Iran’s complex of crises catches up with the regime
The weight of banking, pension and water problems, plus its expensive military adventures, are dragging the country into a deep sense of malaise
A jump in poultry prices sparked Iran’s protests of the past several days according to media reports. If this is true, the spark landed on long-prepared tinder. Iranian authorities claim that the 40% jump in egg prices in some Iranian cities was a temporary effect of an outbreak of avian flu, although egg prices had already risen by nearly 30% year-on-year as of November. The Iranian rial’s black-market exchange rate declined to 42,000 per dollar from 39,000 per dollar during December, portending a significant but hardly extreme rise in the overall inflation rate, which now stands at around 11%, far below the 35% rate of 2013.
Higher egg prices are an annoyance, but don’t explain the ferocity of the protests. The location of some of the most violent protests, though, is revealing. Radio Farda, an affiliate of America’s Radio Liberty, posted a disturbing smartphone video Jan. 2 showing a mob burning down the police station in the Iranian town of Ghahdarijan, 24km from the ancient city of Isfahan and too small to be found on Google Maps. It seems unlikely that the reach of Western intelligence agencies stretches into this central Iranian hamlet. But the villagers did have a grievance: the river Zayandeh Rud (“life-giver”) which gave rise to Isfahan dried up before reaching the city, the victim of Iran’s mismanagement of its dwindling water resources. Canals to distribute water to the city’s periphery were built by the Savafid dynasty in the 17th century and fostered a green city in the midst of the central Iranian desert.
Ghahdarijan’s protests have been long in the making. Two years ago, an adviser to Iran’s environment ministry, Issa Kalandari, warned 50 million Iranians would be left without water, due to the exhaustion of 70% of Iran’s groundwater and the ill-considered diversion of rivers to compensate. Agriculture consumes 92% of Iran’s water. Capital-intensive farming methods could conserve water, but they also would drive peasants off the land into cities already suffering from about 30% youth unemployment.
For the past year, numerous observers have been warning of an impending economic crisis. “Estimates of Iran’s military expenditure in Syria vary from US$6 billion a year to $15-$20 billion a year. That includes $4 billion of direct costs as well as subsidies for Hezbollah and other Iranian-controlled irregulars,” I wrote last March 14. “Assuming that lower estimates are closer to the truth, the cost of the Syrian war to the Tehran regime is roughly in the same range as the country’s total budget deficit, now running at a $9.3 billion annual rate….The Iranian regime is ready to sacrifice the most urgent needs of its internal economy in favor of its ambitions in Syria. Iran cut development spending to just one-third of the intended level as state income lagged forecasts during the three quarters ending last December, according to the country’s central bank.”
According to SIPRI (Stockholm International Peace Research Institute) and various other sources, Iran military expenditures in 2016 were $12.4 billion; by comparison, those of Saudi Arabia amounted to $61.4 billion (2016) and the UAE $23.7 billion (2014 figure). The 2017-18 budget deficit was estimated by the central bank of Iran at $9.6 billion (2.1% of GDP). By comparison, the Saudi deficit in 2017 was $57 billion (8.9% of GDP). The off-balance sheet liabilities of the Iranian state, however, are huge even by the dodgy accounting standards of emerging-market governments.
For nearly four decades, Iran has cannibalized its physical and human capital, leaving the Islamic state with multiple crises and a deep sense of malaise. Water management is only one of several hidden deficits that the Islamic state has accumulated since the 1979 revolution. Large parts of Iran’s pension system face bankruptcy in the short term, and the government’s annual arrears to its underfunded social security system are many times the size of its official budget deficit. With the world’s fastest-aging population, Iran’s demographics will make an already-critical problem much worse during the next several years. Iran is the first country to get old before it got rich, setting in motion a pension crisis more acute than any other in the world.
Iran’s banking system, moreover, is insolvent, in part because of economic strains and partly because of massive insider lending to real-estate investors connected to the regime. The cost of a bailout might be as high as 50% of GDP, the costliest in recent financial history. Alireza Ramezani wrote last year in Al-Monitor, “Toxic assets account for 40-45% of total banking assets in the country, economic newspaper Donya-e Eqtesad reported Nov. 9, citing official data. Nearly 15% of these assets consist of immovable assets such as land and buildings. The rest consists of nonperforming loans and government debt. No official data is available about the banks’ fixed assets, but a report by Serat News website in December estimated the total value of immovable property owned by 31 Iranian banks and credit institutions at 448 trillion rials ($13.8 billion), without it providing any details on the surplus properties.”
