ECONOMY: Pretty good for a country under siege

14 February 1997

BETTER management and higher oil prices have put the economy back on course after a potentially crippling debt crisis. Most of the economic indicators are positive and there should be healthy growth in 1997. But the population is paying a high price for past mistakes and there is unease over the quality of structural reforms.

Nearly a decade after the devastation of the 1980-88 Gulf war, economic planners are having to cope with a new set of constraints imposed from outside that are intended to cripple the oil industry. The unilateral economic sanctions that were imposed by the US in 1995 were followed by secondary oil industry sanctions last year. Although secondary sanctions have so far not had a serious effect, they could become problematic if they continue into the next decade.

For the moment, the sanctions mainly contribute to the government's sense of urgency in ensuring that its books are balanced. The economy is entering its third year of cutbacks and restrictions designed to restore confidence and ensure repayment of about $25,000 million in debts incurred in the heady spending days of the early 1990s.

Since slashing imports in 1994, Iran has been producing large surpluses on its balance of payments. The trade surplus averaged about $6,000 million a year in the two years up to March 1996, and the current account surplus averaged well above $4,000 million. In the latest Iranian year, ending 20 March 1997, the trade surplus appears to be about $6,500 million and the current account is nearly $4,000 million in credit.

These surpluses have enabled the central bank to service without difficulty annual foreign debt repayments which have averaged about $5,000 million. At the same time, strategic foreign exchange reserves have increased to $8,000 million-9,000 million and are sufficient to cover contingencies such as a collapse of international oil prices.

In the event, a buoyant oil market since early 1996 has provided extra revenue, allowing not only reserves to be replenished but for the import cutbacks to be less severe than feared. Had the government been forced to cut imports below $10,000 million, compared with about $25,000 million in 1992, industry would have run down, the economy would have gone into recession and there could have been serious political consequences. But imports averaged nearly $13,000 million in 1994/95 and 1995/96 and look like exceeding $15,000 million in 1996/97.

Instead of falling, the economic growth rate showed a modest increase in 1994/95 and rose to 3.5 per cent in 1995/96, according to official data. Bank Markazi and the IMF predict a 4 per cent rate for 1996/97, and officials see similar growth continuing into 1998.

Fragile structure

Such a macroeconomic snapshot gives a very favourable impression of Iran's economic performance. But, as the IMF has pointed out, Iran still has 'a balance of payments structure that is quite fragile', depending largely on oil exports. Dependence on oil has been reduced since the 1970s, but there is still a long way to go before Iran can claim to have a diversified economy.

The extensive economic reforms heralded in the first term of the Rafsanjani administration were slowed down during the second term. This is partly because the targets were too ambitious for the country's political circumstances, and partly because the state was not up to the task of managing a major restructuring almost overnight.

Privatisation has resumed after almost coming to a complete halt in 1994, when the majlis intervened to demand a share-quota system for those who had sacrificed themselves in revolution and war. The number of companies quoted on the Tehran Stock Exchange now exceeds 200, but privatisation is still somewhat selective and the pace is such that it will take many years to shift the burden of industry away from the state. Something like 60 per cent of the annual general budget expenditure still goes into propping up inefficient state industries and banks.

One generally unacknowledged success in privatisation is the extent to which state services have been devolved. Without much fanfare, many civil service jobs have been privatised and municipalities have contracted out most of their functions, including street-sweeping and rubbish collection.

The broader restructuring of the economy is advancing slowly. Subsidies which cost the government billions of dollars a year are being reduced gradually. Under a political formula approved by the majlis for the rest of the decade, energy prices are going up by about 20 per cent a year. In the case of oil products, the subsidy reductions are not only a way of reducing costs, but are also a tool for cutting rampant consumption.

Some experts warned a few years ago that under existing trends, Iran could become an oil importing country in less than 20 years. The rate of increase in consumption has since slowed, but it is difficult to know which official claims to believe - those citing a record low growth rate of about 3 per cent a year in 1996 or those talking of an actual fall in consumption since 1995.

The slow pace of restructuring is, in some respects, a function of the sensitivity over inflation. Inflation, which had been rising by about 20 per cent a year since the 1980s, soared to an official 50 per cent in 1995/96. This was seen as politically unsustainable and the central bank acted to prevent a crisis.

