Rouhani's New Budget Offers Pain Without Hope

February 14, 2015 Topic: EconomicsPolitical Economy Region: Iran Tags: Hassan Rouhani

Rouhani's New Budget Offers Pain Without Hope

Contradictory economic goals won't rescue Iran from its present crisis. The economic chaos of the Ahmadinejad years could come back.

The government also hopes to raise 27 percent of its budgeted revenues from “privatization and financial transactions.” This can prove difficult if not impossible given the past experience with privatization. Most state enterprises show loss, and many of the semi-finished projects are too bulky for the weak private sector to handle; it may only afford to take shares in enterprises or projects which have immediate profit prospects, leaving the losing ones for the government to shoulder. Besides, in the past, even when the government was able to sell its profitable enterprises or transfer its semi-finished projects, they have ended up in quasi-public foundations that pay little to no cash-outs or taxes. And these public transactions tend to be seriously afflicted by corruption.

Under this revenue condition, and given that the international sanctions will not allow Tehran to borrow or benefit from the global financial markets anytime soon, the government will be forced to spend a permissible portion of the reserves or oil funds, which the Rouhani government has said is about $30 billion. Yet, the budget bill as proposed to the Parliament does not allow the government to withdraw from this national savings from past oil exports. Despite this pledge, the government will certainly have to spend some of the reserves to cover the expected huge budget deficit. Even if this was allowed, the Parliament will certainly limit the government on where the reserve dollars can be spent, legally only on infrastructure and “productive sectors.”

Uses of the Budget

The new budget is also problematic on the expenditures side. First, operating spending far outweighs development funds in the new budget. This is bad news for an economy that must grow quickly to produce jobs and income if it is to remain stable. Iran has only just clawed its way back to zero growth after negative 5 percent growth in 2013. It will again fall into recession if the required infrastructural and productive investments are not made soon. The need for these investments is in the billions of dollars. Thus far the Rouhani government has neglected this problem as it has focused on nuclear negotiations and controlling inflation. Neoliberalism prioritizes foreign trade and price stability over production and job creation. With inflation expected to climb next year and Khamenei’s autarkic visions standing on the hose of foreign trade, even those goals will be hard to meet.

Second, apparently the government will spend 11 percent more in this budget than it did in the previous one, much of it on operational expenditures, with the Office of the President receiving a 29 percent jump. However, given that a 20 percent inflation rate is assumed, real government spending will be 9 percent less. In reality, the shortfall will be much higher given that the assumed inflation rate for 2015 is already appearing illusory. Cuts in subsidies will make food and fuel more expensive for the populace, while the official devaluation will raise input prices for production, leading to further economic stagnation and an inflationary multiplier effect across the economy.

Third, the budget is based on two legs: austerity and security. Neither of these legs can be cut without serious consequences. On the austerity side, thanks to the IMF’s “stabilization” advice, the government may have already crossed the red line of a pauperizing population struggling to make ends meet. On the security side, powerful forces will make it impossible for the government to suggest any savings given the continuing old threats and the looming new threats from ISIS and other regional adversaries. Indeed, the claimed increases in government spending is largely going to the defense and security sector, including a 17 percent pay raise for their personnel.

Thus, the defense budget is boosted by 33 percent (of which 64 percent will go to the IRGC and its Basij militia), the Intelligence Ministry budget by 40 percent, and the Special Revolutionary Court budget by 37 percent. These budget increases do not account for the assumed inflation rate. Regardless, the 17 percent increase in salaries of the civil and defense personnel is below the official inflation rate. Although Iran’s defense-security budget is only about 4 percent of its GNP, in terms of its percentage of the government budget, it is highly notable. One key reason the USSR collapsed was the fact that the United States had effectively forced it to spend more and more on its military and security.

