Iran's Economic Policy Dilemma

Abstract

IN 1979, THE ISLAMIC REPUBLIC OF IRAN (IRI) inherited an economy that was heavily dependent on oil with a small and inefficient manufacturing sector. An eight-year war with Iraq, an influx of refugees, rapid population growth, US economic sanctions and politically expedient policies have resulted in the economic conditions of today, conditions under which the IRI has little room for manoeuvre. The medium- and long-term policies that are called for are obvious yet politically difficult to implement.This article provides a brief overview of the Islamic Republic's economic performance since the revolution of 1979, describes its policy record, and addresses the economic policy dilemma at hand.ECONOMIC PERFORMANCEIn 1988, Iran's real gross domestic product (GDP) was about what it was in 1977, and given population growth of about 60 percent, per capita real incomes had fallen by roughly 40 percent. Recently, GDP growth has been more satisfactory, at an average annual rate of 6.7 percent for 1990-1995 (although unbalanced and with heavy external financing); 3.8 percent for 1995-2000; and more recently, after adopting some reforms, a more balanced 5.8 percent on average for 2000-2003. During 2002-2003, overall growth reached 6.8 percent even though the oil sector contracted, and 6.5 percent growth is projected for 2003-2004. Yet even after these recent successes, real per capita GDP in 2000 was some 30 percent below the levels of the mid-1970s(1) and 20 percent below those levels in 2003. These figures suggest subpar economic performance and rapid population growth over the long haul, although with significant improvement in recent years.Iran's overall export growth has also been less than stellar since the revolution. Total exports in current dollars declined at an annual rate of 2.5 percent, with fuel oil exports--on which Iran depends heavily--declining at an annual rate of 4.3 percent. (Non-fuel exports increased at an annual rate of 10.9 percent.) Petroleum exports declined for most major oil exporters over the same period. But in the case of Iran, two internal developments further exacerbated the decline in oil export revenues: a decline in oil output (and capacity) and a rapid increase in domestic petroleum consumption. The decline in production capacity was due largely to investment shortfalls in the oil sector. The increase in domestic consumption was due to high population growth and one of the world's highest petroleum product price subsidies.Although the economy underperformed and total exports did not fare well, Iran did not resort to significant external borrowing until 1988, after the Iran-Iraq war. Between 1988 and 1993, Iran's external debt exploded from $5.8 billion to $28.5 billion (all figures in US dollars) because of the rapid increase in imports (to meet pent-up demand in the aftermath of the war) and resulted in large current account deficits. Unfortunately, the increased external borrowing did not finance productive investments and Iran received little long-term benefit from the external debt it incurred. This period was followed by several years of current account surpluses because of lower imports. These current account surpluses reduced the stock of external debt to around $7.2 billion 2002.(2) At the same time, gross official reserves increased from $5.3 billion in 1997 to an estimated $21.8 billion in 2002. Iran's debt/GDP ratio stood at 6.3 percent in 2001; its ratio of debt to exports was 30.4 percent; and its debt (excluding short-term debt) service ratio was 6.3 percent.(3) These are low figures by any standard and represent a significant accomplishment relative to most other developing countries.In the social arena, Iran has enjoyed much more success since the revolution: the average Iranian's life expectancy has risen steadily; infant mortality rates have fallen; access to safe water, sanitation and health care have shown significant improvement; the number of physicians, dentists and nurses per person have increased; and immunization rates have risen. …