IMF Executive Board Concludes 2009 Article IV Consultation with the Islamic Republic of IranPublic Information Notice (PIN) No. 10/24
February 18, 2010
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.
On February 3, 2010 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Islamic Republic of Iran.1
Iran’s economic performance was strong in recent years, supported by high oil prices and expansionary fiscal and monetary policies. Real GDP growth was above 5 percent a year, the external position strengthened, and welfare indicators improved. The recent drop in oil prices and rising inflation, however, led the authorities to tighten fiscal and monetary policies since the second half of 2008/09. Real GDP growth is estimated by staff to have decelerated to 2–2½ percent in 2008/09, from almost 7 percent in 2007/08, owing to a reduction in oil production and slower growth in the non-oil sector. At the same time, inflation has declined significantly.
The current account surplus is estimated to have remained strong in 2008/09 despite the drop in oil prices, reflecting a good performance of non-oil exports. Preliminary estimates suggest that the surplus narrowed from 12 percent of GDP in 2007/08 to 7 percent in 2008/09. Gross official reserves, including the Oil Stabilization Fund (OSF) foreign assets, declined slightly from $83 billion at end-2007/08 to $80.5 billion at end-September 2009. Large debt amortizations have further lowered the outstanding external debt to an estimated $20 billion (6½ percent of GDP) in 2008/09. The rial depreciated in nominal terms by 9 percent against the U.S. dollar in the period March 2008-September 2009.
Twelve-month CPI inflation dropped to 7½ percent in October 2009, from almost 30 percent in October 2008, as money (M1) growth slowed, reversing the increasing trend of recent years. The drop in international commodity prices contributed to the decline in inflation. In 2008/09, the non-oil fiscal deficit is estimated to have declined by one percentage point of GDP, to about 18 percent of GDP. This was mainly achieved through a reduction in government expenditure. In addition, a VAT with a three percent rate was successfully implemented across Iran in September 2008 to replace the system of integrated levies. The Central Bank of Iran (CBI) also introduced measures to tighten monetary policy, in particular, in the second half of 2008/09 it restructured its lending facilities and issued high-denominated notes to replace commercial bank checks.
The recent performance of the banking sector shows a steady increase in the market share of private banks, which have become leaders in the provision of participatory facilities, and a weakening of soundness indicators because of credit policies and slower domestic demand growth.
In the structural area, the approval of an ambitious energy price reform by the Parliament in December 2009 is expected to bring about an improvement in both the fiscal and external positions, facilitate higher investment in the energy sector, and support higher real GDP growth. In the financial area, the CBI established an interbank market in July 2008 to reduce the banks’ demand for central bank facilities and help improve liquidity management. The authorities have also improved bank supervision by implementing a new banking supervision framework, including a new loan classification system. In addition, the CBI has put in place a credit rating agency to enhance transparency regarding customer credit risk. The authorities have also adopted implementing regulations for the Anti-Money Laundering (AML) law as another step toward establishing a more comprehensive AML framework. The authorities have requested additional technical assistance with the drafting of a law on combating the financing of terrorism and to bring Iran’s AML/CFT more in line with international standards.
Looking forward, the authorities’ main macroeconomic challenges are to support non-oil GDP growth, further reduce inflation, and lessen Iran’s fiscal dependency on oil by expanding domestic sources of revenue. The 2009/10 budget envisages a reduction in the non-oil fiscal deficit to be achieved through an increase in non-oil revenue. Gross official reserves are projected to remain at a comfortable level at end-2009/10, and inflation is expected to decline further. Over the medium term, based on current WEO oil price projections, measures will be needed to further reduce the non-oil fiscal deficit. Against this background, the implementation of the proposed energy price reform is a critical step to improve the medium-term fiscal outlook and increase economic efficiency.
Executive Board Assessment
Directors noted that Iran’s economy had performed strongly in recent years supported by high oil prices and expansionary fiscal and monetary policies. However, declining oil prices have had an adverse effect on output and external fiscal balances. In light of this, Directors supported the authorities’ plans to increase non-oil revenue and reduce subsidies, and stressed the need to address forcefully the soundness of the banking system.
Directors emphasized the positive medium-term impact of the planned domestic energy price reform on the macroeconomic outlook. This reform would help strengthen the fiscal and external accounts, enable higher investment in the energy sector, and support stronger and more sustainable growth.
Directors stressed that the success of the planned energy price reform will depend importantly on the effective and timely implementation of a well-targeted mechanism of cash transfers to the poor as well as the transition to using energy efficient technologies. Anchoring expectations through prudent macroeconomic policies will be important for limiting the secondary effects of the energy price increases on the general price level. Directors particularly stressed the need to avoid quasi-fiscal operations through the banking sector. This will also require a sufficiently tight monetary policy, while providing adequate liquidity to the banking sector.
Directors encouraged the implementation of a rolling medium-term fiscal framework which integrates the operations of the central government budget and the Oil Stabilization Fund to help reduce domestic and external vulnerabilities.
Directors complimented the authorities for sharply bringing down inflation by tightening fiscal policies and liquidity conditions. They recommended that access to the CBI’s liquidity facility be made subject to the use of collateral. Directors welcomed the steps taken to equalize the rates of return on term deposits between public and private banks, and stressed the need to gradually liberalize rates of return, particularly on the lending side. Many Directors called for strengthening the independence of the central bank.
Directors emphasized the importance of addressing the increase in banks’ nonperforming loans and welcomed the authorities’ intention to take additional measures as necessary. They noted that balance sheets of banks were likely to be affected by the impact of the increase in energy prices on corporate profits and encouraged the authorities to recapitalize the banking system.
Directors observed that recent estimates suggested that the rial was broadly in line with fundamentals. However, they were broadly of the view that in light of the high oil price volatility, greater exchange rate flexibility would help adjust the external current account and preserve a strong international reserves position.
Directors noted the progress made towards establishing a more comprehensive AML/CFT framework and urged the authorities to strengthen this effort so as to bring their AML/CFT framework in line with international standards.
Directors considered that economic data were broadly adequate for surveillance purposes but recommended that its timeliness be improved.