This Selected Issues paper on Iran focuses on the Targeted Subsidy Reform Law (TSRL). This is the basic law governing the implementation of the subsidy reform in Iran. The TSRL envisaged bringing subsidized prices close to international levels over a five-year period. The paper reviews the implementation of the first phase of the subsidy reform, with a particular emphasis on macroeconomic management. The sharp depreciation of the exchange rate and high inflation significantly undermined progress under the reform. High inflation partially reversed the relative price change under the reform.


This Selected Issues paper on Iran focuses on the Targeted Subsidy Reform Law (TSRL). This is the basic law governing the implementation of the subsidy reform in Iran. The TSRL envisaged bringing subsidized prices close to international levels over a five-year period. The paper reviews the implementation of the first phase of the subsidy reform, with a particular emphasis on macroeconomic management. The sharp depreciation of the exchange rate and high inflation significantly undermined progress under the reform. High inflation partially reversed the relative price change under the reform.

The National Development Fund of Iran: Issues and Challenges1

1. Iran, like other resource-rich developing countries face the challenges of transforming resource wealth into other assets that support sustained development, while also maintaining mechanisms to avoid the boom-bust cycles that stem from volatility in natural resource revenues (IMF, 2012). Since 2000, when Iran established its Oil Stabilization Fund (OSF) to address the fiscal stabilization challenge, the country has embarked on developing the needed institutions to address these challenges. In 2010, Iran established the National Development Fund of Iran (NDFI) to improve the intergenerational allocation of its hydrocarbon wealth. This chapter discusses the NDFIs’ role in Iran’s macroeconomic and fiscal policy frameworks and challenges to ensure the fund can meet its main objectives.

2. Reforms to the fiscal policy framework could aim to strengthen its countercyclical role and enhance macroeconomic coordination. A revised fiscal framework that is supported by the OSF and the NDFI could better balance the goals of macroeconomic stability, intergenerational equity, and development. For this, OSF resources could be replenished soon to support noninflationary budget financing and build buffers for future shocks. Decisions on how to save and invest NDFI resources could be better coordinated explicitly with macro policies and underpinned by more explicit safeguards and transparency. Adopting a multi-year budget planning and expanding the coverage of the general government could enhance the operational conduct, monitoring, and accountability of fiscal policy and, therefore, contribute to improved long-term macroeconomic stability to better support economic growth.

3. This chapter reviews international experience on the design and integration of SWFs with the fiscal framework and offers some suggestions for consideration. The international experience and literature offer lessons for improving the design and strengthening the management of the NDFI, including by better integrating it into Iran’s short and long-term fiscal frameworks. A well designed development fund can play an important role in a comprehensive economic reform aimed at increasing productivity, employment and economic growth.

A. The NDFI in the Context of Similar Institutions in Other Countries

4. The NDFI is a subclass of SWFs that undertakes domestic activities to contribute to national economic development. SWFs are defined in a number of ways. The definitions have different focus. This diversity of approaches makes international comparisons of the institutions, their activities, size, and market impact difficult. Ang (2010) defines them as “a mechanism for moving country’s savings and investments from present to the future.” Monk (2008) sees SWFs as “government owned and controlled (directly or indirectly) investment funds that have no outside beneficiaries or liabilities (beyond the government or the citizenry in abstract) and that invest their assets, either in the short or long term, according to the interests and objectives of the sovereign sponsor.” Balding (2008) defines SWFs as “pools of capital controlled by a government or government-related entity that invests in assets seeking returns above the risk free rate of return.”

5. The number of countries that established or contemplate establishing national wealth funds has risen rapidly since mid-2000. A number of factors contribute to the interest in starting and expanding SWFs, including the rise of global imbalances and long-term oriented fiscal policies in some noncommodity exporting countries and regions, which have led to the accumulation of large fiscal and external account surpluses. These surpluses have created the need to develop novel approaches and institutions to manage them.2 Iran’s large hydrocarbon resources and export potential are likely to generate large external surpluses for years to come, justifying the creation of the NDFI. Also, the uncertainty about the sustainability of public finances of some developed countries and the low yields on safe assets, have encouraged search for alternative investments.