Iran is riddled with wildcat banks offering deposit interest of up to 30%. Early in 2017 the regime capped the deposit rate at 15%, but few banks complied, the economic daily Donya-e Eqtesad reported June 8. The government responded by allowing 10 private credit institutions to fail, wiping out the savings of scores of millions of small depositors. Eurasia Diary reported Jan. 2, “A major groundswell of anger has also been building over the collapse of unauthorized lending companies that left millions of investors out of pocket. These companies mushroomed in the financial free-for-all under former president Mahmoud Ahmadinejad, lending wildly during the construction boom and collapsing when the bubble burst. Rouhani said in December that such lending companies had captured a quarter of the financial market with three to four million accounts by the time he took power in 2013 and started shutting them down.”
Parviz Aghili, chief executive of Middle East Bank, estimated that a full re-organisation of the Iranian banking sector’s roughly $700 billion balance sheet would cost $180 billion to $200 billion, or 50% of Iran’s GDP. “And we cannot afford it,” he said, according to an October 2017 Reuters report. Iran’s GDP is a bit over $428 billion.
Iran’s pension funds are running enormous losses. At most immediate risk is the Civil Service Pension Fund, with a million insured. The Iranian Financial Tribune reported Nov. 21 that CSP “has more than one million first named insured while the number of its pensioners exceeds 1.2 million, suggesting that pensioners outnumber the employed insured population… which is horrific.” The Social Security system still has four insured for every pensioner, but in fiscal year 2016-2017, “premiums made up only 21% of pension funds’ revenues and the profits gained through investment of funds and sale of assets only accounted for 8% of resources, leaving the government to shoulder the costs of the funds. Currently, the government owes more than 1,400 trillion rials ($35 billion) and counting” to Social Security.
Less than 10% of Iran’s population is over 60, the result of a surge in the country’s fertility rate to a peak of seven children per female in 1979. Fertility since has declined to between 1.6 and 1.8, the lowest in the developing world. As the present generation ages, the ratio of Iranians over 60 will jump to 35% by around 2045 and to 45% later in the century.
Iran has talented people but can’t employ them. Youth unemployment stands at 20%, but that does not take into account disguised youth unemployment in the form of 4.7 million undergraduate students: “According to the UNESCO Institute of Statistics, the number of students enrolled at the tertiary level increased by 258 percent in the past 15 years – from 1.3 million in 1999 to 4.7 million in 2014,” World Education News reports. But “only 6 percent of approximately 900,000 applicants to master’s degree programs and merely 4 percent of 127,000 doctoral applicants reportedly got admitted to a program in 2011.” Undergraduates account for 30% of Iran’s total population aged 15-30. If we estimate conservatively that half of the students are warehoused in mass diploma mills like the Islamic Azad University system with 1.7 million students, the true youth unemployment rate is 45% rather than the official 30%.
Iran has several top engineering schools, but the vast majority of their graduates emigrate. In all, 3.5 million Iranians are preparing to leave the country, according to Masoud Khansari, head of the Tehran Chamber of Commerce.
Adding together the costs of recapitalization the banking system, bailout out the pension funds, and repairing the country’s water system put the government’s off-balance-sheet liabilities far above its GDP. Although direct government debt is small, the Iranian regime is drowning in unfunded obligations.
It is not at all clear how, or whether, the present regime or any successor regime will resolve these interlocking crises. Iran requires an anti-corruption program as tough as Xi Jinping’s, and the marshalling of public and private resources to reverse what some analysts call its “water bankruptcy.” It must open its closed and kleptocratic financial system to domestic and foreign entrepreneurs who can put its young people to work and persuade the talented few who graduate from its elite engineering schools to remain in the country. It cannot sustain foreign military adventures and an ambitious ballistic missile program at the same time.
The present regime is incapable of carrying out this complex and costly transformation, and no opposition is available with a clear vision of how to replace it. The street protests indicate that regime has lost credibility, which will make it all the more difficult to maneuver.
Faced with problems on this scale, third world governments typically reduce their liabilities through devaluation and inflation. Iran’s pension and financial liabilities are owed to its people, but the government earns money in hard currency. Currency devaluation and inflation represent a transfer of wealth to the regime from the people. During the past year, the Iranian rial has lost more than 10% of its value, falling from 36,000 to the US dollar to 41,000. The likeliest outcome is a prolonged period of instability punctuated by sporadic but violent street protests, and further economic deterioration.