Iran: Election suggests new beginnings

The Iranian economy has enjoyed a period of unprecedented above-trend growth in rcent years underpinned by strong crude oil prices and in 2003 increased oil production. Once again, however, positive economic news has in recent months been overshadowed by less than favourable international political headlines.

First, February's disputed general election, which saw the conservatives sweep back into power. Second, revelations that Iran failed to disclose fully its nuclear development program to the UN's International Atomic Energy Agency. Whilst neither event is likely to disrupt the immediate economic outlook, they add to Tehran's problems vis-à-vis relations with Washington.

February's general election marked the end of the reformists four-year dominance of parliament. The conservatives' landslide victory came as no surprise after the un-elected Guardian Council disqualified over 2,000 prospective reformist candidates ahead of the election and many more reformists boycotted the poll in protest.

Condemned by the international community and Iran's reformists, the election was largely ignored by a majority of Iranians disillusioned with the country's politicians. The new conservative dominated parliament (Majlis) will assume office in June.

The return of a conservative government has raised concerns about the future direction of reform and the possibility that reforms introduced by the outgoing government may be reversed. We do not share this view.

Although we expect many social and political reforms to go on hold most conservatives acknowledge the need for economic reform. With unemployment of 12.8% and rising, youth unemployment even higher at 31% and an estimated 800,000 new entrants entering the labour force each year, the authorities know the current economic status quo is unsustainable.

On the policy front, job creation is one of the key objectives of the budget for the new Iranian year 1383 (that started 20th March 2004). As usual, total expenditure is much higher than originally planned. Total spending is set at USD 137.7bn, a 19% increase on 1382, and USD 10bn higher than provisional proposals.

Even this could understate actual spending. The conservative establishment, fearful of public criticism, has resisted previous attempts to cut subsidies. With presidential elections scheduled for early 1384 (mid-2005) it may also decide to pursue a populist policy agenda, at least in the short-term.

Oil revenues are conservatively forecast at USD 16.1bn, based on an oil price assumption of USD 19 per barrel. Actual revenues are expected to be higher. The government will continue to dip into the Oil Stabilisation Fund (OSF), which was established in 2000 to provide a cushion when oil prices fall short of projections, to meet spending requirements.

The outgoing reformist government has repeatedly used the fund to cover overdue debt repayments and to meet project spending commitments. It recently withdrew USD 5bn to meet budget obligations in 2003/04. The balance in the OSF is estimated to be around USD 10bn. In the absence of an improvement in fiscal discipline further withdrawals look unavoidable.

Real GDP growth has remained close to 7% in each of the past couple of years and is heading for another good year. A mix of low interest rates and fiscal stimulus will help underpin domestic demand. Business confidence is relatively robust and will benefit from expected share market reforms.

With presidential elections scheduled for next year we do not expect the new conservative-dominated government to undertake any aggressive policy tightening during FY04/05. This could put upward pressure on inflation, which is targeted to ease to 14.5% in 1383.

The external accounts will benefit from the continuing strength of oil prices, which should partly offset predicted lower output. The trade balance could come under further pressure as liquidity fuels import demand. The authorities may try to re-impose import restrictions, but we expect any move to be gradual.

Economic Forecasts

Growth: 2001 4.7%, 2002 7.4%, 2003 6.7%, 2004 5.0%, 2005 4.5%

Inflation: 2001 11.4%, 2002 14.3%, 2003 16.0%, 2004 15.0%, 2005 14.0%