Islamic Republic of Iran
Recent Economic Developments

This paper reviews economic developments in the Islamic Republic of Iran during 1990–96. 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 12-month consumer price inflation to 59 percent in May.


This paper reviews economic developments in the Islamic Republic of Iran during 1990–96. 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 12-month consumer price inflation to 59 percent in May.

I. Overview

1. After the war with Iraq (1980–88), Iran embarked on a program of infrastructure reconstruction and economic reform constituting the First Five-Year Development Plan (FFYDP), covering the period 1989/90–1993/94 (fiscal year ending March 20). 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; in particular, the growth rate of real GDP averaged 7 percent over the period; social indicators also improved significantly during this period. Progress under the FFYDP was hampered, however, by overly expansionary financial policies and the resulting macroeconomic imbalances. 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 in 1993/94 led to severe pressure on the balance of payments and eventually to a growing stock of external payment arrears.

2. Against this background, the unification of the official exchange rates—a key objective of the FFYDP—that was introduced in March 19931 could not be sustained. The floating of the official exchange rate was abandoned in December 1993. when the official rate was effectively fixed at Rls 1,750 per U.S. dollar. 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 service transactions.

3. The authorities achieved a measure of progress in reducing financial imbalances in 1994/95. The overall fiscal deficit was reduced while the growth of net domestic credit slowed and monetary growth tapered off to 29 percent compared with 35 percent in 1993/94. However, inflation remained high (at 35 percent) as the demand for Iranian rial-denominated assets was weakened by increasingly negative real rates of return; the growth rate of real GDP declined; and exchange rate developments put upward pressure on costs and prices (Table 1 and Chart 1). Success was also achieved in refinancing a large part of the overdue external payments through bilateral arrangements, thereby reducing the stock of external arrears.

Table 1.

Islamic Republic of Iran: Key Economic Indicators, 1992/93–1996/97 1/

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

Iranian years ending March 20.

Changes in percent of initial broad money.

Chart 1
Chart 1


(Annual percentage changes)

Citation: IMF Staff Country Reports 1998, 027; 10.5089/9781451818901.002.A001

Source: Data provided by the Iranian authorities.

4. 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 (Table 2). As a result, the current account of the balance of payments shifted into a surplus of US$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 U.S. dollar. 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 U.S. dollar, applicable to non-oil exports and nonessential imports. In January 1995, a 50 percent repatriation and surrender requirement was imposed on non-oil exports.

Table 2.

Islamic Republic of Iran: Aggregate Output and Expenditure Trends, 1992/93–1996/97 1/

article image
Source: Bank Markazi Jomhouri Islami Iran.

Iranian years ending March 20.

Includes oil and gas production, refining, and distribution.

In percent of GDP at factor cost, current prices.

In percent of GDP at current market prices.

5. The authorities embarked upon the Second Five-Year Development Plan (SFYDP) in 1995/96. The objectives of this plan are to: (i) achieve a 6 percent real growth rate with a single digit inflation performance; (ii) reduce the reliance on oil revenues; and (iii) unify the exchange rate system.2 However, initial progress toward these objectives was slow as 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 up to Rls 6,200 per U.S. dollar and consumer prices rose by 14 percent during April-May which pushed the 12-month consumer price inflation to 59 percent in May. The authorities responded by raising the export repatriation and surrender requirement to 100 percent 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 U.S. dollar.

6. In 1996/97, despite a relaxation of import compression facilitated by higher oil revenues, Iran’s current account surplus continued to strengthen to reach US$5.5 billion (compared with US$3.4 billion in 1995/96). However, the performance of the non-oil sector continued to weaken, reflecting the impact of an increasingly appreciated exchange rate applicable to these exports and a weaker demand for Iranian products in some export markets. The fiscal deficit was further reduced to 2.2 percent of GDP (from 3.6 percent in 1995/96), reflecting the increase in oil revenues and containment of budgetary expenditure. However, money growth was maintained at the high level recorded in the previous year, partly due to an overrun in bank credit at the end of the year for financing imports of industrial goods by the nongovernment sectors. Nevertheless, the 12-month rate of inflation declined steadily through 1996/97 from its May 1995 peak, reaching 17 percent at end 1996/97.

7. A positive development since the end of the Iran-Iraq war has been a marked improvement in social indicators. In the area of health and demographics, the coverage of health care, safe water and sanitation has increased from approximately half the population to almost the entire population, albeit with the rural areas to some extent still lagging behind. Infant mortality has been reduced and life expectancy has improved. In the area of education, the enrollment rates in primary and secondary schools have increased, which has led to a significant improvement in the literacy rate. University studies and other higher education have experienced a significant expansion.

II. The Domestic Economy

A. Economic Performance During 1992/93–1996/97

Overall trends in production and expenditure

8. Real GDP growth (at factor cost) increased to 4.5 percent in 1996/97, compared with an average growth rate of 3.8 percent experienced during the period 1992/93–1995/96 (Appendix II, Table 6). Growth in the oil sector remained moderate at 1.5 percent in 1996/97 but this was compensated by a relatively solid growth of 5.0 percent in the non-oil sector compared with a non-oil average growth rate of 4.5 percent experienced between 1992/93–1995/96.

9. Both consumption and investment expenditures displayed strong growth in 1996/97. Total consumption expenditure rose by 8.5 percent in real terms in 1996/97, with private sector consumption growing by 9.1 percent, and public consumption by 5.8 percent (Appendix II, Table 9). This was a sharp turn around from the developments in 1995/96, when total consumption expenditure was compressed by 3.5 percent due to a fall in private consumption by 4.9 percent. As a ratio to GDP, consumption expenditure reached 74.1 percent in 1996/97, with private consumption accounting for 60.7 percent of GDP. Real gross fixed capital formation also recorded a strong performance in 1996/97—6.9 percent in real terms—significantly higher than in the three preceding years when the average growth amounted to 3.3 percent. Over the period 1992/93–1996/97, the ratio of gross national savings to GDP has displayed sharp annual fluctuations, reflecting inter alia the large exchange rate movements, the effect of import controls, changes in real rates of returns, and swings in consumer confidence (Appendix II, Table 8).

The oil and gas sector

10. Crude oil production remained at 3.6 million barrels per day (mbd) in 1996/97, in line with the quota set by OPEC from 1993/94 (Appendix II, Table 10).3 A modest increase in domestic consumption in combination with a decline in exports of refined products maintained crude oil exports at 2.44 mbd in 1996/97. The average price of crude oil exports was approximately US$20 per barrel in 1996/97, representing a gain in excess of US$4 per barrel over the previous three years, which led to an increase in oil export earnings by 27 percent to US$19.3 billion. Domestic consumption of petroleum products grew by 1.8 percent in 1996/97, approximately half of the average annual growth rate from 1992/93–1995/96. To supply the domestic market with refined products, and to reduce the dependence of crude oil exports and concentrate on export products with higher value added, Iran has continued to expand its domestic refining capacity (Appendix II, Table 12).

11. In addition to the development of domestic refineries, the government has sought to promote expansion of the petrochemical industry, which also generates products with higher value added and, therefore, higher export earnings than crude oil. Total petrochemical output is estimated at 11.2 million tons in 1997 compared with 2.4 million tons in 1989. In the period through 2010, 30 projects are to be implemented in five phases that will require investments in an amount equivalent to US$24 billion. In the first two stages of the plan, 12 projects are envisaged, with total capital requirements of US$6.4 billion. The projects are envisaged to double refining capacity to an estimated 21 million tons by 2010.

