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02/16/15

Iran's Neoliberal Austerity-Security Budget

By Hooshang Amirahmadi



President Hassan Rouhani submitted Iran’s 1394 (the Persian New Year begins on 21 March 2015) Budget Bill to the Iranian Parliament this last December. The budget was put together before the sharp fall in oil prices and before the nuclear negotiations failed to reach the expected “comprehensive” deal on November 24, 2014. The Parliament is expected to make some changes to the Bill before passing it into law. Thus, the figures cited here for various budget items could change, but the economic policy underlying the budget will remain largely unaffected.

This budget should be of particular interest to Iran watchers at a time when sanctions are biting, oil prices have fallen and the country is in the midst of nuclear negotiations. Tehran blames a foreign plot by Saudi Arabia and the US for these troubles, but such complaints are of no use for a besieged economy that needs a far deeper understanding of global economic trends, a better appreciation of successful development models, and smarter economic management. However, if the new budget is any indication, that understanding, appreciation and management are still lacking, despite promises by the Rouhani government.

Conceptual Basis of the Budget

The Budget Bill, which has been produced by the newly‑revived Organization of Management and Planning, offers no explicit conceptual framework within which the budget is formulated, nor is it based on any “planning” for the economy- budgeting is no planning. This is despite the fact that the Budget Bill document begins with a quote from Imam Ali (the first Shi’ite imam) saying “correct (economic) planning increases trivial wealth while incorrect planning destroys abundant wealth.” It also does not begin with a discussion of the nation’s economic development pre-requisites nor give any indication of its trajectories.

However, the Budget Bill is based on an implicit economic philosophy that one must glean from the relative distribution of budgeted revenues and expenditures as well as priorities bestowed on various socio-economic sectors. The key concept behind the budget is a twisted “neoliberal” model, the laissez-faire economic policy that became popular in 1970 and 1980s. The proponents of the neoliberal economic policy support extensive economic liberalization, free trade, and reductions in government spending in order to enhance the role of the free market, individual and private sectors in the economy. Economic liberalism assumes political liberalism which is absent in the Islamic Republic.

Accordingly, “austerity” measures in the form of significant cuts to social and subsidy programs, devaluation of the national currency, “privatization” of the public enterprises, and regressive taxations become the main policy tools. Together, these economic policy measures are the cornerstone of “stabilization” and “structural adjustment” policies of the IMF and the World Bank respectively. However, in a conflicting twist, the budget also gives the highest priority to defense and security spending, which defeats the neoliberal purpose of reducing the size of the public sector and promoting individual liberty.

The budget also incorporates the idea of the “resistance economy,” decreed by Supreme Leader Khamenei, which again runs counter to the laissez faire (free market) and laissez passer (free trade) perspectives of neoliberalism. In a speech earlier this month, as if Rouhani had forgotten that his budget was in part based on the dictated self-sufficiency idea, said that Iran’s economic development cannot happen in the context of “isolationism.” Thus, an intelligent reader will become bewildered by the fact that the conflicting economic policy ideas are juxtaposed to provide a seemingly harmonious budget philosophy.

A No‑Growth Budget

This budget is capped at $294 billion (at the official exchange rate of 28,500 Rials to 1 US Dollar) and is 4 percent larger than the 2013 budget. Given the fall in oil prices, even if an unlikely nuclear deal was to be struck, the predicted figure can hardly be realized. The modest increase in the budget relative to its predecessor also suggests a no-growth scenario for the economy. This is despite the fact that a no-growth budget is terrible news for a population that is growing at 1.8 percent per year, is seeing its income decline while prices rise, and is facing a youth unemployment rate in the high double digits.

The preference for muddling through and preserving the status quo of zero growth is evident in the uses of the budget. Thus, while the supply side of the economy is neglected, the demand side is depressed through the use of contractionary fiscal and monetary policies. The budget also disregards growth-friendly educational, industrial and trade policies while it only gives lip service to construction and infrastructure. Most significantly, the sanctions-crippled Iranian economy needs serious popular mobilization and attention to social justice, but the elite-centered budget is equally oblivious to these requirements.

Sources of the Budget

The primary revenue sources for this budget include oil and non-oil exports, taxes, devaluation of the national currency, and proceeds from privatization. The projected oil price for the budget is $72 per barrel (p/b). However, oil prices have already dropped to below $50 p/b. According to the IMF, Iran’s budget predicament is even more serious. It predicts that, given sanctions, the country must sell its oil at the impossible price of $131 p/b for the next two years just to cover its budget shortfalls. To make up for part of this shortfall, the government will not be required to deposit 3 percent of oil revenue in the National Development Fund (oil reserve fund) that the law had mandated till now.

