Historical background (1970–99)

46. While the oil sector has played an important role in the Iranian economy, the sector was very volatile during the 1970s–1990s.²⁹ In the 1970s, oil value added accounted for over 40 percent of GDP due to high oil prices and production volumes. However, following significant declines in oil production, this share shrank to about 10 percent immediately after the 1979 Revolution (Figure III.1). During the war with Iraq (1981–88), the contribution of oil value added to GDP bottomed at 3 percent in 1986, mainly because of war-related damages to oil production facilities and declining oil prices. In the 1990s, the oil sector recovered somewhat, with oil extraction value added fluctuating around 15 percent of GDP, reflecting the volatility of oil prices. As a result of oil sector fluctuations, government oil revenue ranged from 3 percent of GDP (25 percent of government revenues) in 1986 to about 16 percent of GDP (73 percent of government revenues) during 1993–94. This revenue volatility was reflected in large expenditure fluctuations, particularly in capital expenditures. The pro-cyclical fiscal stance exacerbated the variability of output, inflation, and the real effective exchange rate.

Islamic Republic of Iran: The Role of the Oil Sector in the Economy, 1965/66-2007/08

Citation: IMF Staff Country Reports 2008, 285; 10.5089/9781451819069.002.A003

Sources: CBI; IMF IFS; The Laws of the Third and Fourth Economic, Social, and Cultural Development Plans; and Fund staff estimates.1/ Average crude oil price; the 2007 constant price calculated based on the U.S. CPI.

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Islamic Republic of Iran: The Role of the Oil Sector in the Economy, 1965/66-2007/08

Citation: IMF Staff Country Reports 2008, 285; 10.5089/9781451819069.002.A003

Sources: CBI; IMF IFS; The Laws of the Third and Fourth Economic, Social, and Cultural Development Plans; and Fund staff estimates.1/ Average crude oil price; the 2007 constant price calculated based on the U.S. CPI.

• Download Figure
• Download figure as PowerPoint slide

Islamic Republic of Iran: The Role of the Oil Sector in the Economy, 1965/66-2007/08

Citation: IMF Staff Country Reports 2008, 285; 10.5089/9781451819069.002.A003

Sources: CBI; IMF IFS; The Laws of the Third and Fourth Economic, Social, and Cultural Development Plans; and Fund staff estimates.1/ Average crude oil price; the 2007 constant price calculated based on the U.S. CPI.

• Download Figure
• Download figure as PowerPoint slide

OSF objectives

47. To address the shortcomings stemming from expenditure volatility, the Iranian authorities set up an Oil Stabilization Fund (OSF) in 2000 as a separate public sector institution.³⁰ Article 60 of the Third Five-Year Development Plan (TFYDP, 2000–05) established the following objectives of the OSF:

• Stabilize the government’s annual budgets; and

• Provide financial means to commercial banks for on-lending to private and cooperative entities carrying out projects in the priority sectors identified by five-year plans.

OSF accumulation and spending rules

48. The accumulation of OSF deposits was to be driven by the difference between projected and actual oil revenues. Specifically, Article 60 of the TFYDP and Article 1 of the Fourth Five-Year Development Plan (FFYDP) stipulated that annual crude oil export revenue up to a certain limit should be directly drawn by the central government, and that all excess oil revenue should be deposited in the OSF. The oil revenue projections were based on conservative oil price assumptions.

49. The TFYDP and FFYDP envisaged two types of withdrawals from the OSF. First, at the beginning of the plan’s third year, the central government could draw from the OSF account if the government’s oil export receipts fell short of the budgeted amount for that year. Second, an amendment to the TFYDP law in November 2000 stipulated that up to 50 percent of the OSF’s balance should be set aside for lending foreign exchange to domestic private entrepreneurs in priority sectors via commercial banks. Loans were to be repaid in foreign exchange within eight years, with a three-year grace period, at an interest rate of LIBOR+2 percentage points (later capped at 10 percent).

OSF’s institutional arrangements

50. Management and supervision:

• Through mid-May 2008, the OSF was managed by a seven-member Board of Trustees. It comprised the Head of the Management and Planning Organization (MPO),³¹ the Minister of Economy and Finance, the Governor of the Central Bank of Iran (CBI), and four representatives who are appointed by the President (of whom at least two are appointed from among the ministers). The Board set the priorities for projects that can use loans from the OSF; determined loans terms and conditions; specified the contractual framework between the MPO and the banks that on-lend OSF resources; and approved banks’ charges and commissions for OSF-funded loans.

• In mid-May 2008, the OSF Board of Trustees was dissolved, and the Government Economic Committee was made responsible for OSF oversight.

51. Transparency of operations:

• In practice, members of the OSF’s Board of Trustees periodically disclosed information about OSF asset holdings to mass media. In addition, the CBI disseminates information on the accumulated balances and sectoral allocation of OSF loans.³² Furthermore, aggregated data on OSF cash flows are reported to the Fund during annual Article IV consultation discussions and published in IMF staff reports. However, the OSF itself does not disseminate the information on its operations to the public on a regular basis nor does it have its own website.