12. Production of natural gas increased by 8 percent in 1996/97, similar to the growth rate achieved in the previous years, having reached 64.2 billion cubic meters. The majority of the output was consumed domestically; in particular, no export of gas has been recorded since 1995/96. The policy followed by the Iranian authorities is to substitute natural gas for petroleum products domestically, partly because petroleum products require less downstream investment (like pipelines) to be exported, but also because of environmental consideration. In the long run, the gas sector is expected to continue to grow at a rapid rate since Iran has the world’s second largest proven gas reserves (estimated at 21 trillion cubic meters in 1995/96). In 1997, Total (a French oil company), Gazprom (a Russian state-owned oil company), and Petronas (a Malaysian oil company) have agreed with the Iranian authorities on the terms of a buyback operation to develop the South Pars gas field. A crucial factor in the development of the gas sector is the construction of pipelines. A recently opened pipeline has linked the gas networks of Turkmenistan and Iran, thereby providing the northeastern part of Iran with an initial 4 billion cubic meters of natural gas in 1998. A larger project would aim at transporting Turkmen gas to Turkey via a pipeline across Iran.


13. Real growth in agriculture improved to 3.5 percent in 1996/97 from a modest 2 percent in the preceding two years. Due to the relatively slow growth, the share of agriculture in nominal GDP declined from 22.2 percent in 1995/96 to 20.9 percent in 1996/97. A major factor contributing to the continued slow growth in agriculture was an 11 percent decline in wheat production due to a reduction in cultivated area and in the yield, the latter being attributable in part to adverse weather conditions. Moreover, another important crop, barley, also experienced a drop in output (by 9 percent). With a view to reducing the sensitivity to changes in rainfall, the government has prepared a number of irrigation and dam projects. In 1996/97, 49 dams were under construction and another 79 projects were at the planning stage. In 1997, the irrigation and drainage network is projected to cover 1,127 thousand hectares, compared with the coverage of 935 thousand hectares in 1989.

14. Except for the provision of infrastructure, the government aims at reducing its role in agriculture and promoting private sector activities and the growth of cooperatives. The amount of subsidies to agricultural inputs has been reduced over the last few years; in this context, the subsidies to agricultural machinery have been removed and the subsidies to pesticides and fertilizers have been reduced in real terms. However, there are still substantial subsidies to some basic agricultural products, in particular to wheat which accounts for about two-thirds of the total.

15. The government sets its procurement prices for agricultural products by applying a cost-based approach which allows for a gross profit margin of 20–25 percent and also takes into account international prices. These prices serve as a guaranteed benchmark which usually falls below market prices. In addition, in some cases the government’s intervention to support the market price can be of a limited magnitude. For example, rice production grew to such an extent in 1997 that the government entered the market to support the price. However, government purchases of rice were limited to 40 thousand tons out of a total production of 1.6 million tons.


16. The industrial sector has continued to be dominated by relatively few but large public enterprises that account for approximately 70 percent of value added in manufacturing. Public enterprises have relied on relatively capital intensive production while the private sector has been characterized by more labor-intensive activities. Real growth in the industrial sector in 1996/97 reached 6.3 percent while the share of industry in the total value added continued to increase, having reached 21 percent. During 1992/93–1996/97, the average growth rate in industry was 5 percent per year, one percentage point higher than the average growth of real GDP.

17. The construction sector was the most dynamic sector in 1996/97, having grown by 10.6 percent, compared with the 4.5 percent growth recorded in 1995/96 and to the 5.3 percent average growth achieved in the period 1992/93–1995/96. An important reason for the strong growth in construction in 1996/97 was the expansion in both housing and commercial construction in Teheran, partly as a result of local government policies to relieve shortages of housing and office space. As a share of GDP, the value added in the construction sector increased to 4.4 percent in 1996/97 (from 3.5 percent in 1995/96).


18. The services sector is the largest sector in the economy, contributing with almost 43 percent of the total value added in 1996/97. The growth performance in the services sector was mixed in 1996/97, with trade showing a modest growth of 2.7 percent; dwellings and public services growing rapidly, at 6.2 percent and 7.1 percent, respectively; and transportation and communications expanding at about the same rate as GDP, at 4.9 percent.

B. Prices, Employment and Wages

Prices and subsidies

19. The 12-month rate of change in the consumer price index declined sharply from its peak of 59 percent in May 1995 to 17 percent at the end of 1996/97, with the year-on-year inflation coming down to 23 percent from 49 percent in 1995/96 (Box 1 and Appendix II, Table 24). During the first seven months of 1997/98, inflation fluctuated in the 15–20 percent range. In 1996/97, the food, beverage, and tobacco group of goods (accounting for more than 35 percent of the CPI basket) displayed the largest drop in year-on-year inflation, decelerating from 60 percent in 1995/96 to 15 percent. However, the prices of housing and clothing (which represent another 35 percent of the CPI basket) grew by 35 percent in 1996/97, implying a significant swing in relative prices between this group and the food group.

Iran: Inflation in Iran

Since the Islamic Revolution (1979/80), the 12-month rate of inflation in Iran has averaged 22 percent, with a peak of 59 percent in May 1995, a low of 3 percent in June 1990, and a standard deviation of 11 percent. Thus, inflation has not only been high but also fairly volatile. One of the major goals of the SFYDP is to bring down inflation to a consistent single digit level.

In a more extensive study being prepared by the staff, some econometric models of inflation have been estimated. Although it is difficult to get robust results of the short-run effects due to the limited amount of data, some robust long-run results emerge. First of all, monetary expansions transform almost one for one to inflation. Secondly, GDP growth has a dampening impact on inflation, with elasticities in the range of -0.5 to -1. Thirdly, there is a positive but less significant relationship between the parallel market exchange rate and inflation, and most of the effects seem to go from inflation to the exchange rate rather than the other way around.1 Fourthly, the official exchange rate has a very limited and statistically insignificant effect on inflation. Finally, the real oil price is very closely linked to real GDP growth, and thus implicitly is important in explaining inflation.

The policy conclusions from these findings can be summarized as follows: the most powerful way of reducing inflation is to control money growth and at the same time promote real GDP growth, while the exchange rate in itself is of limited importance. However, if a depreciation of the official exchange rate is accompanied by a loose monetary stance, this can have serious implications for inflation. Similarly, the elimination of the existing price controls and subsidies and the adoption of a more flexible official exchange rate policy may reinforce the influence of the exchange rate on price formation.

1The fact that a change in the parallel exchange rate has a limited impact on the inflation rate may be due to the existence of widespread price controls and subsidies and/or the composition of the consumer basket used to measure inflation.

20. A number of goods and services are subject to price controls and subsidies, which have mainly been administrated by the Consumer and Producer Protection Organization (CPPO). During 1992/93–1996/97, CPPO performed three main functions: (i) determining administered prices; (ii) paying subsidies for basic goods (through 1995/96);4 and (iii) collecting the difference between some officially determined prices (which are, however, not administrated) and market prices. The price-setting function of CPPO covers goods that are subsidized and made available through the coupon system (sugar, wheat, edible oil, milk, cheese, red meat, rice, fertilizers, pesticides); related goods and services (flour, labor used to produced sugar cubes, sugar beat waste to feed animals, etc.); goods produced by monopolies (e.g., paper, agricultural machinery, petrochemicals, and automobile batteries); other goods imported at the exchange rate of Rls 1,750 per U.S. dollar (e.g., detergents, medicine); and selected other goods (e.g., syringes). For the price-controlled goods numbering about 25, prices are determined at all levels (producer, wholesale, retail). Price determination is based on cost calculations allowing for a certain markup; these calculations are made at all stages of the production and distribution chain, i.e., from the producer all the way to the retail level. While most of the officially determined prices are not administered prices, nonobservance of CPPO price guidelines is subject to payment of a fine. For certain goods, the companies selling them for more than the official price pay some of the difference between the official price and the actual price to the Ministry of Finance (prior to 1997/98 the payments were made through the CPPO). Specifically, 30 percent of this difference can be used by the company for approved investments.

21. Budgetary subsidies in 1996/97 amounted to Rls 5,980 billion, with wheat subsidies accounting for approximately two-thirds of the total. A coupon system is in place for all subsidized goods except wheat. Coupons are issued by the Ministry of Commerce through the banking system. Currently, imports of subsidized goods are made mainly by the government trading corporations (GTCs) at the exchange rate of Rls 1,750 per U.S. dollar. Imports of these goods can also be made by the private sector at Rls 3,000 per U.S. dollar, which is profitable in situations when not all demand is met by the subsidized supply.

