Islamic Republic of Iran
Recent Economic Developments

This paper reviews economic developments in Iran during 1990–95. The growth rate of real GDP declined from an average of 11 percent in 1990/91–1991/92 to 2.7 percent in 1994/95. This decline was associated with developments in both the oil and non-oil sectors, such as capacity constraints in the industrial sector; adverse movement in international oil prices; reduction in oil export volumes; and quantitative import restrictions, which adversely affected industries that depended on imported inputs. The real value added in the oil sector declined by 5.6 percent in 1994/95.

Abstract

This paper reviews economic developments in Iran during 1990–95. The growth rate of real GDP declined from an average of 11 percent in 1990/91–1991/92 to 2.7 percent in 1994/95. This decline was associated with developments in both the oil and non-oil sectors, such as capacity constraints in the industrial sector; adverse movement in international oil prices; reduction in oil export volumes; and quantitative import restrictions, which adversely affected industries that depended on imported inputs. The real value added in the oil sector declined by 5.6 percent in 1994/95.

Islamic Republic of Iran: Basic Data 1/

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Sources: Data provided by the Iranian authorities; and Fund staff estimates.

Fiscal years ending March 20.

Foreign assets and liabilities valued at Rls 1,650 per US$1 in 1993/94 and at Rls 1,748 per US$1 in 1994/95.

At the weighted average exchange rate of Rls 1,650 per US$1.

I. Overview

After the war with Iraq, Iran embarked on a major program of infrastructure reconstruction and economic reform constituting the First Five-Year Development Plan (FFYDP). Policies undertaken in the FFYDP included decontrolling most domestic prices, raising public utility rates, removing many nontariff trade barriers, lowering income tax rates, eliminating bank credit ceilings, starting to privatize public enterprises, and liberalizing the exchange system. These policies led to a number of important achievements. The growth rate of real GDP averaged 7 percent over the period, which compared favorably with those of other fuel exporting developing countries partly reflecting the broad base of the Iranian economy. At the same time, agricultural production, which responded well to the liberalization policies, increased and became more diversified; non-oil exports grew at a compound annual rate of 26 percent; and social indicators improved markedly.

Progress under the FFYDP was hampered, however, by overly expansionary financial policies and the resulting macroeconomic imbalances. Monetary growth was in the range of 20-25 percent per annum during 1990/91-1992/93 (Table 1). These imbalances, combined with administered price adjustments, led to inflation of about 20-25 percent per annum. The associated overvaluation of the official exchange rates contributed to a surge of imports in 1991/92 and 1992/93. This, combined with lower oil exports, resulted in a pronounced weakening in the current account to an average deficit of US$9 billion in 1991/92-1992/93, compared with a deficit of less than US$1 billion in 1990/91. With limited access to longer term external financing, the current account deficit was reflected in a reduction of external reserves and the incurrence of a large amount of short-term debt. The ensuing bunching of debt obligations at a time of much lower-than-anticipated world oil prices led to severe pressure on the balance of payments and eventually to a growing stock of external payment arrears that totaled US$11.2 billion by the end of the FFYDP (March 1994).

Table 1.

Islamic Republic of Iran: Key Economic Indicators, 1990/91–1994/95 1/

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Sources: Data provided by the Iranian authorities; and Fund staff estimates.

Fiscal years ending March 20.

For calendar years 1990–94.

A key objective of the FFYDP was the unification of the official exchange rates at a market-related level. In March 1993, an official floating rate was introduced at about Rls 1,600 per US$1, compared with a prevailing weighted average exchange rate of Rls 515 per US$1. 1/ However, the market-based official rate was not immediately applied on a comprehensive basis which led to quasi-fiscal losses, further aggravating the macroeconomic situation. In particular, foreign exchange continued to be provided (for essential imports and for repayments of short-term foreign debt contracted prior to the unification) at the previous, more appreciated rates (Rls 70 and Rls 600 per US$1). This gave rise to sizable quasi-fiscal foreign exchange losses in 1993/94, largely reversing the sharp improvement in the budgetary position that had been achieved theretofore under the FFYDP (a reduction in the budget deficit equivalent to 8 GDP percentage points by 1992/93).

The floating official exchange rate was abandoned in December 1993, when the official rate was effectively fixed at Rls 1,750 per US$1. This exchange rate level then came under increasing pressure given the highly inflationary environment. Administrative allocation of foreign exchange at the official rate was reintroduced and the free market rate depreciated sharply. In an effort to reduce these pressures, the authorities reduced the limit on the amount of foreign exchange that was available for travel purposes. Until 1992/93, the real effective exchange rate depreciated moderately; in 1993/94, as a result of the above developments, both the real and the nominal effective exchange rates (based on a weighted average which includes the free market exchange rate) depreciated markedly, which continued in 1994/95.

The authorities achieved a measure of progress in reducing financial imbalances in 1994/95. The overall fiscal deficit was reduced to 4.9 percent of GDP as quasi-fiscal foreign exchange losses were contained. In addition, the growth of net domestic credit slowed. Although this was partly offset by an increase in net foreign assets, monetary growth tapered off to 29 percent compared with 35 percent in 1993/94. However, inflation remained high (at 36 percent) as the demand for rial-denominated assets was weakened by increasingly negative real rates of return; and (as discussed below) the growth rate of real GDP declined and exchange rate developments put upward pressure on costs and prices (Chart 1). Success was also achieved in refinancing most of the overdue external payments through bilateral channels, thereby reducing the stock of external arrears to US$3.3 billion.

CHART 1
CHART 1

Islamic Republic of Iran: Real GDP Growth and Inflation, 1990/91-1994/95

(Annual percentage changes)

Citation: IMF Staff Country Reports 1995, 121; 10.5089/9781451818888.002.A001

Continued weakness of international oil prices and the lack of fresh external financing meant that the timely servicing of external debt and the increase in reserves required a one-third contraction in imports (to half their level in 1991/92), which contributed to markedly slower growth in non-oil output. As a result, the current account of the balance of payments shifted into a surplus of US$4.5 billion. This was achieved in part through a strict administrative allocation of the oil export receipts, initially at the official exchange rate of Rls 1,750 per US$1. To alleviate the foreign exchange constraint, the authorities reverted to a dual official exchange system and introduced, in May 1994, a more depreciated official rate the “export rate”) at Rls 2,345 per US$1, applicable to non-oil exports and nonessential imports. 1/ In January 1995, a 50 percent repatriation and surrender requirement was imposed on non-oil exports.

Iran experienced heightened macroeconomic instability in the first quarter of 1995/96. Among the contributing factors, the announcement by the United States of intensification and extension of sanctions had a pronounced negative impact on expectations. This triggered a run on the foreign exchange market and buying in the goods market. The free market exchange rate shot to Rls 6,200 per US$1 and consumer prices rose by 14 percent during April-May which raised the twelve-month consumer price inflation to 59 percent in May (from 34 percent in December 1994). The authorities responded by raising the export repatriation and surrender requirement to 100 percent (from 50 percent set in January 1995) and requiring all foreign exchange transactions to be effected through the banking system—which effectively ended the free nonbank market. Concurrently, they depreciated the export rate from Rls 2,345 to Rls 3,000 per US$1.

II. The Domestic Economy

1. Background

During the Iran-Iraq war (1980-88), the Iranian economy contracted sharply and the public finances deteriorated as the Government gradually took on responsibility for a vast range of economic and social activities at a time when its financial resources were coming under increasing constraint. The combination of a weakening fiscal position and war-induced shortages gave rise to significant inflationary pressures. High rates of population growth forced the Government to allocate scarce financial resources to support the importation of consumer goods side by side with war-related imports. As a result, the government budget deficit rose to more than 50 percent of total public expenditure, leading to rapid liquidity expansion and high inflation.

At the cessation of the war, the high inflation, widespread unemployment, and destruction of infrastructure induced the Government to formulate economic policies that went beyond the standard corrections for macroeconomic imbalances. These policies, constituting the First Five-Year Development Plan (FFYDP), aimed at rehabilitating the economic infrastructure, transferring the control of economic activities back to the private sector, raising productive capacity, reducing Government’s role in economic decision making, and allowing price mechanisms to determine resource allocation. Toward these ends, a number of policy measures were introduced. They Included: (i) liberalizing trade, including promoting exports and removing nontariff barriers on imports; (ii) reforming the exchange rate system, including simplifying the multiple exchange rates with the aim of, in due course, unifying the exchange rates; (iii) decontrolling most domestic prices; (iv) reducing subsidies and raising public utility rates; (v) reforming the tax system; (vi) eliminating bank credit ceilings; and (vii) privatizing a large number of public enterprises.

