## 1. Energy Sector in Iran ## Source details **Canonical URL:** [1. Energy Sector in Iran](https://www.imf.org/-/media/files/publications/cr/2018/cr1893.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr1893.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr1893.pdf.json) --- ### Context - President Rouhani elected for a second term in May 2017. - U.S. administration waived application of nuclear sanctions for 120 days on January 12, 2018 but is seeking substantial changes to the JCPOA. - Street protests occurred in several cities in late-2017. - Policy objective emphasized: implement a holistic reform package to entrench macroeconomic stability, develop the private sector, and ensure resources benefit all citizens. ### Economic developments, outlook, and risks - Growth and labor market - Growth expected to reach 4.3 percent in 2017/18 as oil production stabilized at Iran’s OPEC cap. - Recovery broadened to the non-oil sector in 2017/18 aided by supportive fiscal and monetary policies and recovery in construction and services. - Unemployment declined from 12.7 percent in H1 2016/17 to 11.7 percent in H1 2017/18; remains high among youth and women. - Outlook and projections - Real GDP growth projected at 4.0 percent in 2018/19 and to remain in that range in the medium-term. - Non-oil sector growth improves gradually towards 4½ percent over the medium-term reflecting completion of bank recapitalization in 2019/20. - Oil production expected to remain flat through 2018, in line with OPEC commitments. - Current account expected to remain in surplus as improved oil prices and higher gas exports allow international reserve buffers to rise gradually. - Risks - Risks are tilted to the downside (see Box 2): re-imposition of sanctions, continued banking stress, difficulties advancing reforms, FATF counter-measures, and regional conflicts among key high-likelihood risks. ### Price developments and inflation - CPI inflation - Average inflation declined from 11.8 percent in 2016/17 to 9.9 percent during the first 11 months of 2017/18. - Average inflation rises to 12 percent in 2018/19 reflecting recent depreciation pressures. - CPI inflation remains in low double digits in the medium-term. - Inflation drivers - Depreciation of the Rial since November 2017 will keep inflation in double digits during the remainder of 2017/18. - Moderation in food prices and stable administered prices aided the decline. - Inflation momentum remains high with re-emergence of depreciation pressures and strong liquidity growth of 23 percent. ### Money, credit, and banking sector measures - Liquidity, interest rates, and emergency lending - Liquidity growth remains robust, reflecting CBI support to pay depositors of former Unlicensed Financial Institutions (UFIs) and ongoing assistance to distressed banks. - CBI required banks to submit liquidity management plans to continue access to emergency lending facilities (ELA). - ELA was converted to credit lines for several banks with interest rates reduced from 34 to 16 percent if collateralized, and 18 percent if not. - The Money and Credit Council (MCC) short-term deposit rate cap is 10 percent; interbank rates fell from 27 percent in 2015 to 18 percent by end-2017. - Central Bank support and fiscal interaction - Government drew on the CBI’s unrealized FX revaluation gains (2.5 percent of GDP) to partially recapitalize some state-owned banks and clear some arrears to banks. - Amendments to the banking law to strengthen the CBI’s supervisory and resolution powers and define the role of the Deposit Insurance Fund (DIF) in bank resolution were submitted to Parliament. - Banking sector indicators (system-wide, end-June 2017) - Average Capital Adequacy Ratio (CAR): 4.9 percent (fell from 5.2 percent a year earlier). - Nonperforming loans (NPLs) ratio: 11.4 percent. - Provisioning rate on NPLs: 43.6 percent (from 48.5 percent in March 2016). - Policy recommendations for monetary framework and bank resolution - New Central Bank Law should enshrine price stability as core objective, replace government representatives with independent experts, streamline governing bodies and prohibit CBI financing of the government. - Emergency lending facility restricted to viable banks, temporary liquidity against high-quality collateral with pre-established limits. - Avoid further use of CBI revaluation gains to recapitalize banks; securitize government debt to the CBI with market-rate bonds to allow open market operations. - Undertake an independent Asset Quality Review (AQR) including related-party lending assessment; require banks to raise capital or be resolved under a least-cost principle. - Link issuance of recapitalization bonds to implementation of banks’ recovery plans; strengthen supervisory and resolution powers via new CBI Law and banking law amendments. - DIF should be adequately funded and have access to funding facilities to repay depositors in a timely manner. - Tighten provisioning and loss recognition standards (towards Basel II); quantify impact and provide under recapitalization plan. ### External sector developments and assessment (Appendix I summary) - Current account, reserves, and external buffers - Current account surplus estimated to have reached 4.3 percent of GDP in 2017/18; current account surplus increased from 0.3 percent in 2015/16 to 4 percent in 2016/17 following lifting of nuclear sanctions. - Gross official reserves: $120.7 billion at end-2016/17, equivalent to almost 16 months of imports; reserves declined by US$8.7 billion between end-March 2017 and early 2018. - Some reserves remain inaccessible due to limited CBRs; authorities converting dollar reserves/export earnings into other currencies and denominating oil sales contracts in euros. - External debt low at below 2 percent of GDP. - Exchange rate assessment - Staff calculations: official exchange rate was overvalued by 13–16 percent and the market exchange rate broadly in line with fundamentals at end-2016/17. - Premium between parallel and official rate: averaged about 16.4 percent in calendar year 2017 and widened further since start-2018 amid heightened uncertainty. - The gap between official and market rate constituted a subsidy to importers of priority list goods of 1.4 percent of GDP in 2017/18. - Staff recommends faster progress toward exchange rate unification; authorities planned unification by end-March 2019 (noting transfer of export earnings and CBRs complicate timing). - Reserve adequacy indicators (selected figures, gross official reserves) - 2014: 126.2; 2015: 128.4; 2016: 120.7; 2017: 111.7; 2018: 124.9; 2019: 143.5; 2020: 158.5; 2021: 181.4; 2022: 204.2 (billions of U.S. dollars). - Policy recommendations - Fiscal consolidation and a tighter monetary policy stance to protect macroeconomic stability and strengthen the external position. - Exchange rate unification to correct estimated overvaluation, contain imports, and strengthen non-oil exports. - Improve correspondent banking relationships (CBRs) and progress on AML/CFT issues to facilitate repatriation of export proceeds and access to reserves. - Reforms to improve the business climate and labor market to address productivity gaps and competitiveness. ### Fiscal developments, outlook, and sustainability - Fiscal balances and deficits - Central government (CG) cash-based fiscal deficit estimated at 2.3 percent of GDP in 2017/18. - CG non-oil deficit improved to 8.7 percent of non-oil GDP in 2017/18. - Staff’s estimate of the non-oil augmented central government (ACG) deficit widened to 12.6 percent of non-oil GDP reflecting the non-adjustment of fuel prices. - Debt, arrears, and securitization - Ongoing audit of arrears improved transparency but pushed public debt to near 50 percent of GDP at end-2016/17. - Authorities securitized 9 percent of these arrears through bonds bearing marketable profit rates. - Expected recapitalization of the banking system in 2018/19 raises public debt to about 54 percent of GDP; staff estimate issuance of bonds for bank recapitalization will push debt to almost 54 percent of GDP in 2018/19. - Interest associated with banking recapitalization bonds expected to push central government interest bill to 4.8 percent of GDP by 2019/20. - Fiscal outlook and MTFF recommendation - Assuming NDFI’s share of oil proceeds lowered to 20 percent and gradual fuel subsidy reform under NDP, CG fiscal deficit projected to average 3 percent of GDP in the medium-term. - High nominal GDP growth will reduce debt-to-GDP ratio to 40 percent of GDP by 2022/23 (Appendix II). - Medium-term general government fiscal framework (MTFF) targeting gradual adjustment over 10 years recommended to reach PIH norm. - PIH norm: 5.4 percent of non-oil GDP. - Measures of 4.5 percent of GDP over the next four years would create space to preserve growth-enhancing investment and social spending (figure context). - Staff estimate additional fiscal measures of 5.4 percent of non-oil GDP are needed over the next four years to attain the gradual path toward PIH norm. - 2018/19 Central Government Budget (key figures) - CG spending increases to 20 percent of GDP reflecting higher investment spending. - Revenue rises owing to higher global oil prices, increased share of oil proceeds ear-marked for CG investment, and a one percentage point increase in the customs tax rate. - CG deficit projected to narrow to 1.4 percent of GDP in 2018/19. - CG non-oil deficit widens to 12.9 percent of non-oil GDP as spending increases are largely funded by higher oil revenues. - Non-oil ACG deficit widens to 17.8 percent of non-oil GDP reflecting higher outlays by the NDFI for subsidized on-lending and PPP investments. - Budget authorized an offsetting operation of 7.4 percent of GDP to tackle payment arrears to private contractors (government debt to contractors offset against their debt to banks, banks reduced CBI overdraft by equal amount). - Budget clarified government authorized to adjust fuel prices and reform the cash transfer system during the Sixth National Development Plan ending 2020/21. ### Fuel subsidies, cash transfers, and options to create fiscal space - Fuel subsidies cost 1.6 percent of GDP in 2017/18. - Adopting an automatic price adjustment mechanism would support gradual increase in pump prices and phasing-out of fuel subsidies. - Better targeting of cash transfers by removing the richest 20 percent of households from beneficiary list could create space to raise cash transfer to the poorest households by 1 percent of GDP. - Options to create fiscal space (percent of non-oil GDP) - Reducing NDFI's spending: 2/3.4 - Increase revenue base by removing exemptions and administrative measures to reduce tax evasion: 1.9 - Pension reform: 0.1 - Cumulative impact: 5.4 - Note: 1/ Cumulative effect 2019/20 - 2022/23. - Note: 2/ Oil proceeds currently shared: NIOC 14.5 percent, central government budget 62.8 percent, and NDFI 22.7 percent. NDFI spending assumed to decline with reduction in its share. ### Pension system reform (Box 3 summary) - Coverage and fiscal pressures - Only 29 percent of the working age population contribute to any pension scheme. - Three largest pension schemes (90 percent of the system) are insolvent: accrued-to-date benefit obligations exceed reserves. - Two schemes illiquid and require budget transfers of 1.6 percent of GDP per year. - SSO liquid but borrowing from banks and will deplete reserves by 2027. - Key parametric reforms proposed - Gradually increase retirement age to 65. - Reduce accrual rates to 2 percent per year. - Expand pension benefit calculation period, gradually, to 20 years. - Projected outcome: these measures would lower the pension deficit to 0.5 percent of GDP by 2030. - Institutional fixes - Unification of pension schemes, clear definition of general government pension obligations, and rationalizing asset management. ### Financial sector: recapitalization, supervision, restructuring - Recent actions