22. Large implicit subsidies stem from underpricing domestic consumption of petroleum products in comparison with the international price levels of these products. These implicit subsidies are estimated in the neighborhood of Rls 30 trillion, or close to 10 percent of GDP in 1997/98. The largest implicit subsidy is on the consumption of gas oil, which has a price that amounts to one-fourteenth of the international level, and also constitutes the largest share of domestically consumed petroleum products. The weighted average price of domestic petroleum products is less than one-eighth of comparable international prices. Real annual increases in domestic petroleum prices are part of the SFYDP objectives but, due to inflation, the price adjustments for petroleum products (about 20–30 percent in the last three years) have had only a negligible impact on their relative prices.

Employment and wages

23. Total employment in the economy increased from 11 million to 14.6 million (91 percent of the labor force) during the decade ending in 1996/97. In the service sector (the largest employer), employment increased from 4.7 million in 1986/87 to 6.5 million in 1996/97 while industrial employment rose from 2.7 million to approximately 4.4 million. The unemployment rate declined from 14.2 percent in 1986 to 9.1 percent in 1996 despite an average annual increase in the active population of about 2 percent.

24. The only available data on wages outside the civil service is on compensation to private sector construction workers, who experienced an increase of nominal wages of 28 percent from end-1995/96 to end-1996/97, implying that real wages in private construction increased by about 10 percent (compared with a virtual stability in real terms in the preceding year). This large increase in the construction sector is likely to reflect the high real growth rate in the construction sector in 1996/97 and, therefore, is not likely to be representative of the pace of wage increases in the private sector as a whole. In particular, as noted below in the fiscal section, base wages in the civil service continued to decline in real terms in 1996/97.

C. Foreign Investment

25. Foreign direct investment has remained at a low level, with flows in 1996/97 of $14 million. In order to be eligible to repatriate investment income, foreign investors must obtain approval under the Law of Attraction and Protection of Foreign Investment (LAPFI), which requires, inter alia, that the investment be in industry, mining, agriculture or transportation; and that it be at least self-sufficient with respect to foreign exchange. Between 1993 and October 1997, 50 projects, totaling US$722 million, were approved; however, actual investment inflows amounted to a total of only US$40 million. Direct investments are limited to joint ventures but there are no longer restrictions on the share foreigners can hold.5

26. An alternative to foreign direct investment which is taking on importance in Iran is the so-called buyback mechanism, wherein the foreign investor receives a portion of the output generated by a project. This is the mechanism whereby investments in the oil and gas sector are carried out, two recent examples being the estimated US$2 billion agreement with Total, Gazprom, and Petronas for the development of the South Pars gas field, and the agreement with Bow Valley from Canada for the development of the Balal oil field.

D. Social and Environmental Issues

27. The key social indicators have improved in Iran since the beginning of the 1980s, and policies have been implemented to improve both education and health in the country. The enrollment rate in primary education is approximately 100 percent (compared with 87 percent in 1980), and many students continue to secondary education, where the enrollment rate has increased to close to 70 percent (compared with 42 percent in 1980), (Appendix II, Table 22). The literacy rate increased from about 50 percent in 1987 to more than 70 percent in 1996. In the age group between 6 and 29 years, the education effort is even more evident, bringing up the literacy rate to more than 90 percent for the total population in 1996 and to close to 100 percent in urban areas. Higher education has also experienced a significant expansion, with the number of students increasing from about 500 thousand in 1989 to 1.2 million in 1996/97.

28. There have also been significant improvements in several health-related indicators over the last 10 to 20 years. These include the coverage of health services, access to safe water and sanitation, as well as the numbers of physicians, nurses, and hospital beds per person (Appendix II, Table 23). Furthermore, special attention has been given to the immunization of children. The health policies have achieved a decrease in infant mortality rates (26 per 1,000 live births in 1997, compared with 92 in 1980), and an increase in life expectancy at birth (68 years in 1995 compared with 60 years in 1980). In order to rationalize population growth, a family planning program has been implemented; it has contributed to a reduction in population growth from 3.2 percent in 1984 to 1.6 percent in 1996.

29. Over the last 15 years, there has also been an improvement in income distribution, but there are still vulnerable segments of the population that require support. In order to improve the situation for the most vulnerable segments, especially in rural areas, the government is considering an anti-poverty program comprising expanded provision of food, clothing, health care, education, social security, and bank credits to these groups. In addition, 300 thousand homes and 500 thousand jobs would be created for poor families within five years, with credits guaranteed and subsidized by the government.

Environmental policies

30. Over the last several years, environmental issues have been the object of special attention on the part of the government. There are several environmental research centers in the country and a network of provincial offices is in charge of enforcing environmental standards. An assessment of the environmental impact is required for every government project. The newly elected government has taken a number of steps to further promote environmental objectives side-by-side with economic development. In this context, a national plan of action for environmental protection is being developed by nine subcommittees covering such areas as air and water pollution, and soil erosion whose members have been drawn from government agencies, nongovernment organizations, the private sector, and universities. At present, one of the authorities’ top priorities is the reduction of air pollution in Teheran. In this regard, all taxis and a large number of buses have been converted from gasoline to natural gas.

III. The Public Finances

A. Introduction

31. The public sector in Iran comprises the general government (the central government and 27 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 state-owned oil company National Iranian Oil Company (NIOC), receive transfers from the general budget to cover capital expenditures which are recorded as capital expenditure in the general government budget. Starting in 1993/94, the operations of the CPPO, which were previously totally extrabudgetary, have been consolidated into the budget.6

B. Overall Budgetary Developments

32. The FFYDP established the achievement of a balanced budget, defined as zero borrowing from the banking system, as one of its primary goals. This fiscal rule has also been incorporated in the SFYDP. Toward this end, the budget deficit was reduced over the course of the FFYDP from a postwar peak of 9.2 percent of GDP in 1988/89 to 1.2 percent of GDP in 1992/93 (Table 3 and Chart 2). 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 particular foreign exchange losses. In addition, the fiscal position was adversely affected by a large shortfall in oil export earnings;7 and lower-than-expected non-oil revenue. These factors led to marked deterioration in the fiscal position to a deficit equivalent to 7.2 percent of GDP (including the foreign exchange losses of the central bank).8 Since then, the authorities made efforts to mobilize revenues and control expenditure to bring down the deficit closer to the zero deficit target; as a result, the deficit (including the foreign exchange losses) was brought down in steps to the equivalent of 2.2 percent of GDP in 1996/97.

Table 3.

Islamic Republic of Iran: General Government Fiscal Position, 1992/93–1997/98 1/

article image
Source: Bank Markazi Jomhouri Islami Iran.

Iranian years ending March 20.

Additional revenue due to the sale of share of oil revenue at the export rate.

Consists of valuing a portion of the oil and gas revenue at the pre-March 1993 official rate (Rls 70 per U.S. dollar) in order to cover the subsidy to the service of debts contracted before March 21, 1994. This provisioned amount is deposited in a special government account with Bank Markazi-the Foreign Exchange Obligation Account.

Mostly earmarked revenues of the Social Security Organization.

This relates mainly to the service of debts contracted at pre-March 1993 exchange rates more appreciated than the current official exchange rate used for debt service payments. For each U.S. dollar equivalent of debt service payment, the government covers the difference between the official exchange rate (Rls 1,750 per U.S. dollar) and the amount contracted by the debtor or importer (typically, Rls 70 per U.S. dollar).

In 1993/94, it also includes import subsidies.

Comprises the counterpart of the earmarked revenue.

Includes the statistical discrepancy between the above-the-line budgetary data and the below-the-line financing data. In 1996/97, refers to the issuance of government partnership papers.

The extra-budgetary foreign exchange losses correspond to the excess of the amount described in footnote 4 less the provision included in the budget law. This excess is reflected in an expansionary movement of the Foreign Exchange Obligation Account.

Chart 2
Chart 2


(In percent of GDP)

Citation: IMF Staff Country Reports 1998, 027; 10.5089/9781451818901.002.A001

Source: Data provided by the Iranian authorities.