6. Against this background, SWFs are classified into (i) stabilization funds, where the primary objective is to insulate the budget and the economy against commodity price swings; (ii) savings funds for future generations, which aim to convert nonrenewable assets into a more diversified portfolio of assets and mitigate the effects of Dutch disease; (iii) international reserve investment corporations, established to increase the return from official reserves; (iv) development funds, which typically help fund socio-economic projects or promote industrial policies that might raise a country’s potential output growth; and (v) contingent pension reserve funds, which provide for contingent pension liabilities on the government’s balance sheet, but are funded from sources other than individual pension contributions.3 Most funds, like the NDFI, have multiple objectives.

B. The NDFI in the Iranian Fiscal Framework

7. The NDFI was established in Iran’s Fifth Five-Year National Development Plan (March 21, 2010 to March 20, 2015). Articles 80–84 of the Plan established the NDFI and specified its structure. The NDFI has three objectives: (1) Save part of the oil and natural gas rents for use by future generations; (2) Increase income returns from the accumulated savings; and (3) Support Iran’s economic development and diversification. NDFI’s revenues have been defined as a specific percentage of Iran’s oil and gas export revenues. In 2011, the NDFI received 20 percent of oil and gas revenues. The share rose to 23 percent in 2012 and 26 percent in 2013. It is expected to reach 32 per cent in the long term.

8. The NDFI complements the Oil Stabilization Fund (OSF), which was launched in 2000 to play primarily a fiscal stabilization role.4 The OSF was to save all revenues from oil exports in excess of the budget allocation. The OSF, effectively only an account at the CBI, was allowed to lend up to US$10 billion to banks for on-lending to the private sector. In practice, the OSF has not achieved its main stabilization and sterilization role. In contrast to the OSF, the NDFI has been fully institutionalized. The NDFI has its own Board of Trustees, Operating Board of Executive Directors and is subject to professional oversight from the Committee of Supervisors. On June 26, 2012 the NDFI’s Board of Directors approved detailed Manual of Terms and Conditions for Granting Facilities. The NDFI has its own staff and monthly publication that provides broad information on the value of its assets and allocation of loans by the intermediating commercial banks (agents) and sectors of the economy, the ultimate recipients of loans.

Prioritizing a stabilization role

9. There is scope to improve the interactions between the NDFI and Iran’s fiscal framework. The NDFI, the OSF, and the general government rely on the same revenue source—oil and gas exports. Therefore, the funding rules for each entity need to be clearly prioritized and coordinated. Also, NDFI’s domestic development investment mandate needs to be well integrated with the public sector’s development spending and financing needs. A proper design and coordination would make macroeconomic management easier and contribute to overall macroeconomic stability.

10. Therefore, NDFI savings for future generations need to be aligned with Iran’s general government funding needs to help improve macroeconomic stability. Iran’s fiscal revenues and fiscal balance are heavily dependent on oil and gas export income. A fall in oil and gas prices or export volumes has an immediate impact on the budget. Theoretically, the fiscal shortfall should be financed from past fiscal savings placed with the OSF. However, the OSF has not accumulated reserves, while Iran has had no access to external debt financing, and there has been limited demand for public debt in the domestic financial market. At the same time, under the current funding rules and irrespective of the fiscal and overall macroeconomic situation, the NDFI receives a fixed percentage of all oil and gas revenues. The fund has accumulated significant financial savings for use by future generations at the time when Iran had to respond to a fiscal revenue shortfall by drastically cutting public spending and resorting to inflationary financing. The government had to make deep and costly in the longer term cuts in capital spending. At the same time, the high inflation and the resulting volatility in the foreign exchange market undermined NDFI’s ability to promote domestic private sector development.

11. One option could be to adjust the NDFI funding formula to take into account the general government fiscal position. The NDFI should not be used to impose fiscal discipline on the general government, as is currently the case. Rather, fiscal discipline should be at the core of the government’s policymaking. Fiscal discipline should lead to fiscal surpluses and transfers to the OSF and the NDFI. The fiscal formula for using hydrocarbon resources should ensure that the use of revenues from hydrocarbon exports is countercyclical. Specifically, when oil prices and exports are above trend, the excess revenues should be saved in the OSF first. Only when the OSF is adequately funded, fiscal surpluses should be transferred to the NDFI. When oil prices and output fall, forcing the government to borrow, the savings in the OSF and NDFI could be tapped to minimize the negative impact of government’s borrowing on the economy. Maintaining high fiscal discipline and building up stabilization reserves could be particularly important in the near term, following years of high oil and gas export prices.

