SURVEY OF THE IRANIAN ECONOMY

Transcription

1 SURVEY OF THE IRANIAN ECONOMY 2016

2 SURVEY OF THE IRANIAN ECONOMY

3 SURVEY OF THE IRANIAN ECONOMY 3 In spring of 1393 (spring of 2014) Iran s economy finally managed to put an end to eight consecutive quarters of GDP contraction and started to register positive growth rates. But the steep fall in international oil prices that started in the fall of that year checked that growth and kept it at low levels. Oil price drops in 1394 were so sharp that even though Iran managed to raise its oil exports by 12 percent and get close to regaining its pre-sanctions share of the global market, its oil revenues hardly increased at all. Given the structural problems in the country s money market, shortcomings in the capital market, and the direct and indirect dependence of many economic activities on oil revenues, the fall in oil revenues further exacerbated the existing credit crunch and low demand. The necessary cuts in government development expenditures led to sharp contractions in the construction sector that had already been plagued with recession since Latest estimates indicate that in 1394 the agriculture and services sectors grew while industry contracted, bringing about a 1.0 percent growth in the GDP. The negative growth of the industry was partly due to a 16.4 percent contraction of the value-added in construction. On the expenditure side, private and public consumption increased by 2.5 and 7.3 percent, respectively, while gross fixed capital formation contracted by 15.6 percent, further endangering GDP growth prospects. In 1394, the economic participation rate of the population aged 10 and above increased by one percentage point and reached 38.2 percent;. This rate was 63.2 percent for men and 13.3 percent for women. Even though in net terms the economy added more than 664 thousand new jobs, the 883 thousand new entrants to the economically active population raised the unemployment rate by 0.4 percentage point to 11.0 percent. As in previous years, the unemployment rate among women was much higher than among men, and was much higher in urban areas than rural. Unemployment rate in the age group was 23.3 percent, underlines the fact that the youth remained particularly under pressure. In operating budget of the government, tax revenues grew by 7.2 percent in the first 11 months of 1394 which, in light of the inflation rate of 11.9 percent, indicates a drop in real terms. Regarding performance of the government budget, the 73.9 percent tax revenue realization and 91.1 percent current expenditures realization indicate that the government s actual performance in operating balance deviated from the Budget Law. The 10.0 percent fall in government s oil revenues in the first 11 months of 1394 compared to the same period in 1393 also contributed to a 16.6 percent reduction in the development expenditures. The budget deficit also grew by percent even though the share of the National Development Fund in oil revenue had decreased from 32 percent to 20 percent. For the financing of its budget deficit, the government relied less on the privatization of state-owned companies and more on utilizing the treasury revolving fund and issuing securities. Consequently, privatization of the state-owned enterprises, which constituted the largest part of the disposal of financial assets in the government s budgets of recent years, fell by 27.7 percent in the first 9 months of 1394 compared to the same period the year before. In real terms, only 1.9 percent of the disposal of financial assets during took place in 1394, illustrating the slow-down in the privatization of stateowned enterprises. As for cash subsidies under the Subsidy Reform Law, the 1394 Budget Law required the government to eliminate 6 million recipients of cash subsidies, but only 3.3 million eliminated and so, once again, the disbursed cash subsidies exceeded the legislated amount. The balance of payments in 1394 was influenced by factors such as changes in oil revenues and the conclusion of the Joint Comprehensive Plan of Action (JCPOA) agreement between Iran and the so-called group of 5+1 countries. The latest data at the time of writing this report is for the first three quarters of the year, during which the current account balance dropped by 41.0

