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

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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,

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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