Abstract
This chapter assesses various indicators of competitiveness of the non-oil tradable sector in Iran and examines some of its determinants, including the real exchange rate and structural factors. The note is organized as follows. Section A assesses the recent performance of the tradable non-oil sector. Section B reviews developments in the real exchange rate using various measures and examines their relation to competitiveness. Section C discusses the structural factors affecting competitiveness.
III. Competitiveness of the Non-oil Economy in Iran12
A. The Recent Performance of the Non-oil Tradable Sector
38. After the difficult years of 1995–97, non-oil exports have been growing since 1998 at an average annual rate of 10 percent in dollar terms (Box III-1). This performance was comparable to those of other countries in the region and countries with similar per capita incomes (Figures III-1). As a result, Iran managed to preserve its world-wide market share during 1996-2001, with a loss of positions on the European markets being offset by increased penetration in Asia and the Gulf countries (Figure III-2). However, the growth in non-oil exports somewhat decelerated over the last two years, resulting in a decline in the worldwide market share.
Iran: Non-Oil Sector Indicators, 1991/92-2001/02
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
Source: Iranian authorities, and IMF staff estimations1/ Ratios between Iran non-oil exports and the country grouping non-oil exports, valued in dollar terms and expressed in index. Regional Peers include Algeria, Egypt, Jordan, India, Indonesia, Malaysia, Pakistan, Syria, Tunisia, Turkey, Morocco.2/ Market shares are ratios between Iran non-oil exports and the country grouping non-oil imports, valued in dollar terms and expressed in index.Iran: Non-Oil Sector Indicators, 1991/92-2001/02
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
Source: Iranian authorities, and IMF staff estimations1/ Ratios between Iran non-oil exports and the country grouping non-oil exports, valued in dollar terms and expressed in index. Regional Peers include Algeria, Egypt, Jordan, India, Indonesia, Malaysia, Pakistan, Syria, Tunisia, Turkey, Morocco.2/ Market shares are ratios between Iran non-oil exports and the country grouping non-oil imports, valued in dollar terms and expressed in index.Iran: Non-Oil Sector Indicators, 1991/92-2001/02
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
Source: Iranian authorities, and IMF staff estimations1/ Ratios between Iran non-oil exports and the country grouping non-oil exports, valued in dollar terms and expressed in index. Regional Peers include Algeria, Egypt, Jordan, India, Indonesia, Malaysia, Pakistan, Syria, Tunisia, Turkey, Morocco.2/ Market shares are ratios between Iran non-oil exports and the country grouping non-oil imports, valued in dollar terms and expressed in index.
Iran: Industrial And Market Share Indicators, 1991-2001
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
Source: Iranian authorities, and IMF staff estimationsIran: Industrial And Market Share Indicators, 1991-2001
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
Source: Iranian authorities, and IMF staff estimationsIran: Industrial And Market Share Indicators, 1991-2001
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
Source: Iranian authorities, and IMF staff estimations39. The petrochemicals sector was the main source of non-oil growth over the last few years. Having remained marginal until 1999, exports of petrochemicals took off as a result of recent joint ventures with foreign investors, and today account for more than 10 percent of total non-oil exports. Excluding petrochemicals, growth of other non-oil exports from 1999 to 2002 was only 2 percent per year on average (Figure III-1).
40. Import-substituting activities have performed strongly over the last several years. Indeed, manufacturing output, largely representing import substitution, has been increasing by about 9 percent annually over the last three years. However, while car manufacturing, metal industries, and chemicals have enjoyed rapid growth, the output of other industries such as textiles, food and paper manufacturing has been on a declining trend in recent years (Figure III-2).
Factors Affecting Non-oil Exports in Iran in the 1990s
Iran’s non-oil export performance over the last decade has been mixed. Despite the low ratio of non-oil exports to GDP (which amounted to less than 5 percent in 2000), non-oil export performance in Iran during the 1990s was weaker than in middle-income countries. Non-oil exports grew in dollar terms by an average of 5.1 percent per year in Iran compared to 9.4 percent in the middle-income countries. Overall, non-oil export growth in Iran has been lower than the world average, though somewhat higher than in other poor performers in the region (Figure III-1).
