Public Information Notice: IMF Concludes 2003 Article IV Consultation with the Islamic Republic of Iran

September 5, 2003

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2003 Article IV consultation with the Islamic Republic of Iran is also available.

On August 25, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Islamic Republic of Iran.1


During the first three years of the Third Five-Year Development Plan (TFYDP—2000/01-2002/03), real GDP grew by 5.8 percent on average, despite declines in oil output during the past two years. The overall macroeconomic situation improved significantly compared to the previous five-year development plan: the external current account was in surplus, the external debt was reduced to a very low level, international reserves increased significantly, and fiscal savings were accumulated in the Oil Stabilization Fund (OSF). This performance has taken place against the background of increased openness of the economy to international trade and investment, and increased economic reforms, but also benefited from sustained high oil prices and fiscal stimulus.

Notwithstanding these achievements, the Iranian economy continues to face important challenges: employment creation has not been sufficient to meet the rapid increase in the labor force; inflation is high and rising again; price subsidies and controls continue to hinder economic efficiency; and structural impediments for private sector development remain.

Growth was high and broad-based in 2002/03 (fiscal year ending March 20). Real GDP is estimated to have grown at 6.8 percent, with non-oil GDP expanding by 7.9 percent, reflecting a positive impact of economic reforms and favorable exogenous shocks, including good weather conditions and a higher oil price. Unemployment declined somewhat, but remained high at 15.7 percent.

Domestic demand continued to grow at rapid rates in 2002/03, despite corrective fiscal and monetary policy measures. As a result, Consumer Price Index (CPI) inflation accelerated to 15.8 percent from 11.4 percent in 2001/02, and the current account surplus narrowed to 3 percent of GDP despite higher oil prices. Moreover, equity and real estate prices continued to increase rapidly not only in response to economic liberalization measures, but also because of the high growth of money and credit, and a relatively stable exchange rate. Nonetheless, gross official reserves increased to the equivalent of seven months of next year's projected imports, and fiscal savings in the OSF increased by about $500 million.

The overall fiscal balance is estimated to have shifted to a deficit of about 2.3 percent of GDP in 2002/03, compared to a surplus of 1.8 percent of GDP in 2001/02. This deterioration mainly reflects the budgetary cost of the exchange rate unification and rapid growth of capital expenditures. In the meantime, the non-oil deficit is estimated to have widened sharply by 5.4 percentage points to 19.3 percent of GDP, notwithstanding expenditure cuts (amounting to 1.6 percent of GDP).

Monetary policy was accommodating in 2002/03. Although the central bank issued additional central bank participation papers to reduce excess liquidity, it could not independently adjust the rates of return, which in fact were reduced for retail lending. The central bank accommodated the higher credit demand by increasing significantly its claims on banks and nonfinancial public enterprises. This, together with unsterilized purchases of foreign exchange from the government and higher money multiplier, led to the acceleration of M2 growth to 30 percent while credit to the private sector grew by 35 percent. Banking system prudential indicators deteriorated somewhat and state-owned banks remained under capitalized and nonprofitable in part due to controls on rates of return and high operating costs.

The 12-month real effective exchange rate index depreciated by about 4 percent by end-April 2003. Under the managed floating exchange rate regime, the central bank has not committed to or publicly announced a specific exchange rate target, but has aimed to smooth out fluctuations in the exchange rate against an undisclosed basket of currencies.

Progress in structural reforms was uneven across the reform areas. While trade and financial sector reforms advanced and foreign direct investment regulations were liberalized, there was less progress in improving the business environment, reducing labor market rigidities, reforming subsidies, and restructuring and privatizing public enterprises.

Real GDP is projected to grow at 6.5 percent in 2003/04, but the risk of inflation acceleration remains. The fiscal policy stance based on the current budget could exacerbate demand pressures, and lead to high liquidity growth and inflation acceleration. To address these risks, the authorities have approved a range of monetary policy measures and are considering revenue and expenditure measures to reduce the fiscal deficit with the ultimate objective of limiting inflation to 18 percent at most.

Executive Board Assessment

Directors noted that the Iranian economy has performed well over the last three years, as evidenced by the rapid growth of the non-oil sector, a decline in unemployment, a reduction in external debt, the accumulation of gross official reserves and an improvement in key social indicators. These achievements are in large part attributable to structural reforms implemented over the last three years, including the opening up of the economy to international trade and foreign direct investment, exchange rate unification, and further progress in enhancing fiscal management and reforming the financial system.

Nevertheless, Directors expressed concern about the procyclical stance of monetary and fiscal policies and the slow pace of implementation of some structural reforms. Expansionary policies in the current environment of strong private demand—in particular, the use of the Oil Stabilization Fund (OSF) in a period of high oil prices—have contributed to a build-up of inflationary pressures and a narrowing of the external current account surplus. Directors emphasized that the key medium-term challenge will be to achieve sustained high economic growth and a reduction in the still-high level of unemployment while maintaining low inflation and macroeconomic stability. Timely implementation of structural reforms and prudent macroeconomic policies will be crucial to achieve these objectives. In this context, Directors commended Iran's firm commitment to promoting economic reforms under its current Five-Year Development Plan, and urged the authorities to speed up the pace of implementation.

