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IRAN


 

 
Key Economic Data 
 
  2002 2001 2000 Ranking(2002)
GDP
Millions of US $ 107,522 114,100 101,600 34
         
GNI per capita
 US $ 1,710 1,680 1,650 115
Ranking is given out of 208 nations - (data from the World Bank)

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REPUBLICAN REFERENCE

Area (sq.km)
1.648 million

Population
66,128,965

Capital
Teheran

Currency
Iranian rials

President
Mohammad Khatami-Ardakani


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Background:
Known as Persia until 1935, Iran became an Islamic republic in 1979 after the ruling shah was forced into exile. Conservative clerical forces subsequently crushed the westernising liberal element. During 1980-88, Iran fought a bloody, indecisive war with Iraq over disputed territory, which caused large-scale damage to its economy. The key current issue is how rapidly the country should open up to the modernising influences of the outside world, with a conservative faction in control of some key institutions, such as the Council of Guardians, and a reformist faction centred on elected President Khatami. 

Summary for 2002 

US and Iran 
Despite the apparent improvement in the relations between the US and Iran, which had followed the 11 September terrorist attacks, by January 2002 the tension between the two countries had reached new peaks. President Bush accused Iran of being part of an "axis of evil" together with Iraq and North Korea and asked Iran to stop meddling in the internal affairs of Afghanistan and developing weapons of mass destruction. While the Iranian leadership had good reason to be worried about the intensification of American hostility, the Bush administration was clearly not planning any direct action yet. By July, however, with his call for "reform from below", President Bush appeared increasingly interested in fomenting a revolt against the Islamist regime. There are clear signs that the ruling elite felt seriously threatened and feared at least a tightening of the embargo. It seems that at least part of the several billion US$ that returned to the country during 2002 was made up of the gold reserves of the government, previously held by European central banks. By mid-May even the reformist President Khatami felt that he had to take a strong stance and warned the US administration against "threatening, insulting and humiliating" Iran. As a reaction to growing American pressure, Teheran strengthened its efforts to improve its relations with its Muslim neighbours, such as the Central Asian countries, Azerbaijan and even Saudi Arabia. The reformist government of Iran remained in reality keen on improving relations with the US. During 2002 it gave out plenty of signals pointing in this direction. Among them, not only it stated that it was ready to accept a new, tougher resolution on Iraq and collaborated to enforce a stricter embargo, but also took the unprecedented step of declaring that a two-states solution is acceptable for Palestine, so long as the Palestinians accept it. Even the conservatives, who dominate a number of key institutions, first and foremost the Council of Guardians, and count among their members the Supreme Spiritual Leader, Ayatollah Khamenei, were not uniformly hostile to improving Iran's relations with the US, at least not at all times. Some of them argued that such an improvement would make it easier to maintain the status quo internally. Supporting a US war against Iraq could be a suitable way to buy American acquiescence for the lack of internal reforms. The majority of the conservatives, in any case, maintained at least on the surface a strong opposition to reconciliation with the US. Even if the reformists were willing to acquiesce to US war plans in neighbouring Iraq, they feared that in the event of a war its economy would suffer severely, not least because of a likely massive influx of refugees. The possibility of Kurdish nationalism being strengthened by a war in Iraq was also seen with apprehension in Teheran. On the whole, the Bush administration did not openly respond to hints coming from conservatives that a deal might be possible, but the press suggested that it might actually be considering to enlist some help from Iran. For sure, as the international attention turned to Iraq, from October Iran was spared the war of words that had afflicted it during the previous months. In any case, as the end of 2002 approached, the Bush administration maintained that it would welcome an internal overthrow of the Iranian regime. Iran and the rest of the world. The main tool in the hand of the US administration for exerting pressure on Iran is increasing its isolation from the rest of the world, in particular Iran's neighbours and trading partners. During 2002, it appeared clear that the largest economies were the least likely to bow to the pressure. The European Union in particular decided to actually expand its ties to Iran. After some initial anxiety, the EU announced in July its readiness to develop closer commercial ties with Teheran, although conditionally on Iranian willingness to discuss such issues as nuclear proliferation, terrorism and human rights. There have been delays in the negotiation of deals with Russia and Japan in the oil, nuclear and defence industries, but in the end both countries looked intent on continuing their flourishing trade with Iran. The main danger to Iran could have been that Russia could soon be lured towards a more pro-American stance in exchange for economic concessions, which might include forgiving Russia's Soviet era debt in exchange for the termination of nuclear cooperation with Iran. The fact that Russia and Iran developed diverging ideas about how to deal with the resources of the Caspian Sea might have contributed to push Russia away from Iran. President Putin, however, opted instead to strike a delicate balance between continuing Russia's lucrative trade with Iran, while at the same time doing his best to appease American fears of Iranian interest in weapons of mass destruction. By December, Iran responded by showing some more willingness to tackle the issue of the Caspian Sea resources.

