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Make or break for Iran

Gulf Business
July 1999, Vol 4, Issue 3

Iran has been able to bankroll its economy - and its revolution - with oil revenue. But with unstable oil prices and a growing population hammering at the door, isolationism is a luxury the country can ill afford. Brian Scudder reports.

For the past 40 years Iran has been dependent on oil income. The money has gone to the Central Bank, giving us the option of closing all the doors and not being a member of the world economic community. Now, for the first time, we are faced with the problem that the oil industry is not enough to create employment."

So says Bijan Ghodstinat, chairman of Chin Chin Agroindustries, one of Iran's few major private sector industries, and outspoken critic of Iran's economic woes. His is a common refrain.

Across Iran, bureaucrats and businessmen have begun to recognise that state control of the economy has produced an inefficient and unaccountable monolith, unable to guarantee the future health, wealth and happiness of Iran's children. The signs are clear for all to see. Take oil. Iran's nationalised oil industry pumps 3.3 million barrels of oil a day. In its pre-revolutionary prime it could muster six million barrels a day.

The republic's second largest export earner, textiles, has all but collapsed. According to Jamshid Basiri, head of the Iranian Textile Industries Association, the volume of textile exports had fallen 60 per cent by the end of 1998. From March to December 1998, clothing exports decreased by 77 per cent; carpet exports were down 54 per cent, artificial weaves were down 57 per cent, and manufactured rugs were down 28 per cent.

The powerful religious charitable foundation, Bonyad-I Mostazafan va Janbazan, recently closed six textile factories. The manager of its textile industries blames the closures on 'the Central Bank for its foreign exchange policies, the Finance Ministry for its taxes, the Labour Ministry for its labour law, and the Commerce Ministry for importing thread'. You can not get much more critical of state planning than that.

Iran's third largest hard currency earner, the pistachio nut, has also failed to meet its export potential, even though it sells at $2,000 a tonne, $1,600 cheaper than American competitors.

And the trend continues. According to Dr Hamid Zangeneh, professor of economics at Widener University in the United States, non-oil export revenue has paid for a fraction of Iran's imports since 1979. In 1998, non-oil exports were worth a mere $3.3 billion - dwarfed by oil revenue of $11 billion, and this with oil prices at their lowest since before the oil shock of the 1970s.

The government is in a bind. Past attempts at reform under former President Rafsanjani were mired in the political gridlock that has gripped the Iranian state for a decade. But, say analysts, gridlock will have to give way to a methodical approach to economic issues if there is to be an Iranian economy worth speaking of in years to come.

"The thing that is going to change everyone's minds is unemployment," says Ghodstinat. "One to one and a half million people will enter the economy next year. Let's say to create each job someone must invest $10,000. That means we need $10-12 billion of investment to create the right number of jobs. We are just managing with what we have. Where are we going to find $10-12 billion?"

Iran's liberal-minded analysts say the obvious place to look is foreign investment. But such is the vanity of some sections of the Iranian establishment, that the very idea of allowing foreigners to have involvement is fraught with difficulty.

The rejection of foreign ownership of Iranian resources is enshrined in the Iranian constitution. While some in government believe this has to change, many others believe that to change the constitution is to go back on the revolutionary principles that are the foundation of the Islamic theocracy.

It is not simply a battle between the political left and right. The matter has gone to the heart of President Khatami's own government."Some in the cabinet believe we have to rely more on a market economy and let the private sector dominate economic affairs. Others are still insisting that because of social justice and distribution, the government has to control most of the economy," says Jamshid Pajooyan, professor of economics at Allametabatabae University, and adviser to the Majlis and President Khatami.

"The conflict inside the government itself is deeper when it comes to economic discussion than the battle with Khatami's political opponents in the Majlis."Since Khatami's election, the more capitalist-minded of his supporters have had some success in their skirmishes with colleagues and political opponents over the issue of reform. The petrochemicals sector has become the central battle ground (see Gulf Business June issue, 'Debt and downstream dilemmas in Iran' and 'Petrochemical diplomacy'). Legislation has been pushed through allowing foreigners the right to 'buy back' direct investment through the sale of production from the plants they put money in to. This represents an oblique form of production sharing.

In February this year, they went a step further. Text in the budget law for the 1999-2000 fiscal year implied that foreign companies would be offered 49 per cent equity in Iranian companies. This has since been extended to 100 per cent foreign ownership of companies based in Iran's three special economic zones. "It will come sooner rather than later. Within the year," says one diplomatic source.

While this might be regarded as a victory for Iran's economic reformers, new tax moves by Khatami's own Minister of Economy and Finance are making life difficult for Iran's foreign guests. "In the past there was an arbitrary assessment of personal taxes, which set the salary level at about $1,000 dollars a month for the highest level positions like office managers. Now they have increased this seven-fold, and this has caused uproar among foreign companies," says an Iranian tax specialist representing foreign companies, who asked to remain anonymous.