Iran’s economy is heavily dependent on oil revenue; indeed some 70 percent of Iran’s foreign exchange earnings come from the sale of oil, gas, petrochemicals and related products. Sanctions have cut Iran’s oil exports by 40 percent, down to around 1.3 million barrels per day (b/d). This figure includes official sales (to countries exempt from US sanctions) and black market sales, which earn Iran around half the official market price, due to many middlemen and corruption. Because of banking sanctions, a significant share of Iran’s oil revenue gets frozen in buyer countries. Nuclear “mini-deals” have so far given Iran access to about 5 percent of its frozen oil moneys.

The non-oil exports are the next best hope for the government to compensate for the shortfalls in oil income. In the immediate past years, this revenue source brought about $20 billion; it is projected to increase by 20 percent in 2015. Iran’s principal non-oil exports include cheap automobiles sold in Iraq, Syria and Afghanistan; gas-based petrochemicals sold to China; and carpets, packaged foods, vegetables, fruits, and dry fruits shipped to various countries. The projected increase in non-oil exports is based on the assumption that either a comprehensive nuclear deal will be struck or the status quo in the region will remain largely unchanged. While a nuclear deal remains uncertain, the situation in the region is definitely deteriorating.

In 1394, Iran will most likely not earn more than $55 billion from oil and related exports. Of this amount, about $15 billion will be needed by the Ministry of Petroleum just to maintain current production of about 3 million b/d. The non-oil exports could earn another $22 billion, which will net about $17 billion when production and other costs and deductions are accounted for. Thus, the net foreign exchange available for the government to spend will be about $57 billion. The decline in oil prices has already cost Iran around $7 billion. The nation’s annual import bill is about $57 billion with an additional several billion for its foreign operations. Thus, the chronic budget deficit will continue to increase.

Despite an expected decline in oil and non-oil income (by about 28 percent relative to 2014), the new budget assumes a 19 percent increase in government revenues. This additional revenue is expected to come from a few sources. The easiest trick to cover the shortfall was an official 9 percent devaluation of the national currency, from 26,000 to 28,500 Rials to 1 US Dollar. This one “magical” change on paper reduces the 28 percent shortfall to only 8 percent! This same trick also reduces the dollar equivalent of the budget by about 3 percent from $303 in the preceding budget. Surprisingly, this is the budget that is also designed to reduce inflation, even with the devaluation, to an impossible 20 percent in 2015.

Income and value added taxes are two other important sources of revenue, which are hoped to contribute 22 percent to the projected revenues. Ironically, taxes are projected to contribute 22 percent more to this budget than to the preceding budget, even if the economy is expected to grow at zero percent. There are a few sources from which this hoped-for tax increase can be potentially raised. They include the Revolutionary Foundations, businesses, the wealthy, and the middle to lower income groups. Yet, in reality, none of these sources will pay the amount of taxes that the government hopes to collect. Moreover, tax collection is intensely political and has the most inefficient bureaucracy in the country.

While the Parliament has passed a law that subjects the Revolutionary Foundations to tax payment, only Supreme Leader Khamenei can make the ultimate decision because until now these institutions, which directly operate under the Supreme Leader, have been tax-exempt. Even if they were ordered to pay taxes, the amount collected would be symbolic at best, as most claim annual losses. Collecting taxes from the bazaar and wealthy will also be tough, given their past reluctance to pay taxes. Much of the wealth in Iran is held in trade and cash forms, and they are almost impossible to tax. This leaves the manufacturing units and the middle to lower income groups, who already live in a precarious economic condition, to shoulder the tax burden.

The government also hopes to raise 27 percent of its budgeted revenues from “privatization and financial transactions.” This can prove difficult if not impossible given the past experience with privatization. Most state enterprises show loss, and many of the semi-finished projects are too bulky for the weak private sector to handle; it may only afford to take shares in enterprises or projects which have immediate profit prospects, leaving the losing ones for the governments to shoulder. Besides, in the past, even when the government was able to sell its profitable enterprises or transfer its semi-finished projects, they have ended up in quasi-public foundations that pay little to no cash-outs or taxes. These public transactions are hugely corruption-ridden.

Under this revenue condition, and given that the international sanctions will not allow Tehran to borrow or benefit from the global financial markets anytime soon, the government will be forced to spend a permissible portion of the reserves or oil funds, which the Rouhani government has said is about $30 billion. Yet, the Budget Bill as proposed to the Parliament does not allow the government to withdraw from this national savings from past oil exports. Despite this pledge, the government will certainly have to spend some of the reserves to cover the expected huge budget deficit. Even if this was allowed, the Parliament will certainly limit the government on where the reserve dollars can be spent, legally only on infrastructure and “productive sectors.”

