Iran’s economy is characterized by its hydrocarbon, agricultural, and service sectors, as well as a noticeable state presence in the manufacturing and financial services. Iran ranks second in the world for natural gas reserves and fourth for proven crude oil reserves and, while relatively diversified for an oil exporting country, economic activity and government revenues still rely on oil revenues and have, therefore, been volatile.
The Iranian authorities have adopted a comprehensive strategy of market-based reforms for their 20-year economic vision and five-year development plan for 2016/17 to 2021/22. The plan comprises three pillars: the development of a resilient economy, progress in science and technology, and the promotion of cultural excellence. Among its priorities are the reform of state-owned enterprises and the financial and banking sectors, and the allocation and management of oil revenues. The plan forecasts annual economic growth of 8%.
Iran is grappling with the impact of COVID-19 crisis. With more than 1.7 million cases, as of mid-March 2021, and 61,000 deaths, it remains the worst affected country in the Middle East and North Africa region. After stricter lockdown measures in late-2020, the number of new, confirmed cases stayed stable and the number of deaths fell below 100 persons a day. However, a gradual relaxation of lockdown measures raises the likelihood of a fourth wave of COVID-19 cases. The vaccination of frontline medical workers started in February 2021, but full coverage of Iran’s large population of 84 million will take time.
Gross Domestic Product (GDP) has been estimated at US$628 billion for the Iranian calendar year 2020/21, calculated at the official exchange rate for a population of about 84 million. Iran’s real GDP is estimated to grow by 1.7% in 2020/21. Output loss from COVID-19 was less pronounced than in other countries, as Iran’s economy had already contracted by 12% over the previous two years. Economic recovery in Q3 and Q4-2020 was stronger than expected, both in the oil and non-oil sectors, with the non-oil sector’s rebound driven by manufacturing, as exchange rate depreciation made domestic production more competitive.
The COVID-19 pandemic has, however, severely affected jobs and income in many labor-intensive activities, including high-contact services and the informal sector. Discouragement in the labor market, reflected in lower economic participation—of 41.4% in Q4-2020—drove the unemployment rate down to 9.4%, despite employment levels falling by over 1 million YoY as a result of the pandemic.
COVID-19 expenditure and plummeting oil revenues have increased Iran’s fiscal deficit-to-GDP ratio to its highest in decades. Government revenues April to December 2020 (9M-2020/21) were only 55% of the approved budget for the entire year. Similarly, only 14% of anticipated oil income materialized, due to lower oil export volumes and prices. Meanwhile, the higher health and social assistance costs resulting from the pandemic pushed total expenditures up by 28% YoY. As such, the country’s fiscal deficit is estimated to increase to over 6% of GDP and public debt to surpass 50% in 2020/21.
Inflationary pressures also increased in 2020/21, as the Iranian rial depreciated due to a limited supply of foreign exchange and heightened economic uncertainty. Inflation resurged to over 48% (YoY) in February 2021. Since April 2020, the currency has lost half of its value because of US sanctions placed on accessing reserves abroad. Hopes of sanctions’ relief after the November US elections led the rial to regain about 15%. Exchange rate volatility and government financing operations had negative spillover in the stock market.
These recent economic trends have added stress to low-income households and stalled poverty reduction. Poverty increased by 1 percentage point from 2017/18 to 2018/19, reaching 14% before the pandemic. Now, it is estimated that loss in household incomes through the pandemic and the rising cost of living, due to inflation, will push poverty up by 20 percentage points. A range of social protection measures have been introduced in response but, while they partially compensate for the lost incomes, their real value will erode with continued high inflation.
Iran’s economic outlook hinges on the evolution of the COVID-19 pandemic and the pace of global economic recovery. Recovery to its GDP is projected to be gradual, due to slow vaccination rollout and weak demand from regional trading partners. A decrease in inflation is forecast but, nonetheless, inflation is likely to remain above 20% on average in the medium-term. Coming on top of limited fiscal space and high inflation, economic pressure on poor households will continue. Better targeting of cash transfers can help reduce mitigation costs.
In the absence of a pick-up in oil revenues, the fiscal deficit is projected to remain high in the medium term. Slow economic recovery would translate into similarly slow growth in non-oil revenues. Higher reliance on bond issuance, especially of short-term bonds, would increase interest payments and amortizations costs. Further issuance of government debt and the sale of public assets could increase financial contagion risks in the stock market and place more stress on the undercapitalized banking sector.
Last Updated: Mar 30, 2021