and vulnerabilities - CBI merged or closed several UFIs; legal framework revised to make CBI sole authority to license and regulate financial institutions; UFI assets/liabilities transferred to existing Credit Institutions (CIs). - Deposit run in two UFIs prior to transfer triggered deposit shifts to public commercial banks requiring CBI ELA. - 98 percent of depositors in those UFIs have been paid; deposits over $25,000 are frozen pending court decision on CBI’s asset review. - Banking system operates at a loss as margin between mandated lending and deposit rates insufficient to cover high operating costs and increasing provision expenses. - System indicators (end-June 2017) - Average CAR: 4.9 percent. - NPLs ratio: 11.4 percent. - Provisioning rate on NPLs: 43.6 percent. - Staff recommendations (selected) - Conduct independent AQR to identify recapitalization needs, assess related-party lending, collateral values, provisions adequacy. - Prepare and require bank recovery plans; resolve non-viable banks under least-cost principle. - Restructure state-owned banks now; link issuance of recapitalization bonds to implementation of recovery plans. - Require private banks accessing CBI ELA to prepare and implement recovery plans. - Strengthen supervisory and resolution powers through timely passage of new CBI Law and banking law amendments. - Tighten provisioning and loss recognition standards (towards Basel II) and quantify recapitalization implications. ### Structural reforms, labor market, and female labor force participation - Structural challenges and recent performance - Iran’s rank on the 2017–18 Global Competitiveness Index rose seven notches to sixty-ninth. - Between January–November 2017, exports to the Euro Area doubled y/y and are up nine-fold since their sanctions low. - Some 1.3 million jobs were created in the last two years. - Non-oil exports are small (8½ percent of GDP) and dominated by petrochemicals. - Domestic import tariffs averaged 20.9 percent in 2017/18; tariffs applied to Iran’s exports by trading partners averaged 8.9 percent in 2014 (global average 2.9 percent). - It takes 25 days to clear exports. - Labor and FLFP policies - Legal and social barriers limit FLFP (examples: restrictions on foreign travel by married women; tax code income tax deduction). - Measures to raise FLFP: overcome obstacles to employing women in formal sector, expand child care access, reduce gender wage gap. - Staff estimates: closing gender wage gap by half could boost GDP by 26 percent. - Authorities' planned measures: national roll-out of a pilot internship program for university graduates; two-year waiver of employer social security contributions for firms retaining interns; removal of gender caps in recruitment rounds at most ministries. ### AML/CFT, anti-corruption, and statistical/data improvements - AML/CFT and anti-corruption - UN Convention Against Transnational Organized Crime approved by parliament. - Amendments to AML and CFT laws to meet international standards approved by Cabinet and submitted to parliament. - Monitoring of remittances and cash transportation upgraded; National Risk Assessment (NRA) initiated. - CBI requested IMF assessment of AML/CFT framework to commence late-2018 and finalize in late 2019. - Iran gained observer status in the Eurasian AML/CFT group. - Staff urged timely passage of AML/CFT amendments and ratification of UN Convention for suppression of financing of terrorism. - Data and statistics - National accounts: discrepancies between CBI and SCI; current-price GDP estimates omit significant non-observed economy; recommendations to improve coordination and methodology. - Government finance: fiscal data cover only central government, released on cash basis without full expenditure detail; transition to accrual-based accounting recommended. - Monetary statistics: CBI has not submitted SRF-based monetary data to STA; latest monthly data to STA use old forms with long lags (latest February 2017). - External sector: CBI does not submit quarterly or annual BOP data to Fund; sizeable errors and omissions; recommendation to publish IIP and more comprehensive financial account data. - Participation encouraged in E-GDDS. ### Staff appraisal and key policy recommendations (summarized) - Restore banking sector health - Undertake AQR, restructure SBs, require bank recovery plans, securitize government debt to CBI to enable open market operations. - Fiscal package and sequencing - Comprehensive package to accompany financial sector reform; adjustment can be spread over 10 years to minimize growth impact. - Priorities: dedicate higher share of oil revenue to cover interest costs from recapitalization bonds, expand tax revenue, reform pensions, eliminate tax exemptions (especially for foundation-owned companies), improve taxpayer compliance. - Formula-based gradual phase-out of untargeted domestic fuel subsidies combined with targeted income support. - Develop debt management strategy and make MOEF sole authority to borrow and issue government guarantees. - Exchange rate and monetary policy - Unify exchange rate and allow more flexibility; prepare communication strategy and tighter monetary stance around unification. - Transition to market-based monetary policy framework; new Central Bank Law to enhance CBI autonomy and make price stability the core objective. - AML/CFT and international standards - Strengthen AML/CFT legislative and institutional framework per FATF action plan; complete the NRA; improve beneficial ownership transparency and asset declaration systems. - Business climate and labor regulation - Reduce red tape, modernize regulations, strengthen bankruptcy framework, ease market entry, review labor regulations to improve hiring incentives and address informality. - Female labor force participation - Reduce legal and social barriers, address pay gaps, subsidize child care to low-income women, tackle informality. - Data transparency - Improve quality, timeliness and availability of data; participate in E-GDDS. ### Boxes and analytical highlights - Box 1 — Energy sector - Absent new investment, oil production set to decline by about 240,000 bpd annually as fields age. - November 2016: Iran signed a 5-year $4.8 billion deal with China and Total to develop South Pars. - Government hopes to attract $100 billion in foreign investment in oil and gas; introduced new contract to allow partial foreign ownership. - Iran holds world’s largest gas reserves but only 5 percent of production exported; natural gas generates almost 90 percent of Iran’s power. - Authorities expect gas exports to increase to about 10 percent of total gas production by 2022. - Condensate production is 650,000 bpd and expected to increase by 100,000 bpd annually to 2022. - Major challenges: lack of LNG facilities and limited pipeline capacity. - Box 2 — Risk Assessment Matrix (selected high-likelihood risks and policy responses) - Regional conflicts (Relative Likelihood: High; Time Horizon: Short to Medium): Policy Response — Speed up financial sector reform; improve AML/CFT and banking health. - Re-imposition of sanctions or counter-measures (Relative Likelihood: High): Policy Response — Improve fiscal planning; build external and domestic buffers; continue reforms. - Continued banking system stress (Relative Likelihood: High): Policy Response — Build consensus on comprehensive restructuring and recapitalization strategy. - Difficulties in advancing reforms; Weakening of political/social support for reform (Relative Likelihood: High): Policy Response — Improve transparency and outreach; strengthen administrative capacity. - Box 3 — Pension system (see Pension section above). ### Public Sector Debt Sustainability Analysis (selected indicators, baseline) - Nominal gross public debt (percent of GDP): 2015: 11.1; 2016: 42.3; 2017: 49.1; 2018: 40.8; 2019: 53.9; 2020: 49.2; 2021: 45.6; 2022: 42.6; projection end: 40.0. - Public gross financing needs (percent of GDP): 2015: -1.2; 2016: 1.8; 2017: 4.7; 2018: 4.5; 2019: 13.5; 2020: 14.7; 2021: 6.8; 2022: 5.7; projection end: 5.7. - Real GDP growth (percent): 2015: 1.8; 2016: -1.6; 2017: 12.5; 2018: 4.3; 2019: 4.0; 2020: 4.0; 2021: 4.1; 2022: 4.2; projection end: 4.4. - Inflation (GDP deflator, percent): 2015: 19.1; 2016: 0.4; 2017: 1.6; 2018: 11.3; 2019: 16.7; 2020: 11.3; 2021: 10.2; 2022: 10.3; projection end: 10.1. - Staff stress-test results (selected adverse scenarios) - One-standard-deviation real GDP growth shock (real GDP growth declines by 5.5 percentage points from baseline in 2018 and 2019): debt-to-GDP peaks at 84.4 percent before stabilizing at 82 percent; gross financing need rises to 22.5 percent of GDP in 2019/20. - Severe global downturn scenario: debt and financing needs reach 88 percent and 24 percent of GDP, respectively, in 2019/2020. ### Timing of next consultation - It is recommended that the next Article IV consultation takes place on the standard 12-month cycle. *Source: cr1893 — IMF staff report excerpts.* ### 1. Energy Sector in Iran __________________________________________________________________________ 26 ### 1. Energy Sector in Iran ### Context - The authorities face a challenging domestic and geopolitical environment: - President Rouhani was elected for a second term in May 2017. - The U.S. administration waived the application of nuclear sanctions for 120 days on January 12, 2018 but is seeking substantial changes to the JCPOA. - Street protests occurred in several cities in late-2017. - Policy objective emphasized: implement a holistic reform package to entrench macroeconomic stability, develop the private sector, and ensure resources benefit all citizens. ### Economic developments, outlook, and risks — Recent Developments - Growth and sectoral rebound: - Growth is expected to reach 4.3 percent in 2017/18 as oil production stabilized at Iran’s OPEC cap. - Recovery broadened to the non-oil sector in 2017/18 aided by supportive fiscal and monetary policies and recovery in construction and services. - Labor market: - Unemployment declined from 12.7 percent in H1 2016/17 to 11.7 percent in H1 2017/18 but remains high among youth and women. ### Price developments and inflation - CPI inflation: - Average inflation declined from 11.8 percent in 2016/17 to 9.9 percent during the first 11 months of 2017/18. - The depreciation of the Rial since November 2017 will keep inflation in double digits during the remainder of 2017/18. - Inflation drivers noted: - Moderation in food prices and stable administered prices aided the decline. - Inflation momentum remains high, with re-emergence of depreciation pressures and strong liquidity growth of 23 percent. ### Money, credit, and banking sector measures - Liquidity and interest-rate pressures: - Liquidity growth remains robust, reflecting CBI support to pay depositors of former Unlicensed Financial Institutions (UFIs) and ongoing assistance to distressed banks. - The CBI required banks to submit liquidity management plans to continue access to emergency lending facilities (ELA). - ELA was converted to credit lines for several banks with interest rates reduced from 34 to 16 percent if collateralized, and 18 percent if not. - The Money and Credit Council (MCC) short-term deposit rate cap is 10 percent; this helped interbank rates fall from 27 percent in 2015 to 18 percent by end-2017. - Central Bank and bank support: - The government drew on the CBI’s unrealized FX revaluation gains (2.5 percent of GDP) to partially recapitalize some state-owned banks and clear some arrears to banks. - Amendments to the banking law to strengthen the CBI’s supervisory and resolution powers and define the role of the Deposit Insurance Fund (DIF) in bank resolution were submitted to Parliament. - Banking sector indicators and dynamics (figures referenced): - Private sector credit growth and non-performing loans trends highlighted; banks’ reliance on CBI overdrafts and conversions to regular