Uses of the Budget

The new budget is also problematic on the expenditures side. First, operating spending far outweighs development funds in the new budget. This is bad news for an economy that must grow high and fast to produce jobs and income to remain stable. The economy, which has just reached zero-growth from negative 5 percent growth in 2013, will again fall into recession if the required infrastructural and productive investments are not made soon. The need for these investments is in the billions of dollars. Thus far the Rouhani government has neglected this problem as it has focused on nuclear negotiations and controlling inflation. Neoliberalism prioritizes foreign trade and price stability over production and job creation.

Second, apparently the government will spend 11 percent more in this budget than it did in the previous one, much of it on operational expenditures, with the Office of the President receiving a 29 percent jump. However, given that a 20 percent inflation rate is assumed, real government spending will be 9 percent less. In reality, the shortfall will be much higher given that the assumed inflation rate for 2015 is already appearing illusory. Cuts in subsidies will make food and fuel more expensive for the populous, while the official devaluation will raise input prices for production, leading to further economic stagnation and an inflationary multiplier effect across the economy.

Third, the budget is based on two legs: austerity and security. None of these legs can be cut without serious consequences. On the austerity side, thanks to the IMF’s “stabilization” advice, the government may have already crossed the red line of a pauperizing population struggling to make ends meet. On the security side, powerful forces will make it impossible for the government to suggest any savings given the continuing old threats and the looming new threats from ISIS and other regional adversaries. Indeed, the claimed increases in government spending is largely going to the defense and security sector, including a 17 percent pay raise for their personnel.

Thus, the defense budget is boosted by 33 percent (of which 64 percent will go to the IRGC and its Basij militia), the Intelligence Ministry budget by 40 percent, and the Special Revolutionary Court budget by 37 percent. These budget increases do not account for the assumed inflation rate. Regardless, the 17 percent increase in salaries of the civil and defense personnel is below the official inflation rate. Although Iran’s defense-security budget is only about 4 percent of its GNP, in terms of its percentage of the government budget, it is highly notable. One key reason the USSR collapsed was the fact that the US imposed on it an increasingly larger military-security budget.

On the austerity side, except for health, which is receiving a 58 percent increase, the budgets for most other social programs have been cut. Direct subsidies have been cut by 26 percent, and subsidies for housing, education, food, and fuel have also been reduced when the inflation rate is accounted for. About 19 percent of the general budget will go to social and cultural affairs, of which only 37 percent is dedicated to social welfare and security. The budget also fails to devote funds for the repayment of the government’s growing debt to the social security and retirement funds. While the future of the elderly is at jeopardy, funding for the wellbeing of the youth is also suboptimal.

Finally, the budget neglects the productive sectors, infrastructure and the environment. Development funds have been increased by a nominal 16 percent; in real terms that will mean a reduction. Agriculture receives an increase, but its share is minimal relative to the sector’s need. Manufacturing remains cash-hungry given the tight-money policy and a 22 percent interest rate. R&D’s share in the GNP remains at about .06 percent and industry-driven R&D is almost non‑existent. Infrastructure, including transportation and urban development, is equally under-budgeted. Worse yet is the country’s environment, which will need funds to be rescued from a potential disaster, but has only received a 20 percent nominal budget increase.

Possible Fallouts

The austerity cuts will leave the poorer groups (over 50 percent of the population) with no social safety net, creating a highly explosive situation in a stagflationary economy, where youth unemployment and inflation rates are about 20 percent if official statistics are believed. Suboptimal budgets for productive sectors, infrastructure and environment will further depress the economy, creating more malaise. Their development budget, as in the past, will be the first to suffer from the expected further reduction in government revenues. Meanwhile, the economy will continue to suffer from pervasive corruption, rent-seeking monopolies and a highly debt-ridden banking system.

This austerity-security budget will have other far-reaching consequences in an environment of falling oil prices and continuing sanctions. The official devaluation and lack of sufficient development funds will only reduce the purchasing power of the population and increase input prices leading to a decline in productive sectors of agriculture and industries. These sectors are already suffering from low profit rates relative to the interest rates they are charged by the banks. An additional rise in the price of inputs, including wages of labor, will force many of them into closure and bankruptcy. The current stagflation then will further deepen, reducing government revenues from tax and other sources.

Pressed for cash, the government may attempt to recover the decline in revenues by selling hard-earned foreign currency directly or through rent-seeking institutions and individuals in the black markets at exorbitant prices. The result will be a further decline in local currency value and more inflation and corruption. This scenario can happen if the Central Bank remains a subordinate of the government. The cash-hungry government may also allow rent-seeking monopolies and individuals to bust sanctions in export/import deals, further deepening the economy into corruption. The institutional foundation of the economy is already too thin and highly dilapidated.

Under these circumstances, the government will also not be able to maintain its current contractionary economic policy. The tight-money policy was designed to curb inflation without negatively impacting productive sectors. In reality, while inflation was checked to some extent, it did so only at the expense of production, employment, consumption and income distribution. Faced with the new budget realities, the tight money policy will have to be relaxed while an expansionary policy cannot be introduced given the revenue shortfall. Thus, the economic policy will become ad hoc again, and economic trends could revert to when Rouhani took over in the summer of 2013.