The export performance of the non-oil tradable sector in the 1990s largely reflected the structural and macroeconomic policies of Iran. During the early part of the decade, the government pursued expansionary fiscal policy in support of a large infrastructure reconstruction program and an ambitious social agenda. At the same time, the government initiated a program of economic policy reform, decontrolling domestic prices, removing many trade restrictions, liberalizing the exchange system, and encouraging private sector activity. As a result, GDP growth accelerated and macroeconomic indicators improved. Benefiting from the opening-up of the economy, non-oil exports surged, placing Iran in the ranks of the best performers in its income category and in the region. However, the government’s expansionary policies resulted in large macroeconomic imbalances.
The years from 1995 to 1997 were characterized by a series of policy reversals and a sharp deterioration of economic performance. Under the pressures of a fall in oil prices, the U.S. embargo on trade and investment, and a tight debt repayment schedule, the expansionary government policies became unsustainable, which together with the impact of adverse external factors resulted in stagnation and inflation, and culminated in a debt crisis. In this context, the non-oil export sector was particularly constrained by (a) the excessive compression of imports (reaching up to 50 percent reduction in some years) needed to make room for external debt repayments as Iran’s access to external financing was severely limited, (b) the extension of U.S. financial and economic sanctions that restricted market access to Iranian exports, and (c) the tightening of exchange controls, including the reinstitution of multiple exchange rates and the imposition of export repatriation and surrender requirements in an attempt to contain the unfolding foreign exchange crisis. As a result, non-oil exports fell to their level of the early 1990s.
Since 1997-98, Iran has initiated a series of reforms, with the recovery of oil prices since 2000 helping in stabilizing the economy and significantly easing the debt problem. Some progress has been achieved in reforming the areas relevant to the export sector: the various exchange rates have been progressively unified, exporters have been granted easier access to inputs at world prices, most export barriers have been removed, and a large number of nontariff barriers have been replaced by tariffs. As a result, non-oil exports recovered.
The composition and destination of Iranian exports has changed markedly since the early 1990s. Traditional exports (carpets and agricultural products) which in the early 1990s used to represent about 70 percent of non-oil exports, account today for less than 40 percent. Also, exports of home appliances, which accounted for 6 percent of non-oil exports, have become negligible. In contrast, exports of chemicals and hydrocarbons, which were marginal in the early 1990s, now account for 12 percent of non-oil exports. Similarly, the share of other exports have substantially increased. Concomitantly, the destination of Iranian exports has evolved noticeably, with the share of EU markets declining from 45 percent of non-oil exports in 1992-93 to less than 25 percent today, while the importance of Asia and the Gulf has increased substantially
B. Movements in the Real Exchange Rate
41. The CPI-based real effective exchange rate (REER)13 has been volatile over the last five years, with an appreciating trend emerging since end-1999. After appreciating through early-1998, the CPI-based REER, using the weighted average of nominal exchange rates,14 depreciated during the period 1998-99, reflecting the variations in international oil prices, the inflation differential with Iran’s trading partners, and the gradual devaluation of several official rates since 1998.15 Since end-1999, the REER has appreciated by about 40 percent to about 20 percent above its average level of the last five years.16 The most recent appreciation reflects a strengthening of the nominal effective exchange rate, as well as higher inflation differential with Iran’s major trading partners. The real exchange rate now exceeds the previous peak level reached at end-1998 (Figures III-3).
