Economic Reforms Needed to Withstand US Sanctions

EghtesadOnline: What if American sanctions remain in place for the next year? Will their effects be any worse than what was experienced in the past two years? How is it possible to enhance economic stability under sanctions?

News ID: ۷۴۹۴۹۹

20 January 2020

Economic analyst Hamid Azarmand answers these questions in a write-up for the Persian-language weekly Tejarat-e Farda. According to Financial Tribune, excerpts follow:

Iran’s oil exports plummeted after the US sanctions took effect in the fiscal 2018-19, affecting the economy from various angles.

The decline in production and added value of oil sector were the immediate effects of the drop in oil exports.

Iran’s economic growth fell to -5% in the fiscal 2018-19 due to the significant role played by oil in Iran’s economy. The decline in budgetary rial revenues and the resulting budget deficit, the slump in non-oil foreign trade and forex revenues, increased instability of markets, capital outflow and inflation were other short-term impacts of the sanctions.

However, it is not unreasonable to claim that sanctions will be less effective in the near future. As we speak, oil exports and production have reached rock bottom, therefore even in the case of variation as to how the sanctions are leveled, the added value of oil sector will remain unchanged next year. In other words, following two years of negative economic growth, the added value of oil sector will be zero next year.

It is also not unusual to say production will remain unchanged in other economic sectors next year, as they had registered a sharp decline in output.

On the other hand, due to the rise in the value of foreign currencies, non-oil exports, such as petrochemicals and metals, are likely to improve slightly. All in all, the country’s GDP growth will remain unchanged next year.

Thanks to the narrowing gap between foreign currencies at the rates traded through the so-called secondary FX market, known by its Persian name Nima, and those of the unofficial market, motivations behind smuggling and capital outflow have been reduced compared with the fiscal 2018-19.

This is while repatriation of export earnings has increased, which could help enhance the stability of forex market.

Long-Term Effects

Long-term effects of sanctions on the economy might be relatively more severe, though. The decline in oil revenues has led to the slump in capital expenditure and public investments and economic growth accordingly.

Lack of foreign investment and financing will debilitate growth capacities and encourage domestic introversion in the long run.

On how to improve economic stability if sanctions continue to be enforced, we need to have a look at their mechanisms. Sanctions reduced investment by increasing risks and uncertainty on the one hand and cutting resources on the other hand.

As such, they rendered the government incapable of taking the initiative of conducting structural reforms in its financial and budgetary policies. Under the circumstances, the government has incurred debts by borrowing from the central bank to address its budget deficit. This misguided approach is evident in the budget bill proposed for the next year. Further withdrawals from the National Development Fund of Iran, the rise in the treasury’s petty cash funds, higher pressure on the Central Bank of Iran and the imposition of financial commitments to banks would lead to the direct transfer of government’s budget deficit to monetary variables.

In fact, the next year’s budget bill will pave the way for financing the deficit from monetary base rather than financial reforms.

A monetary base is the total amount of a currency that is either in general circulation in the hands of the public or in the commercial bank deposits held in the central bank's reserves. This measure of the money supply typically only includes the most liquid currencies.

The growth in monetary variables will once again result in boosting the the consumer price index within a few months. The government’s insistence on the continuation of absolutely incorrect policies such as allocation of subsidized foreign currency to imports of essential goods will squander more resources under the sanctions regime.

Supervision or management of the distribution of goods and services by the government, also known as market control, will aggravate economic problems. With the aim of managing the market, the government has taken measures over the past couple of years, including imposing ban on exports, pricing and punishing economic entities under the pretext of price gouging. These measures have elevated pressure on and consequently weakened businesses.

If the government is willing to enhance economic stability in the face of sanctions, it must fix its financial policies and prevent the transfer of fiscal imbalances to central bank’s resources.

In addition, it must put the brakes on policies that exploit foreign currency resources. To keep economic enterprises out of bankruptcy and closure, the government needs to ease its pressure on them.

Restoring financial stability of the public sector is the toughest measure of all the aforementioned pieces of advice to the government. It requires structural reform in the budget, including reducing tax exemptions, introducing a unified, floating the exchange rate (in which a currency’s value is allowed to fluctuate in response to market supply and demand) and the total elimination of subsidized exchange rate policy.

Other crucial measures for the stabilization of the public sector include overhauling the energy market by removing hidden subsidies, dismantling overlapping assignments of the public sector, privatizing governmental companies and making public assets more efficient, improving transparency and efficacy of development expenditure, implementing performance-based budgeting and increasing the tax base by introducing capital gains tax and excise tax.