funding facilities described. ### External sector developments - Current account and reserves: - The current account surplus is estimated to have reached 4.3 percent of GDP in 2017/18 reflecting higher oil prices. - Reserves declined by US$8.7 billion between end-March 2017 and early 2018. - FDI and trade: - FDI is materializing albeit more slowly than anticipated. - Trade credits have risen due to difficulties in transferring export earnings from some trading partners. - Exchange rate and market pressures: - Amid heightened uncertainty, the gap between the official and market exchange rates widened to near 30 percent in mid-February; in response, the CBI allowed banks to temporarily issue Rial CDs at 20 percent and foreign-exchange indexed CDs at 4 percent and the gap narrowed to about 20 percent. ### Fiscal developments and prospects - Fiscal balances and deficits: - The central government (CG) cash-based fiscal deficit is estimated at 2.3 percent of GDP in 2017/18. - The non-oil CG deficit improved to 8.7 percent of non-oil GDP in 2017/18. - Staff’s estimate of the non-oil augmented central government (ACG) deficit widened to 12.6 percent of non-oil GDP reflecting the non-adjustment of fuel prices. - Debt, arrears, and securitization: - Ongoing audit of arrears improved transparency but pushed public debt to near 50 percent of GDP at end-2016/17. - The authorities securitized 9 percent of these arrears through bonds bearing marketable profit rates. - Fiscal policy implications: - Fiscal consolidation is needed to create room for higher interest costs due to banks recapitalization and arrears securitization. - The expected rebound in oil revenue aided by favorable oil prices provides scope for a gradual adjustment in the non-oil deficit towards the PIH norm over 10 years. - Measures of 4.5 percent of GDP over the next four years would create space to preserve growth-enhancing investment and social spending (figure context). ### 2018/19 Central Government Budget - Budget stance and composition: - CG spending increases to 20 percent of GDP reflecting higher investment spending. - Revenue is estimated to rise owing to higher global oil prices, increase in the share of oil proceeds ear-marked to fund CG investment spending, and a one percentage point increase in the customs tax rate. - The CG deficit is projected to narrow to 1.4 percent of GDP in 2018/19. - Underlying deficits and operations: - The CG non-oil deficit widens to 12.9 percent of non-oil GDP as spending increases are largely funded by higher oil revenues. - The non-oil ACG deficit widens to 17.8 percent of non-oil GDP reflecting higher outlays by the NDFI for subsidized on-lending to manufacturing and PPP investments in unfinished infrastructure projects (backed by NDFI guarantees). - To tackle payment arrears to private contractors, the budget authorized an offsetting operation of 7.4 percent of GDP where government debt to contractors is offset against their debt to banks, which in turn have reduced their CBI overdraft by an equal amount. - The budget clarified that the government is authorized to adjust fuel prices and reform the cash transfer system during the Sixth National Development Plan (NDP) which ends 2020/21. ### AML/CFT legislative and institutional progress - Legislative and institutional steps: - The United Nations (UN) Convention Against Transnational Organized Crime has been approved by parliament. - Amendments to the AML and CFT laws to bring them fully in line with international standards were approved by Cabinet and submitted to parliament. - Requirements to monitor remittances and the transportation of cash have been upgraded. - The National Risk Assessment (NRA) was initiated; the CBI is bolstering supervision and the Financial Intelligence Unit (FIU) is enhancing financial intelligence quality. - The CBI requested an IMF assessment of the AML/CFT framework, due to commence late-2018 and finalize in late 2019. - Iran gained observer status in the Eurasian AML/CFT group. *Source: cr1893 - 1. Energy Sector in Iran (extracted content).* ### 10. Real GDP growth is projected at 4.0 percent in 2018/19 and to remain in that range in ### 10. Real GDP growth is projected at 4.0 percent in 2018/19 and to remain in that range in ### Growth outlook and external sector - Real GDP growth is projected at 4.0 percent in 2018/19 and to remain in that range in the medium-term (Tables 2–12). - Oil production is expected to remain flat through 2018, in line with OPEC commitments. - The rise in gas and condensate exports following recent investments compensates for declining oil production from older fields allowing the oil sector to sustain growth at 4 percent (Box 1). - Non-oil sector growth improves gradually towards 4½ percent over the medium-term reflecting completion of bank recapitalization in 2019/20. - On-going uncertainty keeps FDI subdued and hampers further expansion of Correspondent Bank Relations (CBRs). - The current account is expected to remain in surplus as improved oil prices and higher gas exports allow international reserve buffers to rise gradually. ### Inflation, liquidity, and monetary framework - CPI inflation remains in low double digits in the medium-term. - Average inflation rises to 12 percent in 2018/19 reflecting recent depreciation pressures. - The forecast reflects full unification of the exchange rate in 2019/20. - Liquidity growth is curbed to limit second-round effects of exchange rate pass-through on inflation and the gradual increase in fuel prices. - Credit to the private sector strengthens after banks’ recapitalization, supporting gradual strengthening of non-oil economic growth. - The CBI kept inflation close to single digits since end-2015 by curbing liquidity growth while managing carefully its support to distressed banks. - The absence of a regular funding facility for banks, together with banks’ unrestricted access to ELA without collateral, undermines control over monetary aggregates. - Recommendations to modernize the monetary policy framework: - New Central Bank Law should enshrine price stability as the core objective of monetary policy, replace government representatives with independent experts, streamline governing bodies and prohibit CBI financing of the government. - An emergency lending facility restricted to viable banks, providing temporary liquidity against high-quality collateral at the CBI’s discretion with pre-established limits, would preserve the CBI’s capacity to absorb losses. - Avoid further use of CBI revaluation gains to recapitalize banks; securitization of government debt to the CBI with market-rate bonds would allow the CBI to use these bonds in open market operations to manage liquidity. - Ensure interest rates support the single digit inflation target and allow lending rates to adjust when the CBI extends rate increases to protect banks’ net interest income. - Re-start the interbank FX market and prepare for exchange rate unification with a careful communication plan. ### Exchange rate and FX policy - Staff calculations show the official exchange rate was overvalued by 13–16 percent and the market exchange rate was broadly in line with fundamentals at end-2016/17 (Appendix I). - The gap between the official and market rate constituted a subsidy to importers of priority list goods of 1.4 percent of GDP in 2017/18 and continues to stimulate imports. - Faster progress toward exchange rate unification would help counter FX pressures and eliminate distortions; unification planned by the authorities by end-March 2019 (though transfer of export earnings and CBRs complicate timing). - Authorities will continue to gradually remove all but pharmaceutical goods from the priority list and consider sustaining interest rate increases and closing the gap more quickly should FX pressures persist. ### Fiscal outlook and sustainability - The fiscal deficit is set to rise driven by higher interest outlays and rising pension system deficits but debt declines. - Assuming the NDFI’s share of oil proceeds is lowered to 20 percent and the gradual implementation of fuel subsidy reform under the NDP, the CG fiscal deficit is projected to average 3 percent of GDP in the medium-term reflecting higher interest outlays associated with the bonds for arrears securitization and bank recapitalization. - High nominal GDP growth will reduce the debt-to -GDP ratio to 40 percent of GDP by 2022/23 (Appendix II). - Staff estimate that the issuance of bonds for bank recapitalization will push debt to almost 54 percent of GDP in 2018/19 which, with the securitization of arrears, will see the budgeted interest bill rise to 4.8 percent of GDP in 2019/20. - The projected non-oil fiscal deficit of the ACG would average 19 percent of non-oil GDP in the medium-term. - A medium-term general government fiscal framework (MTFF) targeting gradual adjustment over 10 years is recommended: - Iran’s oil and NDFI assets imply fiscal space to allow a gradual adjustment to the estimated PIH norm of 5.4 percent of non-oil GDP by 2029. - Gradually lowering the non-oil deficit to about 13.4 percent of non-oil GDP by 2022/23 would create fiscal space, reduce the ACG and CG deficits, and contain gross financing needs. - To attain this path, additional fiscal measures of 5.4 percent of non-oil GDP are needed over the next four years. - The adjustment effort should rely mainly on domestic revenue mobilization given the low tax-to-GDP ratio (8 percent in 2016/17). - Priority measures: eliminate tax exemptions (especially to companies owned by foundations and other exempt entities), improve tax compliance, introduce a VAT registration threshold with a simplified regime for small businesses, organize INTA by taxpayer groups, introduce e-tax processes, and shift to risk-based auditing. ### Financial sector: recapitalization, supervision, and restructuring - Past year actions: CBI merged or closed several UFIs; legal framework revised to make the CBI the sole authority to license and regulate financial institutions; UFI assets and liabilities transferred to existing Credit Institutions (CIs). - A deposit run in two UFIs prior to transfer triggered deposit shifts to public commercial banks necessitating CBI ELA to stem liquidity pressures. While 98 percent of depositors in those UFIs have now been paid, deposits over $25,000 are frozen pending a court decision on the CBI’s asset review of these entities. - It is essential to ensure CIs’ balance sheets are not weakened by the clean-up of UFIs and that ownership and management meet fit and proper standards. Owners and unsecured debt holders of UFIs should have their claims/rights fully written-off before any depositor faces losses. - System indicators (end-June 2017): - Average Capital Adequacy Ratio (CAR) had fallen to 4.9 percent by end-June 2017 from 5.2 percent a year earlier. - Nonperforming loans (NPLs) ratio had risen to 11.4 percent. - Provisioning rate on NPLs fell to 43.6 percent (from 48.5 percent in March 2016). - The banking system continues to operate at a loss as the margin between mandated lending and deposit rates is insufficient to cover high operating costs and increasing provision expenses. - CBI plans and staff recommendations: - Undertake an independent Asset Quality Review (AQR), including related-party lending assessment, to identify recapitalization needs, true extent of non-performing assets, collateral values, provisions adequacy and credit risk management weaknesses. - Move expeditiously with the AQR and be prepared to require banks to raise capital, resolve NPLs, improve credit risk management, tackle related-party lending and demonstrate commercial viability on a forward-looking basis. - Non-viable banks should be rapidly and orderly resolved under a least-cost principle. - Restructuring of state-owned banks (SBs) should proceed now; recovery plans should be prepared by SBs and other government-controlled banks while the AQR