iran’s economy in crisis

8/3/2019 Irans Economy in Crisis

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Irans Economy in Crisis

Farrokh Zandi

Schulich School of Business

York University

Toronto, Canada


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Ease of Doing Business

Economies are ranked on their from 1

183, with first place being the best.A high ranking on the ease of doing

business index means the regulatory

environment is conducive to theoperation of business. This indexaverages the country's percentilerankings on 10 topics.


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Ease of Doing Business

Ranking Table:

SOURCE: THE WORLD BANK GROUP


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Oil- Dependent Economy

Oil and gas exports dominate Irans

export revenues, constituting about80% of total exports and are the mostimportant source of foreign exchange

earnings for the country.


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Oil- Dependent Economy

Oil revenue continues to account for

the majority of export earnings andrepresents the bulk of governmentrevenue (about 40%).

Irans dependence on oil exportrevenues makes the country highlysusceptible to the volatility ofinternational oil prices.


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The lifeblood of Irans economy, its oil

and gas industry, is showing serioussigns of distress.

Due to years of neglect, Irans current

daily oil production has fallen to near3.7 million barrels, which is more than5% below its OPEC quota.


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In contrast, in 1974, five years before

the Islamic Revolution, Iran pumped 6.1million barrels per day.


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Iran oil production levels are limited by

a number of factors. The oil industry faces a high rate of

natural decline of mature oil fields andlow oil recovery rates.


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Iran also has been plagued by aging

infrastructure and old technology.

Most oil fields dating back to 1920s

require significant upgrades in facilities.


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Structural upgrades and access to new

technologies, such as natural gasinjections and other enhanced oilrecovery efforts, have been limited by a

lack of investment.


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It is believed that millions of barrels of

oil are lost annually because of damageto reservoirs and these natural

declines.


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At the current rate of investment,

production of oil is expected to declineat a rate of 13% per year making Iranan oil importing nation by 2020.


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To maintain oil production at its 2008-

2009level of 3.9 million barrels a day,nine billion dollars fresh investment peryear is needed.

The current investment undertaking isunder 3 billion dollars.


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While the supply of domestic oil is

dwindling, there is no sign of abate-ment on the demand side.

In fact, at the current subsidizedgasoline prices, the annual consump-

tion will continue to increase at the rateof 10- 12 percent per year eating intoexports.


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Currently, Irans 7 million vehicles consume

the same amount of gas as Britains 35million vehicles.


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IRANIAN ENERGY SUBSIDIES, ESTIMATED VALUEAND SHARE OF GDP, SELECTED YEARS

Year Energy GDP of Iran* Share of GDPSubsidies Value* (%)

1994 $11 (15.92) $67 (96.99) 16.42 2001/2 $11 (13.39) $116 (139.43) 9.4819 2003 $13 (15.51) $133 (155.07) 10.00 2005 $37 (40.64) $188 (206.52) 19.68 2007 $50 (51.74) $285 (294.89) 17.54

NOTES: *Billions of U.S. dollars in current dollars (historical dollars unadjusted for inflation); numbers converted into 2009 dollars in parentheses;numbers on subsidies value are inexact estimates from varying sources.Other sources say energy subsidies averaged 11 percent of Irans gross domestic product (GDP) in the 1990s; this data indicates subsidies dipped

as a share of GDP near the end of the decade.


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MOTOR GASOLINE LITRES CONSUMED FOR ROAD TRANSPORT IN IRAN AND ITSNEIGHBOURS IN 2007

Country Liters/Day Population Liters/Day/Person

Armenia 627,847 2,971,650 0.2113 Azerbaijan 2,946,049 8,120,247 0.3628 Iran 63,862,027 65,397,521 0.9765 Iraq 14,343,879 27,500,156 0.5216

Pakistan 5,323,693 169,121,963 0.0315 Turkey 9,046,192 74,767,836 0.121 Turkmenistan 3,139,233 4,774,232 0.6575 U.S. 1,376,863,825 301,290,332 4.5699

Source: STRUCTURAL PATRONAGE IN IRAN:IMPLICATIONS OF SUBSIDIES REFORM FOR IRAN AND U.S. POLICY


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Holding an estimated 10% of global proven

oil reserves, Iran boasts the worlds thirdlargest proven petroleum reserves followingSaudi Arabia and Canada.


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The country must import close to half of allrefined petroleum products to meet domesticconsumption needs.

Iranian refineries produce about 44 millionlitres a day, whereas the domesticconsumption is near 65 million litres a day.

Iranian gasoline imports were projected tototal $5.7 billion in 2006 and $6.1 billion in2007.


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OIL REVENUE (real $2000)

0

10

20

30

40

50

60

70

80

90

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

1975-2009

Series1


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With an estimated 15% of the worlds gas

reserves, Iran has the second largest naturalgas reserves globally, following Russia.

Despite its vast gas resources, Iran has beenunable to become a major international gas

exporter. In fact, Iran has been a net importerof natural gas as late as 2005.


