Japan’s need for energy security has long driven relations with the Gulf states, but, under the banner of economic diplomacy, Gulf-Japan ties are diversifying.
In December 2018, Iranian President Hassan Rouhani presented the government’s proposed budget to the Parliament, reflecting Tehran’s key policies to cope with reinstated U.S. sanctions. The government has proposed a total budget for the next fiscal year (March 2019-March 2020) that is 40 percent higher than the previous budget. Rouhani’s administration is planning to generate 38 percent of its revenue from taxes, 35 percent from oil, 13 percent from selling bonds and other forms of borrowing, and the remaining 14 percent from other unspecified sources of revenue. The Parliament approved the bill, after some delay, February 16, showing some disagreements over the proposed budget. The overall structure of the budget indicates that the government is preparing for the heavy impact of sanctions and low oil revenue by cutting costs and allocating resources to support low-income citizens. Nevertheless, the budget allocations show that the government is not compromising financial support for ideologically driven organizations, particularly the Islamic Revolutionary Guard Corps.
The return of U.S. sanctions targeting Iran’s energy, banking, and shipping sectors is expected to put more pressure on the Iranian economy in 2019. To address these challenges in the budget, the government has proposed two main policies: allocating a greater portion of funds toward facilitating trade and decreasing expected revenue from oil exports. The government has increased the budget allocation for the Ministry of Industry, Mine and Trade by about 61 percent over the previous year and funding for the Trade Promotion Organization is projected to increase by 247 percent.
Asia’s oil imports from Iran declined in 2018, with China, India, Japan, and South Korea importing in total 1.31 million barrels of crude oil per day from Iran. This was 21 percent lower than the previous year and was the lowest for these countries since 2015, when they imported about 1 million barrels per day. The countries have continued to import crude since the reimposition of sanctions in November 2018, having received sanction waivers; however, import levels will likely decline further when the waivers expire in May. Even if the waivers are extended, there will likely be a reduction in the waived volumes for imports.
In addition to the oil sanctions, the renewed banking sanctions are also expected to affect Iran’s oil trade. China National Petroleum Corp is reportedly considering ending its financial relations with Iran because of concerns over U.S. sanctions. The Bank of Kunlun, China National Petroleum Corp’s financial arm, which has been the main official financial channel between the two countries, has indicated that it is ending its dealings with Iran, too. The Bank of Kunlun has been under U.S. government pressure since 2012, when it was added, along with Elaf Bank of Iraq, to the institutions that are sanctioned by the U.S. Treasury for doing business with designated Iranian banks.
Iran’s noncommodity trade is also under pressure due to the renewed U.S. sanctions. Iran’s imports from China, Germany, South Korea, and the United Arab Emirates have declined year-on-year since March 20, 2018 by 8.5 percent, 14 percent, 26 percent, and 29 percent respectively; imports from these countries made up 57 percent of Iran’s imports. China constituted about 25 percent of Tehran’s total imports in that period. Such a dramatic decline is caused by a combination of bank payment difficulties (instigated by sanctions) and rial devaluation. Moreover, the government has initiated new trade policies to halt providing foreign exchange at the official rate for importing certain items.
The Rouhani government is looking to increase tax revenue in the 2019-20 budget. The government has indicated 38 percent of revenue would come from taxes while in the previous fiscal year, about 28-30 percent of revenue was generated from taxation. Since his election in 2013, Rouhani’s government has introduced new taxes and fees in various sectors of the economy (e.g. trade, construction, tourism) as well as increasing some of the existing ones, such as building permit charges, fees for changing and obtaining vehicle registration numbers, issuing identification and medical insurance cards, import tariffs, and legal fees.
One of the most controversial tax increases of the Rouhani administration was a 300 percent raise in the foreign travel tax in the 2018-19 budget that prompted a public debate, widely covered by local media. Since March 2018 each Iranian citizen has been required to pay a minimum of 2,200,000 rials (around $50-60, depending on the exchange rate) for traveling outside Iran. This amount is increased by up to 100 percent for individuals who travel abroad more than three times in one fiscal year. In the proposed budget for the 2019-20 fiscal year, the foreign travel tax is expected to contribute significantly to government tax revenue by generating 14 trillion rials (approximately $340 million). The government is aiming to increase taxes on high-income Iranians who can afford foreign travel. Religious travels, however, are less impacted. The travel tax is discounted by 50 percent for Iranians traveling to Mecca for hajj and by 80 percent for Iranians traveling to Iraq to visit Shia holy sites. Further, Iranians who travel by ground to Karbala, Iraq for the Arbaeen pilgrimage, an important Shia ceremony to mourn the martyrdom of the third Shia imam, are exempt from the travel tax.
In terms of the defense budget, the government has proposed reducing its allocations to the army and Ministry of Defense. The government is looking to lower the army’s budget by 8 percent from 111 trillion rials to 102 trillion rials (about $2.64 to $2.42 billion) and cut the Ministry of Defense budget by 50 percent. The Defense Ministry and army budgets are mainly related to items such as: salaries, bonuses, and pension payments; building expansions; building maintenance expenses; and subsidized goods distributed among employees. Such budget cuts do not reflect lower arms or warfare expenditures.