The core of the problem is the rial's weakness, reflecting basic economic problems and the lack of public confidence in the national currency. Going against the previous trend, the government had to intervene in May 1995 to reimpose strict foreign exchange controls, forcing observance of an $1 = IR 3,000 export rate as the only alternative to the $1 = IR 1,750 official rate for essential goods. The black market rate is close to $1 = IR 4,500.

This and other measures cut the rate of inflation to about 25 per cent in 1996/97. But problems cropped up in other areas, particularly in the export of non-oil goods. Forced to repatriate their hard currency earnings at the unfavourable export rate, some exporters, particularly those dealing in carpets and other traditional goods, scaled back their operations. Non-oil export revenues, which were expected to reach well above $4,000 million a year, have since fallen by about one-quarter.

In early 1997, the government was involved in a tussle with the trading community, which was using the majlis to force a reversal or relaxation of the rules. A reversal would, in isolation, be unfortunate.

The clampdown had the very important short-term effect of enabling the government to regain control of the economy. Equally importantly, strict enforcement of the new rules has made life more predictable for the business community - reducing complaints about constant changes in official regulations.

Nevertheless, the controls, no matter how well managed, do not solve the basic economic problem which stems from over-reliance on oil revenue and the extent of state ownership. The government clearly does not intend to subject the population to shock therapy, ensuring that the economic transition period will be lengthy.

Given the constraints, a number of areas of the economy have been doing surprisingly well. The agricultural sector has been growing by between 3-7 per cent a year in the past five years, enabling the government to keep food imports to a minimum.

In the industrial sector, production has been above 60 per cent of capacity for the past two years. This may seem a low level, but three years ago output may have fallen below 50 per cent of capacity; also, even in the pre-revolution boom years of the 1970s, factories were on average operating at less than two-thirds of their capacity.

Self reliant

There is now greater self-sufficiency in terms of goods and specialised equipment, as well as engineering, which has reduced the earlier dependence on imports. Basic products such as petrochemicals, minerals and metals which used to be imported are now in plentiful supply and even provide opportunities for export. This is the payoff from billions of dollars of investment in the 1980s and early 1990s.

Nevertheless, Iranian industry has a high waste factor; and many would question the economics behind much of the industrial investment of the past 15 years. Yet, it is the output, however wasteful, of these investments that is allowing the country to survive on imports that are 50 per cent of the level that pertained in the early 1990s.

There is also now a substantial domestic engineering capacity that goes beyond construction of railways, pipes and roads. For example, several models of foreign car have been re-engineered for domestic manufacture and the steel industry has developed an apparently successful new direct- reduction technology which may be exported.

In the vital oil and gas sector, planners and experts have faced unilateral US sanctions since mid-1995, and US efforts since mid-1996 to prevent third countries from investing in Iran. However, some companies have been prepared to brave US hostility. Total of France, for example, has been proceeding with development of two offshore oil fields near Sirri and may also become involved in the nearby giant South Pars gas field. Other smaller firms from France, the UK, Malaysia and elsewhere also expect to sign substantial contracts in 1997, mostly for offshore fields.

Iran's oil industry appears to have spare capacity of about 10 per cent above its OPEC quota of 3.6 million barrels a day. Given the unlikelihood of OPEC quotas being increased in the near future, Iran's ability to export oil would not be affected until well into the next decade, even if the US investment sanctions were 100 per cent effective.

The coming years will be marked by a big effort in the gas sector. Having spoken of a dozen different gas export pipelines over the years, officials have now adopted a more realistic strategy, undertaking more modest projects which can be expanded gradually.

The projects most likely to succeed include a short line to Turkmenistan to bring in Turkmen gas and another relatively short link to Turkey. Various extensions would eventually allow Turkmen gas to be exported to Turkey, and for both Turkmen and Iranian gas to be piped to Europe.

A MEED Subscription...

Subscribe or upgrade your current package to support your strategic planning with the MENA region’s best source of business information. Proceed to our online shop below to find out more about the features in each package.

Get Notifications