by Djavad Salehi-Isfahani
If there is a big economic payoff to the implementation of the Joint Comprehensive Plan of Action (JCPOA) and the lifting of international sanctions against Iran, the financial markets in Tehran are not yet impressed. The rial barely moved as “implementation day” arrived. The Tehran Stock Exchange, which has been depressed for the last two years, did gain about 4% during the week before. But compared to the weight of the sanctions being lifted, the investors’ response was underwhelming. Of course, financial markets had been expecting the removal of sanctions for a few months and may have incorporated its impact already, but even their recent behavior seems oddly mute.
But the markets are correct to expect little economic improvement in the short run. The economy is in its deepest recession since the Islamic Revolution in 1979, and no one expects it to bounce back any time soon. Last month, an IMF report forecast zero growth for the current Iranian year ending on March 20, 2016, and 4-5% growth for next year. President Rouhani’s promise for economic growth next year, which he is making ahead of the crucial election for the Parliament and the Assembly of Experts next month, is also a modest 5%.
These forecasts are at odds with the long-run benefits for Iran of the lifting of sanctions. Iran expects to receive about $30 billion of its frozen funds in coming months. In addition, it will save about 20-30% on its international trade operations, worth as much as $20 billion per year. For comparison, oil revenues this year are about $20 billion. Foreign investments and loans could easily add another $10-20 billion per year. So, with the infusion of external resources potentially amounting to 20% of the GDP, and vast idle capacity in industry, why such low expectations for growth next year? A normal economy would bounce back with 8-10% growth.
Barriers to Growth
The answer is that Iran’s economy is anything but normal. There are knots and bottlenecks formed in the economic system as a result of sanctions that cash infusions can’t undo. Removing those obstacles would take internal reforms and time. The most important of these reforms is in the banking system, which is unable to help businesses take advantage of the improved business environment because of the accumulation of bad loans. These loans are mainly the result of investments in real estate that went sour after the intensification of sanctions in 2011-2012 triggered an end to the oil boom of the preceding decade. The construction sector is still in deep recession, shrinking by 27.3% in 2014-15 alone.
This situation is not unlike that of the US and European banks after the economic crisis of 2008. The difference is that Iran’s financial institutions are much less regulated and, like the rest of Iran’s economy, much less transparent. The stress tests, the stimulus packages, and the quantitative easing that helped restore solvency to the US financial system are either not well understood in Iran or are not tools available to Iranian authorities.
For starters, the authorities are not quite sure of the extent of the toxic assets held by specific financial institutions. Many unregulated savings and loan institutions— carrying sacred Islamic names to signal honesty and piety—are insolvent but continue to operate Ponzi-like schemes. They offer high interest rates—close to 30% or twice the rate of inflation—to attract funds that they turn around to use to pay interest to existing deposits. To compete, established banks have to offer high interest rates as well. With the real cost of borrowing for the private sector in the 5-10% range, investment is being choked off just as improved ties to the world economy are about to stimulate it.
Rouhani’s own economic policies, focused on reducing inflation, have not helped the situation. This is the message that four members of his cabinet tried to deliver to him when they wrote their famous letter last September warning that continued austerity would undermine national security. Rouhani responded by offering small programs of subsidized credit for middle-class buyers of automobiles and consumer durables, but he has not changed his overall economic austerity approach. His proposed budget for 2016-17, which he submitted to the parliament last week, keeps real government spending constant.
Low oil prices, expected to last at least for the next year, have forced the government to rely more on tax revenues. Oil exports are expected to increase by about 50% in volume over the next year, but this may bring prices further down, resulting in only a small gain in total oil revenues. For the first time in recent history the budget projects to raise more revenues from taxes (one-third of total) than oil (one-fourth). Of course, raising taxes at a time when businesses are struggling to meet their payrolls is not the way to stimulate investment. Development expenditures, which have historically been the main driver of private investment and economic growth in Iran, are staying put at 22% of total expenditures (in Ahmadinejad’s last budget, they were 15%).
The Political Challenge
Despite the lack of apparent public enthusiasm at the time of the lifting of sanctions, few Iranians doubt the significance of Iran’s return to the global economy. Without the nuclear deal, there would have been little chance of getting out of the economic mess any time soon. The challenge for President Rouhani is to not let the weak short-term economic results of the deal undermine the good economic prospects in the longer run. That could happen if a parliament hostile to reform is elected next month.
To push his reform agenda, embedded in the newly drafted Sixth Development Plan, Rouhani needs a parliament that can turn those reforms into law. Politically, he seems to be in a strong position having won the tacit support of the powerful speaker of the current parliament, Ali Larijani, who is a central figure in the conservative Principlist movement.
This week, as the good news of the lifting of one sanction after another arrived, the conservative Guardian Council let it be known that it plans to use its vetting tool to prevent an outright election victory for the moderate and reformist camps. The conservatives that now hold the key levers of power are sending a message to the would-be architects of a globalized Iran that re-integration into the world economy has to be on their terms and not on the terms dictated by markets. From global competition and foreign investment to travel and tourism, they want to make sure that globalization neither disrupts the existing balance of power nor serves as a Trojan horse for what they call a “cultural invasion.”
The nature of the political compromise, or lack thereof, that would allow economic reform to proceed in this environment will determine the extent to which Iran will benefit from the implementation of the nuclear deal.