Economic performance
Apart from the international tensions, the economic and political situation of Iran remained highly uncertain throughout 2002. The development of oil extraction in Iran was negatively affected by project delays and by some flaws in the buy-back deals negotiated with the international investors and it increasingly looked doubtful whether Iran could succeed in increasing its production to the levels planned. A failure would have very negative consequences for the economic stability of the country, due to the rapid growth of internal consumption of oil, which was expected by some analysts to match the volume of exports as early as in 2002 itself. Petrol is sold within Iran at heavily subsidised prices, with a litre costing to the Iranian motorist just $0.063, which encourages therefore high consumption levels and waste, only makes the matter more urgent. The non-oil sector of the economy showed little sign of development in 2002. After having expanded rapidly in the early 1990s, following the adoption of an export-led growth strategy by the government, Iranian non-oil exports have stabilised at around US$5 billion. The economy, dominated by an inefficient public sector and by the notorious foundations, simply demonstrated that it lacked the dynamism to exploit the opportunities offered by the new policy. The free trade zones, set up in the past, have so far failed to generate productive economic activities and are mostly being utilised for import/export activities.

Economics and demographics of a latent crisis 
If the debate about the chances of success of Iran's plan to expand its oil production was still undecided at the end of 2002, there has never been any doubt that the Islamic Republic cannot afford a failure. Although the birth rate has been brought down to manageable levels in recent years, the baby boom generation is beginning to join the workforce, causing a terrible headache to the government. With 5.5 million high school certificate holders expected to join the job market in 2002-2005, the government needs to create more than 1,300,000 new jobs every year to prevent an increase in the unemployment rate and keep the population happy, but in 2000/2001 it succeeded in creating just 400,000. To generate the required amount of jobs, Iran's economy should grow at the yearly rate of 12%. Economic growth reached 4.5% in 2000/2001, short of the 6% target but still not a bad achievement when judged by the standards of Iran's performance over the last decade. In 2001/2002, which according to the Iranian calendar ended on 21 March, low oil prices and a cut in production ensured that growth was lower, around 3.5%. In 2002-2003 very favourable circumstances, including most of all an increase in oil prices, contributed decisively to strengthen economic growth, now expected to reach 6.4%. Many Iranian businessmen, faced with poor performances in the American and European markets, moved their assets back to Iran, which on the other hand has reduced taxes and has approved a more friendly foreign investment law. It is estimated that private funds account for a large part of at least US$7 billion which have gone back to Iran in 2002, underpinning among other things a very good performance of the Teheran stock exchange, which became one of the world's best performing, up by 30%. However, even such as performance will not be enough to cure Iran's economic ills. Moreover, during the early months of 2002 the negotiations with potential investors in Iran's oil and gas industry took a negative turn, although there were signs of improvement towards the end of the summer. In 2002 a wave of financial scandals hit executives of some Iranian oil companies involved in partnerships with foreign investors and Iranian officials showed a marked tendency to delay negotiations, fearful of attracting the attention of a judiciary which is closely aligned with the conservative faction. International investors, on the other hand, became increasingly wary of investing in the Iranian market, in particular as they began to feel that it might be possible to extract better conditions. Only state-owned companies, such as Norwegian Statoil, continued to sign contracts with the Iranian government. Starting from May there were indeed some signs of a growing willingness to offer more appealing conditions to foreign investors, as the chairman of the parliamentary energy committee, Hossein Aferideh, proposed to lengthen the buy-back contracts which represent Iran's approach to reaching agreements with international investors. At present, buy-back contracts last five to seven years, which is considered too short by many players in the oil industry. In 2002, the situation of the oil industry was compounded by an extensive program of well maintenance and by a series of strikes in the industry, which resulted in an estimated 8-9% decline in exports of crude Iranian oil. It is significant, however, that one of Iran's newest gas clients, Turkey, successfully bargained for lower prices after being offered a substantial discount by Russia. Russia's increasingly aggressive marketing practices might cause more problems to Iran in the future, as it continues its efforts to penetrate the European market.

