Iran’s Economy Needs Rehab

EghtesadOnline: Iran’s economy needs rehabilitation, but the state is avoiding it for fear of the shocks of righting the past wrongs.

News ID: ۷۶۸۲۸۵

18 July 2016

President Hassan Rouhani has spent all of his tenure righting the wrongs of his predecessor. He has been mending foreign policy, made a deal to lift sanctions on the Iranian economy, and sorted public finances to curb inflation. He has succeeded. But the damage to Iran’s businesses runs deep.
Masoud Khansari, president of Tehran’s Chamber of Commerce, Industries, Mining and Agriculture, has reminded the government of the right path to take in an editorial in our sister publication Donya-e-Eqtesad.
According to Financial Tribune, his solutions have been advocated by prominent economists, especially liberal ones for decades, but are worth revisiting.
Iran has emerged from a two-year deep recession. Well, at least general economic figures have, but the industrial base is shrinking.
During the last fiscal year (March 2015-16), Iran’s industrial output contracted 2.2%, showing recession’s reign remains.
There’s not much going for industries this fiscal year either.
“No good outcome is expected for industries considering economic indicators in the first quarter,” said Khansari.
Imports plunged 13% during the first quarter. Most of the drop was seen in intermediate goods; in other words, the means of production. On the other hand, exports fell 5% during the period.
“The main reason for the recession is the continuous drop in per capita income since 2011, which in turn snuffed consumer spending,” said Khansari.
The only good result of low consumer spending has been the drop in inflation, which the government is wrongly claiming “all” the credit for, though we should not disregard government actions for curbing inflation in the past 2-1/2 years.
Foreign investment and bank loans are the first two options that come to mind, but they are unavailable for now. Banks remain technically bankrupt. They cannot lend. The government is just keeping a lid on banks, to avoid turmoil.
“What has happened to banks during the eight years of the previous government emptied their coffers and severely limited their power to lend new loans. They now can provide some cash flow for companies.”
Foreign investment, on the other hand, has been growing far slower than previously anticipated. European banks seem reluctant to rekindle ties with Iran. They fear crossing US non-nuclear related sanctions and the ambiguity and low standards of their Iranian counterparts.
So is there a way out? Khansari argues for what all sane Iranian economists have done for the past decade or more.
“We need an economic surgery,” to save Iran’s economy and raise government revenue. The government has to cut subsidies, liberalize fuel prices and change its foreign exchange policy.

False Stability!
Foreign exchange rates are one of the three main sticking points for overhauling Iran’s economy.
Despite the clear damages the Central Bank of Iran’s forex policy continues to have on the economy, the government is reluctant to change its ways.
Firstly, having a dual exchange rate regime creates a breathing ground for corruption and rent opportunities. It also anchors open market rates and creates false stability.
CBI Governor Valiollah Seif and his deputies promised countless times that they would adopt a single exchange rate regime within six months of implementation of the nuclear deal between Iran and the West.
The deal was implemented in January. Since then, there has been no word about the foreign exchange regime from officials, apart from praise about the stability of foreign exchange rates.
This gets us to the second issue with Iranian foreign exchange rate policy: false stability! Foreign exchange rates have remained fairly stable in the past three years.
In effect, the rial has actually risen in value, contrary to the high inflation and interest rates compared to the global average. The recession has lent a hand, though.
One of the worst things about CBI’s forex policy is what top government officials believe and advertise. People like head of the Securities and Exchange Organization, Mohammad Fetanat-Fard, and even Economy Minister Ali Tayyebnia, wrongly call this foreign exchange stability and praise the policy, calling the rial’s appreciation a triumph.
But for exporters to recover, the rial has to devalue. For the economy to move forward, exchange rates must be decided solely by the market. Misinformation disseminated by government officials and also media, especially conservatives who back state economics, raises the political cost of allowing the rial to move more freely.

Annulling Populist Plans
Fuel prices are another cornerstone of this economic surgery. Currently, the government pays 1.2 trillion rials ($34.2 at market exchange rate) of subsidies for gasoil and 300 billion rials ($8.5 million) for gasoline every day. Advanced economies tax it.
The effects of such subsidies deserve a separate story, altogether. But this senseless act has endured for half a century in Iran and has the whole population addicted to cheap energy. Changing it is considered political suicide, though.
The third piece of the puzzle is direct subsidies the government is paying to almost all the population. Iranians get $12 every month for every household member they have. That’s not enough to make a meaningful difference in people’s lives (especially the middle and upper income classes).
It does make a difference for the government though. It is sucking it dry. The entire government subsidies plan should be overhauled.
The money used to fund business and research, says Khansari. Instead the government is cutting spending, increasing taxes, just to keep up with the plan’s cost overruns.
Why? Well, annulling a populist plan like that, which has many supporters among the poor and even middle class, is hard without losing elections, or so politicians think. The same goes for fuel and foreign exchange rates.
Like a heroin addict that fears withdrawal symptoms and keep using more, though we have a faint hope things will be fixed slowly, by some miraculous way.
Foreign investment could help, we think. How about printing money like former president Mahmoud Ahmadinejad did? I bet politicians are praying for oil prices to rise every night before bedtime.
Spending petrodollars has been the only solution for the past troubles. But they all know the truth in their hearts. We have abandoned economic reason for the high cheap fuel, currency and basic goods give to the people.