NS 4053 Spring Term 2017 Iran Resistance Economy

NS 4053 Spring Term 2017 Iran: Resistance Economy

Overview • Speeches marking the Iranian New Year (Nowruz) March 21, 2017 highlighted disagreements between Supreme Leader Ali Khamenei and President Hassan Rouhani • Both promoted a "resistance economy" • However each meant something different • Budget for 2017 -18 highlights linkages and differences between the two philosophies • With regard to differences • President talks of greater transparency, private sector engagement and openness to the international community • Supreme leader emphasizes self-sufficiency and an inward orientation, including a reliance on opaque, cash-rich religious entities. 2

Resistance Economy I • In his speech Khamenei criticized the government for not meeting popular expectations • Referenced youth unemployment which had not been solved despite the promises of the nuclear agreement and • Signaled empathy for Iranians left behind by economic development • As in previous occasions supreme leader named the coming year as the year of the resistance economy • This time with emphasis on production and employment but with few details given 3

Resistance Economy II • While discussing the resistance economy Rouhani has tended to focus on the mess he inherited • When Rouhani became president in 2013 he made two promises: • To fix the economy and • Reach a nuclear deal • On the economy the promises were to: • Reduce inflation • Stabilize the exchange rate and • Generate economic growth 4

Resistance Economy III • Latest IMF report suggests he has achieved these goals • Inflation dropped from 45% to single digits • Foreign exchange market was mostly stable • The differential between the official and market rates narrowed to about 15% • Economy registered 7. 4% real GDP growth in first half of 2016 -17 fiscal year • Full year growth is estimated at 6. 6% • Increase in growth due to higher oil production and prices • Non-oil sector grew only by around 0. 9% • However, job creation far slower than expected because of the difficulties of the non-oil sector 5

Iran: Inflation 6

Resistance Economy IV • Nuclear Deal • With official implementation of the nuclear deal on January 16, 2016 • Iran was reconnected to the non-US financial system • Central bank has re-established correspondence relationships with 238 banks in eleven different currencies • Although top-tier banks are cautious over US policy • Iran has attracted new investment commitments in the automotive and oil industries and commissioned aircraft from Airbus and Boeing to renew its ageing passenger fleet 7

Resistance Economy V • Rouhani also named coming 2017 -18 year of transportation -- plans include • Connecting three Iranian provinces to the rail network and • Upgrading of several ports in the Gulf and Caspian Sea which could have significant implications foreign trade • New routes will also serve as trade corridors with landlocked Central Asian countries and link Iran to the growing business on China's Silk Road 8

Constraints on Growth I • Real growth rate in coming year unlikely to exceed 3. 3% although IMF expected it to stabilize around 4. 5%; in the medium term. • Economy faces several internal and external impediments • Domestic side • Banks have large non-performing positions -- mostly owing to defaults by state-linked companies and individuals • Have chocked off financing for investment projects • The cumbersome business environment which protects the business interests of insiders -- including the IRGG crowds out start-ups and expansions 9

Constraints on Growth II • Externally • Stagnant relations with Washington have dampened investor enthusiasm • Persistence of "primary" sanctions linked to terrorism and human rights still excludes Iran from dollar clearing systems • Periodic missile tests have provoked US Congress to add new persons and firms to already long sanctions list, increasing risk foreign businesses • President Trump so far not reneged on nuclear deal • Although his ambivalence is paralyzing investment in Iran. • European countries support the deal -- foreign investment has picked up from a low base. 10

Iran: FDI 11

Resistance Economy VI • So far term resistance economy has been a poorly defined slogan. Now competing ideas of its content starting to emerge • Employment challenge • Main aim is to address youth unemployment of over 30% • Government deeply worried by prospect of a generation of largely educated men and women bourn after 1979 and constitutes two-thirds of the population 12

Resistance Economy VII • Rouhani's Version • Focuses on • Resilience, • Competition and • Openness to international business • He aims to promote prosperity while providing social safety nets to cushion shocks. • Over past two years he has • Introduced universal health coverage, and • Targeted delivery of services better through means testing 13

