Growth hinges on single deal

20 July 2015

Prudent policies implemented by the government have stabilised Iran’s economy, but progress is dependent on whether a nuclear deal can be agreed with the P5+1 countries

2015 breakeven oil price $93

2014 breakeven oil price $102

More than any other country in the region, the economic outlook for Iran hinges on a single event capable of turning around its fortunes. Tehran is aiming to hammer out a nuclear deal with the P5+1 group of world powers – the US, China, France, Russia, the UK and Germany – by 30 June, which could bring an end to sanctions against the Islamic Republic’s banking and oil sectors.

Discussions were extended twice when representatives met in Lausanne, Switzerland, at the end of March, but a political agreement was finally reached on 2 April. The two sides are now working to draft a final, comprehensive treaty, but it is far from certain whether the remaining differences can be reconciled.

Damage amplified

The damage done to Iran’s economic growth by international sanctions has been exacerbated over the past year by falling crude prices. The Washington-based IMF estimated that real GDP recovered by 3 per cent in 2014 after drops of 6.6 per cent and 1.9 per cent in 2012 and 2013 respectively. However, the fund forecasts slower growth of 0.6 per cent this year and a still sluggish 1.3 per cent in 2016.

“While the agreement will have an impact on the economy of Iran, a lot of what happens will be a function of policies and measures that are put in place within the country itself,” said Masood Ahmed, director of the IMF’s Middle East and Central Asia department, speaking in April. “If you look at what’s been happening in Iran over the past couple of years, you see that the combination of prudent macroeconomic policies and some easing that has come about from the interim agreement have led to a stabilisation of the economy.”

Ahmed highlighted the fact that inflation in Iran has come down, from 40 per cent two years ago to about 16 per cent, and that the economy is estimated to have grown in 2014 after three years of recession.

“Already you see that a combination of good policies and, internationally, a better environment can have an impact, but there’s a lot to be done to continue with the reform of industrial and productive infrastructure in Iran, as well as to continue with the framework of monetary and fiscal policies,” he said.

According to local investment firm Turquoise Partners, the Iranian business community has welcomed a series of government measures aimed at reducing interest rates.

When the new administration led by President Hassan Rouhani took office in 2013, its first priority was to reduce the inflation rate, which was above 40 per cent at the time.

The Central Bank of Iran increased interest rates for one-year deposits from 20 per cent to 22 per cent and
liberalised lending rates for all banks. The interest rate began to fall and reached a 27-month low of 14.8 per cent in April 2015.

“However, due to the evident stagnation in many sectors of the economy, the business community started pressuring the central bank to reduce rates. This resulted in the lender making some significant changes,” Turquoise said in its May report on the Iranian economy.

Reduced rates

The measures taken by the central bank included: decreasing interest rates on one-year deposits to 20 per cent and loans to 24 per cent; cutting reserve ratio requirements for banks on all types of deposits from 13.5 per cent to 13 per cent; injecting money into the interbank lending market at a maximum rate of 24 per cent by the central bank in restricted amounts; and increasing the ceiling for retail loans from $12,000 for each person by 100 per cent for the purchase of cars, housing equipment and other goods.

The decline in inflation and the raised possibility of Iran opening up to investment are positive developments for the country’s economy, but the drop in oil prices will make balancing the national budget difficult for Tehran.

The IMF, after a visit to Tehran from 24 January to 5 February, recommended the government’s fiscal policy should aim to limit the budget deficit to 2.5 per cent of GDP. “The discussions focused on the policies needed for preserving disinflation gains and for supporting the economy in its adjustment to lower oil prices,” says Martin Cerisola, assistant director for the IMF’s Middle East and Central Asia department.

“Monetary policy should continue to aim at keeping inflation expectations anchored by pre-emptively targeting liquidity growth at a prudent level,” he adds, saying this would help absorb shocks and provide more room for credit to flow to the economy.

With Saudi Arabia calling the shots on the policy of oil exporters’ group Opec, there is very little Tehran can do to put upward pressure on crude prices. However, if international sanctions are lifted, Iran should be able to increase government revenues by boosting oil exports to pre-sanctions levels and investing in long-term capacity expansions.

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