Iran’s Goaded Guardian Grimace

Iranian shares seesawed ahead of May presidential elections, with Rouhani seeking a second term, in the wake of venerated moderate Rafsajani’s death and a harder anti-nuclear and terror monitoring and sanctions approach by the Trump administration, which officially put Tehran “on notice” without detailing steps. In December the main US restrictions against prominent state banks and companies, particularly tied to the Revolutionary Guard, were extended another decade, and President Trump attempted to ban immigration from the country in an executive order on national security grounds initially overturned in court. The rising tensions coincided with a positive IMF Article IV report hailing “impressive” economic recovery since the joint agreement reviving global commercial and financial ties, although it cited “urgent” banking reform and stability needs. In the first half of the March 2016-17 fiscal year GDP growth was 7.5 percent but the non-oil component was just 1 percent. Inflation dropped to 9 percent but money supply expanded almost 30 percent with central bank credit support. The current account surplus doubled as a portion of output to 6 percent with FDI in the hydrocarbon, auto and telecom sectors, and exchange rate depreciation continues with the official-market rate gap at 15 percent and unification again postponed. The benchmark lending rate was lowered 2 percent to 18 percent against a reported double-digit bank bad asset ratio, while the fiscal deficit persists at 3 percent of GDP on high subsidies. Capital adequacy was below 6 percent in 2015 and is negative at state intermediaries, with profits crimped by steep funding costs battering stock exchange financial listings. Previously unregulated credit providers are now under the central bank’s sway and pending legislation would update the decades-old enforcement and resolution framework.

Medium-term growth should settle at 4.5 percent but unemployment currently approaching 15 percent will stay steep, the Fund believes. If poor relations with the US scuttle the nuclear pact, recession could resume, and the restoration of correspondent banking ties depends on incipient observance of FATF anti-terror and money laundering standards. The banking system is “fragile” with real estate and public enterprise exposure souring books. Bad loans take a decade to write off and must be fully provisioned, so they are rolled over indefinitely. Only private banks as a small category raise their own money competitively through deposits and interbank lines, and a new corporate insolvency code is required to aid restructuring. The central bank must slash directed credit and gain more autonomy with the elimination of government board seats and inflation-target adoption. The nascent domestic debt market can develop further after securitization of contract arrears, and financial sector initiatives could be underwritten by the sovereign Oil Stabilization Fund. For fiscal discipline cash transfers should be ended for the richest households, and structural reforms can boost the private sector with the low scores in a range of World Bank Doing Business measures. Female and youth joblessness are 20-30 percent and labor and regulatory distortions impede hiring. National accounts lack comprehensive and timely data for investors and multiple exchange curbs prevail beyond the two-tier rate subject to the Fund’s Article VIII approval to retain membership, as doubts linger over nuclear club aspirations.