proceeds. - Government must tackle elevated operating costs, refrain from directed credit, cover interest subsidies, adjust regulated prices so firms can meet obligations to banks, and ensure SBs’ governance, internal procedures, and credit risk management support a profitable business model. - Issuance of recapitalization bonds to cover government’s arrears to banks and capital needs should be linked to implementation of recovery plans. - Private banks accessing CBI ELA should be required to prepare and implement recovery plans. - Strengthen supervisory and resolution powers through early passage of the new CBI Law and amendments to banking law; strengthen resources and capacity for risk-based supervision. - The DIF should be adequately funded and have access to funding facilities to repay depositors in a timely manner. - Tightening provisioning and loss recognition standards (towards Basel II) is welcome; the impact on banks’ capital positions must be quantified and provided for under the recapitalization plan. ### Risks and policy priorities - Risks are tilted to the downside (Box 2). - A rise in social or external tensions could delay the reform process. - Delays or failure to decisively address problem banks, implement fiscal measures or unify the exchange rate risks a return to high inflation and further pressures on the exchange rate. - With little improvement in banks’ balance sheets, credit to the private sector would continue to be devoted to the evergreening of NPLs and ultimately reduce private sector growth. - A more difficult external environment or lower oil prices could increase pressure on the external and fiscal accounts. - Failure to secure FATF approval of the measures taken under the action plan or to effectively implement AML/CFT international standards could reverse the improvement in CBRs and stall prospective FDI inflows. - Upside scenario: - Faster implementation of reforms in a manner that underpins confidence and shares the burden equitably could see growth surprise on the upside. - Policy imperative: - It is paramount the authorities implement a comprehensive reform plan to safeguard stability and build FX and fiscal buffers to preserve space for policy maneuver, while taking measures to reduce unemployment, inequality and to protect the poor. ### Authorities’ views - The authorities concurred with staff’s assessment noting that the growth trajectory is likely to be higher reflecting the impact of planned financial sector and business climate reforms. - They acknowledged the risks and underscored how external uncertainty is hampering investment, and they expect most JCPOA signatories will adhere to the agreement. - The authorities still plan to unify the exchange rate by end-March 2019 but issues surrounding the transfer of export earnings and CBRs complicate the timing. They see the new central bank bill as key to the transition. *International Monetary Fund — Country Report excerpt* ### 32. Staff supports the planned gradual reduction of general fuel subsidies and the better ### 32. Staff supports the planned gradual reduction of general fuel subsidies and the better ### Fuel subsidies, cash transfers, and social safety nets - Fuel subsidies cost 1.6 percent of GDP in 2017/18. - Adopting an automatic price adjustment mechanism would support a gradual increase in pump prices and phasing-out of fuel subsidies. - Better targeting of cash transfers by removing the richest 20 percent of households from the beneficiary list could create space to raise the cash transfer to the poorest households by 1 percent of GDP. - It would be important to ensure that targeting be based on a thorough review of individuals’ assets and disposable income. ### Options to create fiscal space (percent of non-oil GDP) - Reducing NDFI's spending 2/3.4 - Increase revenue base by removing exemptions and taking administrative measures to reduce tax evasion1.9 - Pension reform 0.1 - Cumulative impact5.4 - Note: 1/ Cumulative effect 2019/20 - 2022/23 - Note: 2/ Oil proceeds are currently shared across the National Iranian Oil Company (14.5 percent), the central government budget (62.8 percent), and the NDFI (22.7 percent). NDFI spending is assumed to decline in tandem with the reduction in its share in oil revenues. ### Pension system reform - Iran’s pension system faces a growing deficit. - Policy measures to increase transparency and reduce the deficit: - Unification of pension schemes. - A clear definition of general government pension obligations. - Rationalizing asset management. - Parametric reforms proposed: - Gradually increasing the retirement age to 65. - Reducing accrual rates to 2 percent per year. - Expanding the pension benefit calculation period, gradually, to 20 years. - Projected outcome: these measures would lower the pension deficit to 0.5 percent of GDP by 2030. ### Public financial management and debt management - Public financial management reforms are essential to improve the efficiency and effectiveness of public spending. - Expand rollout of performance-based budgeting to identify cost savings. - Transition to accrual-based accounting in the medium-term and expand coverage of fiscal accounts to sub-national governments, social security schemes, TSO and the NDFI to capture all spending commitments and PPP-related risks. - Rising debt calls for a debt management strategy and annual borrowing program. - A new public debt law should give the Ministry of Economy and Finance (MOEF) the sole authority to borrow and issue guarantees on behalf of the CG, set rules for subnational borrowing, and strengthen MOEF oversight of SOEs and subnational debt. - An issuance calendar would facilitate market development and monetary policy coordination. ### Fiscal stance, revenue, and subsidy reform commitments - The authorities use a conservative oil price assumption of $55 per barrel in the 2018/19 budget to limit risks of deficit overruns. - Authorities aim to eliminate absolute poverty by developing a universal social safety net that merges all social support programs and eliminates untargeted subsidies. - Prepared measures include a draft bill on debt management, a debt management strategy, and a parametric pension reform. - Addressing tax exemptions will require political consensus. ### Growth, job creation, and structural challenges - Recent developments: - Iran’s rank on the 2017–18 Global Competitiveness Index (GCI) rose seven notches to sixty-ninth. - Between January–November 2017, exports to the Euro Area doubled y/y and are up nine-fold since their sanctions low. - Some 1.3 million jobs were created in the last two years. - Structural challenges: - High youth unemployment and falling productivity linked to reliance on oil and the public sector. - Labor force participation is below 40 percent, largely due to very low female participation and high informality and underreporting of employment. - Non-oil exports are small (8½ percent of GDP) and dominated by petrochemicals benefiting from free natural gas. - Key constraints to private sector development: - Access to finance remains the main obstacle, followed by bureaucracy and policy instability. - Restrictive labor regulations (government approval required to dismiss workers) deter permanent hiring and encourage fixed-term contracts. - Domestic import tariffs averaged 20.9 percent in 2017/18. - Tariffs applied to Iran’s exports by trading partners averaged 8.9 percent in 2014 (global average 2.9 percent). - It takes 25 days to clear exports. ### Labor markets, female labor force participation (FLFP), and related reforms - Legal and social barriers limit FLFP (examples: restrictions on foreign travel by married women; tax code income tax deduction). - Measures to raise FLFP and labor supply: - Overcome obstacles to employing women in the formal sector, expand access to child care facilities, and reduce the gender wage gap over time. - Staff estimates suggest closing the gender wage gap by half could boost GDP by 26 percent. - Rise in tax revenues would more than offset the fiscal cost of a child-care subsidy to lower income mothers. - Pension reform could reconsider retirement incentives and eliminate the minimum service time criteria to support workers with short employment histories. - Authorities’ planned measures: - National roll-out of a pilot internship program for university graduates. - A two-year waiver of employer social security contributions for firms retaining interns. - Removal of gender caps in recruitment rounds at most ministries. ### Anti-corruption, AML/CFT, and statistical/data improvements - Bolstering the anti-corruption framework and AML/CFT is a priority: - Enhance transparency of corporate beneficial ownership. - Establish an independent anti-corruption agency. - Continue active pursuit of corruption cases. - Enhance system of declaration of assets of senior public officials and measures to identify domestic politically exposed persons. - Exchange rate regime and MCPs: - The exchange rate regime gives rise to several multiple currency practices (MCPs) and an exchange restriction subject to Fund approval under Article VIII, Sections 2(a) and 3. - MCPs arise from official exchange rates differing by more than two percent from foreign exchange bureaus and from preferential rates for certain imports with FX payment commitments made through letters of credit or bank drafts prior to March 21, 2002 and July 24, 2012. - Data and statistics: - More timely and comprehensive data would enhance transparency and inform policy design. - Developing general government and public-sector debt statistics is key; errors and omissions in the balance of payments are a concern. - Authorities plan to implement recommendations of the 2017 Multisector Statistics TA mission and are encouraged to participate in E-GDDS. ### Staff appraisal and key policy recommendations - Restore banking sector health: - Move expeditiously to restore banks to a sound financial footing so they can finance private sector expansion. - Conduct an AQR to crystallize recapitalization needs; restructure SBs alongside the AQR; private banks should prepare and implement recovery plans. - Securitizing the government’s debt to the CBI would provide a tool to conduct open market operations and enhance the CBI’s ability to contain inflation. - Fiscal package and sequencing: - A comprehensive package of fiscal measures must accompany financial sector reform; adjustment can be spread over 10 years to minimize growth impact. - Priorities: dedicate a higher share of oil revenue to cover interest costs from bank recapitalization bonds, expand tax revenue, reform pensions, eliminate tax exemptions (especially to companies owned by foundations and other exempt entities), and improve taxpayer compliance. - A formula-based, gradual phase-out of untargeted domestic fuel price subsidies combined with targeted income support to compensate the vulnerable would be more sustainable and equitable. - Develop a debt management strategy and make the MOEF the sole authority to borrow and issue government guarantees to contain debt and reduce borrowing costs. - Exchange rate and monetary policy: - Unify the exchange rate and allow more exchange rate flexibility to reduce distortions, promote fairness and export competitiveness, and create space to use reserves to smooth pressures. - To manage potential volatility around unification, enhance confidence with a clear communication strategy and tighter monetary policy stance. - Transition to a market-based monetary policy framework, complemented by full autonomy for the CBI to pursue low and stable inflation. - A new Central Bank Law should enhance the CBI’s autonomy and make price stability the core objective; reduce quasi-fiscal activities from directed credit and administered price controls. - AML/CFT and international standards: - Strengthen AML/CFT legislative and institutional framework in line with the FATF action plan and implement effectively. - Urged timely passage of AML and CFT amendments and ratification of the UN Convention for the suppression of the financing of terrorism. - Complete the NRA, improve transparency of beneficial ownership, enhance asset declaration systems for senior officials, identify domestic politically exposed persons, and move to risk-based AML/CFT supervision of financial institutions. - Business climate and labor regulation reforms: - Faster implementation of business climate reforms: reduce red tape, modernize regulations, strengthen the bankruptcy framework, ease market entry. - Review labor regulation to improve hiring incentives and address informality. - Develop non-oil exports by lowering trade costs, improving infrastructure, and pursuing non-preferential trade agreements. - Female labor force participation: - Reduce legal and social barriers, address pay gaps, subsidize child care to low income women, and tackle informality to create job opportunities and boost growth. - Data transparency: - Improve quality, timeliness and availability of data; participate in E-GDDS. ### Fund-staff recommendation on MCPs and exchange restriction - Staff recommend Executive Board approval of the retention of: - the MCP and exchange restriction arising from the greater than the two percent deviation between the official and bureau exchange rates, maintained for balance of payments reasons, non-discriminatory, and temporary considering the authorities’ commitment to unify the exchange rate by March 20, 2019. - the two MCPs referred to (¶45) through March 20, 2019; these measures are not maintained for balance of payment reasons and do not impede its adjustment, and are non-discriminatory among members. *Source: IMF staff report excerpt (cr1893).