Financing public capital infrastructure

12. At present, there are few clear guidelines or specific goals guiding NDFI’s role in supporting national development. The NDFI is not allowed to lend to the government nor the public sector. Its lending is to promote private sector development. Iranian commercial banks are responsible for screening borrowers and their projects, though the loans are authorized by the NDFI and disbursed mostly as payments for imports. As oil revenues to the government fell in the past two years, the NDFI has come under pressure to support the economy, with risks to the quality of projects and incentives for rent seeking.

13. To address part of this problem, the NDFI could be allowed to support well designed public infrastructure projects. Some SWFs have become active contributors to the development of public goods, including large national infrastructure projects (Clark and others, 2011). The NDFI could engage in financing of projects that offer high social returns and, therefore, are critical for national development. In particular, efficiently designed and implemented public-private partnerships (PPP) could help. An effective PPP model would include strong incentives for private partners to improve the timeliness and quality of the implementation of selected projects compared to the projects implemented directly by the government under its national development program. To pursue such projects, the NDFI would need to develop and implement effective mechanisms for assessing potential projects for their private and social returns and be able to monitor the selected projects.

C. National Insurer, Wealth Builder, and Promoter of National Development

Insurer of macroeconomic stability and lender of last resort

14. The NDFI could offer a fiscal and external buffer to help mitigate temporary shortfalls in fiscal and export revenues. Such centralized pool of savings can increase macroeconomic stability and the country’s international credibility, effectively making the use of the buffer highly unlikely. NDFI’s assets could be seen as another, supplementary to central bank’s international reserves, financial buffer that could be relied upon and drawn on under specific rules or conditions, in times of economic crisis.5 The availability of such reserves would improve Iran’s risk ratings and reduce future international borrowing costs. Some of the countries that are best rated for macroeconomic stability have insured the good outcome of their prudent policies with sizable sovereign fund assets. The buildup of external reserves in most East and South East Asian countries in the aftermath of the Asian crisis, as well as in Norway and Chile, helped them preserve macroeconomic stability.

15. The NDFI would need to ensure that a large share of its assets, relative to Iran’s imports and debt service payments, is invested in reliable and reasonably liquid securities. Also, that part of the investment portfolio would need to be well disclosed, ideally audited by reputable independent (including external) auditors, to ensure the adequate reporting of reserves. The NDFI could continue to benefit from the experience and practices of the SWFs that score high on the SWF’s Generally Accepted Principles and Practices (Santiago Principles), in particular in the principles related to the Transparency and Accountability section of the scoreboard.6 Iran could emulate the SWFs that routinely score high in this area: Norway’s Government Pension Fund Global (GPFG), New Zealand’s Superannuation Fund, Chile’s Economic and Social Stabilization Fund, Alaska’s Permanent Fund, or Australian Future Fund. Singapore strategically discloses some but not all of its reserve and SWF assets.7 The NDFI should continue to improve its governance to earn the trust of other countries and investors.

Long term national wealth builder

16. Well managed assets tend to earn higher returns compared to traditional reserve investments. SWFs have been created to earn higher returns on assets. Long-term investments in equities and lower quality bonds should produce returns that include equity premiums, in addition to the return on riskless assets. Accomplishing such diversification in a cost effective manner is not easy for the time being, and the foreign part of NDFI’s assets will need to remain with the CBI.