Foreign investments and internal politics 
Investment in the oil industry is less controversial, because it tends to be easier to isolate from the mainstream of society and because the rewards are so obvious. But that will likely not be enough to inject enough dynamism in the Iranian economy. The opportunity to attract funds towards other sectors certainly exists. An important sign was the successful launch in July of the new euro bonds, the first denominated in a foreign currency since the Islamic revolution. Soon the government was planning new issues of euro bonds, while the Iranian parliament was asked to examine a proposal to receive oil payments in euros. The attempts to reform the Iranian economy and political system were slowed by the opposition of the conservative faction. The Council of Guardians blocked the introduction of several laws, including the new foreign investment law, despite its approval by the parliament, forcing its amendment. Other such laws were still blocked by the Council of Guardians at the end of 2002, including a project to end the unaccountability of the foundations, which control a large part of the Iranian economy, a large-scale privatisation program, a new labour code and several others. There are however some signs that during 2002 a split began to emerge within the conservative camp, with some taking a more moderate stance. On the other hand, there were divisions within the ranks of the reformists too. At the beginning of 2002, the main item of contention among the reformists was the liberalisation of the economy, with some groups favourable to the liberalisation of the economy and others, such as the Islamic left, who were cold towards it. By the end of the year, however, the picture had been redrawn and the main fault line was now running between moderates, willing to accept Khatami's slow pace, and more radical reformers, who were clamouring for a final confrontation with the conservatives and were beginning to voice criticism of Khatami himself. The renewed pressure of the units of the "moral" police on an increasingly impatient youth, together with the ongoing repression against the reformist press, only contributes to the radicalisation of a part of the opposition. The death sentence against a reformist intellectual, Hashem Aghajari, guilty of having attacked the power of the conservative clerics during a lecture, unleashed in November a new wave of student unrest across the country, the largest after that of 1999. The resurgent student movement took most observers by surprise, as many had diagnosed its demise. On the internal political front, the main development in February was the apparent confirmation that the reformist front is slowly disintegrating. Three separate reformist lists will contest the 28 February municipal elections in Teheran, ranging from the pragmatic right to radicals who criticise Khatami for his lack of action. The electorate appears rather disillusioned and apathetic and in 2,000 municipalities there will be no elections at all because of the lack of candidates. Occasional arrests of dissidents continued in February, although the reformist front could claim at least a partial victory when a re-trial was ordered of outspoken reformist Aghajari, who had been sentenced to death because of his public statements against the regime. However, Aghajari will be re-tried by the same court which had sentenced him to death earlier and it might well be too early to say that his case is closed. Even the 2002-2003 Iranian budget, approved during the spring, reflected the political constraints under which Khatami and his government had to operate. Spending went up massively on the previous year, with tax cuts and massive pay rises to civil servants, whose real income would increase by 17% in real terms. The government expected to pay for a large part of such increases in expenditures through the privatisation program, which however had been stagnating for a while and might well continue to do so in the near future. Most observers therefore believe that Teheran will soon be running a massive deficit, the more so since the 2003/2004 draft budget, presented to the parliament in December, shows a 21% increase in spending on the previous year. While promising to public employees salary increases to match inflation, the draft budget counts on privatisation to reduce spending and getting some extra revenue. Reflecting the compromise character of the budget, military expenditures are also going to increase. Observers estimate that the fiscal surplus of 2001/2002 will turn to a 2.1% budget deficit this year and might still double in 2003/2004. It should be considered, however, that Iran's government debt is comparatively low, at just 19% of GDP. By the end of 2002, on the other hand, there were signs the Iran's financial situation might be improving, with a buoyant stock exchange, growing interest among international investors for the domestic car industry and a more general consolidation of Iran's image on the financial markets. Fearful of losing his own base of support, during September President Khatami finally decided for an all-out assault on the main conservative stronghold, the Council of Guardians. During September the reformist government presented a draft law, which would greatly reduce the powers of the Council, especially as far as its ability to disqualify election candidates is concerned. The government also presented other constitutional and administrative reforms, including greater powers for the president. President Khatami warned that he might resign if his projects were not approved, leaving the country in a state of chaos. By the end of the year there was talk of a conservative coup d'état against the reformists, while the security forces were stepping up indoctrination and "ideological training" of the rank and file, possibly preparing for taking part in a violent repression. Some conservative circles were increasingly promoting former President Rafsanjani as the right man to lead a coalition of moderates, aimed at addressing the economic difficulties of the country, without touching the institutional framework. 

