Although annual economic growth has surpassed 5% on average and high oil revenues have led to large current account surpluses, and despite the correlation between growth and changes in oil output and exports, the diversity and complexity of Iran’s economy extends beyond the energy sector and there are still a number of issues that are impacting the overall economic performance of Iran. 1. Inflation has deteriorated, 2.economic policies have been ineffective, 3. lack of foreign investment has hindered economic growth, 4.unemployment is still in double digits and 5. economic sanctions have had an adverse effect on trade and investment
1. Inflation
High inflation rates are a main cause of economic instability in Iran. The economy works best when the price level is stable and predictable. Monetary expansion due to financing the budget deficit, the depreciation of the market exchange rate, the removal of some subsidies and the suppression of imports have all contributed to rising prices in recent years. (Khatami, 2004) In 1997, average annual inflation was 17.4% and this increased slightly to 18.1% and 20.1% in 1998 and 1999 respectively before falling sharply to 12.6% in 2000, reflecting improved economic conditions and enhanced public confidence in the stability of economy as well as the implementation of non-expansionary monetary and fiscal policies. (www.sci.org) In 2001, the downward trend in inflation continued and at the end of the year it stood at 11.4%. (www.sci.org) While Iran's inflationary environment has worsened due to external circumstances, it is nonetheless mainly a domestic creation and the economic problems are not cyclical but structural and ideological. Based on the latest economic data, the annual rate of inflation has exceeded 20% in recent months, compared with 11% and 14% in 2006 and 2007.(www.sci.org) The Prices of medical care and housing have risen swiftly .Both are income elastic and cannot be imported and as incomes improve their prices have a propensity to rise faster than other kinds of goods. Real estate prices, in particular, have increased significantly, resulting in an unstable real estate price bubble. The major pressure behind the high inflation rates of the past few years is the sudden rise in money supply (liquidity) as a result of President Ahmadinejad’s economic policies. In an effort to redistribute oil revenues more equitably, the Iranian president has allowed, too much of the oil windfall in the last two years to enter the economy, pushing the prices of land, housing and medical care up, and placing Iran’s traditional manufacturing sectors under extreme pressure.(Bakhitar, 2008) Furthermore, these inflation levels have been partially associated with Ahmadinejad's efforts to restrain the interest rate.
2. Economic Policies
The lack of coherence and coordination in economic policies is another source of Iran’s economic weakness. Iran has experienced an intense political struggle between the proponents and opponents of economic reform over the past decade, and this has resulted in an erratic course of economic policy. (Crane, Lal, Martini, 2008) The ensuing conflicting policies have fashioned a tentative business environment and has decreased investors interest in long-term investment in Iran.
The lack of consensus with regard to economic policy was evident during the Khatami regime (August 1997-July 2005). Khatami encouraged a series of privatization programmes and initiated the promotion of private banks and the privatization of a small amount of state-owned banks, and also tried to encourage foreign investment. Khatami’s successor, President Ahmadinejad, also made efforts to pioneer important transformations in banking and monetary policies. He encouraged a cutback in state-controlled interest rates shortly after coming to power . The average lending rate was subsequently reduced from 16% in the 2004–5 fiscal year to 14% in 2005–6 and to 12% in 2006–7. (CBI, Economic Trends) These reductions were enforced with the support of the parliament and regardless of opposition by the minister of Economic Affairs and Finance, and by central bank officials who warned about the inflationary consequences of this policy. (Crane, Lal, Martini, 2008) These bank rate reductions, undeniably, led to excess liquidity and higher inflation rates, and forced many banks to accept heavy financial losses, which had to be covered by large government subsidies. As mentioned already Ahmadinejad’s fiscal policies have added to an increase in inflation, but they have also been a major contributor to budget deficits and have been ineffective in reducing unemployment. The government provides extensive public subsidies on gasoline, food, and housing. Energy subsidies alone represent about 12% of Iran's GDP, while total subsidies are estimated to reach over 25% of GDP. (Bakhtiar, 2008) Heavily subsidized gasoline has induced enormous amounts of smuggling out of the country and domestic over consumption, and because of very low gasoline prices, automobile manufacturers have had little incentive to manufacture fuel efficient automobiles. (Bakhtiar, 2008)
Under Ahmadinejad oil export revenues have been used to pay for social spending. This has been heavily criticised by many economic analysts, who believe these revenues should be invested in future oil reserves, rather than used for current spending. It is also believed that subsidies and cash aids are aimless and do not help the poor. Some economists assert that Ahmadinejad's attempts to lower the interest rate have resulted in excessive liquidity and inflation and critics express worry about the inflationary risks of uncurbed growth in the money supply. (www.Iran daily.com) As a result of the Iranian currency being overvalued Iranian products are much more expensive than foreign produce, and Iranian exports have lost their competitive power in global markets and are unable to compete with likewise imported goods. The governments response to this has been to impose illogical and inappropriate import tariffs to contest excessive imports and to increase domestic product competitiveness and in return has prevented both domestic and foreign investments.
