Thursday, May 6, 2010

Inflation down... but so are prospects

I was perusing the International Monetary Fund's World Economic Outlook, released in April 2010, when a statistic jumped out at me. The rate of inflation in the Islamic Republic had fallen to 10.3% in 2009, from 25.4% the previous year.

What was going on? Had the Ahmadinejad administration shown more economic know-how than has been generally recognized? Most economists have faulted the government for runaway expenditure, low currency reserves, a moribund manufacturing base, a skewed balance of trade (especially if oil exports are taken out of the equation), rising unemployment...

I sought the opinion of two Iranian economists who wish to remain anonymous. They had, of course, already seen the figures and were not particularly surprised.

Falling inflation in a booming environment is a sign of good stewardship, but it can also be the by-product of an economic slowdown. In other words, less activity translates into less purchasing power which puts pressure on the prices of goods. In the case of the Islamic Republic, the rate of inflation is also subject to the massive import of cheap goods (a policy of the Ahmadinejad government, by the way), especially from China. While the price of meat may have risen drastically to 12,000 to 13,000 toumans a kilo, milk to 350 toumans a liter, potatoes to 1,000 toumans a kilo (and the list goes on), the basket of goods and services which is used to calculate the rate of inflation also includes cheaper shoes, cheaper cars, cheaper textiles, cheaper television sets, and so on, from China. This may push down the rate of inflation, but it also has a devastating effect on the manufacturing sector, which will lead to a greater economic downturn in the future. The appearance of imported fruit and vegetables in Iranian markets also paints a gloomy forecast for the country's agriculture.

Emerging countries in the region saw a similar fall in average inflation -- 13.5% to 6.6% -- in 2008 and 2009. However, the Islamic Republic's rate -- 25.4% down to 10.3% -- was still much higher than the average, while some countries even showed deflationary tendencies. The price of a basket of some 350 goods and services had actually fallen (a negative rate of inflation) by 2.8% in Iraq and 4.9% in Qatar over the same period.

A look at the growth of gross domestic product (GDP) in the Islamic Republic provides part of the explanation. In 2008, the economy grew an unimpressive 2.3%, which is still better than last year's disastrous 1.8%. In comparison, the average growth for the region's emerging countries during those two years was 5.1% and 2.4%. Iraq's growth rate was 9.5% and 4.2%, while Qatar's economy surged 15.8% and 9% in the same period. Kuwait had a 6.4% increase in GDP in 2008, but its economy actually contracted by -2.7% last year. However, no one is exactly weeping for Kuwait because it is one of the richest countries in the world when it comes to GDP per capita (estimated by the IMF at over $31,482  per Kuwaiti citizen last year. The Islamic Republic's GDP per capita is estimated to have been $4,460 last year).

Economic growth also has an effect on employment, or to be more precise unemployment in the case of the Islamic Republic. 800,000 new workers enter the country's labor force every year, which means that more than 800,000 jobs must be created annually to chip away at the unemployment rate. This rate is pretty much a mystery. The Islamic Republic has repeatedly advanced a figure of about 11%, whether economic growth has been high or low, which suggests some creative accounting. Most economists estimate the rate is closer to 25% of the labor force, and as high as 34% when it comes to young people. Reza Rahimi Nassab, Majlis representative and member of the legislature's social committee, recently said that the unemployment rate in Lorestan province had reached 40%.

The government's optimistic 4th economic plan called for the creation of 1.2 million jobs last year and it is highly unlikely that figure has been reached. The same plan was supposed to bring about an 8% rise in GDP (actual figure: 1.8%) and reduce unemployment to 8%. The Majlis is currently debating whether the 4th economic plan should continue to be implemented, or whether the country should embark on the 5th economic plan in the middle of this Iranian calendar year.

Economists believe that the Islamic Republic must maintain economic growth of 7% to 8% in order to stabilize the unemployment rate, and that its GDP must increase by 9% to 10% to begin to put a significant dent in the unemployment figures. Unfortunately for the legions of young people entering the market, the IMF predicts that the Islamic Republic's economy will grow by no more than 3% annually over the next three years.

As a futile exercise in going down memory lane, I took a look at GDP per capita in Iran and several other countries in 1978, at the time of the revolution, and 30 years later. I present the stark figures below (These are World Bank statistics, not adjusted for inflation, and converted to US dollars applying market exchange rates, which explains the difference with the IMF's numbers). Conclude what you will...

Iran          $1,997                 $4,027 (2007)
Malaysia   $1,238                 $8,209
Hungary   $1,552                 $15,408
Mexico      $1,595                 $10,231
Oman        $2,566                 $15,272 (2007)
France      $9,193                 $44,507
UK            $5,785                 $43,541
Saudi Arabia $9,373            $19,021
Spain         $4,239                $35,214