Summary for 2003

Impact of war in Iraq
Neither the reformers nor the conservatives were unanimous about the war in neighbouring Iraq. Hard-liners are too hostile to the US to consider anything but complete opposition to whatever the Americans might do. Khamenei, a relatively moderate conservative, appeared to be ready to cooperate with the US, but only in exchange for substantial concessions, such as Iran's removal from the "axis of evil" and for the recognition of Iran's interests in Iraq. Former President Rafsanjani, a more pragmatic conservative, seemed to be ready to content himself with much less, such as a promise that the US will not attack Iran next. The reformist government, on the other hand, continued to focus on an alternative foreign policy, aimed at reminding the Americans and the world how friendly Islamic Iran can be instead. In the end, the real issue turned out to be Iran's attitude after the toppling of Saddam Hussein's regime, when Iraq faced chaos and anarchy. Privately, US diplomats were ready to admit that Iran had been behaving rather well up to mid-May. Nonetheless, the Bush administration kept up the pressure and Rumsfeld warned explicitly Iran not to interfere in Iraq. At the beginning of May Iran was once again being branded the most-active state sponsor of terrorism by the Americans. Secretary of State Powell stated explicitly at the beginning of May that the policy of the Bush administration is to isolate Iran as much as possible, but without closing all channels of communication. It is in fact known that the US and Iran are holding talks about Iraq and Afghanistan. However, there is a strong faction at the Pentagon which is in favour of a strike against Iran's nuclear facilities, if Iran does not accept to stop its nuclear program. 

