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Iran: Economy Needs Sweeping Changes

Victories by reformers in Iran's recent legislative elections could afford new opportunities to reform the country's ailing economy. But as RFE/RL correspondent Charles Recknagel reports in the second of a two-part series on economic reform in Iran, any economic recovery will require sweeping changes.

Prague, 6 April 2000 (RFE/RL) -- Economists say that Iran's domestic economy is ailing but that it can be fixed -- if reformers are willing to back major changes. RFE/RL asked Jahangir Amuzegar, an international economics consultant in Washington, D.C., to describe some of the economy's most urgent problems and what must be done to solve them.

Amuzegar said that the economy's main problems stem from the Islamic Revolution's attempt to build a paternalistic welfare state, which is characterized by an untenable mixture of maximum state control and subsidies yet minimum taxes.

The result is a fiscal imbalance that leaves Iran with few revenue sources beyond its oil exports, which provide some 80 percent of its foreign exchange earnings.

Amuzegar calls the tax situation particularly pressing. The economist says taxes account for less than 30 percent of total annual budget revenues, or only about 6 to 7 percent of Iran's annual Gross Domestic Product, GDP. (By comparison, taxes contribute twice that amount to the GDP of Mexico, a country in the same per-capita income category as Iran.)

The reasons for the tax shortfall are widespread tax exemptions for state and quasi-public enterprises and widespread evasion by those not so favored. Both conditions need fixing.

The government's budgetary problems are further aggravated by the state's own expensive system of providing subsidies for food, fuel, medicine and utilities. The economist estimates the cost of such subsidies at some 15 to 20 percent of the GDP.

Huge subsides also go to propping up money-losing state or quasi-public enterprises. These include many of the Islamic Republic's bonyads, or charitable foundations, which reportedly control some 40 percent of the non-oil economy. The monopolistic bonyads receive easy access to cheap foreign exchange allocations from the government and to low-cost credits from the nationalized banks.

Amuzegar says privatization of loss-making enterprises and cutbacks in the subsidy system are immediate needs if the economy is to become more efficient.

"In the immediate run, I think the most crucial steps would be the privatization of money-losing enterprises and effective de-nationalization of banking and insurance, dismantling of the bonyads and restructuring the public subsidies system toward a more means-tested welfare system."

But Iran's economy faces longer-term challenges, too. Among the toughest is diversification to make it less dependent on oil revenues.

Economists say the oil revenues alone are not enough to bring in the amounts of money Iran now needs for capital investment to spark economic growth. Benchmark oil prices shot up over the past year from lows of around $10 to some two and-a-half times that. But they are now on their way down again after an OPEC accord last month to increase production.

Amuzegar says Iran suffers from a wide gap between its revenues and what it needs to reach the government's own growth target of 5 to 6 percent a year.

"Iran suffers today from a wide resource gap. The national savings are at best only about 15 to 16 percent of the gross domestic product. The need for investment to assure 5 or 6 percent growth, which has been the target of the government in the last 10 or 15 years is for 30 percent or more of GDP. So there is a 15 percent or so resource gap."

He says that gap must be filled by new investment, with the most likely sources being either Iranian exiles or foreign investors.

But to lure those investors, as well as encourage Iran's own domestic investors to keep their money at home, the country will have to undertake other major economic reforms. Among them is putting an end to Iran's multiple exchange rate for the rial, which has been a major discouragement to Iran's non-oil exporters and to foreign companies.

The multiple rates have provided the best exchange values to officials and oil exporters, but highly unrealistic exchange rates for all others. In recent years, the government has moved to create a more market-based rate by allowing currency transactions on the Tehran Stock Exchange. But Amuzegar says that only a single exchange rate would help end the abuses of the multiple rate system, which has strongly contributed to corruption and capital flight. Amuzegar says:

"In the near-term, the things to do would be to unify the exchange rate totally, to remove all barriers against exports of non-subsidized goods and let the proceeds of all non-oil exports be sold in the free market."

Economists say that such reforms will inevitably cause Iranians pain in the short term. With reforms would come dismantling of many subsidies and vested interests upon which people have grown dependent. But Amuzegar says the price of not reforming is much higher.

"There is no doubt that any real economic reform, whether it is privatization or exchange unification or reduced subsidies, will immediately result in more unemployment, more inflation and wider income gaps. But this is the bitter pill that they have to swallow sooner or later. The problems that Iran faces today are the result of the cost-price distortions of the last 20 years. Therefore, the more they wait, the harder the problem gets to solve."

And that, economists agree, should be encouragement enough for Iran to start reforming its economy now.

(This concludes the two-part series on Iran and Economic Reform.)