Iran is the second largest economy in the Middle East and North Africa (MENA) region after Saudi Arabia, with an estimated Gross Domestic Product (GDP) in 2016 of US$412.2 billion. It also has the second largest population of the region after Egypt, with an estimated 78.8 million people in 2015. Iran’s economy is characterized by the hydrocarbon sector, agriculture and services sectors, and a noticeable state presence in manufacturing and financial services. Iran ranks second in the world in natural gas reserves and fourth in proven crude oil reserves. Economic activity and government revenues still depend to a large extent on oil revenues and therefore remain volatile.
Iranian authorities have adopted a comprehensive strategy encompassing market-based reforms as reflected in the government’s 20-year vision document and the sixth five-year development plan for the 2016-2021 period. The sixth five-year development plan is comprised of three pillars, namely, the development of a resilient economy, progress in science and technology, and the promotion of cultural excellence. On the economic front, the development plan envisages an annual economic growth rate of 8 percent and reforms of state-owned enterprises, the financial and banking sector, and the allocation and management of oil revenues among the main priorities of the government during the five-year period.
The Iranian government has implemented a major reform of its subsidy program on key staples such as petroleum products, water, electricity and bread, which has resulted in a moderate improvement in the efficiency of expenditures and economic activities. The overall indirect subsidies, which were estimated to be equivalent to 27 percent of GDP in 2007/2008 (approximately US$77.2 billion), have been replaced by a direct cash transfer program to Iranian households. The second phase of the subsidy reform plan began in Spring 2014 which involves a more gradual fuel price adjustment than previously envisaged and the greater targeting of cash transfers to low-income households. Around 3 million high income households have already been removed from the cash transfer recipient list. As a result, the expenditures of the Targeted Subsidies Organization (TSO) is estimated to have declined to 3.4 percent of GDP in 2016 from 4.2 percent in 2014.
Following a contraction of close to 2 percent in 2015, the Iranian economy bounced back sharply in 2016 at an estimated 6.4 percent. Latest data available for the first half of the Iranian calendar year 2016 (ending in March 2017) suggest that the Iranian economy grew at an accelerated pace of 9.2 percent (year over year) in the second quarter (corresponding to July-September 2016) after a 5.2 percent growth in the first quarter. This brought the overall growth in the first half of 2016 to 7.4 percent, while non-oil GDP grew by a mere 0.9 percent. Despite the dominance of the oil sector—driven by the positive impact of the Joint Comprehensive Plan of Action implementation on oil production and exports, there are some signs of dynamism in the non-oil sectors as well. The unemployment rate returned to a three-year high of 12.7 percent (or 3.3 million unemployed) in the second quarter of 2016 despite the high growth rate in this period. This increase is largely a reflection of an increase in the labor participation rate to 40.4 percent compared to 35.4 percent in Jan-Mar 2014. Male and female unemployment rates of 21.8 and 10.4 percent respectively, also highlight a widening employment gender gap in the job market compared to 2015.
Poverty is estimated to have fallen from 13.1 percent to 8.1 percent between 2009 and 2013 (US$5.5 a day line in 2011 PPP). This was likely due to a universal cash transfer program in late 2010, which preceded the elimination of subsidies on energy and bread. The program appears to have more than compensated for the likely increase in energy expenditures of less-well-off households, thus contributing to positive consumption growth of the bottom 40 percent of the population, even though overall consumption growth between 2009 and 2013 was negative. However, poverty increased in 2014, which may have been associated with a declining social assistance in real terms.
Both external and budget balances improved in 2016. Iran’s current account surplus witnessed a strong boost due to the robust growth in oil exports. The current account surplus is estimated to have increased to 6.5 percent of GDP in 2016 up from 2.7 percent in 2015 benefiting strongly from the removal of oil sanctions and a recovery in exports. Similarly, the fiscal deficit is estimated to have improved in 2016 due to strong growth in revenues, with the central government budget deficit declining to around 1.5 percent of GDP from 1.9 percent in 2015. The government’s proposed budget for 2017 mandates a reduction in the deficit by reducing total expenditures and increasing overall revenue shares of GDP. Annual inflation is estimated to have fall below 10 percent in 2016, for the first time in a quarter of a century due to a less accommodative monetary policy.
In the medium to long term, growth prospects will rely on the pace of Iran’s reintegration with the global economy in banking, trade and investment and the implementation of key structural reforms. Growth rates in 2017-19 are expected to retreat to slightly above 4 percent. As Iranian banks face the challenge of delays in establishing correspondent banking relationship with large international banks, foreign direct investment inflows to Iran and trade relationships with the rest of the world are restrained. Still, recent developments suggest non-oil sector and investments are likely to play a bigger role in the next few year.
Going forward, implementing the domestic reform agenda is likely to bring the highest growth dividend in the medium to long term. The new government’s challenge, after the May elections, will be to prioritize the reforms outlined in the new five-year development plan and steadily implement them. This will involve tackling the structural reform agenda that will boost the non-oil sector growth, through creating a level-playing field for existing and new firms, improving the business environment and the efficiency of labor markets.
Last Updated: Apr 01, 2017