Directors welcomed the authorities' intention to introduce corrective fiscal and monetary policy measures during the current fiscal year. They stressed the need to reduce the fiscal deficit and contain liquidity growth in order to ease demand pressures. They supported consolidating all spending into the budget and a gradual reduction in overall expenditure, particularly subsidies. There was also a need for a strong effort at revenue mobilization over the medium term to ensure that fiscal sustainability is maintained in the face of a possible decline in oil prices. While acknowledging that critical capital and social spending should be protected, Directors emphasized the need to improve prioritization of public investment on the basis of efficiency and productivity considerations. They called for more stringent rules on the use of the Oil Stabilization Fund within the context of a medium-term fiscal framework to ensure its proper use as a counter-cyclical tool.

Directors noted the authorities' concerns over the impact of expenditure cuts on employment. They suggested that the authorities take advantage of the current environment of strong economic growth to accelerate structural reforms with a view to stimulating private investment. They believed that continued positive response of the private sector to economic reforms would lessen the need to stimulate growth and employment generation through government spending policies, which in any case could not be sustained. They encouraged development of an adequate social safety net, with better targeted assistance to poor households, to help cushion the adverse short-term impact of reforms and preserve social stability and political consensus for reform.

Directors endorsed the authorities' intention to tighten monetary policy, and welcomed the range of measures that have been approved to contain domestic liquidity growth—including stepped-up sterilization operations. They urged the authorities to implement these measures forcefully, and to take further steps to increase the effectiveness of monetary policy and the independence of the central bank. Thus, they stressed the need to further develop indirect instruments of monetary policy, curtail the use of direct controls, introduce more flexibility in using rates of return, and limit the recourse by banks to the central bank's overdraft facilities. Directors noted that rapid credit growth has led to a rise in credit risk and deterioration in prudential indicators in the banking system. They took note of the authorities' view that potential financial sector vulnerabilities are low. Nevertheless, they stressed the need to closely monitor vulnerabilities associated with rapid credit growth, a possible downward adjustment in asset prices, and increased activity in the off-shore foreign exchange market. Directors welcomed the authorities' request for technical assistance in the area of prudential regulations.

Directors urged the authorities to continue to deepen and accelerate financial sector reform. They welcomed the recent steps taken, including the licensing of four private banks and the authorization of private insurance companies and the progress in implementing a risk-based regulatory and supervisory framework for the banking system. Directors called on the authorities to press ahead with the reform of banking supervision and capital market oversight and the modernization of the payments system. Directors stressed the need for restructuring and other supporting measures to enhance the efficiency and profitability of the public banks, together with plans for recapitalizing these banks. In this respect, the recent easing of controls on rates of return and on sectoral credit allocation is a step in the right direction, and further liberalization in this area is needed. Directors were encouraged by the authorities' adoption of regulations on anti-money laundering and combating terrorism financing, and urged the authorities to complete the legislative process in this area.

Directors noted that following the smooth transition to a unified exchange rate system, the authorities can move to a more flexible exchange rate management to enhance credibility and facilitate the achievement of monetary policy objectives. Directors were of the view that sustained real appreciation of the exchange rate over the medium term would need to be countered with productivity-enhancing structural reforms and prudent demand management policies to maintain competitiveness. Directors also welcomed the authorities' interest in accepting the obligations under Article VIII, Sections 2(a) and 3 of the Fund's Articles of Agreement, and their intention to establish a timetable for removing remaining exchange restrictions.

Directors were encouraged by the private sector's positive response to economic reforms, and stressed that further progress in structural reforms is key to a sustainable growth and employment creation in the medium term. In this regard, while commending the recent progress in liberalizing trade and encouraging foreign direct investment, they urged the authorities to place greater emphasis on reducing state intervention in economic activity and on improving economic efficiency. They stressed the importance of further efforts to liberalize trade, reduce administrative controls, reform labor markets, foster competition, and restructure and privatize public enterprises. They also encouraged acceleration of key medium-term fiscal reforms, including the introduction of a value-added tax—with Fund technical assistance—and the phasing out of subsidies.

Directors welcomed Iran's continued progress in enhancing transparency and improving the statistical data base. They commended the authorities for identifying the cost of energy subsidies in the budget, and expanding the coverage of fiscal accounts. Directors also encouraged the authorities to implement other recommendations of the Fund's Fiscal Report on the Observance of Standards and Codes, including consolidating extra-budgetary operations in the central government accounts and publishing international reserve data on a regular basis. These and other improvements would go a long way toward facilitating Iran's subscription to the Special Data Dissemination Standard.

Iran is a bilateral creditor for two heavily indebted poor countries. Directors expressed a hope that Iran will provide its share of debt relief to these countries under the Heavily Indebted Poor Countries Initiative.

Islamic Republic of Iran: Selected Economic Indicators






Real GDP growth
(factor cost, percentage change)





CPI inflation
(period average, percentage change)





Unemployment rate





Central government balance
(percent of GDP)





Broad money growth
(percentage change)





Current account balance
(percent of GDP)





Overall external balance
(percent of GDP)





Gross international reserves
(billions of U. S. dollars)





Public and publicly guaranteed
external debt (billions of U.S. dollars)





Exchange rate
(period average, rials per U.S. dollar)





Sources: Iranian authorities, and IMF staff estimates.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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