17. To earn the full benefit from holding assets in a SWF, the NDFI could continue to develop strong in-house corporate management capacity. As a new organization, the NDFI has entered a business where the breadth and depth of knowledge and the experience in financial markets and macro- and micro-economics is in short supply and commands high value in the labor market. At least initially, Iran may have to hire international managers and open offices in key financial centers to be able to attract and recruit the right staff. Setting compensation packages could be another challenge for a public institution. Norway’s GPFG and the two Singaporean funds offer valuable lessons on how to develop in house capacity and what challenges it will likely face. The most important measure will be to ensure merit-based recruitment of staff of highest integrity and ethical standards, and open the fund to international professional staff.8 Norway’s GPFG manager, the NBIM, reports employing 340 staff from 27 countries in its offices in Oslo, London, New York, Shanghai, and Singapore.9 Singapore’s Temasek has 450 staff from 23 countries that bring in diverse experiences, knowledge and perspective to build an institution of character and distinction.10 Singapore’ Government Investment Corporation (GIC) has 1200 staff from 30 nationalities in its nine offices around the globe.

18. NDFI’s managers and staff must understand the full extent of the challenges faced by asset managers. They need to put in place investment policies and operational practices that shield the NDFI from the risks associated with active asset management. Few asset managers tend to succeed in outperforming broad market indices in the long term. The Santiago Principles focus mostly on disclosure of investment practices; but they do not recommend best practices. The best practice for long-term investors, such as over-generational equity funds, has traditionally focused on building portfolios that mostly track broadest possible market indices, to match long-term market returns, while minimizing management and trading costs. Periodic portfolio rebalancing helps too.

19. On the practical side, Norway’s GPFG offers a good model to follow. First, GPFG’s assets are managed by a professional asset management team, Norges Bank Investment Management (NBIM). Second, the management strategy has been focused on minimizing management and other costs. Third, GPFG’s assets are invested in a broadly diversified global portfolio. Fourth, the investment strategies rely on using a combination of passive index-based investments and some modest effort to generate small excess return of 25 basis points.11

20. Chile offers an example of a prudent learning-by-doing strategy. Two Chilean funds, the Pension Reserve Fund and Economic and Social Stabilization Fund, rely on a Financial Committee of six independent investment professionals elected for two-year terms to offer guidance on the fundamental aspects of the investment policy for the sovereign wealth funds.12 Both funds have gradually expanded investments beyond the safety of the high rated sovereign debt and money market funds, to ensure they have adequate in-house capacity to take on higher risk profile.

Promoter of domestic economic development

21. The sovereign fund can be used to support local economic development. The fund provides a pool of investable capital that can be used to finance domestic business expansion, corporate restructuring, startup companies, and infrastructure projects. So far, the NDFI implements its development mandate by using Iranian commercial banks to screen borrowers and projects. If past history is any indication of future performance, some of the Iranian domestic banks may not be able to maximize economic and social returns on the loans. If banks are unable to repay NDFI-funded loans because their borrowers default, the NDFI may become, by default, the insurer of the banking sector. It will take over the banks’ nonperforming loans and may become the controlling shareholder in some of Iran’s banks and their corporate clients.

22. The NDFI could reconsider the way it supports domestic economic development. Specifically, as the first priority, the NDFI should help finance budget deficits to reduce the damaging impact of the currently pursued inflationary financing. Some of this financing could be directed towards capital development projects, possibly under a well designed public-private partnership programs. Only after macroeconomic stability is restored should the NDFI engage in supporting the private sector. This could be done through a number of mechanisms, such as the currently in place lending through banks, but also through participation in special purpose funds, such as private equity and venture funds. The use of such specialized funds that supplement financing with active involvement in corporate management will help address the single biggest challenge facing the Iranian companies: the need to restructure to restore international competitiveness when the massive subsidies from low cost energy, negative real interest rates, and protection from foreign competition are phased out.

23. Furthermore, the NDFI could eventually become more active in corporate restructuring. Many of the privatized enterprises face limited pressure to deliver best performance. Their shares are either dispersed among numerous small investors or are held by large diversified domestic institutional investors. Both cases may give rise to agency problems and costs, misalignment of corporate managers’ interests and incentives with the interests of shareholders (Fama and Jensen, 1983). In the former case, the dispersed investors are unable and not interested in pressuring corporate boards. In the latter case, the managers of the institutional funds lack sufficiently strong incentives to enforce performance. To minimize agency costs, the NDFI will need to address the weaknesses of the agency relationship when the relevant stakeholders are not clear. For example, the NDFI will need to decide whether it strives to maximize social welfare of all Iranians, thus maximizing the value of all its assets, or rather the welfare of the city where it invests, the welfare of the company it invests in, or the welfare of the company’s employees.