* ### 55. It is recommended that the next Article IV consultation takes place on the standard ### cr1893 - 55. It is recommended that the next Article IV consultation takes place on the standard ### Recommendation on Article IV consultation timing - It is recommended that the next Article IV consultation takes place on the standard 12-month cycle. ### Box 1. Energy Sector in Iran - Increasing oil and gas production requires significant investment. - Absent new investment, oil production is set to decline by about 240,000 bpd annually as oil fields age. - In November 2016, Iran signed a 5-year $4.8 billion deal with China and Total to develop South Pars. - The government hopes to attract $100 billion in foreign investment in the oil and gas sector and has introduced a new contract to allow partial foreign ownership in projects. - There is potential to expand natural gas and condensate exports. - Iran holds the world’s largest gas reserves but only 5 percent of production is exported. - Natural gas is generating almost 90 percent of Iran’s power. - The authorities expect gas exports to increase to about 10 percent of total gas production by 2022. - Condensate production is 650,000 bpd and is expected to increase by 100,000 bpd annually to 2022. - One major challenge is lack of LNG facilities and limited capacity of gas pipelines. ### Crude oil and natural gas historical and projected points (as presented) - Crude Oil, Iran, 1972-2022 (Million barrels a day): charted data sources: Central Bank of Iran, OPEC, BP, EIA, and IMF staff calculations. (Labels referenced in source: consumption; export; proj.; events noted: Islamic revolution; Iran-Iraq war ended; nuclear sanctions started; nuclear sanctions ended.) - Natural Gas, Iran, 1972-2022 1/ (Billion Cubic Meters): charted data sources: Central Bank of Iran, OPEC, BP, EIA, and IMF staff calculations. Note: 1/ Excludes gas flared or recycled. (Labels referenced in source: export; proj.; (Production = consumption); events noted: Islamic revolution; Iran-Iraq war ended; nuclear sanctions started; nuclear sanctions ended.) ### Box 2. Risk Assessment Matrix - Purpose: The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). - Methodology note: The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” indicate that the risk could materialize within one year and three years, respectively. - Key risks, likelihoods, time horizons, potential impacts, and policy responses: - Regional conflicts - Relative Likelihood: High - Time Horizon: Short to Medium Term - Potential Impact: Could weigh negatively on Iran's trade development and regional integration. - Policy Response: Speed up financial sector reform. Continued improvements in Iran's AML/CFT framework and the health of its banking system remain essential to facilitate fuller reintegration into the global financial system. - Tighter global financial conditions - Relative Likelihood: Medium - Time Horizon: Short to Medium Term - Potential Impact: An abrupt change in global risk appetite could lead to sudden, sharp increases in interest rates and associated tightening of financial conditions. - Policy Response: Speed up financial sector reform. Continued improvements in Iran's AML/CFT framework and the health of its banking system remain essential to facilitate fuller reintegration into the global financial system. - Structurally weak growth in key advanced economies - Relative Likelihood: High - Time Horizon: Medium Term - Potential Impact: Weak growth in euro area and Japan would negatively impact Iran's oil exports and growth. - Policy Response: Continue domestic reforms that diversify the economy, strengthen domestic productive capacity and enhance resilience to shocks. - Concentration of trade with China - Relative Likelihood: High - Time Horizon: Medium Term - Potential Impact: China accounts for 45 percent of Iran's total exports. - Policy Response: Continue domestic reforms that diversify the economy, strengthen domestic productive capacity and enhance resilience to shocks. - Lower energy prices from weakening OPEC/Russia cohesion or African supply recovery - Relative Likelihood: Low - Time Horizon: Short to Medium Term - Potential Impact: Negative impact on oil revenue, thus reducing scope for increasing growth-enhancing spending. - Policy Response: Improve fiscal planning by articulating fiscal priorities within a medium-term framework and build fiscal buffers. Continue to reduce oil dependency by increasing domestic tax revenue. - Re-imposition of sanctions or counter-measures - Relative Likelihood: High - Time Horizon: Short to Medium Term - Potential Impact: Would lower direct investment and capital inflows, and disconnect Iran from the global financial system; growth and exports would be negatively affected. - Policy Response: Improve fiscal planning; build external and domestic buffers; continue reforms to strengthen domestic productive capacity and the AML/CFT framework. - Continued banking system stress - Relative Likelihood: High - Time Horizon: Short to Medium Term - Potential Impact: Liquidity growth and inflation accelerate, real interest rates remain high, and growth slow. - Policy Response: Build broad-based consensus on a comprehensive restructuring and recapitalization strategy and how it is to be financed. - Difficulties in advancing reforms - Relative Likelihood: High - Time Horizon: Short to Medium Term - Potential Impact: Could hamper growth and job prospects, especially for the youth and women. - Policy Response: Improve transparency and outreach to public and key stakeholders to build support for reforms. Strengthen administrative capacity through technical assistance. - FATF introducing counter-measures against Iran - Relative Likelihood: Medium - Time Horizon: Short to Medium term - Potential Impact: Iran could lose access SWIFT, existing CBRs with European banks could be terminated. - Policy Response: Improve the AML/CFT framework, tighten policies to avoid pressure on the exchange rate and inflation. - Without fiscal and monetary policy reform - Relative Likelihood: Medium - Time Horizon: Short to Medium Term - Potential Impact: Risk of higher inflation, real exchange rate appreciation, and eroding competitiveness. - Policy Response: Reduce non-oil fiscal deficit to support disinflation, while mobilizing tax revenue to create space for growth-enhancing spending. Develop buffers to protect the economy against the consequences of adverse shocks. Develop a medium-term fiscal framework to anchor annual fiscal deficits. - Significant China slowdown and its spillovers - Relative Likelihood: Low/Medium - Time Horizon: Short to Medium Term - Potential Impact: Spillovers on Iran's economy. - Policy Response: Continued efforts to diversify Iran's trade and to attract foreign investors. Speed up structural reform to foster broader based growth. - Intensification of fragmentation/security dislocation in parts of Middle East, Africa, Asia, and Europe (Spillover Risks) - Relative Likelihood: High - Time Horizon: Short to Medium Term - Potential Impact: Spillover risks to Iran. - Policy Response: Speed up structural reforms. Continue efforts to focus on domestic reforms to increase Iran's attractiveness to foreign investors. Increase fiscal revenues by increasing the share of central government budget in oil revenues. Build fiscal and external buffers. - Financial strains from inadequate progress on banking sector recapitalization and restructuring - Relative Likelihood: High - Policy Response: Build broad-based consensus on a comprehensive restructuring and recapitalization strategy and how it is to be financed. - Weakening of political or social support for reform - Relative Likelihood: High - Policy Response: Improve transparency and outreach to public and key stakeholders to build support for reforms. Strengthen administrative capacity through technical assistance. - Limited progress in strengthening the monetary and fiscal policy frameworks - Relative Likelihood: Medium - Policy Response: Reduce non-oil fiscal deficit to support disinflation, while mobilizing tax revenue to create space for growth-enhancing spending. Develop buffers to protect the economy against adverse shocks. Develop a medium-term fiscal framework to anchor annual fiscal deficits. - Uncertainties related to the implementation of the JCPOA - Relative Likelihood: High - Time Horizon: Short to Medium Term - Potential Impact: Uncertain implications for reform and integration. - Policy Response: Continue reforms to strengthen domestic productive capacity, build external and domestic buffers and improve the AML/CFT framework. *Source: IMF staff.* ### Box 3. The Pension System in Iran ### Box 3. The Pension System in Iran ### Financial status and pressures - Only 29 percent of the working age population contribute to any pension scheme. - A demographic transition over the next 20 years will worsen the demographic support ratio and increase financial pressures. - The three largest pension schemes (90 percent of the system) are insolvent: accrued-to-date benefit obligations exceed reserves. - Two schemes are illiquid and require budget transfers of 1.6 percent of GDP per year. - The largest scheme, the Social Security Organization (SSO), is liquid but is borrowing from banks to meet its obligations and will deplete reserves by 2027. ### Key drivers of financial difficulties - Low effective retirement age: - 60 percent of pensioners are under 60 years. - Only 25 percent of those over 60 receive a contributory pension. - Early retirement is used as a policy tool to control unemployment, influencing the low effective retirement age. - Generous benefit calculation rules: - Benefit calculations put replacement rates close to 100 percent of final salaries. ### Regulatory and institutional issues - The pension regulatory and institutional framework creates uncertainty about the government’s explicit liabilities. - SSO’s financial statements are not included in fiscal data or the budget. - Assets (often in SOEs and real sector) are managed as businesses without regard to the schemes’ finances. ### Implications - High rates of economic inactivity and unemployment coupled with demographic change imply rising fiscal risk and sustainability challenges for public finances. - Continued reliance on bank borrowing and budget transfers risks further strain on public and financial sector balance sheets. - Lack of transparency and exclusion of SSO accounts from fiscal reporting obscure the magnitude of contingent and explicit government liabilities. *Source: IMF staff.