Many key decision-makers and ideologists of the Islamic Republic of Iran have repeatedly expressed suspicion of the conventional paradigm of economic growth and development. They consider economic development a Western ploy and have repeatedly declared their intention to pursue other objectives.
Iranian President Hassan Rouhani, however, has publicly committed himself to improving the livelihood of ordinary Iranians. Yet one year into his tenure, Iran continues to suffer from a host of short- and long-term issues. In the short run, the harsh and prolonged stagflation caused by tightening international sanctions remains the most pressing issue. Between 2012 and 2013, for instance, Iran faced 40 percent inflation and an almost 6 percent contraction in GDP. Today, inflation still hovers around 25 percent and GDP is set to contract by another 3 percent by the Persian new year (March 2015). Ironically, of all policy areas, economic growth offered the Rouhani administration its greatest chance of success.
This prolonged recession is primarily an outcome of sanctions, particularly those imposed by the United Nations, the United States and the European Union. These sanctions have been effective; Iran’s economy is in a severe slump. An Iranian minister recently admitted that at least 50 percent of industrial plants are operating below capacity. Without a negotiated agreement with the West over Iran’s nuclear program, the continued freeze of Iranian assets will likely cause the economy to remain in recession. Fears of stagnation and a lost generation are now talk of the town. Iran’s economic recovery road map document, published recently by Rouhani’s economic team, is written with the explicit assumption that international sanctions will be in place for the foreseeable future.
Meanwhile, double-digit inflation rates remain a curse for the Iranian economy. Perennially high inflation, coupled with persistent double-digit unemployment, low labor force participation, low productivity growth, rampant corruption, a hostile business environment that actively discourages entrepreneurship, weak financial institutions and ineffective macroeconomic stewardship, has led to one of the world’s worst peacetime economic performances in the last three decades. These underlying weaknesses are masked to some degree by sizable oil revenues, which buoy the per capita income level.
The Rouhani administration so far has no plan to address these long-term problems. The published recovery plan yields little more than slight changes to pre-Ahmadinejad administration economic policies, which clearly failed to generate sustained growth and keep inflation at bay. The plan does not offer innovative solutions, and reads instead as a wish list, invoking unrealistic assumptions and expectations (for example harnessing “hot money”) as the basis for delivering the desired outcomes (raising capital for investments in infrastructure).
What was new in the document was the administration’s ill-advised intention to scrap the underwriting standards of the financial sector. Banks will as a result lend based on their own judgment rather than by adhering to prudential lending practices. This policy will open the door for abuse and corruption and lead to financial suppression and credit rationing. In plain language, team Rouhani is setting the stage for a banking crisis in the not too distant future.
The document also demonstrates the limits of Iran’s macroeconomic policy toolbox. Since the mid-1980s, officials have removed interest rate targeting from policymaking. Monetary authorities have in response increased the money supply. But in the absence of a developed and active debt market, this process leads to an almost irreversible expansion of the monetary base and perennially high inflation.
For example, the optimism that accompanied Rouhani’s election last year, along with his team’s success in engaging the P5+1 (the five permanent Security Council members plus Germany), led to reduced inflation expectations and an initial drop in actual inflation from 40 percent to 25 percent. However, the administration freely admits that the monetary base expanded by 27 percent in the 2013-2014 fiscal year. Simply put, we can confidently predict another episode of high inflation in the period 2014-2015.
Turning the interest rate into a political and religious issue – by implementing no-interest Islamic banking – has led to a host of unsavory consequences. In the absence of market-based interest rates, investors cannot perform accurate cost-benefit analysis and are more likely to shy away from long-term investments. Because private investment is the main catalyst of job creation, high unemployment and low productivity continue to plague Iran’s economy.
To address these long-term problems, the Rouhani administration should have strengthened its decision-making institutions and enhanced their credibility. The administration has in practice done the opposite. Through repeated appeals to Shiite clergy for support over daily issues, Rouhani’s team has inflicted long-term damage to the authority and effectiveness of economic institutions.
A year into his tenure, Rouhani must reassess his economic policies and his economic team. He holds the future of 78 million people in his hands. Clinging to tried and failed policies will not unlock the gates to a brighter future.
Mohammad Jahan-Parvar is American-Iranian economist. This commentary first appeared at Sada, an online journal published by the Carnegie Endowment for International Peace (www.carnegieendowment.org/sada).