By adopting correct and rational foreign exchange policy, for example, devaluation of the toman against foreign currencies based on the inflation rate and the GDP growth, exports of many production goods will become economical and as a result many foreign products will lose their competitiveness against similar Iranian products.(Khatami, 2004) This will lead to an increase in the country's revenue, domestic employment, foreign currency savings, and domestic and foreign investments. Furthermore, in attempts to create employment opportunities the government has failed to adopt appropriate policies. Offering small and medium size loans in order to reduce unemployment has created temporary and artificial jobs. (Crane, Lal, Martini,2008) This policy, originally developed during the Khatami regime and has continued and evolved throughout the reign of Ahmadinejad. The Ahmadinejad administration developed a plan to create fast return economic units and offered loans to these units to tackle the country's unemployment problem.(Crane, Lal, Martini,2008) Nonetheless, many economists believe that these units are ineffective and have turned the unemployed of the past to the indebted unemployed of today. (Crane, Lal, Martini,2008)
The uncertain nature of policies has not only negatively impacted the expansion of investment and production by firms, but has also long-term consequences for government credibility. The volatility of government policies in Iran has underpinned the governments credibility in the sphere of economic policy with unfavourable consequences for long-term investment. “Policy changes are no longer effective signalling devices and are frequently met with scepticism on the part of a private sector already disillusioned by economic policies which, despite government promises to implement them, have been aborted.” (Bakhtiar 2008)
3. Foreign Investment
One of the most important assessment criteria for foreign direct investment is economic conditions of the host country.(Habibi, 2008) According to UNCTAD's( United Nations Conference on Trade and Development) table on foreign direct investment, international corporations are divided into those seeking market, those seeking resources or assets, and those seeking efficiency. (www.UNCTAD.org) Corporations seeking market, pay the highest attention to size of the market and per capita income, market growth, as well as access to regional and global markets. (www.UNCTAD.org) With these factors taken into consideration, Iran is a good option for investment mainly because of its oil wealth, its large population, and its geographical and strategic position in Central Asia and the Persian Gulf. Foreign investment though has been negatively effected by international sanctions. Although in the early 2000s the Iranian government liberalized investment regulations and foreign investors have concentrated their activity in a few sectors of the economy: the oil and gas industry, vehicle manufacture, copper mining, petrochemicals, foods, and pharmaceuticals. (Bakhtiar, 2008)
Iran has an abundance of cheap raw materials and a large potential workforce, but it is still not an attractive choice for investors in relation to innovation, technology, communication and infrastructure. Iran is not a fitting place for investment for companies that look for efficiency and creativity. The implementation of appropriate monetary, financial and foreign exchange policies by the government are needed for the attraction of foreign direct investment and to stabilize the economy and curb inflation.
4. Unemployment
Another obvious weakness in the Iranian economy is the high levels of unemployment. The latest official population and employment census, conducted in the fall of 2006, revealed that the unemployment rate increased from 9.8% in 1996 to 12.75% in 2006. (Crane, Lal, Martini, 2008) The unemployment rate is higher among younger workers, and the 2006 data also show a sharp increase in joblessness among college graduates. (Crane, Lal, Martini, 2008) Recent semi-official statements by government officials put the unemployment rate at 10.3% during the latest Iranian fiscal year (April 2007–March 2008), indicating a moderate improvement compared with the previous fiscal year. (Bakhtiar, 2008)
Despite the decent record on job growth recently, unemployment is still a major economic concern for the government of Iran. Again it is government policies that have added to this problem rather than alleviate it. In Iran there are strict policies in relation to dismissals, severance pay, and wages. (Bakhtiar, 2008) Such policies make it challenging for companies to adjust their workforces and to attract and motivate good employees. In the future it will be important that government policies in the economic field concentrate on promoting private sector investment activity.