4 4 MIDDLE EAST BANK percent compared to the same period in the year before. This was mainly as a result of a drop in the merchandise trade balance which was in turn due to a more severe contraction of exports compared to imports. The fall in the value of exports but mostly due to a 41.0 percent drop in the value of oil exports during this period. At the same time, the non-oil trade balance deficit fell from USD22.4 billion to USD13.6 billion due to the relative stability of non-oil exports and the 19.0 percent drop in non-oil imports. With the sole exception of the services account whose deficit fell relative to the year before, items on current account balance did not experience much change. The main factor that prevented a severe worsening of the balance of payments in the first three quarters of 1394 was the considerable improvement in the net capital account. Meanwhile, the net capital inflows turned positive for the first time in ten years and reached over USD2 billion, mainly as a result of the JCPOA and the ensuing optimism about economic prospects. The Iranian rial (IRR) strengthened against the US dollar (USD) during the first quarter of 1394 as a result of the gradual firming up of oil prices and renewed optimism about reaching a nuclear deal with the group of 5+1. But in fact after the achievement of the JCPOA on July 14, 2015, that trend reversed course and the IRR weakened against the USD up to the Implementation Day of the JCPOA on January 16, 2016, partly due to the steep falls in oil prices. Reduced speculative activities in the foreign exchange market in post-implementation Day, as well as the gradual increase in oil prices and increased access of the Central Bank of Iran (CBI) to its foreign-exchange reserves, resulted in the strengthening of the IRR through the end of The primary objectives of the CBI in 1394 were price stability, economic growth and financial stability. During the year liquidity grew by 30 percent to reach IRR10,171 trillion as a result of 17.1 percent increase in monetary base and 11.0 percent increase in M2 money multiplier. The stimulus package was responsible for 5.0 percentage points of that 30.0 percent liquidity growth. During the first 10 months of 1394, balance of deposits in both IRR and foreign currencies grew by 21 percent compared to the end of 1393 and reached IRR9,914 trillion, showing a 26.4 percent increase over a 12-month period. During the same period, extended facilities grew slower than deposits after deducting legal reserves. Consequently, the loan-to-deposit ratio (after deducting reserves) continued its downward trend. In 1394, banks extended facilities grew by 22.2 percent and reached IRR4,173.2 trillion. Given the annual inflation rate of 11.9 percent in 1394, the real growth rate of granted loans was 9.2 percent, much below the 25.0 percent in the year before. Banks extended facilities in the form of working capital to all economic sectors reached IRR2,634.3 trillion, or 63.1 percent of the total, registering a 27.2 percent growth from the previous year, and indicating an increase in the share of working capital in total facilities. Another declared objective of the CBI is to bring unauthorized financial institutions under its supervision. They are estimated to be around 6,000 and hold about 20 percent of the M2 liquidity, most of it by fewer than 10 of them. In the current environment Soon after the current government came to office in 5/1392 and started the implementation of its economic policies, Iran s GDP appeared ready to end its contraction of the preceding quarters and in the first quarter of 1393 ended eight consecutive quarters of negative growth rates. The GDP grew by 3.8 percent 1. Real Sector in which interest rates on bank deposits are substantially above the inflation rate, the activities of these unauthorized financial is a major hindrance to reducing nominal interest rates. Given the CBI s increased determination in recent years to bring these institutions under its supervision, and as the public becomes more aware of the risks associated with these unauthorized institutions, it seems their influence on the money market has gradually weakened and this trend is expected to continue. Inflation continued its downward trend for the third year in a row. The monthly point-to-point inflation rate, as measured by changes in the Consumer Price Index (CPI) in urban areas, continued its downward trend to reach 8.3 percent in the last month of 1394 (April 2016). Likewise, the annual inflation rate continued its decline and reached 11.9 percent for the year as a whole, registering a 3.7 percentage points decline from its level in Important factors contributing to this decline included a 2.2 percent drop in M1 money in the first 10 months of 1394 and low global inflation rates that meant low inflation rate in tradable goods. The reduction in the CPI inflation rate was also helped by the fall in the Producer Price Index (PPI) inflation rate which was itself influenced by low GDP growth. The capital market, which is dominated by the stock market, experienced a rather different circumstance in 1394 compared to its previous year. The overall index of the Tehran Stock Exchange (TSE) and its Total Price Index rose by 28.3 percent and 13.1 percent, respectively. In 1394 the total volume of TSE transactions jumped by 37.9 percent. Participation bonds also experienced a substantial growth, both in terms of value and volume of transactions. The first tranche of Islamic Treasury bills that was issued for the first time in 1394, matured and was settled in winter and market determination of their interest rates was an important milestone in the Iranian debt market. Institutional investors accounted for 50.5 percent of the buy value and 53.8 percent of the sell value of these exchanges. The chemical and automotive groups had the greatest impact on the overall TSE index, accounting for around 6,000 of the 18,000 jump in the index. Medical and Optical group was the best performing group with percent growth rate and Plastic and Rubber group was the worst performing group with a negative growth rate of 21.7 percent. Iran s unfavorable business environment, that had been a major deterrence to the inflow of the much needed foreign direct investment, showed signs of improvement in According to the World Bank s Ease of Doing Business report, in 2016 Iran s rank improved to reach 118th among the 189 countries it considered. Likewise, according to the World Economic Forum s Global Competitiveness Report , Iran ascended 9 places to 74th among 140 countries. The Heritage Foundation s Index of Economic Freedom report in 2016 also indicates that Iran ranked 171th among 178 countries surveyed, which is slightly better than in previous years. It gives low grades to Iran s investment freedom, fiscal freedom and property rights but praises it for government spending, financial freedom and business freedom. The Corruption Perception Index report of 2015 ranks Iran 130th among its sample of 167 countries. during the first three quarters of 1393, but sharp declines in international oil prices in the fall of 1393 severely checked that growth. Figure 1 illustrates GDP quarterly growth rates during

