The debate of how much sanctions relief Iran received as part of the November 2013 interim nuclear agreement continues. The Obama administration, which should be overvaluing its concessions to Iran as a negotiating tactic, is instead insisting to Congress that the value of sanctions relief is only $7 billion, or even less. Iran is predictably undervaluing the package, while complaining about problems accessing oil revenues it was promised, and building the case that it will need even greater relief for similar nuclear concessions if the interim agreement is renewed for another six-month period.
A new IMF report released in April 2014 presents macroeconomic fundamentals indicating that Iran is actually experiencing a modest albeit fragile economic recovery. Even under conservative assumptions, GDP growth will be narrowly positive in the current fiscal year as Iran recovers from steep sanctions-induced losses. The official inflation rate has halved to about 20% on a year-over-year basis, and the rial-dollar exchange rate has increased by 20% since the election of Iranian president Hassan Rouhani. Tighter fiscal and monetary policy under Rouhani's new economic team, which is now facing diminished sanctions pressure, is also stabilizing growth and inflation and encouraging consumption.
Admittedly, Iran's recovery is fragile; growth is linked to continued progress on the nuclear issue and Iran avoiding new sanctions. Meanwhile, Iranian unemployment remains stubbornly high, the Rouhani government is facing serious budgetary challenges, and Iranian banks (especially state-owned institutions) are in bad shape because of rising corporate defaults.
The IMF report conservatively estimates that Iran's economy will expand by 1-2% in fiscal year 2014-15 after over two years of recession. It notes that the steep recession of 2012-2013 bottomed towards the end of 2013 as sanctions eased and inflation came under control. Iran has avoided billions of dollars in further economic losses that it otherwise would have incurred had sanctions pressure continued at 2012-2013 levels. In particular, Iranian oil exports have increased in comparison to what would otherwise have been a decline had the Obama administration continued to require significant reductions in Iranian oil purchases (this requirement was suspended for six months as part of the Geneva interim agreement).
|Real GDP growth||3||-5.8||-1.7||1.5||2.3|
|Nominal GDP Iranian rial (trillions of rial)||6.121||6.793||9.068||11.057||13.612|
|Nominal GDP in dollar terms (in billions)||541.1068||554.0783||366.088||442.28||544.48|
The IMF makes clear the benefits that would flow from continued economic reforms (fiscal reform) and a relaxation of sanctions. Conversely, the tightening of sanctions, as a result of a failure in nuclear diplomacy with the P5+1, would constitute a significant economic shock for Iran.
In other words, the current P5+1 negotiations track provides economic growth potential for Iran. The interim nuclear agreement and sanctions relief is helping to stabilize the economy, which could lead to an acceleration of growth. In an upside scenario, the IMF sees growth accelerating to 4-5% in 2015-18, assuming that oil output increases sharply, fiscal cuts are moderate, investment revives, and Iran implements economic reforms. The IMF's baseline estimate is closer to 2% growth, which assumes no increase in oil and gas export volumes (oil exports are capped at late 2013 levels) and a weakening of global oil and gas prices. Since oil exports have already increased from these 2013 levels, growth could be stronger in 2014-2015 than IMF assumptions.
The IMF's Iranian oil export projections are very conservative, with oil exports held steady at the 2013 level (1mbd in oil exports, as required by the interim agreement). The IMF also assumes that global oil prices will fall. However, oil exports have already overshot their expected levels in early 2014, with recent data suggesting a level of 1.3-1.4 mbd, based on import figures from Iranian partners. As a result, Iranian growth will likely be somewhat higher. Roubini Global Economics forecasts that global oil prices will remain solidly over $100 Brent in the coming years, which suggests that Iranian energy revenues will remain closer to $60 billion annually versus the IMF's forecast of $45-50 billion.
Direct Sanctions Relief
The IMF estimates of the benefits of direct sanctions relief are similar to the Obama administration's assessment: $6-7 billion in relief to the Iranian government (access to $4.2 billion in locked-up funds, plus an estimated $1.5 billion in revenue from auto, petrochemicals, and precious metals trade). The IMF forecasts don't, however, account for additional boosts to the economy stemming from the economic benefits of regaining access to imports (car parts, for example), which then fuel domestic economic growth.