24. Developing in-house private equity and venture capital management capacity could strengthen NDFI’s effectiveness in promoting its domestic mandate. To perform its national development function, the NDFI may need to develop in-house capacity to: (a) select the best outside managers for its portfolio companies and (b) actively manage at least some of its portfolio companies. The NDFI may draw on the experience of many funds around the world that have developed in-house private equity and real estate development teams. Singapore’s Temask’s Enterprise Development Group “serves as a development engine, going beyond investing for growth to building for growth. The group focuses on mapping our future business value chain; staying abreast with innovation and macro business trends; and identifying and developing new business enterprises that have the potential to be global, regional or domestic champions.”13 Similarly, Kuwait’s Investment Authority (KIA), Abu Dhabi’s Mubadala Development Company, Qatar Investment Agency’s domestic investment arm Qatari Diar, or Malaysia’s Khazanah Nasional Bhd pursue domestic development efforts, including investments in the SMEs.14

D. Design and Operational Issues

25. There are a number of theoretical considerations and practical lessons from other countries that can inform the design and operations of the NDFI. Singapore and Hong Kong offer lessons in fiscal prudence and overall economic management that Iran may consider. Alaska, Chile, and Norway offer sound fiscal models for establishing the fiscal rules and relations between the general budget and the SWF, and supporting the rules with the right institutions (Frankel, 2011). Norway offers good lessons for managing NDFI’s external assets. Singapore and Malaysia’s funds are examples of development funds to learn from. Some other funds offer lessons of what does not work.

26. The available interdisciplinary research offers some important lessons. In particular:

  • Setting clear objectives. SWFs routinely face multiple objectives. This is unavoidable due to their public nature and exposure to diverse stakeholders. However, ensuring clarity and prioritizing the objectives can help guide daily operations. The NDFI’s founding documents should clearly spell out its two objectives: over-generational saving and promoting economic development, in a hierarchical manner. The objective of saving hydrocarbon rents for future generations should dominate and be supported by the objective of promoting national development. The two hierarchically imposed objectives will guide the fund’s investment strategies, the buildup of its human capacity and organizational structure.

  • Separating political oversight from operational management. The NDFI, like most SWFs, is a “social institution.” As such it is supervised by a political body (Board of Trustees) representing numerous stakeholders’ interests. Such representation is necessary to ensure political legitimacy of the institution. However, it also carries risks.15 Separating political oversight from asset management is the first and foremost challenge faced by a sovereign wealth fund. The executive branch of the Iranian government maintains a voting majority on the fund’s supervisory body. At the same time, to succeed in meeting its major objectives, the fund needs to be operated primarily on a commercial basis. Individual investment decisions must be driven by commercial considerations, not short-term political or even social needs. Therefore, it is important to ensure that the Trustees establish economically sound and internally consistent objectives for NDFI’s Board of Directors to follow and let the professional management implement them without further political interference. There are a number of ways to ensure the needed separation of political oversight from operational management:

    • The fund’s operational management needs to be relatively immune from the changing balance of power in the legislature, government ministries, the central bank, and other politically elected bodies.

    • The fund’s founding documents need to clearly delineate the separation of oversight from operational management. Singapore’s Government Investment Corporation (GIC) offers an example of such an arrangement. The GIC is a private company wholly owned by the Government of Singapore. It manages assets and is paid a fee for services. “The Government, which is represented by the Ministry of Finance in its dealings with GIC, neither directs nor interferes in the company’s investment decisions. It holds the board accountable for the overall portfolio performance.”16

    • The founding documents need to be enforced. Ensuring the legal separation is in theory easy but not in practice. Therefore, at the time the fund is formed, policymakers should envisage situations where a future small political majority could use the fund for its own benefit. Strong legal and practical safeguards to prevent this from happening are needed. Requiring super majority votes and an agreement from other independent bodies to change the fund’s rules could be one way of strengthening the fund’s independence.