Iran: REER and NEER Developments, 1996/97-2001/02 1/
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
1/ Data presented as indices, 1990 = 100.2/ Last observation: January 2002.3/ Last observation: March 2002.4/ Last observation: December 2001.Iran: REER and NEER Developments, 1996/97-2001/02 1/
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
1/ Data presented as indices, 1990 = 100.2/ Last observation: January 2002.3/ Last observation: March 2002.4/ Last observation: December 2001.Iran: REER and NEER Developments, 1996/97-2001/02 1/
Citation: IMF Staff Country Reports 2002, 212; 10.5089/9781451818963.002.A003
1/ Data presented as indices, 1990 = 100.2/ Last observation: January 2002.3/ Last observation: March 2002.4/ Last observation: December 2001.42. The recent appreciation of the REER reflects an increase in the relative price of non-tradable to tradable goods (Figure III-3). After a decline following the sharp depreciation of the TSE exchange rate in the third quarter of 1998, the real exchange rate, as measured by the relative price of non-tradable to tradable goods, started appreciating since end-1999 to reach a cumulative real appreciation of 34 percent between end-1999 and end-2001.
43. The recent evolution of the REER in Iran contrasts with developments in comparable countries, where the real exchange rate has remained broadly stable (Figure III-3). The differences in trends appear to have been substantial and emerged over a relatively short period of time, indicating that the competitive position of the Iranian tradable sector might have deteriorated over the last few years only.
44. The appreciation of the REER is unlikely to have been fully justified by productivity gains. Recent studies have found that despite strong advances in education, the gains in overall productivity in Iran, as measured by the growth in total factor productivity (TFP), were very low throughout the 1990s and even negative during some years (Table III-1).
Islamic Republic of Iran: Evolution of Total Factor Productivity, 1991-99
Growth determinants in Iran 1996-99, Massomeh Hajilcc, CBI.
Productivity Analysis, Asian Productivity Organization, 2001.
Management and Planning Organization of Iran.
Islamic Republic of Iran: Evolution of Total Factor Productivity, 1991-99
| 1991-95 | 1995-99 | ||
|---|---|---|---|
| Average growth rate | |||
| CBI research 1/ | 3.0 | 1.9 | |
| AP0 2/ | -0.3 | -0.6 | |
| MP0 3/ | -2.4 | -0.2 | |
Growth determinants in Iran 1996-99, Massomeh Hajilcc, CBI.
Productivity Analysis, Asian Productivity Organization, 2001.
Management and Planning Organization of Iran.
Islamic Republic of Iran: Evolution of Total Factor Productivity, 1991-99
| 1991-95 | 1995-99 | ||
|---|---|---|---|
| Average growth rate | |||
| CBI research 1/ | 3.0 | 1.9 | |
| AP0 2/ | -0.3 | -0.6 | |
| MP0 3/ | -2.4 | -0.2 | |
Growth determinants in Iran 1996-99, Massomeh Hajilcc, CBI.
Productivity Analysis, Asian Productivity Organization, 2001.
Management and Planning Organization of Iran.
Notwithstanding the likely impact of the recent trade liberalization and other reforms, there is as yet no conclusive evidence that this trend has changed over the recent past. Accordingly, it is unlikely that the equilibrium real exchange rate in Iran has appreciated because of higher growth in productivity relative to trading partners.17
45. Also, the relative evolution of unit labor costs (ULC) has not offset the real appreciation of the exchange rate. In fact, wages in both the private and the public sectors have been increasing rapidly and, as a result, the ULC-based REER has appreciated by 45 percent since end-1999 (Figure III-3).18
46. Pro-cyclical fiscal policies in periods of high international oil prices have contributed to the appreciation of the real exchange rate. Until recently, fiscal policy had not smoothed out expenditure in the face of sharp increases in oil prices, thereby transmitting the terms-of-trade shocks to domestic demand. While excess demand in traded goods caused the decline of the non-oil external balance, excess demand for non-traded goods resulted in increases in their price to preserve home-market equilibrium. In addition, the concomitant boom in construction since 1999 might have further exacerbated what could be seen as an episode of “Dutch Disease” (Table III-2).
