Iran heads for 5% GDP growth in 2003

Politics dominates any assessment of the outlook for Iran. Internally the main focus remains the ongoing power struggle between Iran's elected reformist government and the more extreme sections of the non-elected hardline political bodies aligned with supreme leader Ayatollah Khamenei.

Externally, the US policy of containment remains a major impediment to economic development. However, the current concern is Washington's inclusion of Iran in its 'axis of evil' and US concerns about Iran's nuclear programme. Washington has made no secret that it views Tehran's nuclear programme as a potential source of instability in the Middle East region, but it is not clear how it intends to address the issue.

As such, political uncertainties are likely to remain high. In contrast to the lingering political uncertainties over-hanging Iran, the economic situation has been strengthened by the robust international oil prices of recent years.

Economic growth has averaged 5% a year since plummeting to less than 2% in the Iranian year 1378 (beginning 22 March 1999). Inflation, though still in the high teens, has also been brought under control and national finances strengthened.

After hitting a 12-year low in 1377, the fiscal accounts are now close to balance. The current account has also been in surplus for the past three years and foreign exchange reserves have been rebuilt, and foreign debt servicing obligations brought under control.

Despite the improvement in core macro-economic indicators, the Iranian economy faces considerable challenges. It remains too dependent on oil, which provides close to half of government revenues and 80% of export earnings. Diversification remains a core target of the current five-year development plan (1380-1384), but oil remains the core driver of the economy, and growth prospects inextricably linked to developments in international oil markets.

Oil prices have been at record levels, however, the long term price trend is not encouraging. Within the Iranian industry there are also problems. Political interference has hampered development and efforts to attract international oil companies (IOCs). Recovery rates are low (22%) and depletion rates (around 6%) too high.

State interference stretches to all areas of the economy. Revolutionary foundations (Bonyads) set up post-1979 to control properties and businesses expropriated from the former shah continue to monopolise trade and industry, accounting for some 15-25% of GNP. Controlled by members of the ruling clergy they fall outside the jurisdiction of parliament.

The current five-year development plan commits the government to an ambitious programme of liberalisation, diversification and privatisation. Political obstacles look set to limit progress in areas such as state enterprise reform, privatisation and the overgenerous subsidies programme.

However, positive progress has been made in other specific areas, including trade liberalisation and reform of the state dominated banking sector. The central bank has also unified the exchange rate system, and successfully launched two eurobonds, despite the ongoing internal political struggles and uncertainties about US intentions towards Iran.

The immediate economic outlook remains encouraging despite geopolitical issues. Current strong oil prices and high output levels should support GDP growth of around 5% in 2003. The fiscal accounts will also benefit from another year of relatively firm oil prices, as will the balance of payments.

Inflationary pressures could creep up again in response to a more expansionary monetary stance, but do no pose an immediate threat to stability. The medium term outlook is less certain and will depend on whether President Khatemi can overcome the current political deadlock and force through the necessary economic reforms to enable Iran to reach its full economic potential.

Economic reform is essential if growth is to accelerate to the levels needed to address the country's demographic pressures and cut unemployment of around 16%. Job creation forms a core part of the budget for the new Iranian year, but more radical reforms are needed if the Iranian economy is to build on the achievements of the past few years.