Iran should have prospered under President Mahmoud Ahmadinejad. The ultra-conservative former mayor of Tehran inherited a modest budget surplus and a much larger balance of trade surplus when he became president in the summer of 2003.

Iran’s positive trade balance came almost entirely from its sales of oil and gas. In 2005-06, it earned almost $50bn from oil and gas exports. Since then, the price of a barrel of oil has more than doubled from $51 to a peak of $133.

The government should be awash with cash but it is not. Iran’s modest but reliable budget surplus became a deficit in 2004, just one year after Ahmadinejad came to power. The government spent more than it received in revenues for the first time since the late 1990s, when oil fell to $10 a barrel.

The deficit was 1 per cent of gross domestic product (GDP) in 2006, according to ratings agency Fitch Ratings, which forecasts a deficit of 1.3 per cent for 2007, 3.2 per cent for 2008 and 6.1 per cent for 2009. Iran does not report on its finances but if the deficit becomes as large as these forecasts, it will have one of the worst budget shortfalls in the Middle East, if not the world.

The current account surplus, which should increase in line with the rise in oil prices, remained at 9.3-9.4 per cent of GDP for the first two years of Ahmadinejad’s term in office. Fitch expects the surplus to drop this year to 6.4 per cent of GDP, $21.8bn down from 2007’s record of $26.6bn, before falling further to 2.8 per cent of GDP in 2009.

Where it did all go wrong? Since 2005, Ahmadinejad has used the public finances to reward the people who voted him into power in 2003. Poor Iranians in both rural areas and the major cities, including Tehran, have benefited from tens of thousands of small-scale infrastructure projects, cheap loans and subsidised products.

Political handouts

The handouts have been made on an industrial scale. Money has been distributed according to political allegiance. The contribution that government spending makes to the performance of the economy has rarely been considered.

The budget for 1387, the Iranian year that started on 21 March 2008, was drafted in a new format that gives greater control over spending to Ahmadinejad’s senior aides. The number of public sector bodies that directly receive money under the budget was cut from 610 to just 60. The only people with detailed budgets are the governor generals running Iran’s 30 separate provinces and the 39 members of the Council of Ministers.

The new format enables Ahmadinejad to trim the budget law from 2,400 pages to 600. In the editing process, most of the detailed spending proposals that were normal in previous years have been removed. The changes have made any like-for-like comparison of spending impossible.

According to one financial analyst in Iran, Ahmadinejad has increased the budget for 1387 by 17 per cent to $100bn. But the details are not clear. The new law has no index so anyone who wants to understand public spending in a particular region, industry, or department has to read the whole document to find the information.

Overall, the economy is underperforming. The National Iranian Oil Company produces 4 million barrels of oil a day, but it could be extracting a much higher figure from its vast reserves.

The privatisation campaign started by Supreme Leader Ayatollah Ali Khamenei in 2006 has also consistently generated smaller revenues than expected.

In February, Heidari Kord Zangeneh, head of the Iranian Privatisation Organisation (IPO), told foreign journalists that the privatisation campaign had generated $15bn in revenues. At the same time, he briefed local investors that the number was $9bn.

“Zangeneh claimed that it [the IPO] had privatised $9bn, but it only a capital of $3.5bn,” Ramin Rabii, managing director of Turquoise Partners, a fund manager based in Tehran, tells MEED. “The extra money it gave out as ‘justice shares’ to the poor and needy. That does not generate cash”.

The government’s decision to give away shares worth $5.5bn to poor Ahmadinejad supporters has also lessened the potential benefits of private sector ownership for state-run enterprises. Iran’s state-run banks need private sector financial services skills and information technology to transform their performance and that of the wider economy, says Abdelali Jbili, an analyst at the International Monetary Fund (IMF).

“The undue influence by large public companies and bonyads [voluntary sector organisations] on the management of banks has to be eliminated,” says Jbili.

State-controlled enterprises that privatise part of their equity would be more likely to get outside expertise if the government were to allow a large stake to go to single, powerful, private sector investors.

Some good news is coming from Iran, however. The economy is expected to grow by 5.8 per cent in 2008 before falling to 4.7 per cent in 2009, according to the IMF. “In the budget, they never forecast growth,” says Rabii. “They do not talk about current account forecasting and outstanding debt.”

Any economic forecast in Iran is more of a guess than it would be in most other countries. Nevertheless, the continued high price of oil provides some cushion to Ahmadinejad’s spending.