The real sector of the economy responded well to the FFYDP policies (Appendix V, Table 24). During the FFYDP period (1989/90-1993/94), real GDP grew at an average of 7 percent per annum, reflecting growth in both the oil sector (9 percent) and in the non-oil sector (7 percent). The growth of the oil sector reflected a recovery in oil production and the revitalization of domestic refineries after the war. The non-oil sector grew relatively faster in the beginning of the FFYDP, which was attributable to the liberalization of the economy, reduction of sectoral capacity bottlenecks, and revived investment sentiment. The agricultural sector responded particularly well, achieving increased and more diversified production. However, the growth of the non-oil sector slowed to 5 1/2 percent per annum by the end of the FFYDP, partly reflecting full capacity utilization in some sectors where investment for capacity expansion lagged behind. Real gross domestic fixed capital formation increased at an annual average rate of 14 percent during the FFYDP, as a result of which its share in GDP rose from 11 percent in 1989/90 to 14 percent in 1993/94. Real private consumption grew at an average annual rate of 5 percent. Non-oil exports increased substantially in the later years of the FFYDP.

2. Economic performance during 1990/91-1994/95

a. Overall trends in production and expenditure

The growth rate of real GDP declined from an average of 11 percent in 1990/91-1991/92 to 2.7 percent in 1994/95 (Table 2). This decline was associated with developments in both the oil and non-oil sectors such as capacity constraints in the industrial sector; adverse movement in international oil prices; reduction in oil export volumes; and quantitative import restrictions which adversely affected industries that depended on imported inputs. The real value added in the oil sector declined by 5.6 percent in 1994/95, compared with an average increase of 9 percent per annum during 1990/91-1993/94. Given the importance of oil revenue for the budget, this imposed a severe constraint on government expenditure which, in turn, contained growth of the non-oil sector at 4.5 percent in 1994/95—as compared with an average increase of 8 percent during 1990/91-1993/94.

Table 2.

Islamic Republic of Iran: Aggregate Output and Expenditure Trends,1990/91–1994/95 1/

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Source: Bank Markazi Jomhouri Islami Iran.

Fiscal years ending March 20.

Includes oil and gas production, refining, and distribution.

On the expenditure side, the growth of real consumption expenditure decelerated in 1992/93 and was 3.8 percent by 1994/95, with the ratio of consumption expenditure to GDP declining from 73 percent in 1990/91 to 69 percent in 1994/95 (Appendix V, Tables 8 and 9). In 1994/95, real private consumption grew by only 3.1 percent, compared with an average growth rate of 5.6 percent over the 1990/91-1993/94 period. Meanwhile, real public consumption grew by 7.3 percent, compared to an average growth rate of 11.3 percent over the previous four years. The growth of real fixed capital formation peaked at 41 percent in 1991/92 and then fell sharply to only 3 percent in 1994/95. The improvement in the current account of the balance of payments (see Section V)—from a deficit of US$10.2 billion in 1991/92 to a surplus of US$4.6 billion in 1994/95—corresponded mainly to an increase in national savings in relation to GDP in 1992/93 and to declining investment-to-GDP ratios during 1993/94-1994/95.

b. The oil and gas sector

The petroleum industry in Iran is supervised by the Ministry of Oil, which also manages the operations of the related specialized institutions. The National Iranian Oil Company (NIOC) is responsible for the operation of the oil industry. It has a number of subsidiaries, including: the National Iranian Offshore Company; the National Iranian Drilling Company; the Kala Company (which manages all the foreign purchases of the petroleum industry); and the National Iranian Tanker Company (which handles the transportation of a large part of Iran’s oil exports). The NIOC trades in both Iranian and non-Iranian petroleum products. The Ministry of Oil also oversees the operations of the National Iranian Refining and Distribution Company (which handles the domestic marketing of oil products) and the National Iranian Petrochemical Company (NIPC). In addition, the National Iranian Gas Company manages the production, distribution, and export of natural gas.

Iran’s oil reserves are currently estimated at 88.8 billion barrels, which are expected to last about 70 years at the current production levels. Sustainable production capacity is estimated at about 4.2 million barrels per day (mbd), and the objective of the authorities is to raise it to 5.0 mbd by the year 2000 through development of new fields and wells, combined with expanded gas injection into the existing wells (to correct for a declining gas pressure in these wells). The achievement of this capacity target will depend critically on the availability of financial resources, including external financing. In this connection, the Majlis has approved ten joint-venture projects with foreign investors amounting to US$6-10 billion. In July 1995, Iran reached agreement with the French oil company Total on a project to develop two offshore oil and gas fields in the Persian Gulf on a buy-back basis. 1/

Crude oil production was about 3.6 mbd during both 1993/94 and 1994/95, down from 3.7 mbd in 1992/93 due to a reduction in Iran’s OPEC quota (Appendix V, Table 10). Exports of crude oil were also down—from 2.4 mbd in 1992/93 to about 2.2 mbd in 1993/94-1994/95—on account of lower production as well as an increase in domestic consumption. 1/ The average oil export price declined to US$15.27 per barrel in 1993/94 (from US$16.75 in 1992/93); some of this decline was reversed in 1994/95 when the average export price firmed up to US$15.79 per barrel. The decline in the volume of exports, together with lower oil export prices, caused a drop in crude oil export earnings in 1993/94; export earnings partly recovered in 1994/95 with the improvement in prices.

With the coming on line of the Arak refinery in 1993, and the partial restoration of capacity at the Abadan refinery, total refining capacity reached 1.2 mbd in 1994/95 (Appendix V, Table 11). 2/ However, as the product mix from these refineries does not match the needs for domestic consumption, particularly for light products, Iran imported an average of about 130,000 barrels per day of refined products during 1993/94-1994/95; at the same time, Iran exported surplus fuel oil (Appendix V, Table 12). A new refinery at Bandar Abbas, with a capacity of 240,000 thousand barrels per day, is scheduled to become operational in 1996, which will eliminate the need for importing petroleum products.

Domestic consumption of petroleum products continued to rise by about 4 percent per annum during 1993/94-1994/95 (Appendix V, Table 13). Retail prices of petroleum products, which had remained unchanged for several years, were raised by 100 percent in March 1995 due to concerns about inefficient energy consumption, crowding out of oil exports by the expanding domestic demand, and the magnitude of implicit subsidies on petroleum products (Appendix V, Table 14). 3/ The latter amounted to an estimated Rls 12,000 billion in 1994/95 (equivalent to about US$7 billion at the official exchange rate of Rls 1,750 per U.S. dollar). In spite of the recent price increases, retail prices of petroleum products remain far below international levels. The prices of regular and super gasoline currently stand at Rls 100 per liter (US$0.03) and Rls 140 per liter (US$0.05), respectively. 4/ The price increases in March 1995 are reported to have contributed to some reduction in domestic consumption during the first quarter of 1995/96.

Iran is pursuing a policy of expanding production in the petrochemicals sector, in part through encouraging participation by the domestic private sector. A few projects with private sector participation are scheduled to become operational in the near term. Since the beginning of the FFYDP, production capacity in the petrochemicals sector has increased tenfold to 9 million metric tons per year. With the completion of projects currently under way, this capacity is projected to increase to 12 million metric tons per year.

Iran’s reserves of natural gas are estimated at 21 trillion cubic meters (about 15 percent of the world’s gas reserves)—the second largest after those in Russia. Gas reserves are projected to increase with the development of the off-shore South Pars field over the medium term. The production of natural gas, excluding gas injected into oil wells, rose by about 13 percent during 1994/95 (Appendix V, Table 15). Exports of natural gas dropped from 2.9 billion cubic meters (bcm) in 1991/92 to only 0.1 bcm in 1994/95 reflecting the disruption of exports to Russia. However, the authorities envision an expansion of gas exports over the medium term, particularly to Turkey, Pakistan, and India, as well as the neighboring countries of the former Soviet Union. Plans are also under consideration for exporting gas to Europe. To this end, Iran will need to overcome financial constraints and competition from other gas producing countries.