5 SURVEY OF THE IRANIAN ECONOMY 5 Figure 1 - GDP Level and its Quarterly Point-to-Point Growth Rate at Constant Prices* Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Source: Economic Trends, Central Bank of Iran, and Report of Economic Growth Rate in 1394, Statistical Center of Iran * GDP growth rate for 1394 is based on data released by the Statistical Center of Iran (SCI) for preceding years they are based on data from the Central Bank of Iran. Direct and indirect dependency on oil revenues, the sharp drop in oil prices, structural problems in the money market and deficiencies in the capital market exacerbated the existing credit crunch and weak demand and brought about difficult economic conditions. This led to a considerable reduction of the GDP growth rate in the winter of The fall in oil revenues also led to a reduction in government development expenditures since the fall of 1393 and resulted in sharp contractions of the construction sector. The low per-capita income at the end of two years of recession in conjunction with the effect of a severe decline in oil prices on aggregate demand shifted the economy from a supply side contraction in 1391 and 1392 to demand side contraction in 1394 as evidenced by high inventory levels in many production units. Under such circumstances, positive prospects of reaching a nuclear deal resulted in the expectation that prices of durable goods would fall after lifting of sanctions thus justifying the postponement of demand for durable goods. As a result, weak demand left the government to resort to providing short-term facilities as part of a demand stimulus package in the fall of Granting facilities on easy terms to purchase domestically produced vehicles as well as durable goods was one of the major elements of that demand stimulus package. Despite much criticism, the package somewhat stimulated GDP growth, especially in the industry sector. According to preliminary estimates by the Statistical Center of Iran (SCI), in 1394 growth rates of the GDP and non-oil GDP stood at 1.0 percent and 0.9 percent, respectively, as exhibited in Table 1. Among all three sectors of the economy, only the value-added in the industry sector (including manufacturing and mining and oil) contracted, whereas agriculture and services sectors experienced positive growth rates. In 1394, the agriculture sector with a positive growth rate of 5.4 percent was the main contributor to the positive growth rate of GDP, while the services sector with the highest share in the GDP only experienced a 0.2 percent growth rate. Table 1 - Real Growth Rates of GDP and its Components at Constant Prices* (percent) First 3 months First 6 months First 9 months Year Agriculture Manufacturing Oil Manufacturing and Mining Services GDP Non-Oil GDP Source: Economic Trends No.82, Central Bank of Iran (CBI); Report of Economic Growth Rate in 1394, Statistical Center of Iran (SCI) *Data for are from the CBI at basic prices (1383=100), while data for 1394 are from the SCI at market prices (1376=100). Table 2 illustrates the growth rates of expenditure side components from 1390 to In both 1391 and 1392 the economy suffered from recession and in addition to a sharp decline in gross fixed capital formation and a slight drop in government spending, even private consumption expenditures contracted slightly. In 1394 gross fixed capital formation fell again drastically whereas private consumption expenditures rose. Government expenditures also experienced positive growth in all quarters and increased by 7.3 percent during the year. Table 2 - Growth Rates of Gross Domestic Expenditure s Components at Constant Prices* (percent) First 3 months First 6 months First 9 months Year Private Consumption Expenditures Public Consumption Expenditures Gross Fixed Capital Formation Machinery Construction Source: Economic Trends No.82, Central Bank of Iran (CBI); Report of Economic Growth Rate in 1394, Statistical Center of Iran (SCI) * Data for are from the CBI at 1383 constant prices, while data for 1394 are from the SCI at 1376 constant prices.

6 6 MIDDLE EAST BANK Agriculture The agriculture sector, accounting for a small share of the GDP no more than 10.0 percent had high growth rates in all quarters of 1394 and was the main contributor to the GDP s positive growth in this year. Both subgroups of agriculture, i.e., horticulture, hunting, and forestry and fishing experienced almost equal growth rates and eventually grew by 5.4 percent in One of the major challenges faced the agricultural sector in this year was the absence of an efficient irrigation systems. Traditional and inefficient practices in agriculture had led to the consumption of about 90 percent of the country s annual water consumption by this sector, which is not justified by agriculture low value-added. Table 3 - Growth Rates of Agriculture Group at 1376 Constant Prices (percent) 1394 Year Q1 Q2 Q3 Q4 Agriculture Group Farming, Hunting and Forestry Fishing Source: Report of Economic Growth Rate in 1394, Statistical Center of Iran (SCI) Oil Iran s crude oil production that averaged more than 4 million barrels per day (bpd) during started to fall in 1387 as a result of sanctions and reduced investments in maintaining the production capacity. Consequently, oil exports that had reached 2.7 million bpd in 1384, gradually declined to below 1.5 million bpd in the second half of As shown in Figure 2, oil production and export started to increase in the second half of 1393 and during 1394Q1 the production grew by 2.5 percent and averaged 3.1 million bpd, albeit still 3.8 percent lower than the production in 1393Q1. Production kept increasing and reached 3.3 million bpd in fall of 1394 and, according to OPEC reports, 3.38 million bpd in the last quarter of the year. During the summer and fall of 1394, Iran s oil exports reached 1.55 million bpd. This increase was accompanied by oversupply by USA and KSA on the one hand and lower demand by China and the European countries on the other hand that frustrated a rise in Iran s oil export revenue. Oil prices fell below USD25 in the winter of According to CBI, during the first three quarters of 1394 the USD value of Iran s oil exports dropped by 40.0 percent from the same period the year before to only USD27.1 billion. Figure 2 - Iran s Average Daily Crude Oil Production and Export and Heavy Oil Price Source: Economic Trends, Central Bank of Iran and OPEC Monthly Reports Table 4 - Growth Rates of Manufacturing Group at 1376 Constant Prices (percent) 1394 Year Q1 Q2 Q3 Q4 Manufacturing Group* Manufacturing and Mining Manufacturing Mining Oil and Natural Gas Other Mines Electricity, Gas and Water Construction Source: Report of Economic Growth Rate in 1394, Statistical Center of Iran * The difference between the subgroups of the Manufacturing in this Table and Table 1 is the result of different classifications by the CBI and SCI.

