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03 January 2012

A look at Iran's Economy

Between the last log on Iran and yesterday the Rial lost 10% of its value, just to regain about the same terrain today. Meanwhile there's an ever growing bellicose discourse on the naval chess around the strait of Hormuz. In this log I'll look into Iran's economy and try to understand the possible consequences of the sanctions imposed last weekend by the US and to be followed suit by the EU. It doesn't pretend to be in any way a thorough account of Iran's social-economic fabric, simply a collection of points that are relevant in the present crisis. The data presented here was collected mostly from Wikipaedia and the World Factbook.

Iran is an hybrid Economy, with half of it spread over a diversified portfolio of private enterprises and the other half subject to centralized planning. The country is presently in the middle of a very ambitious 5 year plan ending in 2015. This plan aims at two large goals: become self sufficient and shift the focus of exports from petroleum to industrial goods and gas. It includes investment on ore mining and an increase of steel and cement production; the petrochemical industry should double in size and the rail network largely expanded. The famous energy subsidies (more ahead) are to be completely phased out, in order to force a competitiveness hike of local industries. Iranian leaders have indeed a vision for their country, a modernized industrial economy that transforms abundant energy into value added goods for export.

The analysis on Iran's budget is quite difficult, given the contradictory data one can find. The World Factbook figures are 110 G$ for revenues (27% of GDP) and 90 G$ for expenses (22% of GDP); in Wikipaedia the revenues figure is put at 500 G$, which would come at 125% of GDP. Also from the Wikipaedia it can be learnt that revenues from oil exports stand at about 60 $/b, multiplying this by 2.2 Mb/d and 365 days it gets to 50 G$ for the yearly oil revenue; a plausible figure that's 45% of the budget revenue and 55% of expenses. Gas itself doesn't seem to contribute in any relevant way to the budget, though internal consumption is about 75% of production; what happens to the remaining 25% I couldn't find. But the most intriguing aspect about Iran's budget are the energy subsidies. Wikipaedia quotes a dead link to Iran Daily to claim that this figure was 84 G$ in 2008, including oil products, gas and electricity, implying that over 90% of expenses are used to this purpose (this could be referring to lost revenue instead, but even then it would be too high).

Looking at the trade balance Iran runs an yearly surplus of 28 G$, about 7% of GDP. Exports in 2010 were worth around 84 G$, of which 80% was crude petroleum and 4% petrochemicals. The larger buyers of these goods where China (16%), India (13%) and Japan (12%) in what seems to be a fairly wide portfolio of export partners. Imports in 2010 amounted to 59 G$, of which about half where industrial raw materials and a third capital goods. By a good margin the largest sources of these goods where the UAE and China, with 15% each; again the portfolio of import partners is quite wide, with certain European states showing some relevance, especially Germany (10%) and Italy (5%). Beyond the countries mentioned, Iran also has important commercial relations with South Korea, both on imports and exports. A contradictory account was given days ago by the Tehran Times, claiming that the trade balance will be levelled next year without oil revenues. This latter claim would imply an expansion of non oil exports close to 70 G$, from 17 G$ in 2010.

Although Wikipaedia presents a round figure of 100 G$ for the total foreign currency reserves held by Iran, the World Factbook presents a relatively lower figure, 75 G$ at the end of 2010, and a declining trend from over 80 G$ in 2008. This is one of the important points where the information available is diverse, though the declining trend explains to a good length the rapid devaluation of the Rial since last summer.

As stated above, Iran consumes most of the gas it produces, mostly in relatively inefficient thermal plants to generate electricity. The 2010 – 2015 economic plan obviously pretends to change this with the development of a Nuclear park, freeing this gas for export. Adding to this a rapid expansion of production in the South Pars field, Iran pretends to multiply by five its oil & gas revenues, to 250 G$/year in 2015. Undoubtedly an ambitious figure, especially considering that sovereignty over parts of this mammoth field is still in dispute, especially in the border with Kuwait.

Contrary to what may have transpired from the first post, Iran's agricultural sector appears quite healthy. Long term programming since the 1979 revolution has slowly fostered the country's food output, underpinned on a shift from subsistence to industrial agriculture and the construction of dams that widened the irrigated area. Today Iran produces about 90% of the foodstuff it consumes and has recently become a net exporter of wheat. It imports mostly rice, and since its exports (fruits, nuts, animal hides, spices) are more valuable it could be even running an agricultural trade surplus, though I haven't found hard data to confirm this.

As a final relevant characteristic I'd like to point to Iran's parallel economy, which accounts for 30% of the foreign trade, according to Wikipaedia. This implies huge revenues missed every year by the government, but more that, points to corruption mechanisms deeply installed in state institutions. At this distance, and without hard data, I'll avast from diving further into this subject, though this may have an important impact on the final outcome of Iran's present economic plan.

So what are the possible consequences of the hardening of sanctions from OECD members towards Iran? On the short-term the impact will be on the state's budget, with a decline in revenues from oil exports; this is the driver behind the recent devaluation of the Rial. In fact the amount of oil Iran presently exports to non aligned countries is not that large, a rough estimate points to 500 kb/d to China and India combined; the remainder is relatively scattered. Especially if Korea and Japan join the US and the EU in these sanctions, it could become effectively impossible for Iran to export most of its surplus oil, even if temporarily. Government spending will certainly become under strain, affecting investments and likely the famous subsidies. Imports are also at stake and some other aspects of the economy; as an example, Iranian airplanes have recently been finding difficulties in getting refilled abroad. Nevertheless, given Iran's relative independence in certain sectors, daily life might not be subject to major constrains (i.e. empty shelves), at least in the short-term.

Longer term these sanctions have another outcome: the impairing of the present economic plan. Mare than investment, the transformation of Iran into an industrial economy will certainly require the OECD markets to export the resulting products. The import of certain technologies and industrial goods only available from the West will also be affected, also putting in cause the modernization programme. Even if healthy commercial relations with other Asian nations survive, these are in the most part economies going through similar process of industrial modernization, in all likelihood not that receptive to the same sort of products they export themselves.

Given the amount of foreign currency reserves it holds, Iran should in theory be able to sustain a de facto budget deficit for some time. But it is the vision of the erosion of the budget that is undermining the Rial, investors do not believe present leaders and/or institutions will be able to deal with this crisis and avoid the eventual exhaustion of foreign currency. The easiest way for Iran to solve the problem would be by abiding to international demands for independent inspections to its Nuclear programme. That outcome being unlikely, the Iranian government will have in first place to restore confidence in its capability to conduct international trade, rapidly finding alternative buyers to its surplus oil production.

At this point it is hard to foresee exactly where will this end. If on the one side Iranian institutions will unlikely face the sort of social defiance witnessed recently in the Arab world, the difficulty in reigning the Rial is concerning. The situation isn't desperate at this time, but if decisive action isn't taken rapidly to stabilize the economy, the government can loose control and start facing difficult choices.