Following a 5 percent increase in domestic consumption of gas in 1993/94, the domestic retail prices of gas for household consumption were raised by 100 percent. 1/ Although data on gas consumption during 1994/95 were not yet available, it is estimated that gas currently accounts for about one third of Iran’s total energy consumption. The authorities continue to pursue a strategy of substituting gas for fuel oil (in power generation) and kerosene (in household consumption) in order to increase net exports of petroleum products. Such a substitution will require an expansion in Iran’s gas pipeline network.

c. Agriculture

Agriculture continues to play a vital role in the Iranian economy, contributing about one-fifth of nominal GDP, one-third of employment, and nearly two-thirds of non-oil exports. The growth rate of agricultural output, which averaged about 6 percent per annum during the FFYDP (1989/90-1993/94), was relatively slow at 4.4 percent in 1994/95 (Appendix V, Table 6). This reflected four main factors. First, a gradual reduction of subsidies on the importation of machinery, fertilizer, and pesticides substantially raised production costs. Second, productive capacity was constrained by inadequate irrigation systems over large areas of deep and fertile soils. 2/ Third, a severe drought in the province of Khorasan (a major production area for wheat), significantly affected crop production. 1/ Finally, capacity bottlenecks in the processing industries constrained the growth of demand for inputs from agriculture.

The Government’s agricultural policy aims at self-sufficiency in the production of wheat and maximization of the production of other basic crops. Agricultural issues and rural development activities are handled by the Ministry of Agriculture, the Ministry of Jihad, and the Ministry of Water and Energy. The Ministry of Agriculture provides services to crop production, including research (on higher value added products), credit extension, input supply, and the marketing and processing of certain agricultural products. The Ministry of Jihad provides services to livestock, fishery, and forestry. The Ministry of Water and Energy provides irrigation development services. The Agricultural Credit Bank, supervised by the Ministry of Agriculture, provides subsidized loans to farmers.

During the FFYDP, as noted, the Government moved toward economic liberalization in the sector. Input subsidies were phased out (except for agricultural pesticides and fertilizers); guaranteed procurement prices were limited to a few crops; and distribution of inputs, to a large extent, was transferred to the private sector. However, the influence of the Government remained strong in the distribution of chemical inputs and in the marketing, processing, and pricing of wheat and certain other crops through the operations of rural cooperative organizations.

The Government determines procurement prices for agricultural products based on a number of factors—production costs, international prices, the exchange rate, and provision of a 20-25 percent gross profit margin for farmers. The Government’s procurement prices are generally well below domestic market prices and they are adjusted as needed to reflect changes in the underlying factors. A total of sixteen crops benefit from guaranteed procurement prices (Appendix V, Table 16). However, farmers generally prefer to sell their products directly to the market at the prevailing market prices which, in some cases, are 5-10 times the guaranteed prices (and often higher than international prices due to domestic supply shortages). During the FFYDP period, the Government procured only 7 percent of the agricultural output, with the remaining 93 percent sold directly in the domestic market.

Most subsidized imports for agriculture were reduced during the FFYDP. The subsidies for agricultural machinery and imported seeds were removed. The subsidies for fertilizers and pesticides were substantially reduced and it is expected that they will be eliminated during the Second Five-Year Development Plan (SFYDP, 1994/95-1999/2000). 2/ The agricultural sector has withstood well the impact of removing import subsidies as well as implicit subsidies such as foreign exchange allocation at highly appreciated rates and extension of concessional loans. This is because more than 60 percent of the resources devoted to agricultural production are provided by the farmers themselves, which limits the impact from lowering subsidies. In addition, with increased market prices for agricultural products, farmers are better equipped financially to absorb this impact.

Notwithstanding the general trend toward bringing down subsidies, the Government continues to maintain a preferential treatment for agriculture which is viewed as a high-priority sector. In this context, a foreign exchange allocation at Rls 1,750 per US$1 is available for the importation of agricultural inputs and a limited amount of agriculture crops when needed. The Ministry of Commerce issues import licenses for agricultural products based on the amount of domestic output estimated by the Ministry of Agriculture, which is aimed at preventing unnecessary agricultural imports when domestic agricultural production is not in short supply.

d. Industry

The industrial sector is dominated by medium- and large-scale public enterprises which, despite representing only about 10 percent of total number of registered enterprises, accounted for about 70 percent of total sectoral employment and investment, and for about two-thirds of industrial value added. 1/ Most of these large-scale public enterprise are capital-intensive and import-dependent. Small-scale companies 2/ constitute the bulk of private industry. 3/ During the FFYDP, a large number of small-scale companies were privatized; larger public enterprises were also privatized but at a slower pace (see subsection 4).

Industrial output accounts for about one-fifth of nominal GDP, of which two-thirds correspond to value added in manufacturing (Appendix V, Table 7). At the early stages of the FFYDP, the investments to restore damaged production capacity and increased demand for industrial products stimulated the growth of industrial value added which averaged 15 percent per year in 1990/91-1991/92. A large number of industries, mostly private but also a few state-owned, restructured their operations and upgraded the range and quality of their products to better target the local and export markets. However, the sectoral growth slowed significantly during 1992/93-1994/95, with the growth of industrial value added averaging about 4 percent a year for the period. As noted above, constraints to increases in production became binding as excess capacity was fully utilized and new capacity buildup was slow. Also, depreciation of exchange rates raised production costs and quantitative import restrictions adversely affected import-intensive industries. On the demand side, there was a substantial reduction in public sector investment.

Industrial issues are handled by two ministries and one bank: the Ministry of Industry, 1/ the Ministry of Mines and Metals, and Bank of Industries and Mines (BIM). The two ministries are extensively involved in the execution and management of large-scale industrial projects and in the privatization of public enterprises. The Ministry of Industry is mainly responsible for industrial planning and development, supervising a large number of industrial companies, and managing the operations of heavy engineering industries. The Ministry of Mines and Metals has responsibilities for development and operation of the mining sector, as well as the metallurgical and steel industries. The BIM is responsible for restructuring public enterprises which have defaulted on their loans and require capital infusion and/or upgrading of managerial skills. Once the restructurings are completed, the BIM sells its portion of the shares to the private sector in order to mobilize funds for future restructuring operations.

The Government’s industrial policy in the last five years comprised liberalizing the prices of most industrial products, transferring industrial activities to the private sector, and improving competitiveness. Although the degree of government interference diminished significantly during the FFYDP, the Government has maintained the subsidization of certain industrial inputs (notably energy) and—as in the case of agriculture—allocation of foreign exchange at subsidized rates. Import licensing is currently applied to less than 50 items, aimed at protecting domestic producers.

Manufacturing in Iran consists mainly of food processing, textiles, wood and paper products, chemical products, metal working, and machinery. Manufacturing value added grew rapidly in 1990/91-1991/92, at an average of 17 percent a year. However, the growth rate declined substantially after 1991/92 to an annual average of 2.4 percent in 1992/93-1994/95 (Appendix V, Table 19). Price controls over manufactured goods have been largely removed.

Mining is small in relation to GDP, involving mainly copper, coal, iron ore, gypsum, and salt. The Government’s strategy aims to increase the share of mining and metals in both GDP and non-oil exports. To this end, the Government has been allocating over 90 percent of its outlays for this sector to mineral development. The growth rate of mining averaged 7 percent a year in 1990/91-1993/94. However, the sectoral growth slowed to 4 percent in 1994/95.

Construction and housing are mainly in the private sector. In 1990/91, there was a shortage of construction materials and housing shortages emerged. This induced the Government to adopt policies in 1991/92 to encourage further private investment in construction activities. 1/ Starting in 1991/92, government investment increased substantially for urban development and rebuilding while private investment grew rapidly for new urban construction. As a result, growth in the construction sector rose to an average of 12 percent per annum in 1991/92-1992/93. The rate of growth in construction returned to a more normal level during 1993/94-1994/95, when the sectoral value added grew at an annual average of 4 percent.

Following a 16 percent expansion in 1991/92, growth of the water and power sector moderated to an annual average of 9 percent in the last three years. With substantial public investment to reconstruct power plants and transmission lines, the power supply shortage was reduced from an average power shedding of 6 hours per day in 1989/90 to about 2 hours per day since 1993/94. In recent years, the Government has implemented a pricing policy for utilities which has allowed them to be almost fully self-financing, requiring only small budgetary transfers. This policy was followed consistently during and after the FFYDP, with utility prices being adjusted as needed.

e. Services

The value added by the services sector corresponds to about 42 percent of nominal GDP. The service sector grew at an annual average of 8 percent during 1990/91-1993/94, then decelerated to 5 percent in 1994/95 in line with the overall economic trends. Developments in the service sector have reflected the positive effects of the removal of restrictions on foreign trade, rehabilitation of transportation and communications, and improvements in the health and education systems.