    • Appoint the fund’s operational leadership in a manner that maximizes its operational independence, while ensuring the fund pursues its main objectives. Longer term, difficult to break—except for specific misbehaviors—management contracts offer one way to strengthen operational independence. The contracts must be supported with well designed incentives; and need to impose broad operational limitations, such as objectives, broad investment strategies, and risk limits.

    • Structure compensation rules to create strong long-term performance incentives for both members of the supervisory body and the fund’s leadership and staff. The contracts should have strong incentives for long-term profit maximization under acceptable risk profiles. While increasing the chances of reaching the long-term goals, the contracts should also have short-term performance benchmarks to create strong overall performance incentives and accountability.

    • Define the relationship between the fund and the sovereign’s fiscal needs. The funding formula is important to enhance the fund’s independence. In the case of fiscal stabilization funds, knowing the relationship to the budget allows fund management to anticipate and respond to possible calls on assets. As a result, when the call for fiscal support arrives, the relationship between fund managers and its political overseers is likely to improve. Also, instilling high level of predictability of future inflows and government planned outflows instills confidence in the fund’s operational stability, and fosters healthy relationship with its political supervisors.

    • Develop clear and transparent investment guidelines. In particular, the guidelines should ensure proper domestic and external diversification of assets. The authorities may choose to commit the NDFI to follow the “indexers’ model”. Such simple investment strategy would commit the fund to buy a broadly diversified stock market portfolio. Under more active strategies, NDFI supervisors could impose single-company, single sector, and single country and region exposure limits, and set a matrix of limits on holdings of specific classes of securities. The investment guidelines will depend on the expected timing of calls on the fund’s assets to support fiscal expenditure and other needs.

27. Tax policies inside and outside Iran will influence NDFI’s asset management strategies. The available legal and tax literature discusses the international regulatory and tax policies and practices that affect SWF activities. Fleischer (2008) looks at taxation of SWF incomes and discusses challenges to ensure policy neutrality. Knoll (2009) emphasizes the benefits of cross-border diversification that encourage SWF to invest internationally, even in countries with less favorable tax policies and rates. Also, he shows that relative tax rates matter more than absolute tax rates, and develops recommendations for reforming the international tax system to make it more neutral and encourage cross-border capital flows, including from SWFs.


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Prepared by Roman Zytek.


Aizenman and Glick (2008), Ang (2010), Blackburn and others (2008), Dixon and Monk (2010), among many others offer interesting discussions on the objectives for setting up SWFs.


Theoretical and policy research offers advice on how to establish a SWF, once the decision to establish it has been made (Al-Hassan and others, 2013; and Udaibir and others, 2010).


IMF (2008) examined the operations of the OSF and provided recommendations on how to strengthen the OSF’s role in macroeconomic management by focusing on its stabilization objective and integrating its operations with the central government budget in the context of a rolling medium-term fiscal framework.


Clark and Monk (2009) study the stabilizing role of the Government of Singapore Investment Corporation, the country’s insurer of last resort.


See: International Working Group (IWG) of Sovereign Wealth Funds (2008) for the full list and discussion of the Santiago Principles; and Bagnall and Truman (2013) for the elements of the scoreboard. The Santiago Principles and the work of the International Forum of Sovereign Wealth Funds (IFSWF) represent “a compromise and, as a result, are not as rigorous as outsiders would prefer. For example, they are not explicit about what information should be publicly disclosed. In addition, 10 of the 30 Santiago Principles and subprinciples have little to do with the public and, rather, focus on relations between the fund and its government. Managers of SWFs, like central bankers that are often their philosophical cousins if not their de facto brothers and sisters, treasure their independence from their governments, which is a questionable long-term posture for both” (Bagnall and Truman (2013).


Monk and Bachher, (2012) stress the importance of in-house capacity building. Among other, SWFs should try to bring in a mix of young promising talent and experienced executives.


See: Temasek’s professional ethos and work ethics are rooted in the MERITT values: Meritocracy, Excellence, Respect, Integrity, Teamwork and Trust.


Al-Hassan and others (2013) discuss theoretical and practical issues related to internal and external governance of SWFs.