33. 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 some essential and government imports and for covering the settlement of pre-March 1993 letters of credit by the commercial banks. The associated implicit subsidy was equal to 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.9 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.10 In response to the emergence of quasi-fiscal imbalances as well as to the drop in oil revenue, 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 (a deficit of 0.7 percent of GDP).

34. In 1994/95 and 1995/96, the fiscal deficit narrowed to 4.5 percent of GDP and 3.6 percent of GDP, respectively, as foreign exchange losses tapered off (to Rls 8,513 billion and Rls 9,298 billion, respectively) and other budgetary expenditure declined somewhat in relation to GDP.11 Nevertheless, revenues and in particular non-oil revenue continued to fall in relation to GDP. In 1996/97, the fiscal deficit was further reduced to 2.2 percent of GDP owing to a pick up in the share of revenues to GDP from 25.2 percent in 1995/96 to 26.8 percent of GDP in 1996/97, helped by an increase in crude oil export prices, and to a virtual stabilization of overall budgetary expenditure. Within the latter, foreign exchange losses dropped from the equivalent of 5.2 percent of GDP to the equivalent of 3.1 percent of GDP.

C. General Government Revenue

35. Government budgetary revenue comprises oil and gas revenue, tax and nontax revenue, and earmarked revenues.12 Government revenue from oil and gas arises almost entirely from exports. The government also collects a modest sales tax receipts on domestic sales of petroleum products and gas. Starting in 1995/96, the government has also been collecting new excises on the domestic sales of petroleum products. 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.13 Oil and gas revenue rose sharply in 1993/94 reflecting conversion into local currency at a significantly more depreciated exchange rate, its contribution rising from 42 percent of total revenue in 1992/93 to 75 percent in 1993/94. Since then, because the official exchange rates have lagged behind inflation, this share has steadily declined in percent of GDP despite the sale of an increasing share of oil revenue at the Rls 3,000 per U.S. dollar export exchange rate.

36. Tax revenue consists of income and wealth taxes, import taxes, and taxes on consumption and sales. The tax-to-GDP ratio declined from nearly 6 percent in 1992/93 to about 4 percent in 1995/96 as revenue from import taxes and taxes on consumption and sales did not keep up with the rate of growth in nominal GDP. However, due to tax measures, revenue collection efforts, and higher import volumes, the tax ratio increased to above 5 percent of GDP in 1996/97.

37. After several years of stagnation at a relatively low level in percentage of GDP, revenue from income and wealth taxes have increased substantially as a share to GDP in 1995/96–1996/97. In recent years, important steps have been taken to improve tax administration and tax collection, 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. Personal exemption thresholds have been increased, the maximum personal income and corporate tax rate has been reduced from 75 percent to 54 percent, and the number of tax brackets has been reduced to nine to help stem tax evasion.14 The authorities have also established new procedures to assess and collect taxes on some professions with the assistance and cooperation of the professional syndicates. All these measures, plus considerable efforts to collect tax arrears from corporate taxpayers, have started to bear fruit in the form of higher revenue collection; from 1994/95 to 1996/97, corporate income tax revenues have increased from 3.0 percent to 3.9 percent of GDP; revenues on personal income tax and taxes on professions have also increased as a share to GDP. However, 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. In addition, the foundations (bonyads) and the hundreds of enterprises under their ownership are generally exempted from taxes.

38. Import taxes consist of customs duties, the commercial benefits tax (CBT), the order registration fee, and miscellaneous fees and surcharges. Despite significant increases in the customs valuation exchange rate, import taxes remained largely stable in nominal terms from 1992/93 through 1995/96, at around Rls 1,200 billion per annum, due to the decrease in the average import tax rate and import compression. Over that period, import taxes declined from 2 percent of GDP to less than 1 percent of GDP. However, import tax revenue jumped to nearly Rls 3,000 billion (1.3 percent of GDP) in 1996/97, due to an increase in the value of the order registration fees15 and, more importantly, to the relaxation of import compression, which has translated into a sharp increase in the taxable base.

39. There have been important changes in the import tax regime over the last few years. In November 1993, the exchange rate used for customs valuation purposes was changed from the old official exchange rate of Rls 70 per U.S. dollar to Rls 1,500 per U.S. dollar. In March 1994, the valuation rate was moved to Rls 1,750 per U.S. dollar. Simultaneously, the average combined tariff rate was raised to about 18 percent, partially reversing its lowering to about 11 percent in November 1993. Currently, there are 21 customs duties and commercial benefit combined rates, ranging from 0 percent to 100 percent by tranches of 5 percentage points. As regards exemptions, Iran’s legislation is marked by the existence of 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, have been rescinded. Currently, basic food and defense-related imports are, however, exempted from import taxes and tariff exemptions can be granted on a case-by-case basis.

40. Taxes on consumption and sales, which, for the most part, take the form of specific excises levied on a small number of commodities have been the most inelastic group of taxes in Iran. From 1992/93 to 1996/97, revenue from such taxes dropped from 0.8 percent of GDP to 0.3 percent. However, the budget law for 1997/98 created a new 2 percent sales tax on a list of specific goods (petrochemicals, automobiles, steel and copper, home appliances, and automobile tires and batteries) which is expected to result in a sharp increase in the share of taxes on consumption and sales to GDP. In recognition of the shortcomings in the current system of consumption and sales taxation, the government is considering the introduction of a value-added tax (VAT) for which preparation of the underlying administrative infrastructure is under way.

41. Nontax revenue rose from 1.4 percent of GDP in 1993/94 to 2.8 percent of GDP in 1996/97. Income from government monopolies picked up due, in part, to revenue from privatizations. 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. Furthermore, some CPPO receipts were reclassified and consolidated in this category. More important, however, was the introduction of a series of excises on utilities and other goods and services; in particular, as of March 1995, the domestic retail prices of petroleum products were doubled through the imposition of a new 100 percent excise tax. Petroleum prices have subsequently been raised by about 20–30 percent at the beginning of each fiscal year.

D. General Government Expenditure

42. In 1993/94, government expenditure increased dramatically in Iranian rial terms 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 19.7 percent of GDP in 1992/93 to 38.2 percent in 1993/94. Subsequently, the share of expenditure to GDP decreased to 29.0 percent by 1996/97, partly because the exchange rate adjustments lagged behind inflation and because of the tapering-off of foreign exchange losses in percentage of GDP.

43. As regards the structure of expenditure, current and capital expenditure averaged 19.3 percent of GDP and 7.5 percent of GDP, respectively, during 1995/96–1996/97, down from their peaks of 28.6 percent of GDP and 7.7 percent of GDP, respectively, in 1993/94. The quasi-fiscal foreign exchange losses (included in current expenditure) dropped from 6.5 percent of GDP to 4.7 percent of GDP in 1994/95 and further to 1.9 percent of GDP in 1996/97. Over the period 1992/93–1995/96 (last year for which the functional breakdown is available), social sector expenditure remained constant in percentage of GDP (at 6.1 percent). Between 1992/93 and 1996/97, military expenditure16 decreased from 13.6 percent of GDP to 3.1 percent of GDP. Wages and salaries (including employer contributions) dropped from 10.1 percent of GDP in 1994/95 to 9.1 percent in 1995/96, the last year for which economic classification is available, which reflected a decline in real base wage rates. Explicit subsidies paid through the CPPO (Appendix II, Table 31) declined from 2.9 percent of GDP in 1994/95 to 2.5 percent in 1996/97, reflecting a more restrictive operation of the coupon system. Interest payments on government domestic and foreign debt have been negligible in recent years.

E. Deficit Financing

44. As in previous years, the budget deficits during 1995/96–1996/97 were financed almost entirely through borrowing from Bank Markazi through zero-interest, no-maturity loans. 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 (described above). In accordance with Islamic interest-free banking laws, the government does not sell treasury instruments to the private sector. However, it plans to issue “participation certificates” to finance infrastructure and other capital outlays.17 Starting in 1994/95, the government has mobilized funds from existing World Bank lines of project financing, as a result of which the gross foreign financing of the budget increased from Rls 58 billion in 1994/95 to an average of about Rls 300 billion in 1995/96–1996/97.