3. Prices, employment, and wages

a. Prices and subsidies

Inflation, as measured by the consumer price index, increased to 35 percent in 1994/95, compared with an average of 23 percent in 1991/92-1993/94 (Appendix V, Table 23). The increase was driven by the sharp depreciation of the exchange rate, accommodating monetary policy, decontrol of prices for certain commodities, reduction in the size of government subsidies, and wage increases (in both the public and private sectors). The most pronounced increase was in the food and beverages index (which accounted for 14 percentage points of the overall increase) and in the housing index (which accounted for 5 percentage points). Price increases of clothing (contributing 4 percentage points) and transportation and communication (3 percentage points) were also important. CPI inflation accelerated in April and May 1995 to 51 percent and 59 percent (month-to-month over 12 months), respectively, as the demand for rial-denominated assets weakened and the demand for goods intensified. These developments were associated, in part, with a deterioration in expectations as a result of the announcement of extended sanctions by the United States.

During the FFYDP, significant progress was made in liberalizing price controls and reducing subsidies relating to a large number of agricultural and industrial commodities. In 1993/94, the pricing of tradeable goods subject to price controls was liberalized. By the end of 1993/94, price controls were removed from 290 agricultural and industrial commodities. Only seven food items (wheat products, rice, vegetable shortening, meat, cheese, milk, and sugar) as well as some pesticides and fertilizers remained under price control. Prices of these essential goods are reviewed each year to ensure that they cover the cost of production. In response to the exchange market turbulence in May 1995 and accompanying inflationary pressures thereafter, the Government issued regulations requesting merchants to post their prices (but stopped short of fixing them) for a wide range of agricultural and industrial products.

Despite the drop in the number of commodities subject to price control, the total amount of subsidies increased in the last two years because of exchange rate depreciation, increases in domestic procurement and international prices, and population growth. However, the real amount of subsidies per capita was lowered because fewer coupons were distributed to consumers to buy these subsidized goods. 1/

b. Employment and wages

The labor market has been characterized by the continuing high growth of the labor force, at an annual average of 5.6 percent during 1991/92-1994/95. 2/ Nevertheless, unemployment is estimated to have declined from 11.2 percent at end-1993/94 to 8.7 percent (1.36 million) at end-1994/95 which may have reflected the lower real wages (resulting from inflation) in certain labor-intensive activities (see below). 1/ Partial wage data indicate an increase in wages, salaries, and fringe benefits of workers in large manufacturing establishments at an annual average of 32 percent during 1990/91-1993/94 (data for 1994/95 are not available), implying some increase in real wages during the period (Appendix V, Table 21). For construction workers in the private sector, data suggest a loss in real wages as the corresponding indicators increased at an annual average rate of only 15 percent (Appendix V, Table 22). The situation worsened for private sector construction workers in 1994/95 as wages, salaries, and fringe benefits registered a growth of 24 percent in comparison with an inflation rate of 35 percent. According to the Labor Law of 1990, the minimum wage is subject to reviews by the Supreme Council for Labor (chaired by the Minister of Labor, with representatives of employers and employees from both the private and public sectors). The minimum wage has been raised by 10 percent (to Rls 5,333 per day) in 1995/96. In practice, the minimum wage regulation has not been enforced for small-scale enterprises.

4. Privatization and direct foreign investment

Most public enterprises in Iran are controlled by three government entities: (i) the Ministry of Industry, through its two holding companies—the National Iranian Industrial Organization (NIIO) and the Industrial Development and Renovation Organization (IDRO); (ii) the Ministry of Mines and Metals—through its major holding company, the National Iranian Steel Corporation (NISC); and (iii) the Bank of Industry and Mines. During the FFYDP, 391 companies were privatized, of which 126 companies were sold through the Tehran Stock Exchange (TSE), 160 companies were transferred directly to the original owners, and the remaining ones were sold through tender offers to the highest bidder, or direct purchase negotiations. It is difficult to assess the actual proportion of public assets acquired by the private sector, given that substantial shares were purchased or repurchased by public entities. 2/

Since 1993/94, the authorities have made a number of policy and regulatory changes aimed at attracting direct foreign investment. 3/ In this context, a committee has been established to review the Law for the Attraction and Protection of Foreign Investments in Iran, which dates back to 1955. Under this law, legal protection may be granted to foreign investment in manufacturing and other productive areas which directly or indirectly generate foreign exchange earnings. 1/ However, no similar coverage is given to foreign investment in the service sector and sectors that do not generate foreign exchange earnings. The new regulations governing direct foreign investment are expected to be submitted to the Majlis by end-1995. The Government has also sought to dispel ambiguities regarding Article 81 of the Constitution which might be interpreted as prohibiting foreigners from investing in Iran. 2/ Despite these efforts, the scale of direct foreign investment in Iran is still small compared with that in many other developing countries. By June 1995, 16 joint ventures had been approved by the Council of Ministers, amounting to US$900 million, and ten investment projects were being negotiated. 3/ The authorities expect foreign investments of about US$2 billion a year during the SFYDP.

Foreign investors are allowed to invest through the TSE. However, portfolio investment does not benefit from the protection of the foreign investment law. This reflects the view that the benefits from portfolio investment are relatively limited compared with those of direct investment; in particular, portfolio investment is regarded as not having the same degree of commitment to the development of the recipient country and as being more volatile. In addition, portfolio investment is viewed as a poor vehicle for transferring modern technologies and managerial skills.

III. The Public Finances

1. Introduction

The public sector in Iran comprises the General Government (the Central Government and 25 provincial governments), and over 400 public financial and nonfinancial enterprises and agencies. The comprehensive budget document contains separate budgets for the General Government and for the public enterprises and agencies. The budget of the General Government includes transfers to, and taxes and dividends received from the public enterprises. Some nonfinancial public enterprises, such as the NIOC, receive transfers from the general budget to cover their capital expenditure, which are recorded under capital expenditure in the budget of the General Government. Starting in 1993/94, the operations of the Organization for the Protection of Consumers and Producers (OPCP), which were previously extrabudgetary, have been consolidated into the budget. 1/

2. Overall budgetary developments

The FFYDP established the achievement of a balanced budget, defined as zero borrowing from the banking system, as one of its primary goals. Toward this end, the budget deficit was reduced from 9.2 percent of GDP in 1988/89 to 1.2 percent of GDP in 1992/93. However, in 1993/94, the fiscal operations were heavily impacted by the introduction of a considerably depreciated, market-based official exchange rate, which sharply raised both revenue and expenditure. In addition, the fiscal position was adversely affected by a large shortfall in oil export earnings; 2/ and lower-than-expected non-oil revenue. These factors led to marked deterioration in the fiscal position to a deficit equivalent to 6.3 percent of GDP (including the foreign exchange losses of the central bank). 3/

The emergence of large foreign exchange losses in 1993/94 was due to a failure to allocate sufficient oil export revenue for external payments which the Government had decided to subsidize by providing foreign exchange at the pre-March 1993 basic official rate. Specifically, the 1993/94 budget valued some of the oil revenue at the old official exchange rate of Rls 70 per U.S. dollar (an implicit earmarked deposit with Bank Markazi—the central bank), for imports of some essential and military goods and for covering the settlement of pre-March 1993 letters of credit by the commercial banks. The implicit (extra-budgetary) subsidy to be financed in this manner would equal the difference in the valuation (at the new versus the old exchange rate) of the payments to be made for such operations during the 1993/94 fiscal year. During 1993/94, Rls 6,966 billion were allocated for this purpose by the Government. 1/ In the event, however, the value of the subsidized payments amounted to Rls 13,086 billion, creating foreign exchange losses for the central bank amounting to Rls 6,120 billion. 2/ In response to the emergence of quasi-fiscal imbalances, the authorities made substantial cuts in development expenditure, reducing them to 66 percent of the budgeted level. Excluding the quasi-fiscal operations, the fiscal position would have been virtually balanced in 1993/94.

In 1994/95, the fiscal deficit narrowed to 4.9 percent of GDP as foreign exchange losses tapered off and budgetary expenditure declined in relation to GDP (Table 3 and Chart 2). Nevertheless, non-oil revenue again fell significantly short of the budgeted level and decreased in relation to GDP, due to a sizable shortfall in import taxes. As in the preceding year, the authorities responded to the revenue shortfall by significantly cutting capital outlays from the budgeted levels.

Table 3.

Islamic Republic of Iran: General Government Fiscal Position, 1990/91–1995/96 1/

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Source: Bank Markazi Jomhouri Islami Iran.

Fiscal years ending March 20.

In 1993/94 and 1994/95, adjustments were made to oil and gas revenues to capture the implicit import subsidies and transfers to commercial banks to cover the foreign exchange losses associated with the repayment of external arrears. A counterpart adjustment was made to expenditures. In addition, expenditures have been adjusted to reflect the quasi–fiscal foreign exchange losses of Bank Markazi, which are given by the balance of the Foreign Exchange Obligations Account The use of this account was terminated in 1995/96, and the quasi–fiscal operations related to this account have been integrated into the budget.

