilizing policy. In the framework of the macroeconomic strategy, the stabilization of the input of oil revenues into the budget is considered the main stabilizer of the budget. Tax is considered the most stable income and Islamic securities are regarded a smoothing factor in the final stage. The important point is that, with increasing petrodollars, due to the projections made in the government expenditures, the share of the fund goes up and the dependence of the budget on oil is reduced.

Modifying Foreign Exchange Policies

Another bureaucratic policy is the exchange rate policy. An increase in the value of the exchange rate to the level of the open market rate, which means unification of the exchange rate should take place based on a specific and predetermined timetable. The government should also use a specific exchange rate framework. The current system that is applied is a floating and managed system. In fact, in this system, the Central Bank determines a specific limit for the foreign exchange rate and allows the exchange rate to fluctuate within this limit. This will have two positive effects: First, it will prevent exchange rate swings, and, on the other hand, it allows the Central Bank to make adjustments to the exchange rate in line with changes in prices and inflation in medium and long terms. This will prevent instability at macro level due to sudden increases in the currency rate.

Another point is that the Central Bank must state all its decisions to economic actors and activists so that producers and investors can make optimal and proper decisions according to the market trends. Because it is the expectations from the market which determine the existing interactions in the market, the more transparent and specific the information and trends are the lower will be the risk of decision making, and therefore resources will be allocated more optimally.  

Monetary Policy

Among measures to reform the monetary policies mention can be made of  action to reduce liquidity growth from a range above 20% to 15% by the calendar year 1400. In this regard, we can mention the following: Controlling the growth of the monetary base in the range of 10% by the year 1400, the annual growth rate of increasing liquidity coefficient at 5%, and reducing the real interest rate to 4%.

Iranís Economy in 1400 Under the Brink of Reforms

If the government implements and realizes the reforms that were mentioned above, the picture of Iranís economic growth by 1400 will be as follows: By implementing the proposed policies since the calendar year 1396, the picture of economic growth and inflation will change compared to the option of absence of reforms so that the average annual growth rate will increase to 5% from 1396 to 1400.

In other words, the implementation of macroeconomic reform policies will increase economic growth by 2% per annum compared to economic growth of 3% without reforms. The inflation rate will range from 8% to 10.5%, which is less than the inflation rate range of 10% to 13.5% in the first case. All reform policies have a positive impact on growth, but their effects on inflation are different. Therefore, the role of inflation projection is very important in terms of the proposed policies through monetary policies. In realization of the 5% growth of this option, the increasing role of productivity in economic growth is important for implementing corrective policies. Because in recent years productivity gains have been largely due to the abundance of oil resources.

 

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  June 2018
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