F. Public Enterprises

45. The mission was provided with data on transfers to cover the financial losses of public enterprises in 1992/93–1993/94, as well as information on the budget of these enterprises through 1996/97.18 Transfers to these enterprises averaged 0.4 percent of GDP in 1992/93–1993/94 but were lowered to 0.2 percent in the approved budgets for 1995/96 and 1996/97. Some evidence concerning improved performance of the nonfinancial public enterprises is also available from the monetary accounts.

IV. The Financial Sector

A. The Structure of the Financial System

46. The banking and financial system in the Islamic Republic of Iran consists of the Bank Markazi (central bank), six commercial banks, and four specialized banks which are all government-owned.19 As of August 1997, the six commercial banks together had a total of more than 11,000 domestic branches (representing a 20 percent increase over the past six years) and 62 foreign branches, while the four specialized banks had approximately 2,000 domestic branches (representing a 36 percent increase over the past six years). During 1997, the first private nonbank financial institution since the revolution initiated operations in Iran. In addition, there are insurance companies, pension funds, and various investment and leasing companies, the majority of which are government-owned. Commercial banks accept demand, time, and savings deposits; engage mainly in short-term lending, primarily to the private sector and public nonbank financial enterprises; and act as agents of depositors in the investment of funds. The profits (losses) from these investments are then distributed to depositors based on the duration and amount of the investment. Specialized banks lend mainly on a long-term basis (five years or more) and have equity participation in the agricultural, industrial, mining, housing, and export sectors. Their sources of funds are low-cost, long-term government deposits and loans, with the exception of the housing bank whose resources are largely private deposits.

B. Overall Money and Credit Developments

47. The growth of broad money accelerated from 29.6 percent in 1992/93–1994/95 to 36.8 percent in 1995/96–1996/97 (Table 4 and Chart 3).20 In 1995/96 broad money expansion picked up sharply, reflecting a doubling of both the rate of expansion of net foreign assets (NFA) (to 12 percent of the beginning-of-period liquidity stock) and the growth of credit to public enterprises (to 10.5 percent). These expansionary factors more than offset a deceleration in credit to government to 8.5 percent of initial broad money associated with the tapering-off of quasi-fiscal losses related to foreign exchange guarantees on debt contracted at pre-March 1993 exchange rates. In 1996/97, domestic credit grew rapidly reflecting large increases in credit to the private sector and to public enterprises. Credit to the nongovernment sectors (private sector and nonfinancial public enterprises) expanded by Rls 21,273 billion (25 percent of initial broad money), nearly three times the annual target for credit expansion (Rls 7,500 billion) under the SFYDP. This overrun was partly associated with bank support for the servicing of external debts incurred by the public enterprises and the private sector before March 1993 (typically, at the highly appreciated exchange rate of Rls 70 per U.S. dollar). Specifically, the banking system extended credits relating to debt service payments totaling Rls 2,122 billion directly to the public enterprises and credits totaling Rls 1,126 billion to the private sector.21 Moreover, there was a sharp rise in credit in the final months of 1996/97 that was related to the financing of letters of credit for the import of industrial goods. The increase in imports of such products was allowed by the authorities in order to speed up investment projects, a move made possible by the larger-than-expected oil receipts.

Table 4.

Islamic Republic of Iran: Selected Monetary Indicators, 1992/93–1997/98 1/

article image
Source: Bank Markazi Jamhouri Islami Iran.

Iranian years ending March 20.

Chart 3
Chart 3


(Changes in percent of beginning stock of broad money)

Citation: IMF Staff Country Reports 1998, 027; 10.5089/9781451818901.002.A001

Source: Data provided by the Iranian authorities

48. During the first five months of 1997/98, liquidity expansion slowed down to only 4.1 percent, compared with 5.5 percent in the first five months of the previous year, reflecting a reduction in NFA amounting to 1.8 percent of initial broad money supply, in contrast to a buildup amounting to 3.2 percent of initial broad money supply in the same period of the previous year. The main source of liquidity expansion has, therefore, shifted to net domestic assets (NDA), which accounted for an injection by 5.9 percent of the initial money stock (compared with 2.4 percent in the same period of 1996/97). Credit to the private sector grew by 4.6 percent of broad money, the same as in the previous year, while credit to the nonfinancial public enterprises increased by 2.0 percent of initial broad money (compared with 1.5 percent). Net claims on government fell slightly during the first five months of 1997/98, reflecting a small buildup of deposits.

49. Rates of return on bank time and savings deposits remained constant in nominal terms and, therefore, negative in real terms, despite a sharp reduction in inflation; however, there was a slight decline in the income velocity of broad money. The disintermediation associated with negative real rates of return in the banking system has contributed to the growth, albeit incipient, of alternative channels for financial intermediation. Over the last three years, activity on the Teheran Stock Exchange (TSE) grew rapidly, a number of new investment companies (akin to mutual funds) were formed; also, a private nonbank financial institution has initiated operations, the first such institution since the Islamic Revolution. In addition, there have been a number of issues of “partnership papers” to finance certain public sector projects (Appendix II, Table 48).

C. Central Bank Operations

50. The growth rate of reserve money increased from 16 percent in 1992/93 to 42 percent in 1995/96, faster than broad money growth in 1994/95–1995/96. Central bank credit to the government and the public enterprises was the main source of reserve money growth during 1994/95–1995/96. Credit to the government was associated mainly with quasi-fiscal foreign exchange losses as reflected in the Foreign Exchange Obligations Account. The impact of claims on banks as well as that of NFA shifted from contractionary in 1993/94 to expansionary in 1994/95 and 1995/96. During 1996/97, reserve money continued to grow at a slightly faster rate than money supply.

51. Import deposits had a strongly contractionary impact on reserve money in 1993/94–1994/95. Part of this increase was associated with imports by government agencies, from which the Bank Markazi requires 100 percent advance import deposits. In addition, private importers were required to deposit with commercial banks 100 percent of the import value for cash imports or use of credit lines opened by domestic banks (and guaranteed by the central bank); from 1995/96, it has been required that an additional 60 percent of these import deposits be held with the central bank.22

52. The Banking Supervision Department of the central bank has been receiving technical assistance from the Fund on a regular basis since 1995. Largely as a result of this assistance, the authorities have been gradually stepping up prudential supervision. Presently, the central bank is putting into place the mechanisms for off-site supervision, beginning with the implementation of a system of capital adequacy consistent with international standards as defined by the Basle Committee on Banking Supervision. The recent licensing of new instruments and institutions poses fresh challenges for the regulatory and supervisory framework.23

D. Monetary Policy Developments

53. The main instruments of monetary control available to the central bank have been: (i) credit ceilings; (ii) reserve requirements; (iii) allocation of government bonds to the banking institutions; and (iv) penalties for overdrafts by commercial banks from their agreed credit lines with the central bank. In 1996/97 (as in the previous year), these instruments of monetary control either were not implemented or were ineffective in containing liquidity expansion. As a result, the domestic credit overrun in 1996/97 continued to be partly sterilized, almost exclusively, through the enlarged share of blocked import deposits which the commercial banks were required to place with the central bank. The increase in blocked import deposits amounted to Rls 1,827 billion in 1996/97 (i.e., 2.1 percent of initial broad money).

54. Credit ceilings continued to be administered by the central bank on a bank-by-bank basis.24 Individual banks’ credit levels are monitored on a monthly basis by the Bank Supervision Department of the Bank Markazi based on ratios of credit to deposits and the overall credit ceiling. However, in certain circumstances, such as when large inflows of oil receipts occurred toward the end of 1996/97, the authorities have allowed the banks to extend credit above the agreed limits.