Special revenues are earmarked for Special expenditures.

The financial operations of the OPCP have been integrated in the budget since 1993/94.

The difference between OPCP revenues and OPCP expenditures.

The preliminary figure for 1994/95 has been set equal to the budgetary figure as the actual amount for that year was not available.

Primarily reflects delays in finalizing the accounts.

Chart 2
Chart 2

Islamic Republic of Iran: Operation of the General Government, 1990/91-1994-95

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 121; 10.5089/9781451818888.002.A001

3. General government revenue

Government budgetary revenue comprises oil and gas revenue, tax and nontax revenue, and special (earmarked) revenues (Appendix V, Table 25). Most special revenues (and their use) relate to the operations of the Social Security Organization. Prior to 1993/94, OPCP revenue was extra-budgetary, but it has since been incorporated into the budget. 3/

a. Oil and gas revenue

Government revenue from oil and gas arises almost entirely from exports. The Government also collects sales tax on domestic sales of petroleum products and gas. Starting in 1995/96, the Government is also collecting new excises on the domestic sales of petroleum products. The NIOC surrenders all proceeds from oil export earnings to the Government, which in turn makes transfers to that company to meet development and production costs. 1/ Oil and gas revenue rose sharply in 1993/94 reflecting conversion into local currency at a significantly more depreciated exchange rate. Its contribution rose from 42 percent of total revenue in 1992/93 to 75 percent in 1993/94, declining somewhat to 71 percent in 1994/95 (in this instance, because the conversion factor—Rls 1,750 per US$1—lagged behind inflation). In U.S. dollar terms, however, oil and gas export earnings declined by 15 percent in 1993/94 (on account of lower export prices), and recovered modestly (by 2 percent) in 1994/95 as export prices rose somewhat (see Section V).

b. Tax revenue

Tax revenue consists of income and wealth taxes, import taxes, and taxes on consumption and sales. 2/ The tax-to-GDP ratio declined from nearly 6 percent in 1992/93 to 4 percent in 1994/95. 3/ The share of income and wealth taxes in total taxes rose from 53 percent in 1992/93 to 70 percent in 1994/95. Although there were improvements in tax administration, this was mainly a result of lower receipts from import taxes whose share in total tax revenues fell from 33 percent to 23 percent on account of the sharp drop in imports. Over the same period, the share of taxes on consumption and sales fell from 14 percent to 6 1/2 percent due to a decline in excises on automobiles and, more generally, the inelasticity of these taxes.

Revenue from income and wealth taxes rose sharply between 1992/93 and 1994/95 as a percent of total tax revenue but they remained broadly stable as a percent of GDP (at 3 percent). Important steps have been taken to improve tax administration in recent years, including the issuance of tax identification numbers to a large number of taxpayers, partial computerization of tax administration, and increased recruitment and enhanced training of tax auditors. In 1992/93, the income tax code was revised. Personal exemptions were increased, the maximum personal income and corporate tax rate was reduced from 75 percent to 54 percent, and the number of tax brackets was reduced to help lower tax evasion. 1/ The authorities have established new procedures to assess and collect taxes on some professions with the assistance and cooperation of the professional syndicates. The base for the corporate income tax remains limited on account of exemptions granted to agriculture, cooperatives, a number of manufacturing and mining establishments, and public utilities. Beginning in 1992/93, the foundations (bonyads) and the hundreds of enterprises under their ownership were added to the corporate tax base. In practice, however, they are generally exempted from taxes. In 1992/93, tax holidays for corporations were limited and more strictly codified. During 1992/93-1994/95, corporate income taxes were stable at about 2 percent of GDP.

Import taxes consist of customs duties, the commercial benefits tax (CBT), order registration fees, and miscellaneous fees and surcharges. 2/ Despite significant increases in the customs valuation exchange rate from 1992/93 to 1994/95, import taxes remained largely stable in nominal terms, at around Rls 1,200 billion per annum, due to the decrease in the average import tax rate and import compression. Over this period, import taxes declined from 2 percent of GDP to 1 percent. Revenue from the CBT, which is the most important component of import taxes, has risen, while import duties and order registration fees have declined.

There were important changes in the import tax regime in the last two years. In November 1993, the exchange rate used for customs valuation purposes was changed from the old official exchange rate of Rls 70 per US$1 to Rls 1,500 per US$1, and the average combined import tariff (including CBT) was lowered from 35 percent to 11 percent. In March 1994, the customs exchange rate was changed to Rls 1,750 per US$1 and the average combined tariff was raised to about 18 percent. A further increase in customs duties, originally planned for 1994/95, is expected to occur in 1995/96. There are numerous commodity-specific, user-specific, and activity-specific exemptions from customs duties and the CBT. Starting in 1995/96, however, exemptions for a number of important enterprises, including the NIOC and the NIPC have been rescinded.

Taxes on consumption and sales, which take the form of specific excises levied on a small number of commodities, are among the most inelastic taxes in Iran. 1/ From 1992/93 to 1994/95, revenue from such taxes dropped from 0.8 percent of GDP to 0.3 percent. An important factor behind the decline in sales taxes was the reduction in the excise tax on automobiles in 1992/93, which was intended to encourage their domestic production. As of March 1995, the domestic retail prices of petroleum products were doubled through the imposition of a new 100 percent excise tax.

In recognition of the shortcomings in the current system of consumption and sales taxation, plans are currently underway for the introduction of a value added tax (VAT). A VAT bill, based on a uniform tax rate, is expected to be submitted to the Majlis in the near future. Moreover, during the SFYDP period, the authorities intend to convert all specific excise taxes to ad valorem ones. Moreover, a unified indirect tax code is expected to go into effect starting in 1996/97.

c. Nontax revenue 2/

Nontax revenue rose from 1.4 percent of GDP in 1993/94 to 1.8 percent of GDP in 1994/95. Income from government monopolies picked up due, in part, to revenue from privatizations by the NIIO. Revenue from services and sales of goods by the Government increased by about 90 percent in 1994/95 as a result of some increases in fees. Other revenue increased by over 200 percent due in part to the reclassification and consolidation of some OPCP receipts in this category.

4. General government expenditure

The general government expenditure comprise current, capital, and special expenditure. 3/ Starting in 1993/94, the operations of the OPCP, which were theretofore extrabudgetary, have been incorporated into the budget; for comparability, the staff has also consolidated this expenditure with budgetary current expenditure for the period 1990/91-1992/93. In 1993/94, the size of government expenditure increased dramatically due to the impact of the depreciation of the exchange rate on import subsidies and implicit transfers to public sector entities (mainly the commercial banks) in support of their external debt service payments. Total expenditure, including special outlays and net lending, increased from 20 percent of GDP in 1992/93 to 37 percent in 1993/94. In 1994/95, expenditure declined to 31 percent of GDP, partly because the exchange rate adjustment lagged behind inflation.

As regards the structure of expenditure, current and capital expenditure averaged about 25 percent of GDP and 7 percent of GDP, respectively during 1993/94-1994/95. 1/ In the same period, the implicit subsidies associated with imports of essential goods and debt repayments by the public sector averaged about 29 percent of total expenditure. Meanwhile, OPCP subsidies rose sharply, from 1.6 percent of GDP in 1992/93 to 2.8 percent in 1994/95, due mainly to large increases in wheat and fertilizer subsidies (Appendix V, Table 29); these increases are attributable to the application of more depreciated exchange rates for the imports of some of the subsidized goods, higher procurement and import prices, and population growth. Current transfers to public enterprises rose to 0.5 percent of GDP in 1993/94 (from 0.3 percent in 1992/93), but were budgeted to decline to about 0.2 percent in 1994/95 (Appendix V, Table 30). 2/ Interest payments on government domestic and foreign debt have been negligible in recent years. Military outlays declined by 0.4 percentage points of GDP to 2.3 percent of GDP in 1993/94, but were budgeted to increase to 3.4 percent of GDP in 1994/95—partly on account of the depreciation of the rial.

5. Deficit financing

As in previous years, the budget deficits during 1993/94-1994/95 were financed almost entirely through borrowing from Bank Markazi, including, most recently through zero-interest, no-maturity loans. 3/ Such credit has been largely associated with the foreign exchange losses incurred by the central bank as the result of providing foreign exchange at appreciated rates for selected external payments. The holdings of government bonds by the commercial banks have remained stable during recent years. 1/ In accordance with Islamic interest-free banking laws, the Government does not sell treasury instruments to the private sector. Net foreign financing has been relatively insignificant in recent years.