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Economic Stagnation

Non- oil sector production is stagnant

primarily due to the recent import-drivenpolicy of the current government.

When factories do remain open they

cannot afford to pay workers. Theresulting wild-cat strikes are hamperingproduction in some key industries.


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Economic Stagnation

Non-oil exports TABLE


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Economic Stagnation

Other major export items are petrochemicals,

minerals, carpets, and fresh and dried fruits.


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Subsidy Reform

Although sanctions have hastened subsidies

reform, critical motivations for reform are: the Iranian regimes desires toseize greater political power,

increase the Islamic Revolutionary

Guards Corps market dominance, redistribute income,

and lessen budgetary pressure


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Subsidy Reform

The regime could use subsidies reform

to punish and reward members of Iransbusiness class.

Many of Irans businesses use energysubsidies to lower production costs.


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Subsidy Reform

Reversing these subsidies, which has

already begun, holds the promise ofcompounding inflation, creatingfavouritism, and fostering further public

discontent.


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Credit Crunch

Iran was recently planning to release 1.5

billion euros worth of bonds to finance thedevelopment of its key energy sector,including the giant South Pars gas field inPersian gulf.

This is the second time the regime hasresorted to this sort of measures since itcame to power in 1979.


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Credit Crunch

Iran has limited access to international credit

markets due to several factors including: the sanctions,

the falling price of oil,

the accelerating flight of capital to safetydue to the rising political risk, the growingcrisis in the banking sector, and currencyrisk.


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Exchange Rates Policy

The Government of Islamic Republics efforts

to stabilize the currency is costing it between$180 million to $250 million a day.

Despite these efforts Rial has depreciated byalmost 5% since last December.

It should be noted that the daily oil exportrevenue- currently approximately $150million- does not cover this shortfall.


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Other Stabilization Policies

The loss of income this way has

compounded by rampant inflation causedby Ahmadinejad governments excessivelyloose fiscal policy and the consequentloose monetary policy forcing the

government to resort to the policy of pricecontrol.


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Irans Average Annual Real GDP Growth: 2000-2010

Fiscal Year Average Annual Growth (%)

2000 5.1 2001 3.7 2002 7.5 2003 7.1 2004 5.1 2005 4.7

2006 5.8 2007 7.8 2008 2.3 2009 (forecast) 0.5 2010 (forecast) 0

Source: Economic Intelligence Unit (derived from World Bank, World Development Indicators).


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Irans economic growth has been

hampered by consistently double-digitrates of inflation.

Although high inflation is widespread

among the oil-exporting countries in theMiddle East and Central Asia, Iran hasone of the highest.


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Irans average Consumer Price Index

(CPI) inflation in the last five years hasbeen reported at 18% per year.

The current year is witnessing aninflation rate is near 40%.


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Domestic factors contributing to the rise in

inflation include expansionary fiscal andexpansionary monetary policies that arebehind the growing consumption demands.

External factors include international

sanctions against Iran and rising internationalfood and energy import prices.


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The government has used oil export

revenues from the Oil Stabilization Fund(OSF) to support expansionary fiscal andmonetary policies.

The OSF was created by Irans Central Bank,

the Bank Markazi, in 2001 to store surplus oilrevenue and to smooth economicvulnerabilities associated with oil pricefluctuations.


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Iran has been drawing down on its OSF to

finance discretionary spending, such aspublic subsidies and low-interest loans.

While estimates vary about the size of the OilStabilization Fund (OSF), many observers

express concern that there are no longersufficient funds in the OSF to cushion againstthe global economic turndown.


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Irans Central Bank technically is an

independent institution. However, the Iraniangovernment has direct control over lendingand investment activities of commercialbanks.

Irans Central Bank, is not able to conduct aproactive monetary policy and has nocontrol over the governments fiscal policy.


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In addition, the Central Bank is limitedin its ability to issue direct instrumentsto combat inflationary pressures. The

Central Bank must obtain approval fromthe Majlis in order to issue participationpapers.


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In May 2007, President Ahmadinejad capped

lending rates to 12% for state-owned banksand 13% for commercial banks, despitestrong opposition from the Central Bank.

Setting interest rates below the rate of

inflation reportedly has placed manycommercial banks under financial duress.


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In addition, most of the financial

intermediaries loan portfolios are comprisedof low-return loans to state-ownedenterprises and quasi-government agencies,such as the bonyads.

Currently the commercial banks- state ownedor private- have a $40 billion overdue claimagainst their borrowers.


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To support the expansionary economic

programs of Ahmadinejadsgovernment, the Iranian Central Bankhas resorted to an unprecedentedexpansionary monetary policy.


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The monetary base, ( Currency in

circulation + banks cash reserves),which is the ultimate determinant ofliquidity and supply of money, grew at abreathtaking rate of 93% between 2006and 2008, to be scaled back by 12 %over the following 6 months.


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iran’s economy in crisis

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