* ### Appendix I. External Sector Assessment ### Appendix I. External Sector Assessment ### Overview of Iran’s external sector - External position characterized by low external debt, a sizable reserves cushion, and a current account surplus. - Central Bank of Iran (CBI) has been losing reserves since the beginning of 2016/17 and authorities face difficulties in transferring oil proceeds from some trading partners. - Official exchange rate was 15.5 percent stronger than the market rate in 2016/17, subsidizing a significant share of imports and undermining export competitiveness. - Staff assessment: external position in 2017 is weaker than warranted by fundamentals and desirable policy settings. - Expectations if conditions improve: If the JCPOA remains in place, progress is made on AML/CFT issues, correspondent banking relationships (CBRs) improve, and fiscal adjustment proceeds as planned, then the current account and access to foreign reserves should gradually improve. - Key risks: Lower oil prices, remaining sanctions, and heightened risk of snap-back of nuclear sanctions that could affect exchange rate stability and external position. ### Current account and financial account - Current account surplus increased from 0.3 percent in 2015/16 to 4 percent in 2016/17 following the lifting of nuclear sanctions. - Imports picked up reflecting pent-up demand and an overvalued official exchange rate. - The current account surplus is expected to stabilize near 5.5 percent of GDP in tandem with the rise in oil and gas exports. - Financial account: poised to improve moderately as CBRs improve over time, FDI commitments materialize gradually, and errors and omissions normalize. - Assessment: Unifying the exchange rate at the market rate would help contain imports, stimulate non-oil exports, and reduce dependency on oil revenue over time. ### Exchange rate assessment and REER findings - The market rate was 15.5 percent more depreciated than the official rate in 2016/17. - Staff analysis suggests the market rate was broadly in line with fundamentals at end-2016/17; the official rate was overvalued. - Current account approach: REER overvalued by 12.9 percent; CA in 2016/17 of 4 percent of GDP was below the norm of 5.8 percent of GDP. - Main drivers of the CA norm: private credit, demographic trends, institutional and political environment, change in reserves, and a large policy gap. - Over the medium-term, planned fiscal consolidation to reach the PIH norm by 2028, improvement of CBRs, and exchange rate unification should help close the current account gap. - EBA-Oil current account approach: official REER overvalued by 12.4 percent at end-2016/17; fiscal deficit and foreign reserves loss contributed to CA underperformance. - Real effective exchange rate approach: official REER overvalued by 16 percent and market REER overvalued by 1 percent at end-2016/17. - Overvaluation drivers: financial home bias and lack of trade openness. - Exchange rate unification and greater trade openness would help manage terms-of-trade shocks and improve growth prospects. - Premium between parallel and official rate: - Averaged about 16.4 percent in calendar year 2017 and widened further since start-2018 amid heightened uncertainty, though higher interest rates helped narrow the gap. - As of September 2017, 78 percent of goods categories (52 percent at end-2016/17) and 44.5 percent of imports by value (44 percent at end-2016/17) were valued at the market rate. - Since September 2017, tourism-related goods, rice, airline fuels and airplanes were removed from the priority list. ### External buffers and access to reserves - Gross official reserves stood at $120.7 billion at end-2016/17, equivalent to almost 16 months of imports. - Some of the stock of reserves remains inaccessible due to limited CBRs; authorities have reached agreements to convert dollar reserves and export earnings into other currencies and are increasingly denominating oil sales contracts in euros. - Large trade credit accumulation has emerged because of difficulties in receiving payments. - Assessment: Level of gross foreign exchange assets appears comfortable but rise in external uncertainties and difficulties in accessing reserves require tightening of policies to strengthen external position. ### External debt and international investment position - External debt is low at below 2 percent of GDP and forecast to remain stable at around 2 percent of GDP. - Foreign assets of the banking system, including the CBI, are equivalent to about 50 percent of GDP; however, a non-negligible share of foreign assets is encumbered and not available for payment purposes, even after sanctions relief. - Iran appears to have a large positive IIP, but lack of information on corporate and household net foreign asset holdings adds uncertainty. ### Policy recommendations - Fiscal consolidation and a tighter monetary policy stance to protect macroeconomic stability and strengthen the external position. - Exchange rate unification (moving the official rate to the market rate) to correct estimated overvaluation, contain imports, and strengthen non-oil exports. - Improve correspondent banking relationships (CBRs) and progress on AML/CFT issues to facilitate repatriation of export proceeds and access to reserves. - Reforms to improve the business climate and labor market to address productivity gaps and competitiveness. ### Reserve adequacy indicators (selected figures) - Gross official reserves (billions of U.S. dollars): 2014: 126.2; 2015: 128.4; 2016: 120.7; 2017: 111.7; 2018: 124.9; 2019: 143.5; 2020: 158.5; 2021: 181.4; 2022: 204.2 - Months of current imports of goods and services: 2014: 17.1; 2015: 20.8; 2016: 18.2; 2017: 14.6; 2018: 14.5; 2019: 16.6; 2020: 18.0; 2021: 20.2; 2022: 22.3 - Percent of short-term debt at remaining maturity: 2014: 883.5; 2015: 3475.5; 2016: 561.6; 2017: 482.1; 2018: 379.0; 2019: 482.4; 2020: 590.2; 2021: 635.8; 2022: 665.1 - Percent of the IMF composite measure (fixed): 2014: 324.0; 2015: 296.6; 2016: 239.8; 2017: 201.8; 2018: 209.5; 2019: 259.2; 2020: 267.0; 2021: 283.4; 2022: 298.1 - Percent of the IMF composite measure (flexible): 2014: 38.2; 2015: 574.6; 2016: 464.9; 2017: 392.6; 2018: 407.9; 2019: 503.1; 2020: 518.6; 2021: 550.9; 2022: 579.7 ### External sustainability and vulnerabilities - Overall assessment: no significant external sustainability risk given low external debt and ample gross official reserves, but access constraints to some reserves due to limited CBRs raise vulnerabilities. - Data gaps: international investment position data not available due to shortcomings in compilation of private sector external assets. - Staff conclusion: external position in 2016/17 was weaker than warranted by fundamentals and desirable policy settings. ### Scenarios and stress tests (from Public DSA, Appendix II) - Banking recapitalization and arrears: - On-going arrears audit revealed government arrears of about 30 percent of GDP and brought debt-to-GDP to near 50 percent in 2016/17. - Expected recapitalization of the banking system in 2018/19 raises public debt to about 54 percent of GDP. - Interest associated with banking recapitalization bonds expected to push central government interest bill to 4.8 percent of GDP by 2019/20. - Gross financing need rises from 4.5 percent of GDP in 2017/18 to about 15 percent in 2019/20. - Debt declines to 40 percent of GDP by 2022/23 as arrears are securitized through 2023/24 and higher oil prices boost revenues. - Adverse scenarios: - One-standard-deviation real GDP growth shock (real GDP growth declines by 5.5 percentage points from baseline in 2018 and 2019): debt-to-GDP peaks at 84.4 percent of GDP before stabilizing at 82 percent of GDP; government gross financing need rises to 22.5 percent of GDP in 2019/20. - Historical-average scenario with deterioration of primary balance by about 1.3 percent of GDP in 2018/19 combined with increase in effective interest payments by 1.2 percentage points: debt-to-GDP peaks above 70 percent of GDP in 2019/20 before declining. - Severe global downturn scenario (real GDP shock, higher effective interest rates, deterioration in primary balance): debt and financing needs reach 88 percent and 24 percent of GDP, respectively, in 2019/2020, and increase in the medium term. - Recognition of additional arrears and higher cost of bank recapitalization would push debt and financing needs even higher under severe shock scenarios. *Source: IMF staff.* ### 3. Measures are also needed to bring the non-oil fiscal balance in line with long-term ### 3. Measures are also needed to bring the non-oil fiscal balance in line with long-term intergenerational equity ### Non-oil fiscal balance and Permanent Income Hypothesis (PIH) benchmark - The 2017/18 augmented non-oil primary deficit is 12.6 percent of non-oil GDP. - The PIH norm that ensures exhaustible oil revenue is sufficiently transformed into financial assets for future generations is 5.4 percent of non-oil GDP. - Measures of about 7 percent of non-oil GDP would need to be identified over the next decade to bring the non-oil primary deficit to 5.4 percent of non-oil GDP by 2027/28. - Footnote on shock assumptions: The primary balance shock assumes a reduction relative to baseline by half of the historical standard deviation; the interest rate shock assumes that for every 1 percent of GDP deterioration in primary balance, the interest rate increases by 25 basis points (see Figure 3). ### Public Sector Debt Sustainability Analysis — Baseline scenario (selected indicators and projections) - As of February 08, 2018. - Nominal gross public debt (in percent of GDP): 2015: 11.1; 2016: 42.3; 2017: 49.1; 2018: 40.8; 2019: 53.9; 2020: 49.2; 2021: 45.6; 2022: 42.6; projection end: 40.0. - Public gross financing needs (in percent of GDP): 2015: -1.2; 2016: 1.8; 2017: 4.7; 2018: 4.5; 2019: 13.5; 2020: 14.7; 2021: 6.8; 2022: 5.7; projection end: 5.7. - Real GDP growth (in percent): 2015: 1.8; 2016: -1.6; 2017: 12.5; 2018: 4.3; 2019: 4.0; 2020: 4.0; 2021: 4.1; 2022: 4.2; projection end: 4.4. - Inflation (GDP deflator, in percent): 2015: 19.1; 2016: 0.4; 2017: 1.6; 2018: 11.3; 2019: 16.7; 2020: 11.3; 2021: 10.2; 2022: 10.3; projection end: 10.1. - Nominal GDP growth (in percent): 2015: 21.1; 2016: -1.2; 2017: 14.3; 2018: 16.1; 2019: 21.4; 2020: 15.7; 2021: 14.8; 2022: 14.9; projection end: 15.0. - Effective interest rate (in percent): 2015: 1.5; 2016: 0.9; 2017: 0.3; 2018: 0.4; 2019: 1.3; 2020: 11.3; 2021: 12.7; 2022: 14.4; projection end: 15.6. - Change in gross public sector debt (cumulative, in percent of GDP): 2015: -0.1; 2016: 30.5; 2017: 6.8; 2018: -8.3; 2019: 13.0; 2020: -4.6; 2021: -3.6; 2022: -3.0; projection cumulative: -2.5; 2006-2014 cumulative: -9.1. - Identified debt-creating flows (cumulative, in percent of GDP): 2015: -3.8; 2016: 1.0; 2017: -3.6; 2018: -5.0; 2019: 24.0; 2020: 3.7; 2021: -3.1; 2022: -2.6; projection cumulative: -2.1; 2006-2014 cumulative: 15.0. - Primary deficit (in percent of GDP): 2015: -1.2; 2016: 1.7; 2017: 2.2; 2018: 2.2; 2019: 1.0; 2020: -2.1; 2021: -2.1; 2022: -2.3; projection cumulative: -2.3; 2006-2014 cumulative: -5.6. - Primary (noninterest) revenue and grants (in percent of GDP): 2015: 19.3; 2016: 16.1; 2017: 17.3; 2018: 15.7; 2019: 18.7; 2020: 19.5; 2021: 19.5; 2022: 19.5; projection cumulative: 19.5; 2006-2014 cumulative: 112.3. - Primary (noninterest) expenditure (in percent of GDP): 2015: 18.0; 2016: 17.8; 2017: 19.4; 2018: 17.8; 2019: 19.7; 2020: 17.5; 2021: 17.4; 2022: 17.2; projection cumulative: 