6. The 1995/96 budget

The authorities aim at significant fiscal adjustment in 1995/96. The budget is projected to have a small deficit equivalent to 0.1 percent of GDP. Oil and gas revenue is budgeted to increase by 15 percent to 16 percent of GDP. 2/ This partly reflects the fact that, unlike in previous years (when oil and gas revenue was converted using multiple exchange rates), such revenue is computed in the 1995/96 budget using a single exchange rate of Rls 1,750 per U.S. dollar. 3/ Non-oil revenue is budgeted to increase by about 87 percent to 9 percent of GDP through a number of measures: (i) an (as yet unspecified) increase in the average CBT rate; (ii) recision of exemptions from import taxes for a number of major enterprises, including the NIOC and the NIPC; (iii) the new excise on the domestic sale of petroleum products, which is projected to generate Rls 1,084 billion (0.6 percent of GDP); and (iv) there are plans to introduce new excises and to raise excise rates. In addition, electricity fees have been raised by 20 percent in 1995/96.

General government expenditure are budgeted to increase by 15 percent to 27 percent of GDP. The budget has allocated the equivalent of US$1.75 billion for imports of essential foods, medicines, and powdered milk, as well as for Iranian students studying abroad. In order to improve fiscal transparency, the transfers to the commercial banks through the exchange system for covering repayment of external obligations have been incorporated formally into the budget. Such transfers are budgeted to decline to Rls 2,729 billion or about 2 percent of GDP (from Rls 8,513 billion or 7 percent of GDP in 1994/95). The basic component of wages and salaries will rise by 20 percent. 4/ Also, OPCP subsidies are budgeted to increase by about 40 percent, to the equivalent of 3 percent of GDP. In the event of a revenue shortfall, the authorities have indicated that the Government will reduce outlays on a number of noncore investment programs. In addition, a part of budgetary expenditure, which is based on earmarked revenue, would be cut back if the associated revenue does not fully materialize.

7. Public enterprises

The authorities were able to provide data on transfers to cover the financial losses of public enterprises, as well as information on the budget of these enterprises for 1995/96. 1/ As noted above, transfers to such enterprises increased from 0.3 percent of GDP in 1992/93 to 0.5 percent in 1993/94, but were lowered to 0.2 percent in the approved budgets for 1994/95 and 1995/96. Some evidence concerning improved performance of the nonfinancial public enterprises is also available from the monetary accounts (Section IV). In 1995/96, the public enterprises are budgeted to have a deficit of Rls 16,225 billion, equivalent to 9 percent of GDP, which would be financed mainly by the domestic banking system.

IV. Financial Sector

1. Overall money and credit developments

The growth of broad money accelerated from 25 percent in 1991/92-1992/93 to 35 percent in 1993/94. In 1994/95, the growth rate of liquidity declined to 29 percent (Table 4 and Chart 3). 2/ In 1991/92-1993/94, broad money growth was driven by net domestic asset (NDA) expansion which peaked at 45 percent of the beginning-of-period liquidity stock in 1993/94. In that year, net credit to Government rose by 15.0 percent of the beginning-of-period liquidity stock; credit to public enterprises by 8.5 percent; credit to the private sector by 19.7 percent; and net other assets by 1.4 percent. In 1993/94, the net foreign asset position deteriorated, with a contractionary effect equivalent to 10 percent of the initial money stock. There has been a steady increase in money velocity, from 1.57 in 1990/91 to 2.05 in 1994/95.

Table 4.

Islamic Republic of Iran: Selected Monetary Indicators, 1990/91–1994/95 1/

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Source: Bank Markazi Jamhouri Islami Iran.

Fiscal years ending March 20.

Chart 3.
Chart 3.

Islamic Republic of Iran: Monetary Developments, 1990/91-1994/95

(Changes in percent of beginning stock of broad moneys)

Citation: IMF Staff Country Reports 1995, 121; 10.5089/9781451818888.002.A001

The deceleration in broad money growth to 29 percent in 1994/95 reflected a substantial reduction in the growth of NDA to 25 percent of the initial money stock which was accompanied by a partial improvement in the NFA position. The change in NDA was distributed as follows: net credit to Government grew by 9.8 percent of the beginning-of-period liquidity stock; credit to public enterprises by 5.0 percent; credit to the private sector by 14.8 percent; other net assets contracted by 5.0 percent.

The expansion of domestic credit has been associated with the deterioration in the fiscal position and a relaxation of the controls over extension of credit by the banking institutions. The flow of credit to the Government and public enterprises accounted for more than half (54 percent) of total increase in domestic credit in 1993/94 and for 50 percent of the flow of credit in 1994/95. The abolition of bank credit ceilings in the beginning of 1991/92 has allowed the banking institutions to substantially expand their credit operations in recent years. Thus, the banks’ share in total domestic credit rose from 56 percent at end-1990/91 to a peak of 67 percent at end-1992/93, with a corresponding decline in the share of Bank Markazi. The banks’ share in total credit declined somewhat in the last two years (to 65 percent) reflecting a pick-up in credit extension by the central bank.

2. Central bank operations

With regard to the central bank’s operations, reserve money growth was considerably slower than that of broad money in 1991/92-1993/94. This reflected the faster expansion of bank credit in the first two years, followed by a contractionary impact of NFA in 1993/94. The growth rate of reserve money increased from an average of 16 percent per year in 1991/92-1992/93 to 26 percent in 1993/94, and accelerated further to 31 percent—faster than broad money growth—in 1994/95. Central bank credit to the Government and the public enterprises was the main source of reserve money growth in the last two years. Credit to the Government was associated mainly with foreign exchange losses as reflected in the Foreign Exchange Obligations Account. 1/ The impact of claims on banks as well as that of NFA shifted from contractionary in 1993/94 to expansionary in 1994/95. 2/

Import deposits had a strongly contractionary impact on reserve money in 1993/94-1994/95. The increase in such deposits reflected an intensification in the commercial activities of the central bank which was associated with reduced willingness of foreign banks to accept letters of credit from Iranian commercial banks following the emergence of external arrears. These banks considered letters of credit opened by the central bank a smaller risk, which led Bank Markazi to open a larger volume of LCs—hence the increase in import deposits. Part of this increase was associated with imports by government agencies, from which Bank Markazi requires 100 percent advance import deposits. The authorities indicated that the central bank is reluctant to engage in this type of function and that it has only done so to support the flow of imports of essential goods.

3. Monetary policy developments

Following the abolition of credit ceilings, the main instruments of monetary control available to the central bank have been: (i) reserve requirements; (ii) allocation of government bonds to the banking institutions; and (iii) penalties for overdrafts by commercial banks from their agreed credit lines with the central bank.

There have been no increases in reserve requirements in the last few years (Appendix V, Table 39). Reserve requirements on 5-year deposits at commercial banks were lowered from 15 percent to 10 percent in 1993/94. In the same year, reserve requirements on deposits of specialized banks were lowered from 15-17 percent to 10 percent. Reserve requirements on noninterest bearing savings deposits of commercial banks have been lowered from 30 percent to 25 percent in 1995/96.

Similarly, there have not been significant changes in banks’ holdings of government bonds. In 1993/94, the central bank made a small net repurchase because it was felt that the banks required additional liquidity. In the first half of 1994/95, the central bank made a small net allocation of bonds to the banks. The rate of return on these government debt instruments ranges from 5.5 percent (for 2-year bonds) to 7 percent (for 7-year bonds); the banks have also been allocated some noninterest bearing government bonds, bringing the average yield on holdings to about 4 percent. There is no limit to the amount of bonds that the central bank may allocate to the commercial banks other than the availability of such bonds in the central bank’s portfolio.

The rate of return on central bank credit to the banks has been set at 14 percent since 1991/92. In 1993/94, the overdraft penalty of 2 percent was replaced by a progressive schedule of overdraft rates at 20 percent, 24 percent, and 30 percent (depending on the amount by which each bank exceeds its agreed credit).

Rates of return are set administratively by the central bank according to the maturity of deposits (highest for 5-year deposits) and the sector of economic activity to which credit is extended (lowest for agriculture, highest for trade and services). Under Islamic banking, these are expected rates of return; ex-post rates may be higher or lower than the quoted rates, depending on the profitability of the projects financed by banks and of the banks themselves. In practice, the ex-post rates are rarely lower than the quoted rates. The weighted average deposit rate rose steadily from 8.5 percent In 1991/92 to 12.4 percent in 1995/96 while the weighted average rate of charge rose from 13.3 percent to 17.6 percent over the same period (Appendix V, Tables 4142); both have become strongly negative in real terms given the high inflation rates of the last two years. This has discouraged savers from holding bank deposits and contributed to the steady increase in velocity noted above. The reduced attractiveness of bank deposits as a form of financial saving is evidenced by the decline in the share of quasi-money in broad money—from 53.5 percent in 1992/93 to 49.6 percent in 1994/95. On the lending side, the negative real rates on bank facilities have contributed to a heightened demand for credit, reducing the effectiveness of the instruments of monetary control at the disposal of the central bank.

