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Iran’s Economy in Crisis

Iran’s Economy in Crisis. Farrokh Zandi Schulich School of Business York University Toronto, Canada. Ease of Doing Business. Economies are ranked on their from 1 – 183, with first place being the best.

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Iran’s Economy in Crisis

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  1. Iran’s Economy in Crisis Farrokh Zandi Schulich School of Business York University Toronto, Canada

  2. Ease of Doing Business • Economies are ranked on their from 1 – 183, with first place being the best. • A high ranking on the ease of doing business index means the regulatory environment is conducive to the operation of business. This index averages the country's percentile rankings on 10 topics.

  3. Ease of Doing Business • Ranking Table: SOURCE: THE WORLD BANK GROUP

  4. Oil- Dependent Economy • Oil and gas exports dominate Iran’s export revenues, constituting about 80% of total exports and are the most important source of foreign exchange earnings for the country.

  5. Oil- Dependent Economy • Oil revenue continues to account for the majority of export earnings and represents the bulk of government revenue (about 40%). • Iran’s dependence on oil export revenues makes the country highly susceptible to the volatility of international oil prices.

  6. Iran’s Economy in Crisis The lifeblood of Iran’s economy, its oil and gas industry, is showing serious signs of distress. Due to years of neglect, Iran’s current daily oil production has fallen to near 3.7 million barrels, which is more than 5% below its OPEC quota.

  7. Iran’s Economy in Crisis • In contrast, in 1974, five years before the Islamic Revolution, Iran pumped 6.1 million barrels per day.

  8. Iran’s Economy in Crisis Iran’ oil production levels are limited by a number of factors. The oil industry faces a high rate of natural decline of mature oil fields and low oil recovery rates.

  9. Iran’s Economy in Crisis • Iran also has been plagued by aging infrastructure and old technology. • Most oil fields dating back to 1920s require significant upgrades in facilities.

  10. Iran’s Economy in Crisis • Structural upgrades and access to new technologies, such as natural gas injections and other enhanced oil recovery efforts, have been limited by a lack of investment.

  11. Iran’s Economy in Crisis • It is believed that millions of barrels of oil are lost annually because of damage to reservoirs and these natural declines.

  12. Iran’s Economy in Crisis At the current rate of investment, production of oil is expected to decline at a rate of 13% per year making Iran an oil importing nation by 2020.

  13. Iran’s Economy in Crisis • To maintain oil production at its 2008-2009 level of 3.9 million barrels a day, nine billion dollars fresh investment per year is needed. • The current investment undertaking is under 3 billion dollars.

  14. Iran’s Economy in Crisis While the supply of domestic oil is dwindling, there is no sign of abate-ment on the demand side. In fact, at the current subsidized gasoline prices, the annual consump-tion will continue to increase at the rate of 10- 12 percent per year eating into exports.

  15. Iran’s Economy in Crisis • Currently, Iran’s 7 million vehicles consume the same amount of gas as Britain’s 35 million vehicles.

  16. Iran’s Economy in Crisis • IRANIAN ENERGY SUBSIDIES, ESTIMATED VALUE AND SHARE OF GDP, SELECTED YEARS • Year Energy GDP of Iran* Share of GDP Subsidies Value* (%) • 1994 $11 (15.92) $67 (96.99) 16.42 • 2001/2 $11 (13.39) $116 (139.43) 9.4819 • 2003 $13 (15.51) $133 (155.07) 10.00 • 2005 $37 (40.64) $188 (206.52) 19.68 • 2007 $50 (51.74) $285 (294.89) 17.54 NOTES: *Billions of U.S. dollars in current dollars (historical dollars unadjusted for inflation); numbers converted into 2009 dollars in parentheses; numbers on subsidies value are inexact estimates from varying sources. Other sources say energy subsidies averaged 11 percent of Iran’s gross domestic product (GDP) in the 1990s; this data indicates subsidies dipped as a share of GDP near the end of the decade.

  17. Iran’s Economy in Crisis • MOTOR GASOLINE LITRES CONSUMED FOR ROAD TRANSPORT IN IRAN AND ITS NEIGHBOURS IN 2007 Country Liters/Day Population Liters/Day/Person • Armenia 627,847 2,971,650 0.2113 • Azerbaijan 2,946,049 8,120,247 0.3628 • Iran 63,862,027 65,397,521 0.9765 • Iraq 14,343,879 27,500,156 0.5216 • Pakistan 5,323,693 169,121,963 0.0315 • Turkey 9,046,192 74,767,836 0.121 • Turkmenistan 3,139,233 4,774,232 0.6575 • U.S. 1,376,863,825 301,290,332 4.5699 • Source: STRUCTURAL PATRONAGE IN IRAN:IMPLICATIONS OF SUBSIDIES REFORM FOR IRAN AND U.S. POLICY

  18. Iran’s Economy in Crisis • Holding an estimated 10% of global proven oil reserves, Iran boasts the world’s third largest proven petroleum reserves following Saudi Arabia and Canada.

  19. Iran’s Economy in Crisis • The country must import close to half of all refined petroleum products to meet domestic consumption needs. • Iranian refineries produce about 44 million litres a day, whereas the domestic consumption is near 65 million litres a day. • Iranian gasoline imports were projected to total $5.7 billion in 2006 and $6.1 billion in 2007.