55. There have been limited changes in the ratios of reserve requirements in the last few years (Appendix II, Table 43). Reserve requirements on five-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 non-interest-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 normally ranges from 5.5 percent (for two-year bonds) to 7 percent (for seven-year bonds); the banks have also been allocated some non-interest-bearing government bonds, bringing the average yield on holdings to about 4 percent.

56. Bank rates of return are set administratively by the central bank according to the maturity of deposits (highest for five-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 10.0 percent in 1992/93 to 12.4 percent in 1995/96 while the weighted average rate of charge rose from 13.8 percent to 16.8 percent over the same period (Appendix II, Tables 44 and 46). These rates have been unchanged in the last two years and both have remained negative in real terms given the inflation rates during this period. 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 50.7 percent in 1995/96–1996/97. 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. 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).

E. Credit Allocation

57. The commercial banks are required to follow central bank guidelines for the sectoral distribution of credit to the nongovernment sector (Appendix II, Table 45). 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. In 1996/97, the authorities allocated bank credit to the nongovernmental sectors as follows: 25 percent for the agricultural sector, 33.5 percent for the industrial and mining sectors, 29 percent for the housing and construction sector, and 12.5 percent for the trade and services sector. In addition to the sectoral ceilings, until 1996/97 banks were required to lend up to 55 percent of their resources to the private sector and 45 percent to the public sector (excluding quasi-fiscal foreign exchange losses); in 1997/98 these ratios have been changed to 60 percent for the private sector and 40 percent for the public sector.

F. Capital Market Developments

58. In recent years, there has been a development of new financial instruments and increased activity in the TSE. In 1994/95, the issuance of partnership papers in line with Islamic principles was approved by the Money and Credit Council. The first issue of partnership papers was carried out by the Teheran Municipality and all subsequent issues have thus far been on behalf of specific public sector agencies, and have been related to specific projects (Appendix II, Table 48). In addition, the Bank Markazi is studying the possibility of issues of participation papers by the private sector. After three years of steady growth, activity in the TSE slowed somewhat in the first six months of 1997/98 which was associated with the slower growth of the general economy. On the other hand, the steady rise of activity by investment companies (akin to mutual funds) has contributed positively to activity in the TSE. 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. The External Sector

A. Overall Trends

59. The external developments over the last five years have been influenced both by fluctuations in oil export revenues and the macroeconomic policy stance. The relative strength of oil export revenues and substantial increase in non-oil export receipts in the early 1990s encouraged the authorities to undertake major reconstruction and infrastructure projects during the Iran-Iraq postwar period in the context of expansionary fiscal and monetary policies and a significant exchange rate misalignment. The accompanying surge in imports contributed to substantial increases in current account deficits in 1992/93–1993/94 and the accumulation of a large amount of short-term external debt in the wake of much lower-than-anticipated oil export receipts. Given the policy stance, the absence of repatriation and surrender requirements for non-oil exports and the relaxation of exchange restrictions relating to external services and transfer payments translated into a sharp deterioration in the external reserves position and the build-up of large external payment arrears in 1993/94. The policy response of the authorities since 1994/95 has been to resort to exchange restrictions and tight controls on imports. These policies have brought about surpluses on the external current account which, together with refinancing agreements with foreign creditors, has enabled a virtual elimination of external arrears and a strengthening of the external reserve position.

B. Current Account Developments

60. The external current account balance strengthened substantially in recent years (Table 5 and Chart 4). It turned from a deficit of US$11.5 billion in 1992/93–1993/94 to surpluses in the US$3.4–5.5 billion range in 1994/95–1996/97. Oil and gas export receipts, which comprised about 80 percent of total exports over the last five years, fluctuated in the US$14.3–19.3 billion range, which reflected changes in international oil prices.25 Within oil and gas exports, exports of gas and refined petroleum products expanded at an average growth rate of about 30 percent per year during 1992/93–1996/97 (Appendix II, Table 49). Following an exceptional performance in 1994/95, non-oil export growth declined from a peak of US$4.8 billion in 1994/95 to US$3.2 billion in 1996/97. On the import side, strict import controls were imposed following the 1993/94 debt crisis. The import compression policy has been geared, in particular, at limiting the importation of products with domestically produced substitutes through import licensing. As a result, imports declined from an average of US$21 billion per year in 1992/93–1993/94 to an average of less than US$13 billion per year in 1994/95–1995/96. In 1996/97, a relaxation of import compression was reflected in an increase in imports to the vicinity of US$15 billion; however, given higher oil export revenues, Iran’s trade surplus rose to US$7.6 billion (compared with US$5.6 billion in 1995/96).

Table 5.

Islamic Republic of Iran: Summary Balance of Payments, 1992/93–1996/97 1/

(In millions of U.S. dollars)

article image
Source: Data provided by Iranian authorities and Fund staff estimates.

Iranian years ending March 20.

Chart 4
Chart 4


(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 1998, 027; 10.5089/9781451818901.002.A001

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


61. Oil and gas exports declined by about US$2.5 billion in 1993/94 to US$14.3 billion as a result of decreases in both the volume and price of oil exports. Over the next two years, these receipts recovered somewhat to US$15.1 billion by 1995/96, largely as a result of a recovery in international oil prices and substantial growth in exports of refined petroleum products and gas. Oil and gas exports performed strongly in 1996/97, having reached US$19.3 billion, on account of favorable international crude oil prices.26

62. Non-oil exports increased by about 25 percent in 1993/94 and 29 percent in 1994/95 to reach an average of about US$4.2 billion per year. As a result, the share of non-oil exports in total exports increased from 15 percent in 1992/93 to almost 25 percent in 1994/95. The growth of non-oil exports in 1992/93–1994/95 was relatively broad based, as both the exports of traditional sectors (mainly carpets and pistachios) and those of industrial sectors increased at a rapid pace. However, as noted above, the non-oil exports weakened substantially in 1995/96–1996/97 and decreased to an average of US$3.2 billion, reflecting the impact of an increasingly appreciated exchange rate, a weaker demand for Iranian products in some export markets, and the anti-export bias in trade policy. In particular, the single largest component of non-oil exports—carpets—declined markedly to US$600 million by 1996/97, compared with US$2.1 billion in 1994/95.


63. Following the balance of payments difficulties faced by Iran after the 1993/94 debt crisis, import controls were sharply tightened and total imports plummeted. The import compression measures consisted, inter alia, of a tightened import licensing procedure, as a result of which imports contracted sharply by US$6.7 billion to US$12.6 billion in 1994/95. In 1995/96, imports remained low at about US$12.8 billion, only marginally higher than their 1994/95 level. After two years of import compression, total imports recovered somewhat in 1996/97 to about US$14.9 billion (a growth rate of 16.5 percent in U.S. dollar terms), which was facilitated by the increased availability of foreign exchange due to higher world crude oil prices. However, the tight licensing scheme geared at restricting importation of products with domestically produced substitutes remained in place.

Direction of trade

64. The direction of Iran’s trade changed substantially in 1995/96, the last year for which data are available (Appendix II, Table 51). While Japan has remained Iran’s largest export market abroad with a share in total exports of about 15 percent, the United States has dropped from the second largest destination of Iran’s exports to ninth in 1995/96. Concurrently, there was a sharp increase in oil exports to Italy, which became the second largest market for Iran’s exports in 1995/96 (representing 9 percent of total exports). The United Kingdom and South Korea maintained the third and fourth positions, respectively, while the share of exports to Germany (consisting mainly of non-oil exports) and Switzerland declined markedly. As regards the distribution of imports, the shares of Iran’s imports from Europe and Japan declined in 1995/96 (Appendix II, Table 55); Germany (with 14 percent) and Japan (with 7 percent) were Iran’s major suppliers of imports.

Services and transfers

65. The balance in the services account has remained stable over the last three years, with imports exceeding exports by about US$2–3 billion. Services payments rose in 1996/97, due in part to services relating to increased imports and a pick-up in public sector projects. The increase in services payments in 1996/97 was, however, partially offset by the increase in service receipts, associated with the higher oil exports. Transfer flows, which consist mainly of private transfers, fluctuated substantially during the period under review. Net private transfers—mainly worker remittances according to the official banking data—dropped from about US$1.3 billion per year in 1992/93–1994/95 to virtually nil in 1995/96 but recovered modestly in 1996/97 to about US$470 million.