Iran's nuclear program
The Iranians are divided on how to react to American pressure. There is a general agreement that Iran should maintain its nuclear program. The majority of Iranians, including leading reformists, reacted negatively to former president Rafsanjani's proposal to reopen a dialogue with the US, claiming that such a public statement would just be interpreted as an admission of weakness. Russia's decision not to abandon its ties (and profitable trade) with Iran appeared in all its importance in January, when the Bush administration dropped its objection to the building of a nuclear power station in Iran, with the clear aim of softening Russia's opposition to the war against Iraq. However, by March the tension was up again, as US claims were for the first time substantiated at least in part by inspectors of the International Atomic Energy Agency (IAEA). If US fears about the nuclear reactor being completed in Bushehr continue to appear unjustified, the uranium processing plant in Isfahan, which is about to start operations, and the enrichment plant construction site found in Natanz look definitely more suitable for the development of nuclear weapons. In February President Khatami had admitted for the first time that Iran is mining uranium. Some sources now estimate on the basis of the new discoveries that Iran might be just a couple of years away from producing an atomic bomb. It is possible that the climax of admissions and discoveries of the last two months is part of a plan to trade Iran's stricter adherence of the non-proliferation treaty against the lifting of the sanctions imposed by the US. In fact, Iranian officials have clearly hinted at the possibility of such a deal. In the meanwhile, the Iranians have been quite successful in forcing their interlocutors to drop their political demands. In September the Japanese dropped the attempt to link progress towards an agreement and Iran's good behaviour on the nuclear issue. The three leading European powers (Germany, France, UK) also appear to have offered a bargain in August, against the advice of the Bush administration, offering to share technology in exchange for the end of the controversial fuel enrichment program. The Russians too, despite being increasingly puzzled by Iran's attitude, are trying to salvage the program, for obvious economic reasons, since they build Iran's nuclear stations. As the end of October approached, the Iranian government finally showed a greater willingness to cooperate with IAEA. The pressure was such that Iran had to do something, although nobody wants Iran to lose its face or the nuclear enrichment program to be completely halted. The Iranians look set to use their influence among Iraq's Shiites as a bargaining chip in their secret negotiations with the US, which have been going on for some time, although with several interruptions.
The release of the IAEA draft report in early November appeared as a major victory for Iran, as the Agency accepted that Iran, despite some violations of the Non-proliferation Treaty, could not be proved to be developing nuclear weapons. However, the Bush administration engaged in a major lobbying effort to turn the situation around and to convince the Europeans to adopt a harsher language in the IAEA resolution, condemning Iran's behavior. This, despite the Iranian government's efforts to appease the Bush administration by providing some cooperation in Iraq. Apart from its apparent role in restraining the Iraqi Shiite population since the fall of Saddam Hussein, Iran recognized the Iraqi Governing Council in November and declared its readiness to arrange swap oil deals with Iraq, which would facilitate the recovery of the oil industry in that country. Few observers doubted that Iran was actually seeking to develop the potential for producing nuclear weapons and that the signing of the protocol would not be the end of the story, but it also appeared likely that such program could be traded off against some substantial concessions from the Bush Administration.
By year's end, in any case, there was enough uncertainty concerning Iran and its nuclear program to discourage some of the more cautious investors. BP, for example, decided to drop out of the bidding for the Bangestan field, for which it had been shortlisted together with Total.

Human rights
While the hard bargaining with the EU on the issue of human rights will continue for a some time, the Iranian government could in January show at least an initial success in this regard, with the abolition of death penalty by stoning. By the summer, however, the negotiations for a trade agreement were getting stuck because the conservatives within the Iranian establishment refuse to concede enough on the human rights front. The harsh repression of the demonstrations in June was a further blow to those in favour of engaging Iran. As the end of the summer approached, the relations with Europe and other Western countries were strained further by the cases of Iranian-Canadian journalist, Zahra Kazemi, beaten to death in custody, and of former ambassador Soleimanpur, arrested in Great Britain (and denied bail) for complicity in the bombing of a Jewish centre in Argentine. Finally, on 22 November the General Assembly of the UN expressed "serious concern" about the violation of human rights in Iran. In January important trade agreements were signed with India and Afghanistan, which are likely to greatly increase Iran's influence in the East. On the other hand, Teheran's position in the Caucasus and central Asia is likely to remain weak, as shown in March by the failure of the visit of Turkmen President Niyazov to Teheran to produce the expected consolidation of the alliance between the two countries. 