17.2; 2006-2014 cumulative: 106.7. - Automatic debt dynamics (in percent of GDP): 2015: -1.6; 2016: 0.3; 2017: -5.1; 2018: -6.7; 2019: -6.7; 2020: -2.0; 2021: -0.9; 2022: -0.2; projection cumulative: 0.2; 2006-2014 cumulative: -16.3. - Other identified debt-creating flows (in percent of GDP): 2015: -1.0; 2016: -0.9; 2017: -0.7; 2018: -0.5; 2019: 29.7; 2020: 7.8; 2021: -0.1; 2022: 0.0; projection cumulative: 0.0; 2006-2014 cumulative: 36.9. - Privatization (negative) (in percent of GDP): 2015: -1.0; 2016: -0.9; 2017: -0.7; 2018: -0.5; 2019: 29.7; 2020: -0.2; 2021: -0.1; 2022: 0.0; projection cumulative: 0.0; 2006-2014 cumulative: 28.9. - Contingent liabilities (in percent of GDP): 2015–2018: 0.0 each year; 2019: 0.0; 2020: 8.0; 2021–2022: 0.0; projection cumulative: 0.0; 2006-2014 cumulative: 8.0. - Residual, including asset changes (in percent of GDP): 2015: 3.7; 2016: 29.5; 2017: 10.4; 2018: -3.3; 2019: -10.9; 2020: -8.4; 2021: -0.5; 2022: -0.5; projection cumulative: -0.4; 2006-2014 cumulative: -24.0. - Note: The large residual in 2015 corresponds to the recognition of government arrears. ### Underlying assumptions and alternative scenario indicators (selected) - Baseline real GDP growth (in percent): 2017: 4.3; 2018: 4.0; 2019: 4.0; 2020: 4.1; 2021: 4.2; 2022: 4.4. - Baseline inflation (in percent): 2017: 11.3; 2018: 16.7; 2019: 11.3; 2020: 10.2; 2021: 10.3; 2022: 10.1. - Baseline primary balance (in percent of GDP): 2017: -2.2; 2018: -1.0; 2019: 2.1; 2020: 2.1; 2021: 2.3; 2022: 2.3 (reported in Figure 1 table). - Effective interest rate under alternative scenarios shown rising to double-digits in projection years (e.g., 11.3, 12.7, 14.4, 15.6 in baseline projections). ### Stress tests — key scenarios and assumed shocks - Primary Balance Shock: assumes a total primary balance lowered by 1.3 percent over the projection period, with interest rate increased by 0.25 percent. - Real GDP Growth Shock: assumes growth lower by 1 percentage point in 2017 and 2018, while inflation and interest rates increase by 0.25 percent. - Real Interest Rate Shock: assumes a real interest higher by 2 percent. - Real Exchange Rate Shock: assumes a real depreciation of 100 percent, with a passthrough of 25 percent. - Combined Shock: takes the worse impact on each variable of the shocks mentioned above. - Selected stress-test indicator values (examples from Figure 3 assumptions): - Real GDP growth under Real GDP Growth Shock: 2017: 4.3; 2018: -1.5; 2019: -1.5; 2020: 4.1; 2021: 4.2; 2022: 4.4. - Effective interest rate under Combined Shock: 2017: 0.4; 2018: 3.3; 2019: 14.4; 2020: 16.4; 2021: 18.6; 2022: 19.7. - Stress-test outputs show gross nominal public debt and public gross financing needs can rise substantially under adverse shocks (figures and percentile bands shown in the chapter). ### Risk assessment and vulnerability indicators - Heat map methodology: cells highlighted in green if debt burden benchmark of 70% is not exceeded under specific shock or baseline; yellow if exceeded under specific shock but not baseline; red if benchmark is exceeded under baseline; white if stress test not relevant. - Benchmarks referenced: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for public debt held by non-residents; 20 and 60 percent for share of foreign-currency denominated debt. - External financing requirement defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period. ### Policy implications and required measures - Fiscal consolidation of about 7 percent of non-oil GDP over the next decade is needed to align the non-oil primary deficit with the PIH norm of 5.4 percent of non-oil GDP by 2027/28. - The analysis highlights vulnerability to primary balance shocks, real GDP growth shocks, real interest rate shocks, and real exchange rate shocks; policy measures should consider buffers against these risks (as modeled in stress tests). *Source: IMF staff (Islamic Republic of Iran — Public Sector Debt Sustainability Analysis, As of February 08, 2018).* ### Appendix III. External DSA ### Appendix III. External DSA ### External Debt Sustainability Framework: Key projections and balances (Table 1) - Debt-stabilizing non-interest current account 6/: -1.2 - 1 Baseline: External debt (in percent of GDP) by year: - 2012: 2.0 - 2013: 1.7 - 2014: 1.2 - 2015: 2.7 - 2016: 2.3 - 2017: 2.0 - 2018: 2.2 - 2019: 2.3 - 2020: 2.6 - 2021: 2.5 - 2022: 2.5 - 2 Change in external debt (2012–22): - 2012: -1.3 - 2013: -0.3 - 2014: -0.5 - 2015: 1.5 - 2016: -0.4 - 2017: -0.3 - 2018: 0.2 - 2019: 0.2 - 2020: 0.2 - 2021: 0.0 - 2022: 0.0 - 3 Identified external debt-creating flows (4+8+9) (in percent of GDP): - 2012: -4.2 - 2013: -7.4 - 2014: -3.3 - 2015: -0.3 - 2016: -4.8 - 2017: -4.6 - 2018: -7.3 - 2019: -6.6 - 2020: -6.1 - 2021: -7.3 - 2022: -7.4 - 4 Current account deficit, excluding interest payments (in percent of GDP): - 2012: -6.3 - 2013: -6.9 - 2014: -3.4 - 2015: -0.8 - 2016: -4.3 - 2017: -4.9 - 2018: -7.3 - 2019: -6.6 - 2020: -6.1 - 2021: -6.2 - 2022: -6.3 - 5 Deficit in balance of goods and services (in percent of GDP): - 2012: -5.6 - 2013: -6.3 - 2014: -2.7 - 2015: -0.1 - 2016: -3.7 - 2017: -4.2 - 2018: -6.5 - 2019: -5.8 - 2020: -5.2 - 2021: -5.3 - 2022: -5.4 - 6 Exports (in percent of GDP): - 2012: 26.8 - 2013: 25.2 - 2014: 23.6 - 2015: 19.8 - 2016: 23.4 - 2017: 25.4 - 2018: 31.1 - 2019: 30.9 - 2020: 31.7 - 2021: 30.8 - 2022: 30.0 - 7 Imports (in percent of GDP): - 2012: 21.2 - 2013: 19.0 - 2014: 20.9 - 2015: 19.7 - 2016: 19.7 - 2017: 21.2 - 2018: 24.6 - 2019: 25.1 - 2020: 26.5 - 2021: 25.6 - 2022: 24.6 - 8 Net non-debt creating capital inflows (negative) (in percent of GDP): - 2012: 0.2 - 2013: -0.7 - 2014: 0.0 - 2015: -0.1 - 2016: -0.6 - 2017: -0.2 - 2018: -0.2 - 2019: -0.2 - 2020: -0.2 - 2021: -1.4 - 2022: -1.3 - 9 Automatic debt dynamics 1/ (in percent of GDP): - 2012: 1.9 - 2013: 0.2 - 2014: 0.1 - 2015: 0.6 - 2016: 0.1 - 2017: 0.5 - 2018: 0.3 - 2019: 0.3 - 2020: 0.3 - 2021: 0.3 - 2022: 0.2 - 10 Contribution from nominal interest rate (in percent of GDP): - 2012: 0.3 - 2013: 0.2 - 2014: 0.2 - 2015: 0.5 - 2016: 0.3 - 2017: 0.6 - 2018: 0.3 - 2019: 0.3 - 2020: 0.4 - 2021: 0.4 - 2022: 0.3 - 11 Contribution from real GDP growth (in percent of GDP): - 2012: 0.4 - 2013: 0.0 - 2014: -0.1 - 2015: 0.0 - 2016: -0.3 - 2017: -0.1 - 2018: -0.1 - 2019: -0.1 - 2020: -0.1 - 2021: -0.1 - 2022: -0.1 - 12 Contribution from price and exchange rate changes 2/: - 2012: 1.2 - 2013: 0.0 - 2014: -0.1 - 2015: 0.1 - 2016: 0.1 - 2017: .................. - 13 Residual, incl. change in gross foreign assets (2-3) 3/ (in percent of GDP): - 2012: 2.8 - 2013: 7.1 - 2014: 2.8 - 2015: 1.8 - 2016: 4.5 - 2017: 4.3 - 2018: 7.5 - 2019: 6.8 - 2020: 6.3 - 2021: 7.3 - 2022: 7.4 - External debt-to-exports ratio (in percent): - 2012: 7.4 - 2013: 6.7 - 2014: 5.1 - 2015: 13.4 - 2016: 9.8 - 2017: 7.9 - 2018: 7.0 - 2019: 7.5 - 2020: 8.0 - 2021: 8.3 - 2022: 8.4 - Gross external financing need (in billions of US dollars): - 2012: -9.8 - 2013: -23.3 - 2014: -12.5 - 2015: -0.4 - 2016: -12.4 - 2017: -13.7 - 2018: -25.6 - 2019: -22.4 - 2020: -19.2 - 2021: -20.6 - 2022: -22.5 - Gross external financing need (in percent of GDP): - 2012: -2.5 - 2013: -5.9 - 2014: -3.0 - 2015: -0.1 - 2016: -3.1 - 2017: -10-Year10-Year-3.2-6.1-5.4-4.8-4.9-5.0 (note: table shows "10-Year10-Year-3.2-6.1-5.4-4.8-4.9-5.0" — preserved as in source) ### Scenario with key variables at their historical averages and identified assumptions - Scenario with key variables at their historical averages 5/: 2.0 3.4 3.8 3.4 4.0 4.6 0.2 - Key Macroeconomic Assumptions Underlying Baseline — Historical average and standard deviation (selected series preserved as in source): - Real GDP growth (in percent): -7.7 -0.3 3.2 -1.6 12.5 2.2 5.5 4.3 4.0 4.0 4.1 4.2 4.4 - GDP deflator in US dollars (change in percent): -26.9 2.2 3.5 -9.9 -4.3 3.0 14.4 2.4 -6.8 -5.2 -7.4 1.4 1.6 - Nominal external interest rate (in percent): 5.6 12.1 12.4 35.2 12.6 11.0 9.0 28.7 16.7 15.6 15.0 14.6 14.2 - Growth of exports (US dollar terms, in percent): -32.6 -4.0 -0.1 -25.5 26.9 3.9 23.0 15.9 19.0 -2.1 -1.1 2.8 3.3 - Growth of imports (US dollar terms, in percent): -13.6 -8.8 18.0 -16.6 7.5 3.3 13.5 15.1 12.8 0.4 1.6 2.0 2.3 - Current account balance, excluding interest payments: 6.3 6.9 3.4 0.8 4.3 5.4 3.0 4.9 7.3 6.6 6.1 6.2 6.3 - Net non-debt creating capital inflows: -0.2 0.7 0.0 0.1 0.6 0.0 0.4 0.2 0.2 0.2 0.2 1.4 1.3 - Footnotes (preserved text): - 3/ For projection, line includes the impact of price and exchange rate changes. - 4/ Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period. - 5/ The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP. - 6/ Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year. - 2/ The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator). - 1/ Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt. ### External Debt Stress Tests and Scenario Outcomes (Figure 1 summary) - Tests and shocks applied: - Individual shocks are permanent one-half standard deviation shocks (note from figure). - Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance. - One-time real depreciation of 30 percent occurs in 2016 (real depreciation shock 4/). - Selected box figures preserved from the Figure 1 panels: - Baseline / Scenario / Historical (first box set): Baseline: 15.2; Scenario: 19.7; Historical: 11.0 - Baseline / Scenario / Historical (current account shock box): Baseline: 4.1; Scenario: 1.4; Historical: 2.2 - Baseline / Scenario / Historical (growth shock box): Baseline: 6.5; Scenario: 5.0; Historical: 5.4 ### Data and Statistical Issues: assessment and recommendations - General assessment: - Data provision is broadly adequate for surveillance with some data shortcomings. Data are reported with delays and also provided infrequently. - The Central Bank of Iran (CBI) disseminates key statistical aggregates in its quarterly Economic Trends. - National Accounts: - National accounts estimates published by the CBI and the Statistical Center of Iran (SCI) are significantly different. - Current-price GDP estimates do not cover significant parts of the non-observed economy; imputed rent of owner occupied dwellings appear overestimated. - Recommendations: improved coordination between CBI and SCI; improve accessibility and consistent time lag of quarterly estimates; implement double deflation for selected activities; improve compilation of taxes on products. - Price Statistics: - Monthly CPI and PPI for main urban areas are produced and disseminated by the CBI, use 2011 as the base year, are of good quality, and are released in a timely manner. - Government Finance Statistics: - Fiscal data for surveillance cover only the central government, are released on a cash basis without full expenditure detail, and are irregular. - The Treasury General’s Office collects budget execution data with expenditure breakdowns and evidences availability of data to compile complete GFS for budgetary central government. - Authorities lack capacity to compile general government fiscal data due to shortcomings in the chart of accounts and inability to track general government transactions. - Plans: strengthen Treasury functions, transition to a treasury single account, gradual move to accrual based accounting (Fund TA received). - Reporting of GFS data for publication in the Fund’s Government Finance Statistics Yearbook (GFSY) was discontinued in 2010; resumption is encouraged. - Developing general government and public sector debt statistics is key; expand coverage to include National Development Fund of Iran, Targeted Subsidy Organization, public pension funds. - Monetary and Financial Statistics: - CBI has not compiled/submitted monetary data to STA using standardized report forms (SRFs); latest monthly monetary data reported to STA use old forms with long lags, latest being for February 2017. - Data are highly aggregated hindering classification and sectoring of financial instruments. - Authorities plan improvements