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Rouhani’s bad news budget

The Rouhani administration’s proposed budget for the coming Iranian year is set to be contractionary in real terms and could lead to a credit crunch.

With the recent wave of protests in Iran igniting debate over the government's budget bill for the next Iranian year (beginning March 20), it is important to understand how President Hassan Rouhani's administration has been approaching the matter.

In the bill Rouhani submitted to parliament Dec. 10, the government’s general budget is set at $103 billion, 6.1% higher than the previous budget in rial terms. The general budget excludes the state-owned enterprises, which are included in the much larger total budget. Given a projected inflation rate of at least 10% over the coming year, the general budget is set to be contractionary in real terms.

Three main points can be made about the elements of the budget bill: taxes and sales of debt securities are expected to be 11.2% and 26.6% higher, while oil, gas and petrochemicals proceeds are set to fall by 11%; current expenditures are predicted to surge by about 9%; and funding for infrastructure spending will decrease the most, as in preceding years.

One of the underlying flaws of the budget bill is that it is fraught with unrealistic revenue expectations. For instance, the Islamic Parliament Research Center (IPRCI) estimates that revenues in the coming year will only reach $82 billion, some $21 billion short of what is projected in the draft budget. Thus the Rouhani administration would once again experience a budget deficit. In this vein, it should be noted that the National Tax Administration has collected less in taxes than expected for the current year. In light of the difficult economic situation, despite limited improvement in the business climate in recent years, projecting a more than 11% hike in tax receipts can be characterized as unrealistic.

Despite Rouhani’s success so far in keeping current expenditures and payrolls in check — both major components of general budget costs — it seems he is beginning to lose sight of this important task. Current spending in the coming Iranian year is bound to continue to hover around $76 billion, while discretionary outlays are expected to remain at some $6.5 billion. The latter sum is needed to cover civil servant salaries and pensions, repay outstanding debts and support civil engineering projects. According to IPRCI’s figures, the government will need to spend $25 billion in all these areas — almost four times what it anticipates.

As for infrastructure spending, it appears there will be a sharp decline. This is both due to the volatility of available development funding and a reduction in its share of total government expenditures. Having said that, Adel Azar, head of the Supreme Audit Court, remarked to the parliament, “On paper, the budget increases every year, but in practice, year by year, government credits for construction projects are reduced, with an average of 87% of the state budget devoted to cost credits.” With the current budgeting, Azar reiterated, development projects will have to be shut down.

Azar has also criticized the budget's negative operational balance as another symptom of its ills. He said, “The operational balance, which is the difference between actual revenues and credit costs, has risen annually and reached $19 billion over 2016-17. … So far, to finance the budget, oil and state companies have been sold. But now, there is the odd occurrence of credit [being] generated from the sale of bonds and treasury bills. This means that we settle bonds for [other] bonds and [thus] sell the future of our children to fund [current expenditures]."

Indeed, the lion’s share of revenues from oil exports, taxes and sales of sovereign securities has in recent years been largely allocated to covering current spending and paying off debts. Consequently, this has undermined the allocation of funding for development projects. Worryingly, should major financial resources be allotted for them, it is highly probable that they would be chiefly sponsored through debt sales. As things stand, the Rouhani administration’s financial condition is set to deteriorate given the current situation on oil markets and the broader state of the Iranian economy.

IPRCI’s estimates indicate that if state spending climbs in accordance with the average of the last 20 years, namely around 20%, the government has no chance of being able to allocate funding for development projects. In this vein, it should be noted that the Treasury has been saying that it has no funding left for infrastructure spending since it needs to repay some $9 billion of various types of debt that will soon mature. Hence, the government will likely be forced to borrow from the Central Bank to meet its obligations. This, in turn, could translate into a credit crunch, which could have a dire effect on the economy. It would also mark the return of higher inflation for the medium term. As such, since non-oil revenues are set to be devoted to mounting current expenditures, civil engineering projects are doomed to suffer the most.

Given that both Iranian and international institutions expect oil prices to remain south of $55 per barrel, the government's move to calculate the budget based on that price in its bill is risky. Indeed, the Rouhani administration would lose about $446 million for each dollar that oil prices drop. For instance, a $5 drop would equal the spending for infrastructure projects in the first half of the current Iranian year.

Moreover, the government setting the dollar rate at 35,000 rials for next year’s budget at a time when it trades for 43,000 on the open market is indicative of faulty estimates. Indeed, the inclusion of 100 trillion rials ($2.77 billion) as revenue in other parts of the budget bill based on calculations of a dollar exchange rate of 39,000 rials suggests that the latter will be the Central Bank’s real conversion rate in the coming Iranian year.

Rouhani's budget bill has huge holes since effective measures to address the challenges facing the Iranian economy have not been devised. Indeed, solutions to issues pertaining to water shortages and the environment, pension funds, budget deficits and the banking crisis, to name just a few problems, have not been addressed in an open and clear manner. When scrutinizing the budget proposal, it is thus evident that the country's age-old dilemmas continue to be ignored and that there is still a lack of determination to tackle them in the foreseeable future.

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