Moderate recovery on the horizon

After strongly contracting in 2018 and 2019, in the wake of the reinstatement of sanctions, the Iranian economy was hit by COVID-19 in 2020. The difficulties in accessing vaccines and the limited health infrastructure made Iran one of the most affected countries worldwide. As of early November 2021, the ratio of fully vaccinated people to the total population remained at 39%, while the death toll reached 126,000. The highly transmissible nature of the Delta variant also weighs on the economic outlook for 2022. Growth will be supported by high hydrocarbon (around 15% of GDP) prices and rising external demand for Iran’s manufactured products such as chemicals, metals, and plastics. The private market (55% of GDP) should remain weak due to the low level of vaccination - which may cause a new round of mobility restrictions - and high inflation. Consumer prices rose above 45% year-on-year (YoY) in August 2021, on an annual basis, partly due to the rising costs of imported intermediate goods globally and currency depreciation. With these factors extending into 2022, inflation will remain above the central bank’s target of 22% for the fiscal year ending in March 2022. Although the unemployment rate stood at 9.6% in the second quarter of the Iranian year 2021/2022, the participation rate was meager at 41%, and the level of employment was estimated to have fallen by over 1 million posts because of the pandemic. This will also weigh on the purchasing power of households. Conversely, after falling sharply over 2019-2020, oil exports are expected to increase in the upcoming period, mainly due to rising energy prices. However, the sector still lacks significant investments and expertise, which will weigh on its future export performances. Investments are expected to remain muted due to the difficult business environment (Iran ranked 127 out of 190 countries in the World Bank’s Doing Business 2020 report), international sanctions, power cuts caused by low rainfall that hurt hydroelectricity, and insufficient gas to run thermal plants.

Current account surplus maintained by high energy prices, fiscal deficit represents a challenge

For the first time in nearly a decade, the current account balance fell into negative territory in 2020. The traditional trade in goods surplus dropped in the wake of the unilateral withdrawal of the U.S. in 2018 from the nuclear agreement with Iran (known as the Joint Comprehensive Plan of Action) and the re-imposition of the sanctions on oil exports. Crude oil exports have declined to 200,000 barrels per day (b/d) from about 2.8 million b/d in 2018. Similar to 2021, the current account should be in surplus in 2022 due to high oil prices, accounting for around 60% of total merchandise exports. The inauguration of U.S. President Biden in 2020 has been considered a good omen for returning the U.S. to the deal and lifting sanctions. In April 2021, Iran and six powers started discussions. Although talks resumed after a halt due to the election of Iran’s new President Ebrahim Raisi in June, any potential removal of the sanctions would be unlikely before the end of end-2022. Agricultural exports should remain weak due to the renewed tensions in Afghanistan, an important market for Iran’s agricultural exports, following the return of the Taliban. On the other hand, limited import demand due to currency depreciation will contribute to the current account surplus. Indeed, the rial has lost over 75% of its value against the U.S. dollar since 2018, hovering at 280,000 as of September 2021. The traditional trade-in services deficit remains.

Regarding public accounts, the budget deficit to GDP ratio is expected to widen further due to unsustainable general revenue sources and a lack of fiscal discipline. The rising aversion of investors to Iran’s Islamic bonds means that the authorities will be obliged to resort to more inflationary monetary financing.

Persistent risks on the political front

President Ebrahim Raisi will face substantial challenges. Poor economic conditions, such as high inflation and low available employment, and a new wave of COVID-19 may increase the risk of social unrest. The most critical issue is the negotiations over a possible return to the nuclear deal in concomitance with the U.S., as leaders from both countries stated their positive intentions on this eventuality, albeit under different (irreconcilable?) conditions. However, an agreement would not take place before the end of end-2022 at the earliest, significantly as Iran’s current higher nuclear activity increases tensions with the West, although Iran says it is in its sovereign rights and can be reversed once the U.S. removes sanctions.