Iran budget under scrutiny as oil revenues fall

Bourse and Bazaar | Navid Kalhor: Next week, President Hassan Rouhani will submit a budget proposal for the forthcoming Persian year (covering March 2019-2020). The budget bill’s adherence to fiscal rules and the reasonableness of its estimates will be under intense scrutiny given the volatile political and economic climate in Iran.

Policymakers and business leaders see the budget as having four purposes: to maintain economic stability, to boost economic growth, to expand redistribution for poverty reduction, and to supply public goods. Given limited resources related to the reimpositon of sanctions, the Rouhani administration intends to focus on the latter two goals. For example, the administration is slated to earmark USD 14 billion of its hard-earned oil dollars to ease importation of a group of 25 items classified as basic goods and medications.

In the face of such emergency expenditures, the cabinet must carefully balance its budget to ensure that spending is kept in line with revenue, especially given the impact of sanctions on the contribution of oil revenues.

Assuming that Iran will continue to sell 1 million barrels per day (mbpd) of crude oil at USD 54 per barrel, total oil revenues next year will reach approximately USD 20 billion or about IRR 1,140 trillion, at the effective official exchange rate of IRR 57,000. More optimistically, if Iran can manage to keep exports around 1.5 mbpd, the state will earn USD 30 billion, or IRR 1,710 trillion.

According to Iran’s Sixth Development Plan, which establishes guidelines for government budgets and covers a five-year period from 2016, revenue estimates for oil and gas condensate exports cannot exceed a forecasted IRR 1,150 trillion by more than 15 percent. As such, the budget must technically be balanced based on oil revenues of IRR 1,300 trillion. A draft version of the budget places oil revenues at IRR 1,690 trillion, flouting the rule.

Moreover, the Sixth Development Plan mandates that 14.5 percent of oil revenues be allocated to the National Iranian Oil Company, 34 percent to the National Development Fund of Iran (NDFI) and 3 percent for investment in Iran’s underdeveloped regions. The remaining revenues are earmarked for use by the central government.

In an effort to increase its available resources, the Rouhani administration planned to cancel the allocation of oil revenues to NDFI. But Iran’s Supreme Leader, Ayatollah Ali Khamenei, intervened to ensure NDFI secures at least a 14 percent allocation. When allocations are reduced, the government typically does not actually transfer the diverted revenue to the Central Bank of Iran, maintaining the funds outside of Iran. This means that the government is effectively printing money, adding inflationary pressure.

A further challenge for the Rouhani government will be that even if oil revenues can be sustained, sanctions will force the government to receive most of its foreign exchange earnings in currencies such as the Indian Rupee, Iraqi Dinar, Turkish Lira and Chinese Yuan. These funds, deposited into escrow accounts as governed by the Significant Reduction Exemptions (SREs) issued by the Trump administration to eight of Iran’s oil purchasers, will not prove as valuable or liquid.

While some have speculated that allowing the rial to depreciate could have served to minimize a budget deficit given the large proportion of foreign exchange revenues, the overall reduction in oil revenue and the need for new expenditures, such as allocations for the import of basic goods and pharmaceuticals, negates any benefit.

In the same vein, given high interest rates on Iran’s debt market during the sanctions era, the government will face difficulties in repaying its deferred debts through the issuance of bonds. Furthermore, the Plan and Budget Organization of Iran is set to issue new debt in 2019-20 close to the IRR 560 trillion ceiling specified in the Sixth Development Program.

With revenue squeezed for the reasons outlined above, Rouhani will be under pressure to reduce spending, especially through the elimination of subsidies. First, the administration could decide to end the allocation of subsidized dollars for the import of essential goods and medication. This may exacerbate inflation, but it is not clear as to whether the subsidies are actually serving to keep consumer prices low, or whether importers and wholesalers are padding their profits. If inflation continues slow in coming months as the rial regains value, there may be a case for reducing the subsidy.

Second, the some economic commentators have proposed eliminating subsidies for fuel in the favor of shopping cards that enable households to get discounted prices for essential foodstuffs. This would replace a subsidy for essential goods importers with a subsidy for consumers. Not only would such an approach protect foreign exchange reserves, it arguably would more effectively support underprivileged groups in the society.

Currently, the Rouhani administration has few options as it seeks to avoid a budget deficit. Yet the political tradeoffs required when devising a budget under sanctions may prove more difficult to manage than the economic challenges.