"They are also now departing from an original ruling that foreign companies or representative offices whose activities are purely promotional, and whose costs are reimbursed by their mother companies, are exempt from taxes. Now they are saying these companies are subject to taxes because they are promoting the sales of their companies.

"This is a lot bigger than the issue of personal taxation, and we are fighting it out. So far we have had mixed reactions from the tax office. We believe if this goes ahead a lot of companies will reduce their size to skeleton staff or move out of Tehran altogther and move to Dubai for example.

"On the one hand they want foreign investment, and on the other they come up with all this ridiculous taxation," says the specialist. "It makes a mockery of all their attempts to attract foreign investment."charitable challenge Attempts at freeing domestic investment have met a similar fate. The Iranian economy is, by most estimates, 80 per cent controlled by Iran's charitable foundations, the Bonyads. These religious institutions were a major driving force in the nationalisation of private property following the fall of the Shah in 1979, and continue to be a dominant political force. For many of Iran's businessmen, they are a millstone around the private sector's neck.

"The economy is ruled by the Bonyads," says Pajooyan. "If you don't let the private sector compete with the Bonyads, then they will dominate and they will have a monopoly and most of the economy will depend on their decisions. "You don't have to destroy the Bonyads," he says. "Tax them like the private sector. After a couple of years their dominance in the economy will diminish. You can subsidise the charity side of the Bonyads directly. It shouldn't be by exemption. The tax structure is not good, it has to change."Easier said than done. "Khatami would love to bring [the Bonyads] under government control," says one diplomatic source. "But they are directly affiliated to [spiritual leader and final arbiter of state policy] Khamenei, and there is a lot of vested interest."

President Khatami did recently manage to tax the Bonyads a nominal one per cent on annual profits, giving the government the ability to track their operations, says the diplomat. But this is still far from the kind of anti-monopoly legislation favoured by most in private business.

Banking is another sector that Iran's economic reformists want restructured. "Some believe we have to change the constitution where it restricts private banking," says Pajooyan. "Some believe the banking system has to open up side by side with the private market. You can't work with the private sector when you have a centralised banking system."

Iran had a flourishing, if nepotistic, banking sector on the eve of the Islamic revolution. After 1979, private banks were nationalised and effectively became holding companies for nationalised enterprises. "The law stated that lenders must exchange their loans for equity shareholding," says Ghodstinat.

Consolidation left a handful of very powerful, centralised institutions. "The core people of the banks stayed intact as management, but they were weighed down by the enormous ownership of companies they didn't want. They were more preoccupied with running their businesses rather than their role of providing financial backing to the doers," says Ghodstinat. "At least now there is a recognition of the problem."

For a land that has been run on principle rather than pragmatism, for 20 years, light may be at the end of the tunnel for Iran's economic reformers. President Khatami has made a series of policy statements on economic affairs that cut to the heart of Iran's oil dilemma. Just as importantly, they have the backing of the spiritual leader, Ayatollah Khamenei.

"Khatami has said: 'Oil is a national wealth. It should not be considered income but the liquidation of assets, and should be replaced with other assets. It is a depletable resource. If you keep selling it and not replacing it with other assets, we become used to a certain level of consumption, but we are not building. We are selling our wealth for our expenses,'" says Ghodstinat.

"This is the first time it has been said in this country. If it becomes an active policy - that we can't depend on consumption - then we have to go after other markets with non-oil products and go for investment."

But the path to a genuinely open Iranian economy is strewn with the wreckage of good intentions. The struggle is intensely personal. Powerful men like Minister of Oil Zanganer, and Nematzade at the National Petrochemical Company are pro-reform, but hamstrung by their own colleagues, heavyweight clerical opponents and a deadweight bureaucracy. Several of those who have popped their heads above the parapet in the past have had their heads taken off.

PRISON SENTENCE Former Mayor of Tehran, Karbaschi Gholamhossein, stands for reform with a strong economic element, but his principled stand against the theoretical foundations of the Islamic state (Vilayet-e-faqih) have left him at the mercy of the religious right. He has been convicted of fraud by the right-wing controlled judiciary, a charge he claims is politically inspired, and sentenced to prison.

At the end of the day, there is only so far anyone can go to change today's Iran. "A Gorbachev? Yes, In terms of opening up to the press and free speech, there are direct parallels with Khatami. But in terms of structural reform, far less so, because he is a cleric. Khatami is convinced his decisions are in the best interests of the regime," says the diplomat.

Without economic reform, it is not just the regime that will suffer, but Iran's businessmen - and they would prefer the politicians focused less on ideological battles and more on how to practically manage the economy.


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