5. Economic Sanctions
Currently, Iran is subject to two types of sanctions: “the official United Nations economic sanctions and the unilateral sanctions of the United States (and more recently the European Union)”. (Habibi, 2008) The United States tried extremely hard to make these international sanctions more comprehensive, but it faced strong resistance from Russia, China, and to a lesser extent the European Union. (Habibi, 2008) The UN sanctions have not imposed any serious costs on the economy as a consequence of their limited scope. Over the past few years the United States has been able to discourage many foreign firms from engaging in trade and investment activities in Iran and accordingly several major European banks have terminated their business relationships with Iran, which has had an adverse effect on Iran’s trade and investment ties with Europe. (Habibi, 2008) Up until 2005 the volume of trade between Iran and the European Union was on the rise, but the latest data show a decline in 2006 and 2007. (Habibi, 2008)
To overcome this Iran has directed its economic attention at Russia, Asia, and the GCC countries. The US have been alerted to this though and they have been putting growing pressure on financial institutions in Asia and the GCC to cut their business ties with Iran. These sanctions have impacted negatively on Iran’s manufacturing sector and have also created problems for Iranian importers. (Habibi, 2008) The potential spread of financial sanctions to GCC countries and in particular the UAE (United Arab Emirates), which has emerged as one of Iran’s most important trade partners, is a problem Iran could do without. The United States though continues to have close relations with the federal government of the UAE, and has requested it to improve its cooperation with the financial sanctions applied against Iran. (Habibi, 2008) Iran’s main trade partner in the UAE, however, is the Emirate of Dubai, which benefits heavily from its economic ties with Iran and so far has been reluctant to sever those ties. (www.adnkronos.com) A cut-off of Iran-Dubai economic ties would be a serious setback for the economy of Iran, a fact I am sure the United States is well aware of.
Conclusion
The varied economic performance of Iran has been the result of a number of domestic and external factors. The most significant external factors have been oil and economic sanctions. Oil prices and economic sanctions have had contrary influences on the Iranian economy, with high oil revenues to some extent compensating for the economic sanctions. The main barriers to economic growth on the domestic front have been the result of inconsistent and ineffective economic policies which have had overlapping effects across the economy causing high inflation rates and high levels of unemployment. Despite worsening economic sanctions and poor economic management, the economy has managed to grow by an average of 5.8% per year in the past three years. (www.sci.org) This has been possible due to the high oil revenues that have allowed the government to finance its fiscal expansion. (Bakhtiar, 2008) Economic sanctions have undoubtedly kept foreign investment in the manufacturing and energy sectors far below its potential, however, high oil revenues have also enabled the government to increase domestic investment to make up for the lack of foreign investment. High oil revenues have also made it possible to increase the amount of imports of important commodities. Oil revenues have enabled the government to protect households and consumers from the effects of stagnation in the short-term, but economic sanctions have prohibited the development of Iran’s energy and manufacturing sectors, which are essential for the growth of the economy in the long run.
References.
- Crane, Lal, and Martini, 2008. Iran’s Political, Demographic and Economic Vulnerabilities. Rand Corporation.
- Habibi, Prof. Nadar, 2008. The Iranian Economy in the Shadow of Economic Sanctions.
Brandeis University.
- Khatami, Siamak, 2004. Iran - A view from within, Political Analysis. Janus publishing.
- Ocampo, Jose Antonio, 2005. A Broad View of Macroeconomic Stability. UN/DESA Working paper no.1.
Websites
- www.scoop.co.nz Bakhtiar, Dr. Abbas, 2008. Iran and its Economy.-retrieved on 20th Nov 2008.
-
chekideh/Labor_Force_Indices_winter_2007.PDF Statistical Center of Iran. Retrieved on 20th Nov 2008
- AKI, "Iranian capital flight to Dubai continues", retrieved on 26th Nov 2008.
- Iran Daily: Vast economic potential landed. Retrieved on 21st Nov 2008.
