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Iranian President Mahmoud Ahmadinejad attends the opening of the first Asian Mayors Forum in Tehran November 19, 2008. (Reuters Photo)
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These days many developing countries, including Iran, are deeply concerned about the impact of the current financial crisis on their economies. The crisis first started in the financial market of the United States, and then spread to Europe and many other countries in Asia and Latin America that have been keeping close economic relations with the West.
Certainly, there are historical precedents for the current financial crisis; Asia experienced an economic crisis in the late 1990s, and various other countries, such as Argentina, Turkey, Mexico, Sweden, South Korea and Iran, also went through stock market meltdowns, bank failures and credit crunches at various times in the past.
It can be argued that the free market economy is the most efficient way to run an economy, but it has never been argued that it will always bring stability. As a matter of fact, the free market economies of the world have experienced about 100 crises over the past three decades.
In response to the crisis, Western leaders have taken a step backward on their firm stance on the effectiveness of the self-correcting market mechanism solution to the crisis, and have come forth as governments to the rescue of the collapsing banks and the plummeting stock markets in an effort to restore the confidence that has been steeply eroding on the economic scene.
Although it is not easy to pin down the real cause of the current financial crisis, many economists believe that the so-called subprime lending in the United States that essentially targeted the more risky customers–those with poor repayment record and those lacking resources to make larger down payments, and the tendency to link the lending to the rising prices of houses, or the phenomenon of so-called “shadow banking system”, is apparently what sparked the crisis.
The central element in that phenomenon was mortgage securitization, i.e. mortgage brokers starting off mortgages that they sold to others. Borrowers were told that housing prices would rise and that they could refinance to pay for their debt and also benefit from the capital gained. The mortgage brokers benefited from starting off as many mortgages as they could. The brokers’ allies in investment banking bought them and “sliced and diced the risk,” and then passed on as much as they could.
But the miscalculation was that with real disposable incomes shrinking due to deregulation, demand for housing stumbled and housing prices did not rise as expected and the mortgage crisis began.
As banking crises are normally contagious, the crisis spread to the banking systems in Europe and other countries with major links to the US and European banking systems.
Even though it is still premature to speculate the impact of the current financial crisis on Western countries, there already are some indications that a tough road might be lying ahead. And if the crisis worsens, the US and European flow of high-tech investment to developing countries is going to become severely constrained.
Furthermore, if the crisis turns into a depression, there is a likelihood of reversion to more inward looking policies in the United States and Europe. If this happens, the countries outside the US-European orbit, such as Iran, will suffer on different levels; they will lose their export markets and hence export revenues; they will have to pay more for imports; and they will lose access to US and European technology, which will slow down their economic growth.
Thirty Years of Sanctions
| There is a widespread belief that if the current financial crisis persists, the West will tighten sanctions on Iran. |
Iran is one of the countries expected to be badly hit by the international financial crisis. However, in order to assess the impact of the crisis on the Islamic Republic, it is important to understand that Iran has already been under substantial economic pressure resulting from the sanctions imposed by the West, the internal economic situation, and the declining oil prices.
Economic sanctions have been imposed since the 1979 revolution, depriving Iran of having direct access to capital or sophisticated technology, which has negatively affected Iran’s industrial and agricultural sectors. The more recent sanctions that targeted some of Iran’s financial institutions will obviously hinder Iran’s plans for increasing its non-oil exports and for attracting more foreign investments.
In the past, Iran has tried to alleviate the impact of the sanctions by adopting three strategies. First, it has been diversifying its trade partners and establishing economic relations with countries other than its traditional allies. In 2006, for example, Iran’ major trade partners were China, Japan, Italy, South Korea, Turkey, Germany, the UAE and Russia respectively.
So far, Iranian non-oil exports have been mostly limited to traditional goods and food items, such as carpets and pistachios. With few exceptions, food items are needed domestically; therefore, exporting them tends to exacerbate their already high prices domestically.
Second, Iran has been attempting to build its own technological capabilities. Interestingly, notable advances have been achieved in the fields of construction, electronics, oil refining and defense. Yet, without a comprehensive research and development program as well as a plan capable of stopping the brain drain phenomenon, Iran’s ability to produce the type of technological products that are needed to modernize its economy will remain limited.