C. Capital Account Flows and Official Reserves

66. The capital account of the balance of payments shifted from a surplus in 1992/93 to sizable deficits in 1993/94–1994/95 (US$1.7 billion in 1993/94 and US$2.9 billion in 1994/95, respectively), mainly owing to large debt service payments linked to short-term import financing (at about US$5 billion and US$3 billion, respectively, in 1993/94 and 1994/95). Since 1995/96, the capital account has been dominated by the repayment of external debt in the context of bilateral refinancing arrangements. In that year, repayments of medium- and long-term debt amounted to US$3.7 billion; this amount was, however, partly offset by net short-term inflows in the form of trade credit and/or oil export prefinancing. The deficit in the capital account increased to US$4.3 billion in 1996/97 (from US$2.6 billion in 1995/96), mainly due to the large repayments of medium- and long-term debt in an amount of US$4.7 billion (of which US$4.3 billion related to payments arising from the refinancing arrangements).

67. Reflecting the weaker oil receipts and the high level of imports, together with the large debt repayments, the overall balance of payments registered a deficit amounting to US$11.7 billion in 1993/94 and external arrears rose to about US$12 billion. The latter permitted an end-year external reserves position of US$2.9 billion (equivalent to 1.6 months of imports). In 1994/95, while oil receipts remained weak, the sharp contraction of imports led to a large surplus in the external current account, which contributed to a reduction in the overall deficit to US$2 billion despite the continuing capital account deficit. Supported by bilateral refinancing arrangements of US$10.8 billion, gross official reserves recovered substantially in 1994/95 to US$3.9 billion (equivalent to 3.4 months of imports). In 1995/96, the overall balance of payments registered a surplus which, together with the support of the refinancing arrangements, contributed to a buildup in external reserves to a level of US$6.4 billion (equivalent to 5.5 months of imports). Owing in large part to the high current account surplus, the overall surplus in the balance of payments improved to US$2.8 billion in 1996/97, which contributed to a further increase in gross official reserves to US$9.1 billion (equivalent to 6.6 months of imports).

D. External Debt and Debt Service

68. Further progress was achieved in 1996/97 in reducing the outstanding stock of external debt and improving its maturity structure (Appendix II, Table 58 and Chart 5). Total outstanding external debt declined from its peak of US$23 billion in 1993/94 to US$16.8 billion in 1996/97. Medium- and long-term debt, which had surged to US$16 billion in 1994/95 (due to refinancing arrangements), declined by about US$4 billion (to about US$12 billion) in 1996/97, which was driven by repayment of refinanced debt. Concurrently, outstanding short-term debt dropped substantially from its peak of US$17.6 billion in 1993/94 to US$4.7 billion at end-1996/97. As a result of the refinancing operations, external arrears were virtually eliminated (a total reduction of US$11 billion during 1993/94–1996/97). The residual arrears (US$341 million) at end-1996/97 resulted mainly from difficulties in identifying creditors to whom the residual amounts were due.27 With the reduction in the debt stock, improvement in the debt structure, and strengthening of the external reserve position, the international environment for mobilizing medium- and long-term external financing had become more favorable, with terms for short-term financing of imports markedly improved. In this context, the authorities succeeded in eliminating in 1996/97 the resort to short-term usance letters of credit (LCs) as means of import financing,28 and replacing them with short-term bank-to-bank lines of credit. The average interest rate for short-term import financing has dropped from about 20 percent per annum in the context of usance LCs to LIBOR plus 0.75 percent currently—a decline of about 13 percentage points.

Chart 5
Chart 5


(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 1998, 027; 10.5089/9781451818901.002.A001

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

E. Exchange Rate Developments

69. The government maintains a dual official exchange rate system. The two official rates (the “floating” rate, Rls 1,750 per U.S. dollar, and the “export” rate, at Rls 3,000 per U.S. dollar) have remained unchanged since May 1995. Consequently, the official exchange rates have become increasingly overvalued in real effective terms. Specifically, the Iranian rial has appreciated by about 80 percent in real effective terms since the last adjustment of the export rate in May 1995, of which 27 percent during 1996/97 which has been driven by the double-digit inflation in Iran and appreciation of the U.S. dollar in the more recent period (Chart 6). This real effective appreciation has been partly compensated, however, by the effective depreciation in the weighted average exchange rate as a result of shifts of transactions from the more appreciated “floating” rate to the export rate. Accordingly, on a weighted average basis, the real effective appreciation amounted to only about 16 percent (for current account transactions) in 1996/97.



Citation: IMF Staff Country Reports 1998, 027; 10.5089/9781451818901.002.A001

Sources: Data provided by the Iranian authorities; and IMF staff estimates.1/ Prior to May 1995, refers to the free market exchange rate.2/ An increase in the index implies an appreciation of the rial.3/ Based on the weighted average exchange rate.

F. Developments in the Exchange and Trade System

70. The exchange system in Iran is based on the dual exchange rate structure introduced in May 1994 with the creation of the “export” exchange rate. Since May 1995, the exchange rates are Rls 1,750 per U.S. dollar for the “floating” rate (a level effectively fixed in December 1993) and Rls 3,000 per U.S. dollar for the “export” rate (following the adjustment effected at that time). In general, the “floating” rate applies to oil and gas export receipts, imports of essential goods and services, and public sector debt services, and the “export” rate to all other official current account transactions, including non-oil export, imports of industrial goods, spare parts, raw materials, and service receipts and invisibles. Also, since May 1995, the authorities have been implementing a phased strategy aiming at unifying the exchange rates in the context of liberalizing the trade regime. In this context, the import coverage of the more appreciated “floating” exchange rate (Rls 1,750 per U.S. dollar) has been gradually reduced and a market for import certificates has been created through the TSE (Box 2) covering 29 groups of imports (Appendix II, Table 60). The price of such certificates (currently about Rls 1,600) provides an indication of the level at which the official exchange rates would need to be unified in order to clean the foreign exchange market.29

Iran: Key Changes in the Exchange System, 1995/96–1997/98

March 21, 1995: A bonus scheme was introduced for the early repatriation and surrender of export earnings within the specified deadline with a rate of one and one-half percent per month of the amount surrendered from early repatriation.

May 20, 1995: The export exchange rate was depreciated to Rls 3,000 (from Rls 2,354) per U.S. dollar. The repatriation and surrender requirements on all non-oil exports were increased from 50 percent to 100 percent with a period of three months (six months for carpet exporters).

March 21, 1996: The period required for the repatriation of non-oil export earnings to the banking system was extended from six to eight months for carpet exporters and from three to five months for other exporters.

April 17, 1996: Importation rights out of non-oil export earnings were granted at the share of 50 percent for industrial exporters and 30 percent for other exporters.

February 21, 1997: Importation rights out of non-oil export earnings were increased to 100 percent for carpet exporters (from 30 percent).

March 21, 1997: Importation rights out of non-oil export earnings were increased to 50 percent for other exporters (excluding industrial exporters).

July 11, 1997: Import certificates were allowed to be traded through the TSE. Trading started effectively in late July 1997.

Imports and import payments

71. In view of the misalignment of the “floating” rate, allocation of foreign exchange for imports at Rls 1,750 per U.S. dollar is subject to tight administrative controls based on pre-specified sectoral ceilings. The amount of foreign exchange allocation to each sector is communicated to the relevant ministries responsible for the approval of import licenses. Moreover, regardless of the exchange rate at which the import is effected, all importers are required to obtain import licenses which involves: (i) obtaining an identification card from the Ministry of Commerce for the right of purchasing foreign exchange at the official exchange rates; (ii) obtaining an import license from relevant ministries, specifying the commodities to be imported and the amount of foreign exchange to be approved; and (iii) registering the import with the central bank to obtain the approved amount of foreign exchange. Following these steps, the importer is required to open a letter of credit with a commercial bank.30 For goods imported at the export exchange rate of Rls 3,000 per U.S. dollar, a license is generally granted by a relevant ministry if the item considered is not produced domestically or if domestic production cannot meet domestic demand. For industrial goods, the required approval is granted by the Ministry of Industry, while for some other goods the required approval is granted by other ministries.