Other problems will also be exacerbated. On the domestic front, the income gap between the rich and the poor will further widen, and absolute poverty will increase. Social justice is expected to be a key tenet of the Islamic economic system, where the poorer strata have so far constituted the popular basis. Regionally, the falling oil price will reduce Iran’s influence as it becomes less capable of financing its friends in the region, stretched from Syria, Iraq, Lebanon and Palestine to other countries. Internationally, this constellation of economic difficulties will negatively impact Iran’s ability to negotiate a better nuclear deal, forcing it to make more concessions in return for less sanctions relief as in the past.

Some Words of Advice

Iran’s 2015 budget is not based on a development plan, its outlook spans to no longer than a year, and it is built around the neoliberal idea of curbing inflation by shrinking public welfare and the national market, while hoping to boost foreign trade in the context of international sanctions. The principal victims of this approach are employment, domestic production, the national market, consumption and a more balanced income distribution. This economic management thinking is particularly ironic for Iran, where 70 percent of its 80 million people are below 40 years old, 50 percent suffer from absolute or relative poverty, and the young talented people are a hugely‑underutilized national asset. The policy is also oblivious to improvements in factors, institutions and general conditions of production.

Iran’s economic woes under President Rouhani can worsen if he does not listen to the voice of reason and world experience. His most challenging problem will be to maintain equilibrium between the Islamic ideal of a better income distribution and the real national demand for rapid economic growth. Striking that balance will be a tough call in the context of declining public resources both in material and human terms (secular Iranians are greatly underutilized). However, given Rouhani’s neoliberal economic direction, it is almost certain that under his leadership, income inequality and popular dissatisfaction will increase while the economy will fail to grow at an appropriate rate, leading to a double jeopardy.

Rouhani has already lost the opportunity to attract hundreds of the nation’s economic and planning experts. He needs to get all the expert help possible, but that can only come when his government looks beyond the neoliberals. He must also focus attention on implementing national and local economic policies to boost rapid economic growth with income redistribution through progressive tax policies. A contractionary economic policy will be wrong moving forward. Iran needs an expansionary policy that creates jobs in smaller economic units across the nation. Controlling inflation cannot be helpful when it depresses the economy. Any price stability must account for job creation and rapid economic growth.

It is unfortunate that the Rouhani team is trying to reinvent the economic policy wheels while plenty of experience exists demonstrating what needs to be done: the state needs to get “prices wrong,” take the lead, implement expansionary policies, and create internal discipline. All development experiences, including in South Korea, Taiwan, China, Turkey, Malaysia and Brazil, indicate that in the early stages of economic development, the state has led, not the private sector, and that the state has been able to do so only after it disciplined itself (became lawful) and brought the rent-seeking private sector under a tight leash.

Rouhani needs to adopt a developmentalist approach requiring a strong state (abiding by the rule of law) and smart management. It also needs to apply time-tested economic policies including programs for labor force development, technological advancement, entrepreneurship training, and environmental protection. Iran also needs to thicken its badly battered legal and financial institutions, improve its political geography, develop its urban and village settlements, and rapidly build its telecommunications and transportation networks. Being weak and undisciplined, the Iranian state denies itself of the economic leadership legitimacy and takes refuge in a private sector that is even weaker and less disciplined.

Hanging between the public and private sector, Iran’s economy is increasingly controlled by corrupt oligarchies. To reverse course, Rouhani must apply bold and non-conventional policy rules and tools, make the public join him on a massive scale, and mobilize the nation’s economic assets towards an economic revolution. Waiting for the sanctions to be lifted, oil income to increase or foreign investment to arrive will only waste time and move Iran closer to an economic cliff. The time has come for real change towards a better Iran, and unless Rouhani listens to the voice of balanced economic reasoning and a very rich world experience with economic development, he will do no better than his predecessor.

About the author: Hooshang Amirahmadi is a professor and former director of the Center for Middle Eastern Studies at Rutgers University. He holds a PhD from Cornell University and is the founder and president of the American Iranian Council. He is also a Senior Associate Member at Oxford University in the U.K. His publications include The Political Economy of Iran under the Qajars, Revolution and Economic Transition, and three other books in Persian on civil society, industrial policy, and geopolitics of energy. Dr. Amirahmadi is also editor of ten books on Iran and the Middle East, and 16 conference proceedings on US-Iran relations, as well as numerous journal articles. A frequent contributors to international media and conferences, Dr. Amirahmadi’s advice has been sought by major multinational agencies and international corporations around the world. www.Amirahmadi.com; hooshang@amirahmadi.com

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