7 SURVEY OF THE IRANIAN ECONOMY Petrochemicals Iran s petrochemical industry enjoys comparative advantages including the country s vast reserves of oil and gas, ease of access to land and sea routes, availability of skilled labor and a sizeable domestic market, and yet the size and product diversity of this sector is much below those in industrial countries. From 1384 to 1390 this industry grew by 21.0 percent a year. But its growth slowed down and turned negative during due to poor policies and the tightening of international sanctions and so in 1391 and 1392 production contracted by respectively 7.2 percent and 5.8 percent, and the USD value of exports fell by 30.1 percent and 18.2 percent. The IRR value of domestic sales experienced a considerable increase though, thanks to high domestic inflation rates and sanction related constraints on exports. With the easing of sanctions, production rose in 1393, registering a 17.8 percent growth. Official data for 1394 is not available as of the writing of this report but unofficial sources indicate 6.0 percent and 26.0 percent growth in production and exports, respectively. In 1394 about 60 percent of production was exported - from less than 50 percent in the preceding two years - and the export volume is expected to increase further in coming years. Table 5 exhibits the performance of Iran s petrochemical industry during Table 5 - Performance of Iran s Petrochemical Industry Level Percent Change Sum of Exports and Domestic Sales (thousand tons) 27,352 32, Value of Exports (USD millions) 9,869 10, Value of Domestic Sales (IRR billion) 313, , Source: Annual Review 1393, Central Bank of Iran Automotive Industry Following the lifting of sanctions on Iran s automotive industries, imports of raw and intermediate goods for auto production increased and production and sales jumped by 53.4 percent in Following the jump, heightened expectation about imports of higher quality foreign cars in the aftermath of the sanctions led to the postponement of demand in 1394 and a production fall of 13.6 percent. Table 6 presents data on automotive production in Table 6 - Number of Vehicles Produced in Iran Thousand Units Percent Change All Vehicles 1, , Passenger cars and Vans 1, , Heavy vehicles Source: Iran Vehicles Manufacturers Association Website Steel Industry Vast reserves of iron ore, massive energy resources, access to international waters, abundant labor force and a strong domestic market are among factors favoring steel production in Iran. Yet, Iran has not enjoyed a high rank among global steel producers. Table 7 exhibits Iran s crude steel production during and shows that after several years of growth, in 1394 production dropped by 2.9 percent to reach 16.2 million tons. Table 7 - Crude Steel Production in Iran (in thousand tons) Crude Steel (thousand tons) 10,858 12,509 13,270 14,362 15,627 16,692 16,201 Growth (percent) Source: World steel association, 1388 to 1394 Monthly Reports In recent years, steel production grew even as GDP was contracting. With the lifting of international sanctions steel export is expected to increase. According to reports by Iran s Mines, Mining Development and Renovation Organization (IMIDRO), exports of crude steel and steel products in 1394 grew by 4.0 percent to reach 4.0 million tons, 2.2 million tons of finished steel products and million tons of ingot steel, while imports of crude steel and steel products fell by 1.0 percent to reach 4.4 million tons Housing and Construction Iran s housing market recession began in the mid-1392 and was still present at the end of This relatively long recession took place following the sharp jump in housing prices in 1390 and 1391 due to the previous government s

8 8 MIDDLE EAST BANK expansionary policies, absence of a disciplinary monetary policy, misuse of oil revenues and generally inappropriate housing policies. The unprecedented increase in housing prices by mid-1392, acceleration of inflation, contraction of the GDP and the construction of a large number of new housings led to disequilibrium in the housing market and ignited one of the most severe recessions in the past three decades. The implementation of the second phase of the Subsidy Reform Plan and the escalation of international sanctions against Iran led to an increase in the cost of construction and a decrease in the construction of new buildings that pushed up housing prices. The government s massive intervention in the construction and housing market during coupled with activities of construction companies affiliated with banks drove away the private sector from new investments in this sector and pushed the market far away from equilibrium. In addition, both luxurious and low-quality 1 housing units were over-supplied while demand was increasing for medium size units. Figure 3 shows investment in newly-started buildings as well as the number of construction permits in urban areas. An examination of these two variables reveals the reluctance of investors to enter the housing market during the past 3 years. The number of construction permits issued by municipalities fell continuously since the end of 1392 and fewer investors applied for these permits. Following a 32 percent drop in the number of issued construction permits in 1393, it fell by another 12 percent during the first three quarters of 1394 compared to the same period in the year before. During these three quarters, private investment in newly-started buildings in urban areas dropped by 20 percent in nominal terms compared to the same period in 1393 and reached IRR117.5 trillion. Figure 3 - Private Sector Investment in Newly-started Buildings and Number of Construction Permits in Urban Areas Source: Economic Trends, Central Bank of Iran Services The services sector value-added was stable in all quarters of 1394 and its growth rates were hovering around zero, ranging from minus 0.3 percent in the summer and positive 0.8 percent in the winter. Among services subsectors, public services, training and health and social, personal and household services experienced the highest growth rates while transports, storage, and communication and financial and monetary institutions services experienced the lowest. Table 8- Growth Rates Services Group at 1376 Constant Prices (percent) 1394 Year Q1 Q2 Q3 Q4 Services Group Trade, Restaurants and Hotels Transport, storage and Communications Financial Services Real Estate and Professional Services Public Services Social, Personal and Domestic Services Source: Report of Economic Growth Rate in 1394, Statistical Center of Iran According to the latest census conducted by the Statistical Center of Iran (SCI) the average age of Iran s population is about 30 years, pointing to Iran as a country with fairly young population and making job creation an important issue. In 2. Labor Market order to have an accurate assessment of the labor market in Iran, unemployment rate alone does not suffice and indicators such as economic participation rate and underemployment should also be considered. Table 9 shows the main indicators