72. The list of goods which can be imported at Rls 1,750 per U.S. dollar is reviewed each fiscal year and has been substantially streamlined over the last three years and currently covers about 20 categories of goods.31 The foreign exchange allocated at this rate covered about 62 percent of the value of imports in 1996/97 (compared with about 75 percent in 1995/96), including essential goods, military items, medicines, strategic raw materials, and certain capital goods for the construction of national projects. Other authorized imports were effected at the “export” rate of Rls 3,000 per U.S. dollar; most of them were industrial inputs, spare parts, and raw materials. In addition, as noted, 29 groups of commodities can be imported through the market for certificates operated by the TSE at an effectively more depreciated rate (currently around Rls 4,600 per U.S. dollar).

Exports and export proceeds32

73. During 1996/97, the authorities implemented several changes in the regime governing export proceeds (Box 2): (i) they extended the period between the date goods are exported and the date when foreign exchange earnings must be repatriated to the banking system while, at the same time, increasing the share of export earnings that could be used for imports at Rls 3,000 per U.S. dollar (and expanded the coverage of such importation to the above-noted 29 categories of goods); (ii) the importation rights out of export proceeds were increased to 100 percent for carpet exporters (from 30 percent) and 50 percent for other nonindustrial exporters (from 30 percent) for export proceeds repatriated within eight and five months, respectively;33 and (iii) the authorities reactivated an earlier bonus system to encourage the speedy repatriation and surrender of export proceeds; under this system, exporters receive 1.5 percent per month in advance of the time limit for surrendering their export earnings (accordingly, a carpet exporter with a maximum repatriation period of eight months could receive a payment in Iranian rials as high as 12 percent over the amount repatriated).

74. Iran has virtually no operative bilateral trade and payments arrangements, except for small amounts of outstanding liabilities with the Czech Republic, the Slovak Republic, Romania, and Turkey which are in the process of being settled, and outstanding claims on the Baltic countries, Russia, and the other countries of the former Soviet Union. In addition, Iran maintains a regional arrangement for the settlements of current transactions with other member countries of the Asian Clearing Union (ACU)—Bangladesh, India, Myanmar, Nepal, Pakistan, and Sri Lanka. Settlements of current transactions with member countries of the ACU are effected in Asian Monetary Units (AMUs), whose value is equal to one SDR.

G. Relations with the World Trade Organization (WTO)

75. In 1996, Iran notified WTO of its interest in gaining membership.

APPENDIX I Iran: Key Objectives and Policies of the Second Five-Year Development Plan (SFYDP)

The SFYDP commits the government to continue structural reforms and macroeconomic adjustment. The SFYDP’s key objectives and policies are:

1. External sector

  • The foreign exchange system will be based on a managed unified floating exchange rate that is consistent with maintaining convertibility of the rial for current international payments.

  • The customs tariff will be set at an appropriate level that takes account of the need to protect domestic producers and consumers as well as to maintain comparative advantage for Iranian goods in the international market.

2. Financial sector

  • Measures will be taken to rationalize bank interest rates by setting rates at a level that would ensure positive real returns on bank deposits, thus generating greater incentives for saving.

  • Issuance of long-term participating/investment bonds will be considered as an effective element in monetary and financial policies. Provisions will be made for issuing these types of financial instruments and for enhancing their acceptability to the general public.

  • The specialized development banks will be supplied with funds commensurate with the government’s economic, social, and cultural development objectives; and its determination to ensure a balanced development among various sectors and regions.

  • Private sector entry in the financial system through nonbank financial intermediaries will be encouraged.

  • The relationship between GDP growth and the rate of increase in the money supply will be closely monitored to help control inflation.

3. Fiscal sector

The government’s revenue policy will be formulated so that government revenue increases in the long run to meet government expenditure while increasing the share of taxes in total revenue. The SFYDP directs the government to:

  1. increase the share of direct taxes (excluding wage taxes) in total tax revenue;

  2. gradually eliminate tax exemptions granted to various sectors, except for the agricultural sector and related industries;

  3. redraft the tax laws with a view to establishing indirect tax rates based on the value of the commodities;

  4. channel oil revenue to development expenditure;

  5. grant tax exemptions or reductions to infrastructure investments and investments contributing to the production of strategic goods, generation of foreign exchange, development of deprived regions, and creation of jobs;

  6. include all subsidies, government aid, and revenue transfers in appropriate budgetary categories; and

  7. undertake a tax system reform, including improving tax administration and a review of tax exemptions.

4. The domestic economy

The objectives of agricultural policy are to:

  • maintain sustained growth in agriculture, while strengthening the conservation of water, soil, and forestry;

  • ensure sufficient food supply, balance trade flows between agriculture and other sectors, and promote import substitution;

  • improve productivity through expansion of research and training programs;

  • promote the development of food processing and related industries;

  • reduce the use of chemical pesticides in agricultural production;

  • provide crop insurance for farmers;

  • establish coordination between the Ministry of Agriculture and the Ministry of Industry in order to develop techniques for food preservation; and

  • restructure the monopolized or semi-monopoly controlled distribution mechanisms for agricultural products and fertilizers, transferring some public activities to the private and cooperative sectors.

Subsidies will be reduced while making them more transparent in the budget and raising the amount of subsidies to vulnerable groups.

5. Quantitative targets

The SFYDP seeks to achieve an average annual real GDP growth of 5.1 percent. The main sectoral growth objectives are: 1.6 percent for the oil sector; 4.3 percent for the agricultural sector; 5.9 percent for industry and mining; and 3.1 percent for the services sector. The SFYDP targets an average annual growth rate of 6.2 percent in real gross domestic investment; 4 percent in real private consumption; and a decline of 0.9 percent for real government consumption expenditure. The rate of inflation is targeted at an annual average of 12.4 percent. To this end, total liquidity is to grow at 12.5 percent per annum, imports are targeted to increase at an average annual rate of 4.3 percent; oil exports at 3.4 percent; and non-oil exports at 8.4 percent.


Table 6.

Islamic Republic of Iran: Gross Domestic Product by Industrial Origin at Constant Prices, 1992/93–1996/97 1/

article image
Source: Bank Markazi Jomhouri Islami Iran.

Iranian years ending March 20.

Includes oil and gas production, refining, and distribution.

Table 7.

Islamic Republic of Iran: Gross Domestic Product by Industrial Origin at Current Prices, 1992/93–1996/97 1/

article image
Source: Bank Markazi Jomhouri Islami Iran.

Iranian years ending March 20.

Includes oil and gas production, refining, and distribution.

Table 8.

Islamic Republic of Iran: Gross Domestic Expenditure at Current Prices, 1992/93–1996/97 1/

article image
Source: Bank Markazi Jomhouri Islami Iran.

Iranian years ending March 20.

Includes statistical discrepancy.

Staff estimates based on balance of payments data provided by the authorities which have been converted into rials at weighted average exchange rates based on current account weights.

Table 9.

Islamic Republic of Iran: Gross Domestic Expenditure at Constant Prices, 1992/93–1996/97 1/

article image
Source: Bank Markazi Jomhouri Islami Iran.

Iranian years ending March 20.

Includes statistical discrepancy.

Adjusted for changes in terms of trade.

Table 10.

Islamic Republic of Iran: Production, Exports, and Domestic Consumption of Oil, 1992/93–1996/97 1/

(In thousands of barrels per day)

article image
Source: Bank Markazi Jomhouri Islami Iran.

Iranian years ending March 20.

Crude oil exports for refining abroad, or in exchange for refined products.

The discrepancy between domestic consumption and the amount obtained by subtracting net exports from production reflects changes in inventories, crude oil flowing in the pipelines, and refining wastage.

Includes aviation fuel, tar, lubricants, solvents, and insecticides.