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January 2017, No. 82


Economy

Signs of Boom in Iranian Economy


One of the main constituent elements of aggregate demand in Iran’s economy is the household consumption with a share of over 50 percent.


Dr. Masoud Nili, Economic Advisor to the President

According to the information released by Iran’s Statistics Center, economic growth in first quarter of 1395 (2016/17) has been announced at 4.4%.  This information raises two important questions. Firstly, what has caused the economic growth in 2016/17? Secondly, can this growth continue in the coming years? In order to respond to these questions, first factors influencing developments in the two directions of aggregate supply and demand in 2016/17 should be reviewed.

Prior to compilation of the package to come out of recession in 1393 (2014/15), an analysis was released by the government according to which, the financial bottleneck in the supply and drop in demand were introduced as the two major problems in Iran’s economy at that juncture. Studies show that Iran’s economy has entered a period of low economic growth since 1386 (2007/08) and in continuation, in 1391 (2012/13) and 1392 (2013/14) has experienced significant negative growths. As a result, the level of per capita income encountered a tangible cut and the result of this reduction was evident in falling demand. This was to the extent that in 1393 (2014/15) when the 3% economic growth was registered and production level of many industrial units increased, many of these units simultaneously wrestled with the problem of selling their products and their remarkably growing stored stocks.

On the other hand, the problems of financing also seriously affected the activities of production units. Under these circumstances, the Iranian economy in 1394 (2015/16) with the shock from plummeting oil revenues and uncertainties coming out of the nuclear talks escalated the problems on the side of economic demand and consequently resulted in reduction of economic growth in 1394 (2015/16). In continuation, developments in 1395 (2016/17) changed the conditions on the side of economic demand and supply. We will discuss the results of this situation on the economic growth of Iran in 1395 (2016/17).

One of the main constituent elements of aggregate demand in Iran’s economy is the household consumption with a share of over 50 percent.  Other elements of the demand are: government consumption with a share of about 12 to 14 percent, investment with a share of around 25 to 30 percent and finally export, which together with these elements constitutes the aggregate demand in the economy. This combined share of the demand, on average, during the past few years has been dominant over Iran’s economy and almost all of these components have assumed an inappropriate trend. On the supply side as well, the economic sectors such as agriculture, industry and mine, oil, services, and imports are also subjects of our discussion. 

Lifting of Oil Embargo 

The first phenomenon influencing economic growth in 1395 (2016/17) is the lifting of the oil embargo against Iran. Given that it had been anticipated that in the final months of 1394 (2015/16) the Joint Comprehensive Plan of Action (JCPOA) would start showing results and the sanctions would be lifted, the Ministry of Petroleum since a couple of months earlier had made plans for the implementation so that as soon as the sanctions were cancelled it would increase its oil output substantially. With the implementation of JCPOA, the increase in production was realized and a 50 percent value added in the oil sector appeared as one of the main factors for the 4.4% growth in gross domestic product (GDP) in the spring this year. However, the drop in global oil prices, the growth in oil exports, will have no tangible impact on the volume of hard currency revenues in the current year.

It can be said that currency revenues fetched from oil exports in 1395 (2016/17) will not make much difference with the previous year; because firstly the average price of oil in 1394 (2015/16) was higher than in 1395 (2016/17) and secondly in the closing quarter of 1394 (2015/16) practically parts of the oil revenues of 1395 (2016/17) were spent and thereby some sort of leveling of revenues has been done between the two years. Finally, the hard currency revenues from oil exports in the past year amounted to about $34 billion and it is projected to stand at $36 billion in the current year, with no significant increase. Revenues obtained from crude oil exports during the two years of 1394 (2015/16) and 1395 (2016/17) are only slightly more than one-third of the average of these revenues in the years 1388 (2009/10) up to 1392 (2013/14).

If oil output continued with at the level produced before the implementation of JCPOA (equivalent to the production of the first 10 months of 1394), in 1395 (2016/17), only about $22 billion would be gained from oil exports. With this level of oil revenues, the government budget would have certainly experienced difficulty, and in this case without reliance on the resources of the Central Bank would become non-manageable.