9 SURVEY OF THE IRANIAN ECONOMY 9 of the labor market by gender and urban/rural dichotomy in In 1394, 63.2 percent of males and 13.3 percent of females were economically active, resulting in a 38.2 percent economic participation rate percent of the economically active population, i.e., about 2.7 million individuals, were unemployed. As in previous years, females unemployment rate was much higher than the males and the unemployment rate in urban areas was much higher than in rural areas. Furthermore, the 23.3 percent unemployment rate of individuals in the year age group underlines the undesirable conditions of youth s employment. Besides, 9.8 percent of people were underemployed. Table 9 - Labor Force Indices in 1394 Total Male Female Urban Rural Participation of 10 Years Old and Over Rate (percent) No. (million people) Unemployment of 10 Years Old and Over Rate (percent) No. (million people) Unemployment of Years Old Youth Rate (percent) No. (million people) The Portion of Population with Underemployment Time (percent) Source: Summary Results of the Workforce Survey Project 1394, Statistical Center of Iran In 1394, 10.9 million individuals were employed in the services sector, 7.1 million in industry, and 4.0 million in agriculture. As shown in Figure 4, the services sector has accounted for an average of 47.2 percent of the employed during the past 10 years. Figure 4 - Economic Sectors Average share of Employment during Last 10 Years Source: Workforce Survey Project 1394, Statistical Center of Iran An interesting aspect of Iran s employment is that the number of economically active population has not changed much during but the unemployment rate has decreased by 1.1 percentage point, mainly because of a considerable drop in participation rate rather than job creation. The fall in participation rate is partly due to an increase in the number of university graduates that have exited the active population after getting disappointed with finding a suitable job. Besides, the excessively low female participation rate has caused the overall economic participation rate to be lower than the average for developing countries. As shown in Figure 5, this rate in 1394 increased by 1 percentage point. In 1394 the number of the employed increased by 664 thousand and that of the economically active population increased by 883 thousand, resulting in an employment rate of 11.0 percent. The number of the underemployed also rose by approximately 108 thousand to reach 2.2 million. Figure 5 - Some Labor Force Indices (percent) Source: Statistical Center of Iran

10 10 MIDDLE EAST BANK The labor market was much influenced by the air of optimism in the aftermath of the JCPOA. The number of economically active population increased due to the return of some of the unemployed who were now more optimistic about finding jobs, graduation of students who were extending their formal education as a refuge from facing unemployment, along with a slowdown in the rate of retirement. These developments pushed up the participation rate and the trend is expected to continue at a faster pace in coming years. On July 14, 2015, Iran and the group of six countries known as the group of 5+1 agreed on a Joint Comprehensive Plan of Action (JCPOA) whereby in exchange for lifting international sanctions, EU sanctions and the nuclear-related sanctions by US against Iran, Iran would allow higher levels of inspection of its nuclear program and postpone or dismantle certain other parts of it. Milestones in this agreement included Adoption Day on October 18, 2015 when participants began taking steps to implement their commitments, and Implementation Day of January 16, 2016 when upon verifying that Iran had done its part of the agreement, the UN, US, and EU lifted nuclear-related sanctions on Iran. JCPOA reestablished Iran s access to its frozen assets overseas In the budget bill for 1394, based on the assumption that oil prices would on average be around USD72 per barrel, the government assumed it will receive around IRR736.2 trillion from its disposal of non-financial assets (mostly oil revenues), and so when oil prices started their sharp declines, the proposed budget had to be revised. Given wide uncertainties, the Budget Law was eventually legislated with two ceilings, one based on oil prices averaging USD45 per barrel, and the other in which expenditures were allowed to overrun to the second ceiling Description 3. Sanctions 4. Government Budget and also opened the door to foreign investors other than American companies that remain barred from Iran as a result of sanctions unilaterally imposed by US in 1995 unrelated to the nuclear issues. But complications in US regulations relating to trade with, and investment in Iran, and fearful of penalties imposed by the United States on banks that had been found to have broken US laws, most international banks remained hesitant to re-enter Iran. Measures were taken by all sides to the JCPOA, including meetings of US officials with government representatives and bank executives in more than a dozen countries, to clarify US laws and alley some of international banks unfounded fears in working with Iran. budget if revenues were higher. This form of budgeting was unusual and exposed government s fiscal situation vulnerable to external shocks. The general government budget stood at IRR8,467 trillion, registering a 5.4 percent growth from its 1393 level, which is lower than the annual inflation rate of 11.9 percent in Therefore, in 1394, the government became smaller. Table 10 compares Budget Laws of 1393 and Table 10 - Main Subdivisions of the Budget Laws of 1393 and 1394 (IRR trillion) Budget Law of 1393 Growth in Comparison to 1392 (percent) First Ceiling of Budget Law of 1394 First Ceiling Growth in Comparison to 1393 (percent) Second Ceiling of Budget Law of 1394 Second Ceiling Growth in Comparison to 1393 (percent) General government budget* 8, , , General budget 2, , , General resources 2, , , Dedicated revenues Budget of State-owned companies, Banks and Profit institutions affiliated to government 5, , Source: Government Budget Laws * General government budget in 1394 for first ceiling was not mentioned in the budget law and is estimated based on sum of general budget and State-owned companies, Banks and Profit institutions affiliated to government budget minus double counting of second ceiling General Budget The general budget consists of general resources and dedicated revenues. Oil and tax revenues have the biggest share in general resources and usually the share of current expenses is higher than development expenditures. Table 11 presents the two sides of the legislated general budget for 1394 in some detail.