While the budgets for the army and Ministry of Defense are reduced in the proposed budget, the budget for the Islamic Revolutionary Guard Corps is increased by 25 percent. Given the importance of the IRGC in the security – and more recently, economic and political –infrastructure of Iran and the dramatic rise of inflation over the last year, this increase is not particularly unusual or unexpected. Over the past three decades, the IRGC has become the most powerful entity in Iran, expanding its activities beyond the defense sector into various economic activities such as banking, construction, and imports. Rouhani has frequently indicated that his administration is pushing for limiting the IRGC’s unregulated business and economic activities. On various occasions he has publicly alluded to the IRGC affiliates’ tax evasion and promised Iranians that his government is working on more transparency and ending tax dodging by those entities. However, nothing has materialized from this rhetoric and the allocations within the proposed budget confirm that the government will not be allowed to limit the IRGC’s activities, even if it genuinely wants to.
The proposed budget confirms that the government anticipates a major reduction in oil revenue due to the renewed sanctions. In the proposed budget, the government calculated its oil revenue based on an oil price of around $54 per barrel. Iran’s production is expected to stabilize at a maximum of 1 million barrels per day. Global predictions for 2019 expect the oil price to fluctuate between $68 and $73 per barrel (on average for Brent crude), which is much higher than the government’s calculation in the 2019-20 budget.
Iran’s oil stabilization fund, the National Development Fund, is predicted to be hit hard by the sanctions, too. The government reduced the share of hydrocarbon revenue that will be deposited in the National Development Fund during the 2019-20 fiscal year to 20 percent from 34 percent in the previous fiscal year. Moreover, the government proposed an official exchange rate of 57,000 rials to the U.S. dollar, which is higher than the current official rate of 42,000 rials to the dollar (both significantly lower than market rates, which are as high as 110,000). Increasing the official exchange rate can help the government offset a minor share of its revenue loss caused by the decline in oil exports. By increasing the rial equivalent of its oil revenue the government is trying to lower its widening budget deficit in the next fiscal year. Such mechanisms will have a limited impact on the government budget deficit considering the government will be forced to use costly mechanisms to bypass U.S. sanctions.
Over the past decade, economic hardship has affected the welfare of lower- and middle-income Iranians. Multiple rallies and strikes have been organized around the country demonstrating public frustration. In response to this, the proposed budget includes a 20 percent pay raise for government employees to help them cope with inflation. The Central Bank of Iran reported in September 2018 that consumer goods and products in urban areas were as much as 31.4 percent higher year-on-year. Inflation has further increased since November when U.S. sanctions were reinstated. In addition, the government proposed a 30 percent increase in employment compensation that is mainly allocated to pay the costs of the government’s new “social welfare plan to fight absolute poverty and empower low-income citizens to cope with the financial pressure caused by the tightened U.S. sanctions.” Moreover, existing social welfare plans such as benefits provided by the Foundation of Martyrs and Veterans Affairs are also proposed to be increased. The budget allocated to subsidy cash payments is also increased in the next budget in comparison with the previous one. The government is planning to cut out more citizens from the payment system during the next fiscal year, but about 70 million Iranians will continue to receive the government cash handouts. Furthermore, the government has reportedly allocated $14 billion for importing basic commodities that will be distributed among citizens in order to avoid food shortages and to lower inflation.
Similar to the 2017-18 budget, the new proposed budget is characterized by: a large budget allocated to the entities that symbolize the ideology of the establishment, such as the IRGC as well as religious schools and organizations; an increase in the tax base, tax revenue, and fees; and low oil revenue. There is a stronger emphasis on increasing taxes on high-income Iranian individuals and entities as well as supporting lower-income citizens in response to the soaring inflation, growing unemployment, and general economic hardships.
Due to a combination of the U.S. sanctions and ongoing economic challenges in Iran, the government’s proposed measures to support the poor and underprivileged are expected to have very limited impact on the welfare of Iranians. The government has failed to generate the expected tax revenue in the current fiscal year, which has led to a historically high budget deficit that is likely to reoccur in the next fiscal year. Rouhani’s administration has been heavily criticized by the Parliament for its failure to control the currency devaluation and rising inflation that hit Iran in 2018. The tension between the Parliament and the administration was reflected in some negative responses to Rouhani’s speech when he proposed his government budget in December 2018. However, the Parliament approved the government budget’s bill in mid-February in order to “avoid sending the wrong signal to the public.”
Economic hardship in Iran is intensifying rapidly due to the impact of U.S. sanctions coupled with mismanagement of the economy. This is increasing the public anxiety and possibility of widespread riots, similar to those in 2018. While the government’s new budget tries in some ways to deal with this public dissatisfaction, different power centers in Iran remain primarily interested in protecting the stability of the establishment despite heavy criticism over the government’s economic mismanagement.
is a non-resident fellow at the Arab Gulf States Institute in Washington. She is the managing director of Middle East Risk Consulting, a boutique consultancy firm providing risk management and business intelligence for global clients.
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