4. Credit allocation

The commercial banks are required to follow central bank guidelines for the sectoral distribution of credit to the nongovernment sector (Appendix V, Table 40). Credit is extended at administratively set rates of return for different sectors. The authorities are aware of the distortions for credit allocation arising from the central bank guidelines but they indicated that these would remain in place as long as credit to different sectors of the economy commanded different rates of charge. 1/

5. Capital market developments

Regarding the development of capital markets, there has been a pick-up in the activities of the Teheran Stock Exchange. Part of this activity is associated with nonbank financial instruments—such as partnership papers and municipality papers—for specific projects, with a high rate of return. At end-June 1995, the amount of municipality papers outstanding was about Rls 150 billion (half with four-year maturity and half with three and one-half year maturity). There are no limitations on foreign participation in TSE transactions; however, the inability to purchase foreign exchange from the banking system to repatriate portfolio Investment has kept foreign participation at a low level.

V. External Sector

1. Balance of payments developments

a. Overall trends

During 1991/92-1993/94, the last three years of the FFYDP, Iran ran external current account deficits totalling US$22.1 billion as import growth was fueled by demand related to rehabilitation, an easy credit policy, an overvalued exchange rate up to 1992/93, and excessive use of external short-term financing; while export receipts were depressed by low international oil prices. In the absence of sufficient external financing with adequate maturity, the current account deficit led to sharp reduction of official reserves and to a build-up of external arrears to about US$11.2 billion at end-1993/94. In 1994/95, however, the current account of the balance of payments shifted strongly to a surplus of US$4.6 billion (7.2 percent of GDP), compared with a deficit of US$4.5 billion (5.9 percent of GDP) in the previous fiscal year. The main element in this improvement was a 34 percent decrease in imports from the previous year to half the level of 1991/1992 (Table 5; and Charts 4a, 4b, and 5). 1/

Table 5.

Islamic Republic of Iran: Summary Balance of Payments, 1990/91–1994/95 1/

(In millions of U.S. dollars)

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Sources: Data provided by the Iranian authorities; and Fund staff estimates.

Fiscal years ending March 20.

Chart 4a.
Chart 4a.

Islamic Republic of Iran: Imports, 1990/91-1994/95

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 1995, 121; 10.5089/9781451818888.002.A001

Chart 4b.
Chart 4b.

Islamic Republic of Iran: Current Account Performance, 1990/91-1994/95

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 1995, 121; 10.5089/9781451818888.002.A001

Chart 5.
Chart 5.

Islamic Republic of Iran: Gross Official Reserves and External Arrears, 1990/91-1994/95

(In billions of U.S. dollars, at end of year)

Citation: IMF Staff Country Reports 1995, 121; 10.5089/9781451818888.002.A001

b. Details of balance of payments developments

In 1990/91, oil exports increased substantially to US$18.0 billion, reflecting a high oil export price (at US$20.3 per barrel) and recovery in oil export volume (to 2.3 millions of barrels per day). On the other hand, there was also a surge in imports to US$18.3 billion, induced by very high real GDP growth (11.2 percent); recovery in production and investment; release of pent-up consumption demand; overvalued exchange rates for many transactions; and ample credit availability. In the event, the current account balance recorded only a small deficit of US$1.0 billion.

In 1991/92, the current account balance deteriorated sharply to a deficit of US$10.2 billion. Imports showed another major increase to a peak of US$25.2 billion owing to continued strong demand for imported goods, including large public sector demand, and continued high growth of the overall economy (10.6 percent). Oil earnings decreased to US$16.0 billion due to a much lower oil export price of US$16.1 per barrel. The current account deficit was financed by a large short-term net capital inflow of US$4.4 billion, mostly related to usance letters of credit (LCs), and reduction of official reserves (by US$2.1 billion).

In 1992/93, oil earnings remained low at US$16.9 billion due to a continued weak export price at US$16.8 per barrel. Imports (at US$23.3 billion) were lower than in the previous year due to lower growth of the economy (6.1 percent) and tighter monitoring of the opening of LCs. These developments were reflected in a decrease in the current account deficit to US$7.3 billion. At this point, Iran was still able to secure net short-term financing of US$3.3 billion. However, the large amount of maturing short-term financing acquired in 1991/92 led to incurrence of external arrears equal to US$2.2 billion by the end of the year.

In 1993/94, the current account deficit narrowed further to US$4.5 billion. Imports fell considerably to US$19.3 billion due mainly to the massive exchange rate depreciation after the introduction of a market-based official exchange rate at the beginning of the fiscal year. Oil receipts also fell (to US$14.3 billion) reflecting a weaker oil export price (at US$15.3 per barrel). While Iran succeeded in refinancing some arrears and maturing debt (US$2.8 billion), the limited adjustment in the current account deficit and the large debt service burden stemming from maturing LCs led to a sizable net build-up of arrears by US$9.0 billion.

In 1994/95, oil receipts remained virtually unchanged at US$14.6 billion. However, administrative rationing of oil export proceeds and some domestic adjustment contributed to a further sharp contraction in imports to US$12.7 billion, leading to a shift in the current account to a surplus of US$4.6 billion. This import compression was imposed to offset a large capital account deficit associated with maturing LCs. The net capital outflow resulted in an overall deficit of US$1.7 billion. Nevertheless, because of sizable refinancings amounting to US$10.8 billion (covering both arrears and maturing debt), official reserves recovered by US$1.2 billion to US$4.2 billion (equivalent to 3.6 months of imports).

2. Structure of exports, imports, and invisibles

a. Exports

Oil and gas export receipts, which comprised 77 percent of total exports in 1994/95, decreased by a total of 17 percent from their 1990/91 level due to lower export prices. Receipts from non-oil exports more than trebled during the same period, increasing their share in total exports from 7 percent to 23 percent (Appendix V, Tables 4647). Among non-oil exports, the most important items are carpets (37 percent), followed by fresh and dried fruits (18 percent). Agricultural and traditional items comprise 67 percent of non-oil exports. Industrial goods, such as copper ingots and wires, have a share of 32 percent and their growth rate has been high. Regarding the country distribution, the latest available data (for 1993/94) show Japan (13 percent), the United Kingdom (11 percent), the United States (8 percent), and Germany (5 percent) as the major destinations of Iran’s exports (Appendix V, Table 45). For non-oil exports, data for the first 6 months of 1994/95 indicate that Germany (24 percent), the United Arab Emirates (8 percent), and Italy (8 percent) are the major export markets (Appendix V, Table 48).

b. Imports

One of the most remarkable aspects of the recent developments in the Iranian economy was the surge of imports after the war with Iraq (from US$13.4 billion in 1989/90 to US$25.2 billion in 1991/92), and then their subsequent sharp contraction to US$12.7 billion in 1994/95. The sharp increase in imports in the first three years of the FFYDP reflected the urgent necessity of importing a large volume of capital goods and intermediate goods for rehabilitation after the war. Since 1993/94, in the context of considerable depreciation of the rial, substantial import substitution has occurred in such areas as construction materials and intermediate goods for the petroleum industry.

In 1993/94, intermediate goods and raw materials comprised 63 percent of nondefense imports, followed by capital goods (25 percent) and consumer goods (11 percent). As for the country distribution of imports in the first six months of 1994/95, Germany (18 percent), Japan (10 percent), and Italy (10 percent) were Iran’s major suppliers (Appendix V, Tables 4951).

c. Services and transfers

In general, statistics on services and transfers can be improved. Receipts for transportation services rose in 1994/95, reflecting increased leasing of ships to nonresidents. Payments for transportation services declined substantially over the last three years reflecting the sharp decline in imports and substitution of services offered by foreign companies for those offered by Iranian companies. Within receipts for travel, touris receipts from Armenia, Azerbaijan, and Turkmenistan are important. Payments for travel decreased in the last two years due to the imposition of stricter travel allowances. Iran receives no official grants from other countries. Private transfers, which amounted to US$1.2 billion in 1994/95, consist mainly of transfers from Iranian workers and other nonresidents to their relatives in Iran.