11 SURVEY OF THE IRANIAN ECONOMY 11 Table 11 - Sub-sections of the General Budget in the Annual Budget Law of 1394 (IRR trillion) Resources First ceiling Second ceiling Expenditures First ceiling Second ceiling Revenues 1, ,288.5 Expenses (current) 1, ,747.2 Tax revenues Compensation of employees Proceeds of State-owned properties Cost of properties Proceeds of sales of goods and services Use of goods and services Proceeds of crime and damage Subsidies Other Grants Social welfare Other costs Operating Balance Disposal of non-financial assets Acquisition of non-financial assets (development expenditures) Receipts from crude oil and oil products Construction Receipts from movable and immovable assets Machinery and Equipment Receipts from disposal of projects related to acquisition Other fixed assets of non-financial assets Inventory use Precious items Land Other non-produced assets Net disposal of non-financial assets Disposal of financial assets Acquisition of financial assets Sales of bonds and treasury bills Repayment of bonds Use of foreign loans Repayment of foreign loans Receiving the loan's principal Repayment of bank loans Disposal of state-owned companies Last year payments return Use of the National Development Fund Other Credit related to disposal of stock Unpaid obligations from previous years Foreign cultural and economical contributions Net disposal of financial assets Total government general resources 2, ,362.8 Total government general expenditures 2, ,362.8 Dedicated revenues Expenditures from dedicated revenues General budget Resources 2, ,744.1 General budget Expenditures 2, ,744.1 Source: The Annual Budget Law, 1394 According to the first ceiling legislated budget, operating balance deficit was set at IRR341.7 trillion. Oil revenues were to finance IRR473.9 trillion of development expenditures and IRR91 trillion of the operating balance deficit. Therefore, oil revenues were still looked at as revenues that could be used to finance current expenditures and not only development expenditures. In the Budget Law of 1394, as a routine practice, a proportion of operating balance deficit was to be financed through the disposal of financial assets. Hence, the issuance of Islamic Treasury bills and government bonds was increased in the Budget Law by 83 percent based on the second ceiling while privatization fell by 24 percent. Accordingly, sale of bonds and treasury bills has become an increasingly more important instrument in financing of the budget deficit. Dedicated revenues grew by 60 percent compared to the budget of 1393 and its 10 percent share increased to 15 percent in 1394 budget, signaling an increase in the authority of state-owned institutions and corporations in their own budgets. The share of tax revenues in the Budget Law of 1394 was higher than oil revenues, but this was more due to the fall in oil prices than a deliberate act Government Fiscal Performance During the first eleven months of 1394, the government earned IRR653.4 trillion in tax revenues, accounting for 73.9 percent of the approved IRR883.9 trillion for this item. Other current revenues were IRR241.2 trillion, accounting for 87 percent of the legislated IRR404.6 trillion. Besides, government current expenditures were IRR1,485 trillion, approximately 91.1