Islamic Republic of Iran: Indicators of Dutch Disease, 1998/99-2000/01
Islamic Republic of Iran: Indicators of Dutch Disease, 1998/99-2000/01
| Average Levels in Index | ||
|---|---|---|
| 1998/99 | 2000/01 | |
| Oil price (in dollars) | 100.0 | 161.2 |
| Real domestic demand | 100.0 | 107.7 |
| Budgetary expenditure in constant prices | 100.0 | 120.6 |
| Construction value-added in constant prices | 100.0 | 119.4 |
| Real effective exchange rate | 100.0 | 123.8 |
Islamic Republic of Iran: Indicators of Dutch Disease, 1998/99-2000/01
| Average Levels in Index | ||
|---|---|---|
| 1998/99 | 2000/01 | |
| Oil price (in dollars) | 100.0 | 161.2 |
| Real domestic demand | 100.0 | 107.7 |
| Budgetary expenditure in constant prices | 100.0 | 120.6 |
| Construction value-added in constant prices | 100.0 | 119.4 |
| Real effective exchange rate | 100.0 | 123.8 |
47. A number of offsetting factors have contributed to preserve the profitability and external competitiveness of the non-oil tradable sector and could explain why non-oil exports and import-competing industries have continued to grow under the combination of an appreciating REER and slow productivity growth. These factors include:
Utilization of excess capacity. A large number of enterprises in the tradable sector operate with excess capacity, estimated in large manufacturing companies at about 40 percent in 1999/2000. In this context, rising domestic demand—underpinned by higher government spending—has mainly benefited domestic producers, in particular since a large share of the increased demand is directed to domestic suppliers. In this regard, the recent boom in construction has been a major factor behind the increase in output in some industries, including the metal and construction material industries. In presence of fixed costs of production, higher sales improve the financial position of the enterprises, offsetting to some extent the negative impact of the real appreciation.
Trade Protection. The effects of recent trade liberalization might not have affected all sectors of the economy because of prevailing monopolistic practices and other market restrictions. Consequently, the reform process might have resulted so far in a net improvement of the environment for most companies in the exportable sector while still sheltering large segments of the import-competing industries. In this regard, industries that have enjoyed high effective protection (such as the heavy industry and the car industry) have performed strongly over the last few years. In contrast, industries for which protection has been less effective due to smuggling (for instance, textiles), have registered lower and, in some cases, negative growth rates.
Increased subsidies. In particular, the low domestic prices of petroleum products, which have not been raised in line with international prices, have given rise to a sizable increase in implicit subsidization. However, the implicit energy subsidy has been declining since 2001, implying that the offsetting effect of energy prices might be tapering off. Other policy measures, including tax exemptions might have also contributed to preserve the profitability of the tradable sector.
Cost reductions on imported inputs. An appreciated currency, by reducing the relative cost of imported capital and inputs, could provide a net subsidy to some capital-intensive industries that sell their output domestically and enjoy high tariff protection from competing imports. Moreover, given the outdated capital stock in many sectors in Iran and the lack of an indigenous capital good sector, an appreciated currency might have stimulated investment which might have resulted in productivity gains and further offset the effects of the real appreciation. On the other hand, the effects of the real appreciation are likely to be largely negative on labor-intensive industries.
48. The impact of the above offsetting cost reductions may be diminishing, however, as trade liberalization proceeds, energy prices are raised, and excess capacity is utilized. Under these conditions, a further real appreciation might exacerbate the difficulties of the non-oil tradable sector through further deterioration of profitability, which, if sustained, could undermine the development of the non-oil tradable sector.
C. The Structural Impediments to Competitiveness
49. Iran’s problems of competitiveness have been, and still remain to an important extent, of a structural nature.19 Disentangling the various structural factors that hinder competitiveness in Iran may be difficult, but a number of factors are at the core of the problem, including public sector dominance of the economy, restrictive trade policies, and the lack of a competitive business environment.
The far-reaching system of subsidies and protection provided to the public sector has raised entry barriers for private investors, deterred competition and encouraged monopolistic practices that tend to foster inefficiencies. In the absence of hard-budget constraints, state enterprises have generally had little incentive to restructure, reduce costs, and improve efficiency. Moreover, public enterprises tended to operate with excess labor and continue to suffer from an obsolete capital stock. As a result, despite significant budget transfers and implicit subsidies, a sizable number of state enterprises are loss-making (Table III-3).