On the other hand, the currency market would undergo turbulence. The outcome of this situation would face the economy with another stagflation. In contrast, if global oil prices remained at the level of 1392 (2013/14), with the increase in output that has been achieved because of JCPOA, about $91 billion in hard currency would have been fetched which could cause a situation completely different from the status quo. Paying attention to this point is important because generally in comparison with the pre-JCPOA status no attention is paid to the plunge in oil price and as a result very wrong evaluations are made about the achievements of the nuclear deal and JCPOA.  

Macroeconomic Stability 

Another factor affecting economic growth in 1395 (2016/17) is establishment of macroeconomic stability from 1392 (2013/14) onward. During this period, the rate of inflation has taken a downward trend, no significant fluctuations have occurred in the hard currency market, uncertainties in the economy have dropped and relative possibility has been provided for policymakers and economic activists.

Slight Growth: Long-Term Disease of Iran’s Economy 

Based on what has been mentioned, it could be concluded that at present, the Iranian economy is not in recession and is not expected to experience a negative growth in a near future – if conventional situation persists. What is vitally important for the country’s economy from now on is how to avoid falling into the trap of low growth. The title of the present disease of Iran’s economy is not “recession”; rather the correct label for its main disease is “slight growth”. If the designation ‘recession’ is used the problem it may cause is that the government will be inclined towards policymaking for short-term plans and clinical treatment. Whereas what our economy needs now is long-term approach and implementation of structural reforms. Given that Iran’s economy in 1395 (2016/17), 1396 (2017/18) and 1397 (2018/19) - of course under conventional terms – would not be exposed to negative growth, the main challenge is that the economy would not be faced with ‘slight growths’. As in medical science there is a distinction between cold and a serious disease, in economics too there is difference between recession as a short-term problem and slight growth as a serious and long-term disease.

In the event of lack of proper understanding of these distinctions, the policy maker will be inclined towards measures with short-term results such as supply of the resources from the Central Bank and unhealthy growth of the budget by injecting unreal resources. While what the economy needs at present is providing long-term requirements for economic growth. Whatever is seen as a relative improvement in 1395 (2016/17) is mainly the result of the two factors of JCPOA and macroeconomic stability under the condition of the existing vacant capacities in the economy. For the continuation of the improvement in the coming years both factors should be taken into account; especially stability of the macro economy, the most important coefficient of which is inflation.

One of the major factors that have prevented Iran from gaining access to sustainable economic growth in the past has been the two-digit inflation. No economy in the world could be found to have gained access to sustainable growth with double digit inflation. The answer to most of the important questions such as why the business atmosphere is not favorable in Iran, why governments failed to adjust the energy price and thus fanned the fuel of high energy consumption, why the exchange rate has not been set correctly, and many similar questions can be attributed to the selection of the wrong tools for the control of inflation by the governments.

However, in the case of the fall in inflation, the governments will gradually resume their normal business. In addition, proportional to the change in the composition of the fluid component of liquidity, we should watch out for other economic variables, including the growth of the monetary base, which can be viewed as a threat to inflation. In 1393 (2014/15), a very strict control was applied through the government budget over the monetary base growth and this control resulted in increasing the growth of the monetary base to about 10.5%, which is an outstanding record and showed its achievement in 1394 (2015/16).

However, since 1394 (2015/16) so far, the problems existing in the banking system have prompted the banks to rely on the Central Bank and increase the monetary base. Moreover, the shock the oil price drop created in the state budget caused an increase in the monetary base mainly under the influence of the net increase of government’s debt to the Central Bank as well as debts of banks to the Central Bank. For the preservation of the inflationary achievement in 1395 (2016/17) and future years, careful attention should be paid to these factors.

Among private sector activists, there is this understanding that government insistence on reducing the inflation rate will weaken economic mobility. This hypothesis is not true. Furthermore, it should be noted that the return of inflation to the average of the past decade will affect the growth made this year. Because of macroeconomic stability sustainable growth can be gained. If in 1396 (2017/18) economic activities of the country are followed up in the light of macroeconomic stability, it is expected that the increasing trend of consumption demand and increasing gas output would continue and facilitation of trade and export as well as improvement of the banking system and growth in granting facilities could guarantee continuation of economic growth in 1396 (2017/18), of course at a level lower than 1395 (2016/17). Furthermore, it is expected that the housing sector in the second half of 1395 (2016/17) and in 1396 (2017/18) would flourish. At present the forward indicators of housing show an initial movement in this regard. 


(This text is adapted from Dr. Masoud Nili’s recent speech at Tehran Chamber of Commerce)

 

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