Tyranny of numbers

Rouhani’s new budget cuts back on expenditures, big time

Posted in General, Inflation, Macroeconomy, Sanctions by Djavad on January 31, 2019

If the government of Hassan Rouhani has a plan for fighting the downward trend in Iran’s economy, the one started with the US withdrawal from the nuclear deal, it is not to be found in its proposed budget for the Iranian year 1398 (March 21, 2019 to March 20, 2020).  The budget, which may be modified by Iran’s parliament in the next few weeks, is proposing serious cuts to expenditures.   Blaming shrinking revenues from oil, the government has decided to deal with the shock of the Trump sanctions and fleeing private investment by reducing its own expenditures.  Not a surprise from a government that has made fighting inflation its top priority and jobs creation the purview of the private sector. This is reasonable logic in normal time, but not when factories are cutting back on production and employment or shutting down altogether.    

Starting with the numbers, next year the budget proposes to reduce real public expenditures, in real terms, by 17.4 percent (assuming 30 percent inflation).  Paradoxically, the largest reduction, 27.4 percent, is reserved for development expenditures, which will go down to 13 percent of total expenditures.  Paradoxical, because public investment is the only really policy tool for stemming the rise in joblessness while sanctions keep closed the usual routes to recovery — rising exports following a devaluation. As a proportion of the GDP, about 15 percent, this is one of the smallest budgets in years.

Table.  The proposed budget for 1398 (2019/2020)


Trillion rials change Shares
2018/19 2019/20 Nominal Real 2018/19 2019/20
Revenues 4249.1 4786.3 12.6 -17.4 100.0 100.0
Taxes 1287.2 1535.7 19.3 -10.7 30.3 32.1
Oil 1065.6 1480.4 38.9 8.9 25.1 30.9
Sale of financial assets 680.9 510.0 -25.1 -55.1 16.0 10.7
Other 1215.5 1260.1 3.7 -26.3 28.6 26.3
Expenditures 4249.1 4786.3 12.6 -17.4 100.0 100.0
Current 2764.3 3206.9 16.0 -14.0 65.1 67.0
Development 604.3 620.2 2.6 -27.4 14.2 13.0
Other 880.5 959.2 8.9 -21.1 20.7 20.0

Notes: The budget deficit is reflected in the “sale of financial assets.”

Current expenditures, which account for two-thirds of the total, are expected to fall by 14 percent.   This cut is coming mostly from a reduced government wage bill, which is set to decline by 11 percent in nominal terms and 41 percent in real terms. How the government plans to achieve such a drastic cut in its wage bill while promising to raise public salaries by 20 percent at the start of the new year (March 21, 2019) I do not understand.  By the way, a 20 percent increase will still mean a substantial decline in their pay in real terms.  Someone has to pay for the adjustment to the sanctions shock and, as they say in Iran, no wall is shorter than that of public employees.

But shorter still is the wall of public investment. To see how little the government plans for investment, consider the share of development expenditures in GDP, which next year will amount to roughly 30×10^12 (good to get rid of some of these zeros): a measly 2 percent, much lower than the average proposed share of 3.7 percent in the last four years.  For comparison, note that according to OECD in 2009 Korea, a leader in the pack, spent more than 20 percent of its GDP on public investment and the average was about 7 percent.  Two percent will not pay for repairs, let alone add to the stock of public capital.

The share of taxes in government revenues, 32 percent, are about the same as this year, but the share of oil will increase to 31 percent, despite the expected decline in exports, because the government expects to sell its dollars (I mean euros) at a higher exchange rate. About $14 billion will be sold at the subsidized rate of 42000 rials per USD and the rest at whatever the market determines next year.  Iran’s earnings from oil are expected to reach close to $30 billion, of which $21 billion will be available to the government through the budget, the rest going to the National Development Fund and NIOC.  So, with two-thirds of the national wealth going to subsidize consumption, not much is left for public investment.

Although the entire budget seems too conservative to me, its implicit assumption for oil export is on the optimistic side. The budget assumes about 1.5 million barrels per day of oil exports (including 0.4 mbd of condensates), which is what Iran is doing now but may not last if the experience of the 2012 round of sanctions is any guide.  After 2012, Iranian oil exports were on their way down and stopped only after the nuclear talks got underway.  With little prospects for this round of US sanctions to ease any time soon, and the tight control over Iran’s financial transactions and shipping, maintaining oil exports at 1.5 mbd would require substantial help from Iran’s global partners, who may be getting very tired of US unilateral sanctions.  The EU’s proposed financial mechanism (INSTEX), which was announced this week, may be limited to humanitarian transactions, but it could be the crack that burst the dam.

Ironically, the Iranian government has enormous sources of revenue that is does not tap for this purpose. It sell about 5 million barrels per day of oil and gas to its citizens, worth somewhere between $50-$100 billion per year.  But, instead, the government loses money in distributing this vast amount of energy.  Moreover, rather than being a source of revenue for job creation and economic growth, it is in silent war with jobs.  Cheap energy favors capital intensive production and thus discourages employment.  Energy price reform is the single most important policy failure of various governments in Iran.  It has been much talked about, and even once tried at great cost, with little to show for.

Can the government find money in selling its meagre earnings of foreign exchange?  It plans to allocate $14 billion of its earnings — about one-half — to be sold at 42000 rials per dollar for import of basic and essential goods, but so far this policy has failed to keep the price of those goods from rising.  As long as someone across the border is willing to pay 2-3 times the local price for Iranian goods, these goods will find their way out of Iran’s markets.  The smuggling of 20 percent f Iran’s gasoline is the well-known example, but even live sheep are leaving the country.  Why not sell these dollars at the market price to finance development projects?  It can always use part of the proceeds to support the poor.   The answer is fear of inflation.

 

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