IRAN: ECONOMIC CHALLENGES MOUNT AS AHMADINEJAD BEGINS SECOND

S E C R E T SECTION 01 OF 02 RPO DUBAI 000317 NOFORN SIPDIS E.O. 12958: DECL: 8/3/2019 TAGS: ECON EFIN EIND EINV ETRD PGOV IR SUBJECT: IRAN: ECONOMIC CHALLENGES MOUNT AS AHMADINEJAD BEGINS SECOND TERM REF: A. A) IRPO 261 ¶B. B) IRPO 285 DUBAI 00000317 001.2 OF 002 CLASSIFIED BY: Timothy Richardson, Acting Director, Iran Regional Presence Office, Department of State. REASON: 1.4 (b),(d) ¶1. (C) Summary: As President Ahmadinejad enters his second term in office, his administration will likely be hamstrung by a strained budget, falling GDP growth, the global economic slowdown, and sanctions. Dealing with Iran's budget deficit currently is the government's main priority, though IRPO contacts also point out that growing unemployment and the struggling banking sector are also key challenges. Despite statements by government officials to the contrary, Iran's economy is experiencing a new phase of the global recession, and our contacts predict that the impact will become more obvious this fall as the commercial and financial sectors struggle to remain afloat. Government Searching to Plug Budget Gap ¶2. (S) In light of last year's drop in crude oil prices, the IMF in January 2009 projected Iran's budget deficit could reach USD 12.5 billion by March 2010. There are several indications that Ahmadinejad and the government recognize the extent of Iran's financial difficulties and are pursuing measures to address it. In late June 2009, the government reestablished the Money and Credit Council (MCC)-a group of ministers, MPs, technocrats, and Central Bank of Iran (CBI) officials tasked with formulating CBI policies and supervising monetary and banking programs. On July 12, the Majlis fast tracked legislation to cut public expenditures. The government on July 27 announced plans to merge the Commerce Ministry and Industry and Mines Ministry as well as combine the Ministries of Transportation and Communication. Ahmadinejad is also aiming to again tackle subsidy reform, which would free up a projected USD 20 billion if enacted. (Note: Iranian press projects that reducing select energy subsidies would add USD 8.5 billion in funds available to the government's budget. The Majlis committee charged with reviewing the plan on July 11 decided to allot the president 20 percent of this revenue for discretionary use, although the government and Majlis presidium have not reviewed this proposal.) ¶3. (S) An Iranian financial consultant in late June told IRPO that he viewed merging ministries as a positive step that could reduce administrative costs. He also considered Iran's release of new bonds, for example late June's USD 4 billion for underway development projects, perhaps as a way to finance capital spending outside the budget. Announcements revealing erosion in Iran's non-oil sector make it clear that despite officials' initial claims to the contrary, Iran will not be able to rely on its non-oil sector to substitute for decreased oil revenues, however. In March, the government claimed that it could make up for lower oil earnings through increasing tax revenues and non-oil exports, but Tehran's Taxation Organization announced in early June that it would cut taxes for industries hit by the financial crisis. Slower GDP Growth Leading to Job Losses ¶4. (S) The government will have to contend with a slowdown in Iran's major industrial sectors, especially energy and manufacturing. The IMF projects that Iran's growth will decrease to 3.2 percent this year from 4.5 percent last year, a development that will reduce non-oil and tax revenue and perhaps has increased unemployment. (Note: The Statistical Center's latest unemployment figures show that between January and March 2009 unemployment rose to 12.5 percent from 11.9 percent during the same period last year.) A friend of a longstanding IRPO contact in Iran's business sector owns an Iran-based detergent factory that is struggling because the government owes it USD 25 million. The factory owner has reduced his payroll since last fall, but as of early July feared he may have to shut down. 5.(S) The government's ability to ease pressure on Iranians is being undermined by lower oil prices and a slowing economy. Many companies experiencing large losses in July requested government loans to pay justice shares, and Majlis members are questioning the feasibility of these payments in the current climate, DUBAI 00000317 002.2 OF 002 according to Iranian press reports. (Note: Justice shares are shares from the profits of state-owned companies that Ahmadinejad championed during his 2005 presidential campaign. He began distributing these shares in 2006, which to date have gone mostly to Iran's poor, veterans, underprivileged, and some civil servants.)The government also is being pressed to provide loans to state-affiliated companies so that they can meet payroll, according to the managing director of an oil engineering firm who works with mostly Iranian government and government-affiliated oil and gas companies. He told IRPO in early July that he has experienced problems with these companies, some of which have not paid their employees in six months. Furthermore, many companies on Tehran's stock exchange (TSE) as of early July were also unable to pay their shareholders the profits they originally announced, creating an atmosphere of mistrust in the TSE, according to a newspaper associated with opposition leader and former presidential candidate Mehdi Karrubi. ¶6. (S) Our contacts note that it is difficult to differentiate between the effects of the global recession, government policies, and sanctions. Nevertheless, they see currency devaluation as the key thing the government could do to dilute pressure on Iranian companies. Coupled with Iran's average inflation of 15 to 17 percent, an Iranian financial consultant speculates that the dollar-toman rate should be around 2000 tomans rather than 1000. The consultant and a factory owner maintain that Iran's artificially high toman is bankrupting local companies because they can not compete with cheaper foreign imports. Although the government last summer and fall flirted with currency reform, lower oil prices, falling inflation, and other factors are likely to turn the government off from pursuing it any time soon. Iran's former First Vice President Parviz Davoudi, an economist, best exemplifies the government's approach. On June 24 he ordered all economic-related ministries to avoid importing and advertising for foreign-made goods that were also manufactured domestically. Skittish Banking Sector Cutting Finance ¶7. (S) Iran will need to prop up its banking sector amidst what our contacts described as a major crisis gripping Iran's financial and credit institutions intertwined with problems facing Iran's commercial sector (refs A and B). Central Bank Governor Bahmani announced in early July that outstanding debt to the Central Bank had risen from USD 33 billion to USD 38 billion since March. The general manager of a petroleum engineering company claimed that many of his customers -- typically government-affiliated companies -- cannot provide letters of credit (L/Cs) because they have too much debt. The contact said other options, such as bank guarantees, also have become less available as banks -- including those in Dubai -- reportedly consider these to be risky as businesses struggle to meet their bottom lines. Comment ¶8. (S/NF) The debate over how to make up Iran's deficit may exacerbate differences between the legislative and executive branches; Ahmadinejad has sparred with the Majlis in the past and his rocky re-election probably has not earned him additional support. However, Iran's budget problems and the ongoing effects of the global recession give Ahmadinejad more ammunition to again tackle Iran's subsidy system. Ahmadinejad's first attempt at subsidy reform failed, in part due to pre-election politics. Our contacts actually praised the subsidy reform plan and with the election now out of the way, Ahmadinejad may have more success. RICHARDSON