in line with the December 2017 STA multisector statistics mission. - Data for other financial corporations are yet to be compiled and reported to STA. - Financial Sector: - Financial soundness indicators (FSIs) are compiled semi-annually by the CBI for internal use and shared with Fund staff but not disseminated publicly. - FSIs comprise 23 indicators partially covering Fund recommendations; recommendation to compile at least quarterly and disseminate publicly; submit data to STA. - External Sector Statistics: - CBI does not submit quarterly or annual balance of payments data to the Fund for re-dissemination in the IFS. - Sizeable errors and omissions undermine reliability of BOP data due to undercoverage of transactions in other investment (including foreign deposits of resident nonfinancial corporations) and loans/deposit liabilities. - Direct investment source data deviate from international standards in concepts, coverage, scope, and basis of recording. - Recommendations from December 2017 mission: revive bank reporting system to improve services, investment income, personal transfers; address gaps in unpublished gross external debt statistics by sector/instrument. - International investment position (IIP) statistics are compiled but not disseminated. - Only public and publicly-guaranteed external debt are disseminated; classifications do not fully accord with 2003/2013 External Debt Statistics guidance. - Iran does not participate in World Bank’s Quarterly External Debt Statistics (QEDS) database. - Reserve asset positions are not publicly disseminated; data template on international reserves and foreign currency liquidity is not compiled. - Recommendation: publish the IIP and disseminate more comprehensive financial account data (including separately identifying assets and liabilities by financial instrument). - Data Standards and Quality: - Participant in the General Data Dissemination System (GDDS) since 2012. - Iran needs to improve scope and timeliness to meet Enhanced-GDDS and is encouraged to develop and maintain a national summary data page. - No data ROSC is available. *Source: Appendix III. External DSA, Islamic Republic of Iran — STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX.* ### 12.5 percent in 2016/17 (Iranian year starting March 21), real GDP growth moderated to ### cr1893 - 12.5 percent in 2016/17 (Iranian year starting March 21), real GDP growth moderated to ### Growth outlook and macroeconomic context - Real GDP growth moderated to around 4 percent in 2016/17. - Staff projects growth to be range-bound around 4 percent over the medium term. - Authorities consider potential growth conceivably higher given natural resources and human capital; higher growth needed to: - strengthen resilience to external shocks, - absorb highly educated youth into the labor force, - eradicate absolute poverty. - Full normalization of international trade and financial relations seen as facilitating realization of the economy’s potential. ### Inflation, current account, and reserves - Inflation lowered from over 40 percent in 2013 to around 10 percent by end-2015 and maintained since. - Current account recorded a surplus of around 4 percent of GDP in the past two years. - In 2016 (first full year after sanctions lifted): - Exports to the EU jumped by 344 percent. - Imports jumped by 26 percent. - Foreign reserves remain sizable at 15 months of imports. - Foreign debt is minimal at 2 percent of GDP. - Despite surplus, foreign reserves declined and CBI had difficulties accessing foreign assets with some trade partners. ### Authorities’ risk assessment and reform commitment - Major external risks: adverse geopolitical developments and lower oil prices. - Authorities committed to reforms in the Sixth Five Year Development Plan (6th FYDP, 2016/17-2020/21) and initiatives planned for 2018/19 consistent with 6th FYDP objectives and targets. ### Fiscal policy: outcomes, challenges, and reform measures - “Augmented” central government deficit narrowed to 2.3 percent of GDP in 2017/18 through expenditure restraint and strengthened tax administration. - Since 2015/16, tax collections have exceeded oil revenues as the main source of budget revenue. - Regularization of historical government arrears increased debt-to-GDP almost four-fold to close to 50 percent in 2016/17. - Higher oil revenues in 2018/19 expected to allow increased infrastructure and social welfare spending and trim the deficit to 2.1 percent of GDP. - Interest bill related to bank recapitalization and arrears securitization estimated to increase from 0.2 percent of GDP in 2017/18 to 5.2 percent of GDP in five years. - Staff recommends generating 4-5 percent of GDP in savings over the next 4-5 years through subsidy reform, expenditure restraint, and revenue effort; authorities view this as feasible but contingent on broad political and public support. - Policy measures and targets: - Fuel subsidies to be eliminated before end-2020/21. - Cash transfer program to remove the richest 20 percent of household recipients and implement more targeted means testing. - Disbursements by the National Development Fund of Iran (NDFI) to be curtailed; NDFI financing to be gradually restricted to infrastructure in needy and remote areas. - Focus on expanding the tax base and reducing/eliminating tax exemptions, especially those benefiting foundations and other entities; tax exemption of the largest religious foundation withdrawn earlier this month. - Institutional improvements: - Performance-based budgeting in one third of ministries. - Transition to accrual-based accounting in progress. - Development of a comprehensive debt management strategy. - Strengthening medium-term budgetary framework and aligning annual budgets with 5-year plans, emphasizing nonoil primary balance. ### Monetary and exchange rate policies - CBI determined to preserve gains on inflation; formalizing low and stable inflation as primary policy objective via CBI bill before parliament. - Inflation pressures sources: pass-through of exchange rate depreciation, administered price adjustments, high liquidity expansion; pressures expected to persist until reforms are entrenched. - Tightening monetary conditions: - CD rates issued by banks: 20 percent return on rial-denominated CDs and 4 percent on exchange rate-linked but rial-denominated CDs. - Real interest rates are significantly positive. - CBI lending to banks being contained; emergency liquidity support contingent on advance liquidity management plans. - CBI bill aims to modernize monetary policy framework (market-based instruments, interbank market, enhance central bank independence and operational autonomy). - Exchange rate developments: - Gap between official rate and market rate around 30 percent in early 2018; narrowed somewhat after CBI allowed banks in February to issue high-yield CDs. - Premium of market rate over official rate widened in more recent weeks due to seasonal factors ahead of Iranian New Year. - Exchange rate unification: - Authorities view unification as lynchpin of reform program. - Initial timeline to unify rates by March 2018 slipped by one full year due to external uncertainties and weak correspondent banking relationships (CBR). - As of February 2018: 78 percent of all imports in terms of product code and 48 percent in terms of value were at the market rate; shares are rising. - Intention that, starting in early 2018/19, all imports moved from the priority list to the market rate except basic foodstuffs and medicine. - After achieving critical mass of imports at market rate and supporting conditions, rates could be unified and then revert to a managed floating system. ### Financial sector: weaknesses and reform actions - Banking system burdened by past policy mismanagement and legacy issues: high NPLs, inadequate capitalization, bad-loan provisioning, low profitability across many banks. - UFI problem led CBI to: - Close several UFIs or merge them with commercial banks. - Transfer UFI balance sheets to licensed credit institutions. - Amend legal framework to make CBI sole body for licensing and regulating all financial institutions. - Government actions to address arrears and bank income: - Audit identified additional legacy government debt to creditors including banks. - Interest-bearing and marketable securities issued by government to partially clear arrears and support banks’ income while restricting dividend payments. - Government issued securities to partially recapitalize some state banks. - Planned and ongoing measures: - CBI planning Asset Quality Review in early 2018/19, with MCM advice, to quantify recapitalization needs. - Amendments to banking law pending with parliament to strengthen CBI supervisory authority and resolution powers. - AML/CFT improvements: amendments with parliament to align laws with international standards; dedicated AML/CFT units operational in virtually all banks; Iran gained observer status in the Eurasian AML/CFT group. - CBI requested an IMF assessment of AML/CFT framework to be completed by late 2019. - Pension system concerns: - Rising pension system deficit and unfavorable demographics and high youth unemployment threaten social security financing. - Parametric pension reform plan under development in line with staff recommendations; emphasis on increasing transparency, broadening coverage, and improving finances of general pension system. ### Structural reforms and labor market - 6th FYDP outlines objectives: reduce reliance on energy sector via diversification; improve business climate; broaden private sector role; close infrastructure gap; create jobs for highly-educated youth. - Youth unemployment has structural causes: high capital-intensity of production, young population profile, skill mismatch, high reservation wages, limited labor mobility (high housing cost), family protection for unemployed, social norms. - Female labor force participation (FLFP): - Share of women in total employment increased by 4 percentage points between mid-2014 and mid-2017. - Low FLFP likely reflects under- or nonreporting of part-time work, social norms restricting women in certain occupations, and limited affordable child care. - Increasing FLFP considered imperative to raising growth potential. - Policies to create jobs: - Nation-wide pilot internship program with two-year exemption from social security contributions to employers retaining interns. - Entrepreneurship courses introduced in secondary schools. - Incentives or increased penalties in reformed pension system to extend employment tenure. - Other structural priorities: - FDI seen as critical for oil and nonoil sectors; FDI approvals jumped almost five-fold in 2016 after sanctions removal though inward flows yet to be fully reflected in balance of payments. - New Iran Petroleum Contracts and approvals for large projects in copper and other minerals. - Business environment improving despite weak CBR; proposed customs law amendments expected to reduce administrative export delays. - Access to finance a major constraint; recapitalized banking sector expected to address this. - Environmental policies underway in water management, air pollution control, and protection of green areas and forests. ### Conclusion - Iranian economy strengthened in 2016 and 2017, supported by sound policies, major reforms, successful JCPOA implementation, and recovery of oil production and prices. - JCPOA implementation generated optimism about trade and financial normalization, but the “dividend” so far has been small and uncertain. - Authorities expect most JCPOA P5+1 signatories will adhere to the agreement and are pressing ahead with economic reform program to restore prosperity aligned with natural resource and human capital endowments. - Authorities confident that greater global integration benefits all. *International Monetary Fund staff report content.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1893.pdf_