12 12 MIDDLE EAST BANK percent of the approved. The deficit of operating balance in the same period was IRR597.4 trillion which was higher than the legislated IRR341.7 trillion for the whole year. During the first eleven months of 1394, oil revenues fell by 10 percent compared to the same period in 1393, and accounted for 93.8 percent of the legislated amount. Development expenditures reached IRR211.7 trillion, lower than the legislated IRR473.9 trillion. Actual oil revenues were in line with the legislated amount according to the first ceiling. However, given the excessive imbalance between current expenditures and revenues, the government diverted a major part of oil revenues from development expenditures in order to finance the operating balance deficit. Table 12 illustrates the fiscal performance of the government and budget deficit for 1393 and Description Table 12 - Government Fiscal Performance in 1393 and 1394 (IRR trillion) Eleven-month 1393 Eleven-month 1394 Percentage change 1394 to 1393 Performance (approval percentage) Total revenues 1, , Tax revenues Receipts from crude oil and oil products Other government revenues Receipts from movable and immovable assets Total expenditures 1, , Current expenditures 1, , Development expenditures Budget balance (Operating and non-financial balance) Source: Selected Economic Indicators, Central Bank of Iran, 11/1394 Note: The difference between budget balance and balance of revenues and expenditures is due to Revolving funds. Generally, the budget deficit is financed by the net disposal of financial assets. In the first eleven months of 1394 the net disposal of financial assets stood at IRR302.8 trillion, 20.8 percent higher than the legislated amount and registering a percent increase over the same period in the year before. In 1394, a significant change in the components of disposal of financial assets took place. In the past, privatization constituted the largest share of the disposal of financial assets, but during the first three quarters of 1394 it fell by 27.7 percent compared to the same period in 1393 to reach only IRR64.9 trillion Privatization According to the general policies of Article 44 of the IRI constitution, privatization of state-owned companies should have been completed by the end of 1393, but it did not, and so was again included in the budget of Privatization of stateowned companies started in 1380 and by the end of 1394, out of all privatized state-owned companies, 48.5 percent had been privatized through the stock exchange, 12.7 percent through the National Development Fund The National Development Fund (NDF) was established to allocate a proportion of oil and gas revenues to sustainable and productive economic activities and also preserve a part of it for future generations. Any use of NDF funds by the government as well as exchanging its foreign exchange funds to IRR are strictly prohibited in the Fund s article of association. However, the government converted a part of NDF resources and used it to finance its expenditures in the budget of NDF s share of oil and gas revenues was 20 percent in 1394, 12 percentage Subsidy Reform Plan In the Budget Law of 1394, a sum of IRR543 trillion was legislated to the subsidy reform plan, to be financed by IRR480 trillion from increase in the prices of energy carriers and IRR63 trillion from general budget resources and the elimination of bread and electricity subsidies. According to the subsidy reform law, the government was allowed to spend up to 60 percent of the plan s resources on cash or non-cash subsidies During the same period, others subgroup of the disposal of financial assets, in which the revolving fund of the treasury has the highest share, reached IRR83.2 trillion or 54.8 percent of the disposal of financial assets. The revolving fund of the treasury was required to be cleared by the end of 1394, consequently the share of others is expected to fall by the end of the year, and the issuance of the Islamic treasury bills may have been used to clear a significant part of the revolving fund of the treasury. Due to the sanctions, in 1394 the government was again unable to finance its budget deficit through foreign borrowing. OTC, 38.5 percent through auction, and 0.2 percent through direct negotiation. According to the Iranian Privatization Organization, in 1394 a sum of IRR105.2 trillion of privatization revenues was deposited in the treasury, indicating a 35.8 percent drop compared to IRR91.9 trillion of this revenue was deposited in the treasury s general income account, covering 63 percent of the legislated IRR145 trillion. points below the legislated share in the Fifth National Development Plan. According to the Sovereign Wealth Fund Institute s report, Iran s NDF with assets valued at USD62 billion ranked 24th among 79 sovereign wealth funds. However, the Fund s assets stood at USD68.2 billion at the end of 1393 according to the latest NDF report. The Fund transparency score was 5 out of 10, putting Iran in the 31st place. to households. Given that the government was supposed to cut off the cash subsidies of 6 million individuals based on the Budget Law of 1394, the cash and non-cash subsidies share of resources remained higher than the plan s target, reaching 72 percent. Table 13 presents the resources and uses of the subsidy reform plan in the Budget Law of 1394.

13 SURVEY OF THE IRANIAN ECONOMY 13 Table 13 - Annual Resources and Uses for Subsidy Reform Plan in the Budget Law of 1394 (IRR trillion) Resources From increase in prices 480 From government budget 63 Total 543 Uses Payments to families in cash and kind 390 Support for production, Public transportation, and improvement and optimization of energy use 52 Housing loans interest subsidies 13 Healthcare system 48 Youth employment programs 40 Total 543 Source: The Budget Law of The Performance of Subsidy Reform Plan According to the Deputy Minister of Cooperatives, Labor and Social Welfare, 6 million individuals should have been eliminated from receiving cash subsides in 1394, but only 3.3 million were actually cut off. As a result, government expenditures on cash subsidies exceeded the legislated amount. IRR35 trillion was deposited in the households accounts per month. Therefore, the government failed to meet the budget target on cash subsidies reduction and was unable to meet its other planned activities. Table 14 exhibits the government s performance regarding the subsidy reform plan in the first 8 month of Table 14 - Performance of the Subsidy Reform Plan During the first 8 months of 1394 (IRR trillion) 8-month performance 8-month performance (approval percentage) Revenues Rising Energy prices Expenditures Payments to families Support for production Housing loans interest subsidies Healthcare system youth employment programs Source: eghtesadonline.com/fa/content/ From the start of the subsidy reform plan implementation on December 19, 2010 through February 16, 2016, its total resources and expenditures stood at IRR2,337.5 trillion and IRR2,339.1, respectively. Table 15 illustrates resources and expenditures of the subsidy reform plan up to 11/1394. It can be seen that the receipts of the Organization of Targeted Subsidies from the increase in price of energy carriers totaled IRR1,615.7 trillion, while the cash subsidies paid to households were IRR2,135.0 trillion. Therefore, the increase in price of energy carriers covered only 69% of the total cost of subsidy reform plan. As a result, IRR721.8 trillion was sourced from other resources, resulting in an increase in liquidity and inflation. Table 15- Performance of the Organization of Targeted Subsidies from Beginning to 27/11/1394 (IRR trillion) Sources 2,337.5 Rising Energy prices 1,615.7 From government budget For cash payments For organizations 43.3 Row 25 of table19 of budget law of Remainder of the Revolving fund of Central Bank 57.0 Remainder of the receipts from treasury 2.3 Receipt for compensatory gifts 65.5 Expenditures 2,339.1 Payments in cash 2,135.0 Payments in kind 10.5 Compensatory cost 65.5 Article 7 - B, Social security insurance 8.4 Healthcare 64.6 Support for production, Public transportation, and improvement and optimization of energy use 55.2 Source: dolat.ir/nsite/fullstory/news/?serv=3&id=275798

