Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with the Islamic Republic of Iran

March 5, 2007

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

Public Information Notice (PIN) No. 07/29
March 5, 2007

On February 23, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Islamic Republic of Iran.1


With high oil prices and a significant policy stimulus, the Iranian economy continued to grow strongly in 2005/06 (fiscal year starts March 21). Real GDP growth is estimated at 5½ percent. Oil GDP growth was modest owing to capacity constraints, while non-oil GDP growth was broad-based, reaching 6 percent. The tensions associated with the nuclear issue, however, had some adverse effects on private investment. Unemployment remains relatively high (10.2 percent in the first half of 2006/07).

End-of-period inflation decelerated to 10.2 percent in 2005/06, owing to a fall in food prices and a slower rate of depreciation of the rial. After declining further to below 7 percent in April 2006, the 12-month rate of inflation increased in recent months, reaching 15.9 percent in December 2006. The rial remained broadly stable in nominal effective terms during the 18 months ended in September 2006. Owing to the inflation differential with its trading partners, Iran's real effective exchange rate appreciated by 11 percent over the same period.

Financial policies have been expansionary during the last two fiscal years. Although the overall fiscal position is projected to be in surplus, the central government non-oil deficit (commitment basis) is expected to increase to 17¾ percent of GDP in 2006/07, from 14¼ percent in 2004/05. Large spending out of oil revenues has continued to challenge the ability of the Central Bank of Iran to meet its monetary targets. Broad money increased at an annual rate of about 35 percent in 2005/06 and the first half of 2006/07, and credit to the private sector has continued to grow at a strong pace. In March 2006, the authorities lowered the rate of return (interest rate) on state banks' lending and set the rate on private banks' lending, which was previously freely determined. After a sharp correction experienced in 2005/06, prices in the Tehran Stock Exchange recovered somewhat in April-December 2006.

External indicators continued to improve in 2005/06. The current account surplus rose to 7½ percent of GDP, from 1¼ percent in 2004/05, reflecting higher crude prices and a strong performance of non-oil exports. Gross international reserves, including those in the Oil Stabilization Fund (OSF), rose to the equivalent of nine months of imports of goods and nonfactor services at end-September 2006, and the external debt declined.

Although the pace of structural reforms slowed during the initial period of the current administration, the government has recently provided new impetus to the privatization program. Following the amendment to Article 44 of the constitution and an executive order by Iran's supreme leader, the authorities intend to privatize some 80 percent of the state-owned companies over the next 10 years (excluding the upstream oil sector, crucial infrastructure, and some banks).

With energy prices projected to remain high and external demand continuing to support non-oil exports, Iran's near-term growth prospects look favorable. Real GDP growth is projected at 5.8 percent in 2006/07 on account of continued strong activity in the non-oil sector. Inflation is likely to remain entrenched in the double digits. The external current account surplus is projected to decline owing to the fiscal expansion, but the international reserves position is expected to strengthen further during the remainder of 2006/07. An escalation of the tensions associated with the nuclear program could, however, affect adversely the growth outlook.

The 2007/08 draft budget was submitted to parliament in late January 2007. The proposed budget is based on a conservative oil price and envisages a reduction in the central government non-oil deficit to about 14½ percent of GDP in 2007/08, owing to substantial cuts in current outlays, including subsidies.

Executive Board Assessment

Executive Directors commended Iran's continued robust economic growth and improved external position, which reflected both a strong performance of the non-oil sector and favorable oil market conditions. Directors expressed concern, however, that macroeconomic policies continue to be expansionary and this is fueling inflationary pressures. They noted also that the possibility of a sustained drop in oil prices poses an additional risk to Iran's fiscal sustainability and macroeconomic outlook.

Directors considered Iran's main challenges to be the continued transition toward a viable and efficient market economy, and the attainment of the sustained growth rates necessary to provide employment for the country's fast-growing labor force. Directors reiterated that, to meet these challenges, the authorities will need to tighten financial policies and accelerate structural reforms in order to ensure macroeconomic stability and external competitiveness, build investor confidence, and accelerate further the development of the non-oil private sector.

Against this background, Directors called for a more restrictive fiscal stance to ease demand pressures and prevent an erosion of external competitiveness. They welcomed the authorities' plans to restrain expenditures in 2007/08, introduce a value added tax in the near future, and improve tax administration. In this context, Directors underscored the importance of phasing out energy subsidies while adequately protecting the poor, prioritizing expenditure, strengthening the role of the budget as the main instrument of fiscal policy, and avoiding frequent recourse to the OSF to finance spending. Efforts to increase public awareness of the importance of these reforms will be essential to garner the necessary public support.

Directors also called for a tightening of monetary policy and more effective use of monetary instruments. In this regard, they stressed that the central bank needs greater independence to issue short-term paper as needed to absorb liquidity. More generally, Directors encouraged the authorities to gradually lift controls on banks' rates of return and phase out remaining credit allocations.

Many Directors supported greater exchange rate flexibility, noting that it would buffer the economy against external shocks and increase the effectiveness of monetary policy in controlling inflation. They emphasized that competitiveness is better enhanced through fiscal discipline and appropriate structural reforms. Some Directors instead favored nominal exchange rate stability.

Directors commended the progress made in developing a risk-based prudential framework and broadening the supervisory powers of the central bank. They encouraged the authorities to continue strengthening prudential supervision and regulation. Directors also urged that the impact of ongoing rapid credit expansion on the quality of banks' portfolios should be monitored closely. They welcomed the fact that the authorities have recognized that the current
Anti-Money Laundry framework needs strengthening, and encouraged them to reinforce and quickly adopt the draft laws against money laundering and terrorism financing.

Directors welcomed the renewed momentum to privatize state-owned enterprises, including some of the largest banks. They urged vigorous design and implementation of an appropriate regulatory framework within the privatization program to ensure a level playing field and to enhance competition and efficiency in the economy. They noted that the success of the program in stimulating private investment will depend, in large part, on the effective transfer of majority control to the private sector and on the implementation of reforms to improve the business climate.

Directors welcomed recent improvements in the timeliness of macroeconomic data dissemination. They encouraged further progress on enhancing the availability of data, extending the coverage of the fiscal accounts, and bringing the dissemination practices for some key macroeconomic indicators in line with the IMF's Special Data Dissemination Standards.

Islamic Republic of Iran: Selected Economic Indicators, 2001/02-2005/06

  2001/02 2002/03 2003/04 2004/05 2005/06

Real GDP growth (factor cost; percentage change) 3.3 7.4 6.7 4.8 5.4
CPI inflation (period average; percentage change) 11.4 15.8 15.6 15.2 12.1
CPI inflation (end of period; percentage change) 11.7 17.5 16.0 16.7 10.2
Unemployment rate (in percent) 14.7 12.2 11.2 10.3 11.5
Central government balance (in percent of GDP) 1.8 -2.4 -0.1 1.7 1.1
Broad money growth (percentage change) 25.8 30.1 26.2 29.8 34.6
Current account balance (in percent of GDP) 5.3 3.1 0.6 1.2 7.4
Overall external balance (in percent of GDP) 3.9 4.1 2.1 5.2 6.9

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

16.6 21.0 24.7 33.3 46.3
Public and publicly guaranteed external debt (in billions of U.S. dollars) 7.2 9.3 17.0 23.1 24.3

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

7,9211/ 7,967 8,282 8,719 9,026

Sources: Iranian authorities; and IMF staff estimates.

1/ Average market exchange rate before the March 2002 exchange rate unification.

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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