• Parliament approves the allocation of oil revenue between the central government budget and the OSF based on implicit oil price assumptions in the context of five-year plans. It also approves additional withdrawals from the OSF, as well as annual limits on OSF lending to domestic companies, in the context of annual budgets and mid-year budget revisions. However, the OSF operations are not consolidated with the central government operations in the budget documents discussed by parliament.

52. Investment management:

• OSF foreign assets are managed as part of the CBI’s foreign assets. The Monetary and Credit Council (MCC)³³ determines the rate of return on OSF foreign currency deposits at the CBI.

• The OSF domestic assets comprise claims related to commercial banks’ lending, which it funds. The banks are required to review loan requests to ensure that projects are in conformity with the technical, financial, and economic feasibility criteria approved by the Board of Trustees.

Objectives

58. Maintaining the OSF’s stabilization objective appears appropriate, as the budget is projected to remain vulnerable to oil price declines in the medium term. Precautionary savings are particularly justified in the case of Iran because of lack of access to international financial markets and limited opportunities for domestic non-inflationary financing to ride out a period of lower oil prices.³⁷

59. Long-term sustainability and intergenerational fairness considerations do not represent a binding constraint. The non-oil primary fiscal deficit is estimated at 17 percent of GDP and implicit energy subsidies are estimated at 22 percent in 2007/08. Their combined ratio to GDP is well below the sustainable real expenditure from oil wealth, which is estimated at 65 percent of GDP in 2007/08 assuming a conservative oil price of $85 per barrel (at constant U.S. dollar terms). Therefore, there is no compelling need to save more oil revenue than justified by precautionary motives.

60. Transferring OSF’s domestic lending operations to the budget would facilitate fiscal planning. Should the authorities choose to maintain policy-motivated foreign currency lending, it would be advisable to transfer the administration of this lending to the central government. In this case, lending amounts should be approved by parliament in the context of the central government budget. This approach will de-link the amount of OSF withdrawals from oil price fluctuations, contributing to the fulfillment of the OSF’s stabilization objective.

Accumulation and spending rules

61. The existing OSF accumulation and spending rules should become more flexible and responsive to oil price and macroeconomic developments:

• Align OSF accumulation and spending rules with its stabilization objective. Specifically, allocating all oil revenues to the OSF and limiting the use of its resources to financing the non-oil budget deficit will help focus OSF operations on its stabilization objective and improve expenditure management.

• Implement a rolling medium-term budget framework (MTBF). As a first step in this direction, the existing five-year development plans should be updated annually reflecting the most recent information on oil prices, inflation, and balance of payments developments, as well as shifting government priorities. The authorities may draw on the recent experience of Mexico, the Russian Federation, or Timor-Leste in improving Iran’s national MTBF. Mexico and the Russian Federation embarked on ambitious reforms to introduce rolling multi-year budgets that are updated every year to take into account changes in the outlook, including oil price projections. Mexico’s Fiscal Responsibility Law requires that budgets aim at a zero balance, and the Russian Federation’s framework sets an upper limit on the non-oil fiscal deficit. Timor-Leste adopted a long-term fiscal policy framework that includes rolling three-year projections based on sector investment programs with detailed plans to guide expenditure.

• Review the usefulness of assuming unrealistically low oil prices in the budget planning process. This practice proved ineffective in discouraging pro-cyclical fiscal policy in Iran as well as in other oil-producing countries (IMF, 2007). Instead, it is better to rely on market-based indications of future oil prices and incorporate risk analysis and contingency planning in the MTBF. In particular, the targeted medium-term paths for the non-oil fiscal balance and the accumulation of the OSF deposits under the baseline oil price scenario should take into account possible fluctuations in oil prices. Moreover, contingency plans should describe how the budget would respond to deviations from the budget’s oil price assumptions (e.g., draw-down/or increase in the OSF’s deposits, and areas of expenditure reductions or increases). The extent of such adjustments could be determined based on judgment on the possible duration of the deviations of oil prices from the budget assumptions, or based on mechanical rules (e.g., a moving average oil price).³⁸ In addition, a probabilistic approach can be used to determine the optimal size of the OSF’s foreign assets and the corresponding fiscal balances to stabilize spending (Bartsch, 2006).

• Check the consistency of the non-oil primary balance with the short-term macroeconomic objectives, including economic growth and inflation. This will require improving the coordination between fiscal and monetary policies.

Governance structure and transparency

62. The OSF’s transparency can be further enhanced.³⁹ The information that is publicly available (e.g., the key legal documents governing the OSF operations and disseminated elements of OSF financial operations) could be usefully posted on an OSF-dedicated website. In addition, more detailed information, including annual cashflow statements and summary balance sheets, could be disseminated to the public on a regular basis. Websites of a growing number of oil funds, including Norway’s Government Pension Fund-Global, can serve as good examples of transparent communication with the general public.⁴⁰

Investment policy and management

63. Going forward, the OSF may benefit from diversifying its foreign exchange asset portfolio to increase long-term returns. The current practice of managing the OSF foreign assets in the same pool as gross official reserves appears justified because the end-2007/08 OSF deposits are estimated to cover only about 22 percent of the budgeted 2008/09 expenditure. If the government decides to build up a larger precautionary balance, which can be used to facilitate expenditure adjustment to prolonged periods of oil price declines, the OSF deposits could be invested in somewhat less liquid and riskier assets.