On the austerity side, except for health, which is receiving a 58 percent increase, the budgets for most other social programs have been cut. Direct subsidies have been cut by 26 percent, and subsidies for housing, education, food, and fuel have also been reduced when the inflation rate is accounted for. About 19 percent of the general budget will go to social and cultural affairs, of which only 37 percent is dedicated to social welfare and security. The budget also fails to devote funds for the repayment of the government’s growing debt to the social security and retirement funds. The future of support for the elderly is in jeopardy—and funding for the wellbeing of the youth is also suboptimal.

Finally, the budget neglects the productive sectors, infrastructure and the environment. Development funds have been increased by a nominal 16 percent; in real terms that will mean a reduction. Agriculture receives an increase, but its share is minimal relative to the sector’s need. Manufacturing remains cash-hungry given the tight-money policy and a 22 percent interest rate. R&D’s share in the GNP remains at about 0.6 percent, and industry-driven R&D is almost nonexistent. Infrastructure, including transportation and urban development, is equally under-budgeted. Worse yet is the country’s environment, which will need funds to be rescued from potential disasters emerging around the country, but it’s only received a 20 percent nominal budget increase.

Possible Fallouts

The austerity cuts will leave the poorer groups (over 50 percent of the population) with no social safety net, creating a highly explosive situation in a stagflationary economy, where youth unemployment and inflation rates are about 20 percent each if official statistics are believed. Suboptimal budgets for productive sectors, infrastructure and environment will further depress the economy, creating more malaise. Their development budget, as in the past, will be the first to suffer from the expected further reduction in government revenues. Meanwhile, the economy will continue to suffer from pervasive corruption, rent-seeking monopolies and a debt-ridden banking system.

This austerity-security budget will have other far-reaching consequences in an environment of falling oil prices and continuing sanctions. The official devaluation and lack of sufficient development funds will only reduce the purchasing power of the population and increase input prices, leading to a decline in productive sectors. These sectors are already suffering from low profits relative to the interest rates they are charged by the banks. An additional rise in the price of inputs, including wages of labor, will force many of them into closure and bankruptcy. The current stagflation will then further deepen, reducing government revenues from tax and other sources.

Pressed for cash, the government may attempt to recover the decline in revenues by selling hard-earned foreign currency directly or through rent-seeking institutions and individuals in the black markets at exorbitant prices. The result will be a further decline in local currency value and more inflation and corruption. This scenario can happen if the Central Bank remains a subordinate of the government. The cash-hungry government may also allow rent-seeking monopolies and individuals to bust sanctions in export/import deals, further deepening the economy into corruption. The institutional foundation of the economy is already too thin and highly dilapidated.


Under these circumstances, the government will also not be able to maintain its current contractionary economic policy. The tight-money policy was designed to curb inflation without negatively impacting productive sectors. In reality, while inflation was checked to some extent, it did so only at the expense of production, employment, consumption and income distribution. Faced with the new budget realities, the tight-money policy will have to be relaxed, but an expansionary policy cannot be introduced given the revenue shortfall. Thus, economic policy will be ad hoc again, and economic trends could revert to where they were when Rouhani took over in the summer of 2013.

Other problems will also be exacerbated. On the domestic front, the income gap between the rich and the poor will further widen, and absolute poverty will increase. Social justice is expected to be a key tenet of the Islamic economic system. Yet the poor will be squeezed.

Regionally, the falling oil price will reduce Iran’s influence as it becomes less capable of financing its friends in the region, stretched from Syria, Iraq, Lebanon and Palestine to other countries. Internationally, this constellation of economic difficulties will negatively impact Iran’s ability to negotiate a better nuclear deal, forcing it to make more concessions in return for less sanctions relief.

Some Words of Advice

Iran’s 2015 budget is not based on a development plan, its outlook spans no longer than a year, and it is built around the neoliberal idea of curbing inflation by shrinking public welfare and the national market, while hoping to boost foreign trade in the context of international sanctions. The principal victims of this approach are employment, domestic production, the national market, consumption and a more balanced income distribution. This economic approach will be particularly brutal in Iran, where 70 percent of its eighty million people are under forty, where half the population suffers from absolute or relative poverty, and where young, talented people are a hugely underutilized national asset.