Stability and Reform-The Key to Economic Growth: Iran's Economy Has Performed Briskly over the Past Three Years, More Impressively, Non-Oil Activities Grew by 6% in Real Terms, Reflecting Increased Manufacturing, Construction and Agricultural Output, and Buoyant Domestic Demand. (Iran Economic Report)

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Iran, the world's fourth largest oil producer and the second most populous nation in the Middle East region after Egypt, is slowly integrating into the global economy and financial markets. The path to sustainable growth, independent of crude oil prices, lies in the genuine pursuit of economic reforms, socio-political stability, improving bilateral ties with western countries and greater inflows of foreign investments and technological transfers into the non-oil economy.

In comparison with Arabian Gulf countries, the Iranian economy is much more diversified, with its manufacturing and agriculture sectors comprising one-third of gross domestic product (GDP) and services (including government services) representing about one-half of GDP. Iran's hydrocarbons industry represents only 15% of national output, compared with 30-40% during the early 1970s. However, the non-oil industries urgently require modernisation in order to become more competitive and capable of competing in global markets.

The economy has performed briskly over the past three years, with real GDP growth averaging 5.4% a year, pinned by fixed investments in upstream oil/gas and downstream industries, mainly petrochemicals and steel, stronger energy prices, increased export volumes and government spending, as well as improved business confidence. More impressively, non-oil activities grew by 6% in real terms, reflecting increased manufacturing, construction and agricultural output, and buoyant domestic demand in recent years. But consumer prices (averaging 13% during the past three years) remained high despite 'price controls' over public utilities charges and basic commodities (wheat, rice, vegetable oil, bread and sugar).

The expansionary fiscal policy in 2003/04 could hike inflation and cause real exchange rate appreciation, thereby eroding export competitiveness. Another reason for higher prices is strong liquidity growth pinned by surging public expenditures. This, in turn, reflects rapid credit expansion to public enterprises and the private sector, as well as large capital inflows. Between 1999-2000 and 2002-03, broad money (M2) grew by 25% annually, exceeding the 18% target set by the Bank Markazi Jomhouri Islami Iran (central bank). The International Monetary Fund (IMF) comments: "The continued rapid growth in credit aggregates and its implications for banking system soundness, should be closely monitored." Recently, the Bank Markazi has taken extra monetary measures to remove excess liquidity from financial markets by issuing more Central Bank Participation Papers (CPPs) and new instruments, such as special open deposit accounts. CPPs--mainly held by retail investors--offered at a fixed coupon rate, but are non-tradeable in the secondary market. They can be redeemed at par before maturity. Also, some restrictions are placed on the state banks' access to the central bank's overdraft facilities.

Trade surplus

The external payments position is sound thanks to sustained high oil revenues. Since 1999/2000, Iran's current account balance, i.e. total trade in goods and services, plus (net) capital flows, has remained in surplus, enabling the authorities to accumulate hefty foreign exchange reserves--which in the fiscal year 2003--represented over 10 months of total imports. This surge in forex reserves and a continuous fall in external liabilities have transformed Iran into a net external creditor, with gross official assets equivalent to 312% of total external debt stock. Fitch Ratings, the European rating agency, estimated Iran's net credit at $28bn as of March 2003. Other traceable assets are $15bn in term deposits with foreign banks reporting to the Bank for International Settlements. The oil windfalls of recent years have boosted state deposits in the 'Oil Stabilisation Fund' (for above budgetary receipts) and reduced costly short-term debts. The Islamic republic's debt burden (below $8bn) is low by global standards. …