On March 28, 2014 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with the Islamic Republic of Iran.
Iran had achieved considerable progress in raising per capita income and living standards in previous decades. But in recent years, such progress stalled as both domestic policies and the external environment deteriorated.
Macroeconomic performance worsened markedly following the subsidy reform in late 2010 and the intensification of sanctions in 2012. The economy contracted by almost 6 percent in 2012/13 and 12-month inflation rose from about 12 percent in late 2010 to around 45 percent in July 2013. With the deterioration in the external environment in 2012, the authorities abandoned their unified and managed exchange rate regime until they eventually unified the official exchange rates again in June 2013. The balance of payments remained in surplus, but the current account surplus declined to 6½ percent of GDP in 2012/13, almost halving from the year before. The sharp fall in oil exports was the main factor, partly offset by import compression. The deficit of the capital account remained contained, leaving the overall balance of payments in a surplus of 3½ percent of GDP in 2012/13. Gross foreign assets of the Central Bank of Iran (CBI) rose to about $105 billion by end-2012/13. The fiscal position also deteriorated significantly. With about 10 percentage points of GDP decline in total revenues since 2010/11, the authorities cut spending and the overall budget balance shifted from a surplus of 3 percent of GDP in 2010/11 to an estimated deficit of 1 percent of GDP in 2013/14. The deficit of the Targeted Subsidy Organization remained high, bringing the expanded overall deficit to about 2¼ percent of GDP in 2013/14. Throughout these shocks, monetary conditions were relatively accommodative, as domestic interest rates became increasingly negative in real terms. The financial system was also adversely affected, particularly banks’ asset quality and profitability.
Since the Presidential election in mid-2013, there have been some signs of stability. The exchange rate has appreciated markedly in the bureau/parallel market. The CBI has kept a lid on base money growth thanks to tighter credit to the banking system and some fiscal consolidation, and 12-month inflation has declined to about 29 percent in January 2014.
Looking ahead, the near-term outlook remains highly uncertain. Facing continued constrained prospects for oil revenues and international financial transactions, the economy is envisaged to remain stagnant in 2013/14, with real GDP estimated to decline by 1¾ percent. With some positive tailwinds from the external side and some incipient signs that the pace of contraction in domestic demand is slowing, it is projected that economic activity would begin to stabilize in 2014/15, with real GDP projected to increase by 1–2 percent. But the current outlook remains highly uncertain and subject to downside risks. In the meantime, the authorities are taking steps to make the regulatory framework for foreign investment in the oil sector more attractive, while upside risks emanate from the interim agreement with the P5+1.
Executive Directors acknowledged the difficult economic environment facing the Iranian economy in recent years. While Directors were heartened by incipient signs of stabilization in economic activity and the decline in inflation, they noted that the economic outlook remains uncertain and subject to downside risks. They encouraged the authorities to continue implementing prudent macroeconomic policies and advancing structural reforms to lay the basis for sustained high growth and employment.
Directors emphasized that tight monetary policy, balanced fiscal consolidation, and supply-side reforms are essential to deal with stagflation. They welcomed the removal of the financing of the Mehr housing program from the Central Bank of Iran’s balance sheet, and encouraged the authorities to seek long-term noninflationary financing for this program. Directors also recommended increasing interest rates gradually to bring inflation down and anchor expectations. They welcomed the measures to broaden the revenue base away from oil, as well as the steps to strengthen tax administration and reduce exemptions.
Directors noted that institutional reforms to refocus the Central Bank of Iran’s mandate on price stability are essential to entrench macroeconomic stability. Reforms to the fiscal policy framework should strengthen its countercyclical role, limit risks, and enhance macroeconomic policy coordination.
Directors took note of the staff assessment that the official exchange rate in real effective terms appears to be somewhat overvalued relative to the level implied by medium-term fundamentals, while recognizing the uncertainty surrounding that assessment. They welcomed the authorities’ intention to unify the foreign exchange market and remove restrictions, and encouraged the authorities to manage the exchange rate flexibly in light of external risks and still high inflation.
Directors agreed that subsidy reform should proceed with the right supporting framework and macroeconomic policies. They supported the authorities’ plans to increase domestic energy prices gradually, while improving targeted cash transfers. Directors also noted that the reform should foster the adoption of new technologies and tighter budget constraints in energy-intensive sectors.
Directors urged the authorities to strengthen the central bank’s supervisory powers and enforcement capacity. They encouraged the authorities to level the field of competition through further privatization and reforms to government-mandated credit policies. Directors also agreed that plans to deal with nonperforming loans and recapitalize public banks should be supported by restructuring, enhanced risk management and accountability, a strengthened bank resolution framework, and a financially-sound deposit guarantee fund.
Directors viewed improvements to the business environment as potentially providing a boost to productivity and growth. They encouraged the authorities to review labor regulations to ease the rigidity of contracts and nonwage costs. Strengthening the regime against money laundering and the financing of terrorism would also help reinsert the domestic financial system into the global economy, lower transaction costs, and increase productivity.
Directors welcomed the authorities’ recent steps to improve the timeliness of official statistics and noted that there is scope for further improvements.