Third, The Islamic Republic has been moving away gradually from selling oil in US dollars. So, importers of Iranian oil can now pay in other currencies, such as euro and yen. The central bank of Iran now holds reserves as a basket of currencies rather than a single currency.
It is important to note that there is a widespread belief among Iranians if the current financial crisis persists, the West will tighten sanctions on Iran.
Economic Disparities
| If Iranian oil revenues declined drastically, the budget deficit would be intolerable. |
Another factor that can intensify the impact of the global crisis on Iran is the prevalence of income disparities, a phenomenon that is still out of proportion despite President Ahmadinejad’s efforts to achieve social justice.
In the absence of an effective direct tax system, it is extremely difficult to control income distribution. The project recently launched by President Ahmadinejad, the Scheme for Economic Overhaul, seeks to reform seven key aspects of the Iranian economy: the energy sector, the banking system, the distribution and licensing system, customs, subsidies, and the domestic currency valuation system.
However, there are concerns among some members of the Iranian parliament as well as other domestic observers that the impact of the proposed reforms have not been carefully scrutinized. The Scheme seeks to replace subsidies with cash distributions, which might result in a substantial rise in prices, which will exacerbate the current inflation rate.
Also, one of the most alarming developments of the crisis for the Islamic Republic is the plunge in oil prices.
The oil price has already dropped from about $140 to around $50 per barrel in several weeks. Such a huge decline would mean a considerable cut in development expenditures, which would in turn undermine economic growth.
If Iranian oil revenues declined drastically, the budget deficit would become intolerable. The director of the Economic Commission of the Iranian parliament, Gholam Reza Mesbahi Moghadam, stated that the budget deficit for this year (2008/2009) is 80, 000 billion Rials (eight billion dollars). Also, the government owes the banking system 70,000 billion Rials (seven billion dollars), and it is planning to increase the capital of the banking system by an amount of 80,000 billion Rials, and to pay 70,000 billion Rials for gas imports, which raises the total deficit to 310,000 billion Riyals (31 billion Dollars).
And if oil prices continue to decline, there is a chance of a breakdown in the unity of the OPEC members over oil production cuts. Thus, member countries might end up competing for selling more oil at probably lower prices.
In the current situation, the challenge facing the OPEC members is that if oil prices do not respond to production cuts, they will lose revenue because of the decline in oil prices as well as the reduction of oil exports. This might have severe budgetary effects on those countries.
Institutional Failures
| The Iranian economy is suffering from an inflation rate of over 20 percent. |
There are other facts to consider too. The Iranian economy is suffering from an inflation rate of over 20 percent, and an unemployment rate of over 10 percent among the whole population and over 16 percent among the youth. Every year, fresh graduates come out of Iranian universities to find no jobs that match their qualifications.
Corruption in the public sector is another example of institutional failures in Iran that arise mainly from the fact that both public and private sectors employees accept bribes as a way of compensating for their loss of purchasing power due to inflation. These are some of the tougher issues that are much harder to solve because most often they involve some of the very same decision makers who are supposed to solve them.
In the light of the current situation, Iran’s domestic policy should concentrate on raising living standards, reducing unemployment, providing health care, housing and education for the low-income families, and creating a system capable of engaging the highly educated youth in research and development programs.
On the foreign policy level, it seems that the Iranian government’s best bet would be abstaining from rhetoric and actions that can provoke the United States or any of its allies in the region. The Iranian government’s foreign policy should concentrate on open dialogue that aims at expanding economic relations with countries such as the United States.
According to some views, the current financial crisis might be used by the United States as a pretext to take new and more drastic measures against Iran, with the intension of destabilizing the Iranian economy and weakening the Iranian regime in a bid to affect the balance of power in the Middle East under the banner of protecting US interests.
In the course of time, both Iran and the US should learn that direct negotiations have the potential of clearing up many of the misunderstandings that has created tension in the relationship of the two countries.
The lesson to be learned from the current financial crisis is that it could turn into a global crisis, and a global crisis would require finding a global solution through global cooperation. There is a plenty of room in our world today for shared goals.
Sources:
Stglitz, Josef. How to get out of Financial Crisis. Time, October 17, 2008.
The General Framework of Economic Development (First Edition). The Secretariat for the Working Group on Economic Overhaul. Presidential Office. July 2008.
Etelaat Daily (Issue no. 24323), October 28, 2008, page 2.
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