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  23. Iran’s Economy in Crisis

  24. Iran’s Economy in Crisis • With an estimated 15% of the world’s gas reserves, Iran has the second largest natural gas reserves globally, following Russia. • Despite its vast gas resources, Iran has been unable to become a major international gas exporter. In fact, Iran has been a net importer of natural gas as late as 2005.

  25. Economic Stagnation • Non- oil sector production is stagnant primarily due to the recent import-driven policy of the current government. • When factories do remain open they cannot afford to pay workers. The resulting wild-cat strikes are hampering production in some key industries.

  26. Economic Stagnation • Non-oil exports TABLE

  27. Economic Stagnation • Other major export items are petrochemicals, minerals, carpets, and fresh and dried fruits.

  28. Subsidy Reform • Although sanctions have hastened subsidies reform, critical motivations for reform are:  the Iranian regime’s desires to seize greater political power,  increase the Islamic Revolutionary Guards Corps market dominance,  redistribute income,  and lessen budgetary pressure

  29. Subsidy Reform • The regime could use subsidies reform to punish and reward members of Iran’s business class. • Many of Iran’s businesses use energy subsidies to lower production costs.

  30. Subsidy Reform Reversing these subsidies, which has already begun, holds the promise of compounding inflation, creating favouritism, and fostering further public discontent.

  31. Credit Crunch Iran was recently planning to release 1.5 billion euros worth of bonds to finance the development of its key energy sector, including the giant South Pars gas field in Persian gulf. This is the second time the regime has resorted to this sort of measures since it came to power in 1979.

  32. Credit Crunch • Iran has limited access to international credit markets due to several factors including: • the sanctions, • the falling price of oil, • the accelerating flight of capital to safety due to the rising political risk, the growing crisis in the banking sector, and currency risk.

  33. Exchange Rates Policy The Government of Islamic Republic’s efforts to stabilize the currency is costing it between $180 million to $250 million a day. Despite these efforts Rial has depreciated by almost 5% since last December. It should be noted that the daily oil export revenue- currently approximately $150 million- does not cover this shortfall.

  34. Other Stabilization Policies • The loss of income this way has compounded by rampant inflation caused by Ahmadinejad government’s excessively loose fiscal policy and the consequent loose monetary policy forcing the government to resort to the policy of price control.

  35. Other Stabilization Policies Iran’s Average Annual Real GDP Growth: 2000-2010 Fiscal Year Average Annual Growth (%) 2000 5.1 2001 3.7 2002 7.5 2003 7.1 2004 5.1 2005 4.7 2006 5.8 2007 7.8 2008 2.3 2009 (forecast) 0.5 2010 (forecast) 0 Source: Economic Intelligence Unit (derived from World Bank, World Development Indicators).

  36. Other Stabilization Policies Iran’s economic growth has been hampered by consistently double-digit rates of inflation. Although high inflation is widespread among the oil-exporting countries in the Middle East and Central Asia, Iran has one of the highest.

  37. Other Stabilization Policies • Iran’s average Consumer Price Index (CPI) inflation in the last five years has been reported at 18% per year. • The current year is witnessing an inflation rate is near 40%.

  38. Other Stabilization Policies Domestic factors contributing to the rise in inflation include expansionary fiscal and expansionary monetary policies that are behind the growing consumption demands. External factors include international sanctions against Iran and rising international food and energy import prices.

  39. Other Stabilization Policies The government has used oil export revenues from the Oil Stabilization Fund (OSF) to support expansionary fiscal and monetary policies. The OSF was created by Iran’s Central Bank, the Bank Markazi, in 2001 to store surplus oil revenue and to smooth economic vulnerabilities associated with oil price fluctuations.

  40. Other Stabilization Policies Iran has been drawing down on its OSF to finance discretionary spending, such as public subsidies and low-interest loans. While estimates vary about the size of the Oil Stabilization Fund (OSF), many observers express concern that there are no longer sufficient funds in the OSF to cushion against the global economic turndown.

  41. Other Stabilization Policies Iran’s Central Bank technically is an independent institution. However, the Iranian government has direct control over lending and investment activities of commercial banks. Iran’s Central Bank, is not able to conduct a “proactive” monetary policy and has no control over the government’s fiscal policy.

  42. Other Stabilization Policies In addition, the Central Bank is limited in its ability to issue direct instruments to combat inflationary pressures. The Central Bank must obtain approval from the Majlis in order to issue participation papers.

  43. Other Stabilization Policies In May 2007, President Ahmadinejad capped lending rates to 12% for state-owned banks and 13% for commercial banks, despite strong opposition from the Central Bank. Setting interest rates below the rate of inflation reportedly has placed many commercial banks under financial duress.

  44. Other Stabilization Policies In addition, most of the financial intermediaries’ loan portfolios are comprised of low-return loans to state-owned enterprises and quasi-government agencies, such as the bonyads. Currently the commercial banks- state owned or private- have a $40 billion overdue claim against their borrowers.

  45. Other Stabilization Policies To support the expansionary economic programs of Ahmadinejad’s government, the Iranian Central Bank has resorted to an unprecedented expansionary monetary policy.

  46. Other Stabilization Policies • The monetary base, ( Currency in circulation + banks’ cash reserves), which is the ultimate determinant of liquidity and supply of money, grew at a breathtaking rate of 93% between 2006 and 2008, to be scaled back by 12 % over the following 6 months.

  47. THANK YOU FOR YOUR ATTENTION

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