The IMF provides a rare glimpse at Iran's fiscal policy. It estimates that government revenues fell by 10% of GDP equivalent since mid-2010, prompting sizeable spending cuts. Iran made most of its adjustments by cutting investment spending and shelving infrastructure projects, rather than cutting transfers or public sector wages. The IMF estimates that Iran ran a 1% GDP fiscal deficit in 2013-4. Adding Iran's subsidies program, it was probably closer to 2.5% of GDP. Iran has managed to accumulate around $50 billion in savings in its new development fund, which it can use only for domestic investment. Deploying this capital could help support economic activity in coming years.
Iran's banks, particularly the state-owned ones, are currently in no shape to support domestic demand, let alone buoy the economy. The IMF notes that private sector lending fell (in inflation-adjusted terms) in the year ending in December 2013, as banks sought to reduce their exposure to the private sector. The decline in inflation likely helped encourage deposit growth, but the banks are in bad shape because non-performing loans (NPLs) rose to 14%. Large state banks are even more troubled, thanks to government mandates to lend to corporations. "Private banks," meanwhile, have already launched a recapitalization process and they are in sounder condition.
The IMF sees the current tight fiscal and monetary policy as a positive sign, particularly as it has helped stabilize inflation and growth, improve consumer purchasing power, and reduce Iran's exposure to moderate shocks. IMF forecasts suggest inflation will stabilize around 25% year-over-year by year-end, down from an official inflation rate of 40+% in 2012-2013, but it could climb higher as fuel prices are increased.
Several factors suggest moderate increases in inflation. For one, higher energy costs are bringing the subsidy regimes into better balance. Additionally, there has been an increase in VAT to 8% in 2014-15, which will temporary increase prices (Iran's VAT at 6% is the lowest of all major oil exporting countries). Finally, the 2014-15 budget assumes some consolidation of the foreign exchange rates and a further depreciation of the official rate, which will increase the cost of imported goods. This will help with the competitiveness of non-commodity exports.
Another positive for Iran is the strengthening of the unofficial exchange rate by 20% since the election of Rouhani and an expectation of easing tensions with the West. There are some signs that the gap between official and unofficial exchange rate has started to widen again. The premium between official and unofficial exchange rates has expanded to about 25%, up from 18-20% from August 2013-February 2014. Although it's a far cry from the mid-2012/early 2013 divergence of 300%, it nonetheless marks a decline in Iranian purchasing power. The IMF believes that the official exchange rate is overvalued based on current exports, with the unofficial rate closer to fundamental value. This suggests that the official rate will likely depreciate further, bringing the two in line.
Figure X: Iranian Rial-USD exchange rate and the divergence between official and unofficial rates.
Iran's official unemployment, meanwhile, remains high at around 25%. There has been some shrinkage of the workforce as some workers gave up looking for work, while new entrants struggled to find jobs. Female labor participation fell sharply by 6% during the economic stress of 2005-13, while male participation held up. IMF estimates that non-oil growth of 6% (2% higher than even its most optimistic forecast) would be needed to significantly improve unemployment.
Even as American and Iranian officials undervalue the total sanctions relief package offered as part of the Geneva interim nuclear deal, Iran is experiencing a modest albeit fragile economic recovery. This is supported by a variety of key macroeconomic indicators in the most recent IMF report. Though the Iranian economy cannot fully recover while the toughest sanctions remain and investment is scarce, the reversal of the steep sanctions-induced recession that prompted an economic free fall in 2012-2013 has enhanced Iranian nuclear negotiating leverage. This likely makes it more difficult to conclude a diplomatic deal that dismantles Iran's military-nuclear program or to persuade Tehran to finally come clean with the international community on its past military-nuclear activities.
Mark Dubowitz is executive director of the Foundation for Defense of Democracies. Rachel Ziemba is the director of emerging markets at Roubini Global Economics. This analysis is part of a series from FDD's Iran Sanctions Project's ongoing assessment of sanctions relief on Iran's economy.