Resistance Economy VIII • Goal after stabilizing the macro side of the economy is to implement structural economic reforms to • Reduce the domination by vested interests • Shrink the role of the state in the economy and • Encourage the private sector • Iran currently ranks 120 th out of 190 countries on the World Bank's Doing Business index. • Weakness of Rouhani's plan is that economy not likely to jumpstart through policy alone, though it is important • It will still need a commensurate development budget • Problem investment budget very modest at the moment. 14

Resistance Economy IX • Khamenei's version of resistance economy seeks same outcome, but through very different means • While he identifies mismanagement and bottlenecks he does not see need for • Such major structural reforms or • Too much openness to the West • Supreme leader's thinking looks more towards immunizing Iran against potential US sanctions • This entails • Direct government control of the economy, • Delivering jobs and • Welfare through opaque state-like entities. 15

Resistance Economy X • Hard-liners' economics • Khamenei's philosophy of the resistance economy can be further seen by considering rhetoric of conservative campaigners ahead of the presidential election • Some have criticized Rouhani's policies by advocating a return to the economic principles of the "Islamic Revolution" to improve livelihoods and neutralize sanctions • Some have advocated greater mobilization of cash-rich religious endowments to create jobs -- shift budget away from real estate to "knowledge-intensive" activities 16

Budgets I • 2017 -18 Budget • Tensions between two visions are evident in 2017 -18 budget approved on March 16, 2017 • Total spending projected at around $320 billion up 9% in nominal terms • Budget assumes sales of about 2. 5 million barrels of oil at around $50 -55 dollars per barrel and average exchange rate of 33, 000 riyals to the dollar • Over last five years Iran managed to limit its central government budget deficit to about 2% of GDP, despite continued sanctions and lower oil prices • This allowed government to embark on a longer term strategy of gradually reducing its dependency on oil revenue. 17

Government Finances 18

Budgets II • A VAT scheme was introduced in 2008 • Current rate is 9%. • In 2015 -16 tax income was higher than oil revenues • Nevertheless with increased petroleum sales and higher prices oil dependency will increase again • Oil revenue is expected to increase from 25% to 24% of the total in 2017 -18 to around $110 billion • Current spending absorbs lion's share of the budget • Main items are • Public sector salaries -- set to rise by 10% and • Debt payments • Wider public sector (including all levels of government) accounts for 70% of Iran's GDP 19

Budgets III • Legacy of past public sector debt means significant expenditure on redeeming government securities • Audit when Rouhani took office revealed Ahmadinejad but up public sector arrears and extra-budgetary commitments amounting to 42% of GDP (as opposed to stated 17%) • IMF forecasts that the interest on the debt will rise to 3. 0% in 2017 -18 from 0. 95 2016 -17 • Social spending is also significant • Although Rouhani's government reduced Ahmadinejad's cash subsidy scheme by tightening eligibility criteria, reducing number of beneficiaries 20

Budgets IV • Still pension liabilities are high • One out of every nine Iranians is a pension recipient. • Retirement age in Iran is among the lowest in the world and with rising life expectancies old age entitlement is a significant drag on public funds • Similarly education budget will increase as well spending on Rouhani's universial health care • Budgeted defense spending on the military and the IRGC has also increased to approximately 70 billion dollars -publicly justified by hostile US rhetoric 21

Budget Projections 22

Budgets V • Development squeeze • New budget does have some pro-growth allocations such as: • Foreign Ministry's $55 million to attract the human capital and investments from Iranian-Americans living in the US • The Scince Ministry's $110 million dollar line of credit guarantee through banks to update laboratories and technical facilities to universities and technical colleges • However the high demand for current expenditures has in resent years resulted in sharp cuts in the development budget and pro-growth spending on infrastructure 23

Budgets VI • In 2016 -17, the government earmarked $10 billion for development projects in first eight months of the year but could only come up with 39% of the funding • Repeated underfunding of development allocations has caused the postponement of many projects • Looks set to continue • Weak infrastructure spending is a significant driver of Iran's lingering recession • Prospects • While Rouhani expected to win election -- may be weakened in second term further limiting prospects for economic reform. 24