The import restrictions that were in effect until last year—when most nontariff barriers were eliminated and replaced with tariffs—and the high tariff protection provided to import-competing industries have reinforced monopolistic practices in many sectors. Anti-competitive practices and monopolistic positions can take different forms, including tax exemptions, entry and foreign direct investment restrictions, and limited access to bank credit. Such an environment has not been conducive to efficiency, transfer of technology, and productivity gains. With the more recent advances in trade and exchange reform, however, coupled with efforts to attract foreign direct investment, gains in productivity could be achieved in the period ahead.
Islamic Republic of Iran: Financial Position of Selected State Enterprises, 1994-99
Islamic Republic of Iran: Financial Position of Selected State Enterprises, 1994-99
| Annual Average 1994-99 | ||
|---|---|---|
| In percent of GDP | In percent of revenue | |
| Revenue | 5.4 | 100.0 |
| Opening expenditure | 5.2 | 96.3 |
| Operating balance | 0.2 | 3.7 |
| Current transfer from budget | 0.0 | 0.1 |
| Capital expenditure | 2.9 | 54.9 |
| Overall balance | -2.7 | -51.1 |
| Capital transfer from budget | 1.3 | 24.8 |
| Bank financing | 0.2 | 3.1 |
| Other sources | 1.2 | 23.1 |
Islamic Republic of Iran: Financial Position of Selected State Enterprises, 1994-99
| Annual Average 1994-99 | ||
|---|---|---|
| In percent of GDP | In percent of revenue | |
| Revenue | 5.4 | 100.0 |
| Opening expenditure | 5.2 | 96.3 |
| Operating balance | 0.2 | 3.7 |
| Current transfer from budget | 0.0 | 0.1 |
| Capital expenditure | 2.9 | 54.9 |
| Overall balance | -2.7 | -51.1 |
| Capital transfer from budget | 1.3 | 24.8 |
| Bank financing | 0.2 | 3.1 |
| Other sources | 1.2 | 23.1 |
50. An acceleration of structural reforms over the medium-term would enhance competitiveness. In particular, further efforts to open up the economy, enhance domestic competition and increase the flexibility of the labor market could help the tradable sector adjust to the real exchange rate appreciation. On the other hand, in the absence of reforms that would eliminate the structural impediments to competitiveness, an active exchange rate policy leading to a significant depreciation of the exchange rate might not be sufficient to bring about a lasting improvement in the competitiveness of the non-oil sector.
Reference
Zinnes Eliat, and J. Sachs, 2001, “Benchmarking Competitiveness in transition Economies, Economics of Transitions,” EBRO, Vol. 9(2), pp. 315–53.
Prepared by Patrick Megarbane (MED).
The caveat regarding the use of CPI -based REER in assessing competitiveness is the existence of distortions from price controls and the fact that non-traded goods are included in the CPI basket while intermediate goods are not.
The weights assigned to the Tehran Stock Exchange (TSE) and official exchange rates varied depending on the composition of transactions.
For further indications on the underlying factors affecting the real exchange rate, see Chapter II.
More specifically, the real appreciation amounted to 44 percent between Dec. 1999 and Dec. 2001 when using the TSE rate and to 35 percent when using the weighted average rate (Figure III-l).
Similarly, the relative non-oil terms of trade have remained stable over the last couple of years and thus are unlikely to have caused an appreciation of the equilibrium real exchange rate.
This measure may be the most appropriate as a competitiveness indicator since it proxies production costs when combined with productivity and is an important factor in determining profitability. However, the measure misses some components of actual costs, such as capital and energy. The measurement of productivity, which underlies the ULC-based measure is difficult to assess in practice. As a proxy for productivity growth in manufacturing, we used the growth in the value-added per employee in the industrial sector. Two available series for wages were used: wages in the construction sector and wages in large manufacturing companies.
Competitiveness is determined by structural factors that extend far beyond the level of the real exchange rate. In particular, factors such as good governance, openness, adequate infrastructure, sound financial sector, flexible labor markets, and developed market institutions, in addition to technology, are important determinants of competitiveness (see Zinnes, 2001).