14 14 MIDDLE EAST BANK 5. Balance of Payments In 1394 Iran s balance of payments was influenced by JCPOA and changes in oil prices and exports volumes. As shown in Table 16, during the first three quarters of 1394 the current account surplus fell by 41 percent, mainly due to the substantial drop in merchandise trade balance. During these three quarters both imports and exports fell, but the fall was sharper in the case of exports, mostly as a result of a 41 percent drop in oil exports. Table 16- Balance of Payments (USD million) First 9 Months Percentage change Current Account Balance 23,423 26,440 15,861 16,869 9, Goods Account 28,559 31,970 21,392 20,691 11, Oil Goods Account 65,406 61,771 51,404 43,103 25, Non-oil Goods Account -36,847-29,801-30,012-22,412-13, Exports (f.o.b.) 97,271 93,124 86,471 69,085 50, Oil Export 68,058 64,882 55,352 45,891 27, Non-oil Exports 29,213 28,243 31,119 23,194 23, Imports (f.o.b.) 68,712 61,155 65,079 48,394 38, Gas and Oil Products 2,652 3,111 3,948 2,788 1, Other Goods 66,060 58,044 61,131 45,606 36, Services Account -7,307-7,137-6,985-4,999-3, Income Account 1,661 1, Current Transfers Capital and Financial Account Balance -6,664-11,547-1,664-4,590 2, Errors and Omissions -4,546-1,703-5,635-3,957-8, Overall Balance (Change in international reserves) 12,213 13,189 8,561 8,322 3, Source: Selected Economic Indicators of , Central Bank of Iran Figure 6 illustrates quarterly data on the volume and value of oil exports in and shows that despite exports increases in the second and third quarters of 1394, prices falls were such that oil revenues dropped considerably. Figure 6 - Oil Exports Value and Volume Source: Selected Economic Indicators, Central Bank of Iran During the first three quarters of 1394, the non-oil trade balance deficit fell from USD22.4 billion to USD13.6 billion due to the relative stability of the value of non-oil exports and a 19 percent drop in the USD value of non-oil imports. With the exception of the services account, other current account components did not experience much change. The main factor that prevented a severe worsening of the balance of payments in the first three quarters of 1394 was the considerable improvement in the net capital account compared to the same period in As shown in Figure 7, capital account has been mostly negative during the past decade and during net capital outflow totaled USD107 billion. In 1394, however, net capital account turned positive and in the first three quarters totaled USD2.1 billion, mainly because of JCPOA and the subsequent optimism about Iran s economic outlook. Note, however, that errors and omissions in the balance of payments statistics during the first three quarters of 1394 are much larger than in the preceding three years, undermining the accuracy and transparency of the accounts.

15 SURVEY OF THE IRANIAN ECONOMY 15 Figure 7 - Capital Account Balance (USD billion) Source: Selected Economic Indicators, Central Bank of Iran * First 9 months only Goods Exports Customs data indicate that in 1394 non-oil exports - including petrochemicals and gas condensates, but excluding oil, gas, and suitcase trade - decreased by 16.1 percent, mainly due to the 52.4 percent fall in the value of natural gas condensates exports. Table 17 illustrates the value of non-oil exports from 1392 to Table 17 - Non-oil Exports including Natural Gas Condensates Value (USD millions) Percentage change Gas Condensate 10,295 14,005 6, Petrochemical Products 10,806 14, ,750* -2.2 Other Goods 20,746 22, Total 41,847 50,560 42, Source: Islamic Republic of Iran Customs Administration, Preliminary foreign trade statistics for 1394 *Sum of Petrochemicals and Other Goods Major export items in 1394 were petroleum gases and liquefied hydrocarbon gas mixture valued at USD1.6 billion, liquefied propane at USD1.4 billion, and oil bitumen at USD1.2 billion. These items accounted for 4.4 percent, 4.0 percent and Goods Imports Table 18 presents statistics on Iran s merchandise import during and indicates that in 1394 they decreased in both value and weight, respectively by 22.5 percent and 18.5 percent. Main import items were corn valued at USD1,405 million, wheat at USD862 million, soya bean at USD728 million, rice at USD680 million and soya cake at USD672 million. The percent of the total value of exports, respectively. Major export destinations were, respectively, China, Iraq, UAE, Afghanistan and India. Increased exports to Afghanistan advanced its rank to the third that was taken up by India in value of these items accounted for 3.4 percent, 2.1 percent, 1.8 percent, 1.6 percent, and 1.6 percent of the total value of imports, respectively. China, UAE, South Korea, Turkey and Switzerland were the major sources of imports. The 5th place used to be India s in The gradual increase in oil prices from USD43 a barrel in the last quarter of 1393 to USD60 in the first quarter of 1394 and progress in nuclear discussions in the early 1394 led to a downward trend in the USD/IRR free market exchange rate up to the attainment of the JCPOA on in the second quarter of 1394, on July 14, Then the trend reversed itself mainly as a result of the steep fall in oil prices to USD24 a barrel in Table 18 - Custom Imports Foreign Exchange Market Percentage change Weight (thousands tons) 33,684 43,016 35, Value (USD millions) 49,709 53,569 41, Source: Islamic Republic of Iran Customs Administration, Preliminary foreign trade statistics for 1394 the 4th quarter of Given the considerable fall in the value of imports in the second and third quarters of 1394 from the same periods in 1393, imports demand is unlikely to have been responsible for the rise of the USD/IRR exchange rate. CBI repeatedly intervened to stabilize the exchange rate by selling foreign exchange, mainly USD, in the market at rates slightly below those in the interbank market to the dismay of economists