3. External debt developments

Throughout the duration of the war with Iraq (1980-1988), the authorities refrained from external borrowing to finance the overall balance of payments and maintained an impeccable debt servicing record. In 1989/90 and 1990/91, the rapid pick-up in imports coincided with an upswing in oil export receipts. As a result, the current account was almost balanced and the debt outstanding remained low. At the end of 1990/91, the outstanding external debt was US$6.2 billion (7.1 percent of GDP), of which US$1.8 billion was medium- and long-term debt and US$4.4 billion was short-term debt (Appendix V, Table 48) (Appendix V, Table 53).

In 1991/92 and 1992/93, the external debt situation changed dramatically. A major current account deterioration occurred, which was financed by large net capital inflows. Mainly, this consisted of short-term import financing in the form of usance letters of credit (LCs) opened by Iranian commercial banks (all of which are public entities), which were often covered by export credit agencies (ECA) in exporting countries. 1/ In addition, the National Iranian Oil Company entered into oil pre-lift (advance payment) agreements (of 6 to 24 months), which were the only escrow-type borrowing by Iran. At the end of 1991/92, the total debt jumped to US$10.9 billion of which short-term debt was US$8.8 billion. In 1992/93, Iran started to incur arrears. At the end of the year, the total debt outstanding had risen to US$16.0 billion, of which US$14.3 billion was short-term borrowing (mostly related to LCs), including arrears of US$2.2 billion.

The rapid build-up of debt during 1991/92-1992/93 may be explained by; (i) on the supply side, willingness of foreign creditors to extend credit, reflecting Iran’s excellent past record of external payment; initial limited exposure; and significant commercial potential; and (ii) on the demand side, insufficient domestic savings; overvalued official exchange rates accompanied by expectations of devaluation (which encouraged imports); the delegation of LC approval to the commercial banks; and relaxation of the foreign exchange budgeting procedures.

In 1993/94, despite the narrowing in the current account deficit, Iran incurred new arrears of US$12.1 billion (in gross terms) because of a large amount of maturing short-term repayments. Concurrently, Iran started refinancing negotiations with bilateral export credit agencies and succeeded in reaching refinancing agreements amounting to US$3.1 billion with key creditors including Belgium, France, Germany, Italy, Japan, and Korea. 1/ Thus, the net build-up of arrears during the year was US$9.0 billion. At the end of 1993/94, reflecting such developments, the total outstanding debt was US$23.0 billion, of which US$17.6 billion was short-term borrowing (including arrears of US$11.2 billion). The outstanding medium- and long-term debt was US$5.4 billion, including US$2.8 billion of refinanced debt. 2/

In 1994/95, there were further steps toward regularizing relations with creditors. A much improved overall balance (reflecting mainly the shift of the current account balance from deficit to surplus), together with more successful refinancings with bilateral creditors (including private creditors), contributed to a net reduction of arrears by US$7.9 billion. More specifically, Iran incurred new arrears of US$3.6 billion with regard to LCs opened before the beginning of 1994/95 but it reached agreements with creditors amounting to US$11.5 billion, covering both arrears and maturing LCs. 1/ At the end of 1994/95, the total outstanding debt declined slightly to US$22.7 billion (Appendix V, Table 54). As a result of the refinancing operations, short-term debt outstanding was reduced by US$10.9 billion to US$6.4 billion (of which LCs-related arrears amounted to US$3.3 billion) while the medium- and long-term debt jumped to US$16.0 billion (including US$11.5 billion of refinanced debt). 2/

The Iranian authorities currently attribute the highest priority to effecting debt service on schedule. In this context, it is their policy not to incur any arrears with respect to the LCs opened since the beginning of 1994/95. 3/

4. Developments in the exchange and trade system

The present exchange system functions on the basis of two official exchange rates: (i) the official rate, fixed at Rls 1,750 per US$1, and (ii) the “export rate”, fixed at Rls 3,000 per US$1. The official rate applies to oil export receipts, imports of essential goods and services, and public sector debt service. The export rate applies to all other transactions—non-oil export and service receipts; and imports and invisibles other than those eligible for the official rate.

Before March 21, 1993, there were three official rates used within the banking system and one free market rate outside the banking system. The “basic” official rate, pegged to the SDR at Rls 92.3 per SDR (about Rls 70 per US$1), was applied to oil export receipts, imports of essential goods, and official debt repayment. The “competitive rate”, pegged to the U.S. dollar at Rls 600 per US$1, was applied to imports of intermediate and capital goods which were not eligible for the basic official rate. A foreign exchange budget allocated foreign exchange to transactions applicable to either the basic official rate or the competitive rate. The “floating rate,” which was determined by banks taking into account the free-nonbank-market rate, was applied to other transactions. The free-nonbank-market rate was set by foreign exchange brokers and money changers; foreign exchange was bought and sold without question in this market.

On March 21, 1993 the official rates were formally unified at the floating rate which was announced daily by the Bank Markazi in the context of a managed float reflecting the free nonbank market rate (Appendix V, Table 52). Allocation of foreign exchange through a foreign exchange budget was terminated. However, the official floating rate was not applied comprehensively; foreign exchange continued to be provided for essential imports and repayments of short-term foreign debt contracted before March 21, 1993 at the former basic rate (and the competitive rate for some repayments), which gave rise to sizable quasi-fiscal losses.

The official floating rate depreciated substantially from a weighted average of Rls 515 per US$1 before the unification to an initial level of Rls 1,500 per US$1; it stabilized thereafter at about Rls 1,600 per US$1 until October 1993. At this point, the floating rate started on a faster pace of depreciation following the free nonbank market rate. The pressures on the foreign exchange market originated from unexpectedly low oil export receipts (due to low oil prices) and rapid monetary expansion partly originating from the quasi-fiscal losses. Two additional factors were: (i) the absence of effective repatriation and surrender requirements for non-oil exports (which continued until May 1995) and (ii) a liberal policy which allowed residents to purchase foreign exchange from commercial banks up to US$5,000 per transaction, regardless of the purpose of the transaction, until December 1993.

On December 21, 1993 the authorities discontinued the official rate’s link with the free-nonbank-market rate, fixing it at Rls 1,750 per US$1. Concurrently, to support the peg, the system of administratively allocating foreign exchange was reintroduced. From that date until May 4, 1994 the spread between the official rate (at Rls 1,750 per US$1) and the free market rate widened steadily. To further support the fixed rate, additional restrictions were applied to current payments at this rate through a gradual tightening of the foreign exchange allocation mechanism. Meanwhile, the central bank intervened in the (nonbank) authorized dealers’ market 1/, so that the rate in this market started to lag behind that in the off-shore free market, which was free of any restrictions and was without any central bank intervention. Thus, the free market broke into these two segments.

On May 4, 1994 the authorities introduced a second official exchange rate, the “export rate.” This rate initially floated at Rls 50 per US$1 below the authorized dealers’ rate, but soon was fixed at Rls 2,345 per US$1. The purpose of introducing the export rate was to facilitate the administrative allocation of foreign exchange (corresponding mainly to oil export proceeds) by raising the price of foreign currency for less essential imports. Thus, the more appreciated official rate became applicable to oil exports, imports of essential goods, essential service payments, and payments for official debts, while the export rate was applied to non-oil exports and a positive list of imports and service payments.

By May 1995, the above structure of dual official rates could no longer be sustained in view of high inflation, rapid depreciation in the free market (to as much as Rls 6,200 per US$1), and the impact on expectations of the announcement by the United States of tightened sanctions against Iran. On May 20, the authorities raised the repatriation and surrender requirements for non-oil goods to 100 percent (from 50 percent imposed in February). Surrender is at the official export rate within three months (six months for carpets) of shipment. At the same time, the export rate was depreciated from Rls 2,345 to Rls 3,000 per US$1. Currently, imports of goods and services (except travel allowances) are effected at the export rate without being subject to administrative allocation of foreign exchange; imports effected at the export rate represent about 40 percent of total imports.

Regarding the tariff structure, the Commercial Benefit Tax (CBT), which is an ad valorem tax on imported goods, has been used together with customs duties. At present, only the CBT is being applied because customs duties are being reviewed by the Majlis. In November 1993, the exchange rate used to value imported goods for import taxes was depreciated from Rls 70 per US$1 to Rls 1,500 per US$1. At the same time, tariff rates (the combination of CBT and customs duty) were reduced from a simple average of 35 percent to 11 percent. In March 1994, the exchange rate for tariff purposes was devalued again to Rls 1,750 per US$1; and the tariff rates were raised to an average of 18 percent. It is expected that, after the Majlis’ approval, the new customs duties rates would be zero to 5 percent for essential goods and raw materials; 5 to 15 percent for intermediate goods and machinery; and 15 to 25 percent for nonessential and luxury items.

Islamic Republic of Iran: Recent Economic Developments
Author: International Monetary Fund