Decline of the reformist coalition
Even when a war is over, an Iraq occupied by the Americans will inevitably affect Iranian internal politics. The more radical reformers and the extra-parliamentary opposition are likely to become emboldened, as shown already by the street protests of June 2003, while it is much more difficult to predict how the conservatives might react. The trend which emerged during 2002, of a split between moderate and hard-line conservatives, might well strengthen in 2003, and there are signs that something like that might be taking place within the ranks of the reformists too. In March the defeat of the reformists in the administrative elections, especially in Teheran, highlighted the growing rift between the Islamic left factions and the right-wing reformists of the Executives of the Reconstruction group, which all support Khatami in the national parliament. Division exists also within the Islamic left between clerics, who tend to be more moderate and more supportive of Khatami, and secular members, who are increasingly becoming radicalised. Then, the two moderate factions might ally and form a centrist government, which would try to reform the economy and certain institutions, without challenging however the clerical nature of the Iranian state. Towards the end of 2002, Supreme Leader Khamenei's intervention against the judiciary, which had passed the death sentence against Hashem Aghajari, appeared a sign that Khamenei himself could be willing to support the leadership of the moderate conservatives. However, the leadership of the moderate conservative camp is increasingly being taken by former President Rafsanjani, who in April took a bold step and proposed a referendum on Iran's relations with the USA. Among the leading reformers there seem to be little appetite for a compromise, mainly because their support base opposes it. As the end of 2003 was in sight, there appears to be left little room for a compromise anyway, as the conservatives appeared to be aiming for an all-out victory. During August there were however signs that despite tensions at least two of the three reformist factions will maintain their unity until the future elections. The pragmatist party close to Rafsanjani will likely abandon the alliance, given the projects of its mentor to form a new coalition, but the Society of the Combatant Clergy and the lay reformist parties appear to be trying to maintain their unity. Between May and June 2003 the Guardian Council rejected both reform bills, which would have given president Mohammad Khatami greater authority over a judiciary dominated by the conservatives and limited their ability to screen candidates in parliamentary elections. At this point, political developments within Iran might take three different turns. By mid-June some talks seemed to be going on between Khatami and Supreme Leader Khamenei to find a behind-the-scene solution to the deadlock, such as modifying the bills to some extent and re-presenting them. This is the first option. Should the talks fail, the reformist camp is divided among those advocating a referendum on the issue, those arguing that the MPs should resign in protest and those favourable to accepting a compromise brokered by the Expediency Council. Only about 20 MPs are reported to be serious about resigning, with another 30 or so also considering it, while the other two options obtaining much greater support. The conservatives might still refuse to concede any ground and, if faced with an increasingly militant opposition in the streets, stage a coup d'état. Some prominent conservative leaders, such as Khamenei himself and former president Rafsanjani, threatened openly the recourse to force already during the course of 2002. The conservatives, in the meanwhile, are also getting ready for the next elections by hinting at a social agenda that they might include in their electoral "manifesto". In reaction, the government is increasingly devoting its attention to initiatives in favour of the poorer social strata. At the beginning of 2003 it also appeared possible that the conservatives might succeed in attracting moderate reformers such as Khatami towards a compromise which would still increase his powers, although without weakening the capability of the conservatives to resist the reforms as much as most reformists desire. By the summer, however, the most likely outcome appeared to be a new government headed by moderate conservatives and right-wing reformers, maybe strengthened through recourse to rigged elections. In September Khatami took the unusually bold step to refuse a compromise with the conservatives on the reform bills that he introduced last year and that were blocked by the Council of Guardians. The head of the Council, Mohammed Ali Abtahi, offered to let through the bill which enhances the powers of the President, if Khatami accepted to withdraw the other bill, which reduces the Council's power to pre-select election candidates. At present, there are only scant signs that the politically active minority of the radical opposition is succeeding in establishing links with other sectors of the population. In some factories there have been walkouts in support of the democratic movement, while teachers have been on strike and even in the bazaars, normally a stronghold of the conservatives, there have been shutdowns in support of the demonstrations. So far only the intelligentsia and a part of the clergy show clear signs of drifting towards a more radical opposition, but the potential for a larger movement is there. The Nobel Peace Prize to Shirin Ebadi offered the radical reformers the opportunity to relaunch their campaign, although moderate reformers like Khatami were only embarrassed by the news. The conservatives, however, are not waiting hand in hand and look increasingly set to steal part of the reformist agenda. They promise some social reforms in favour of the poorer strata of the population, while claiming that they too are reformists, although of a different type. It is worth noting the key role played by moderate conservatives like Ayatollah Janati and Hojatoleslam Rowhani in engineering the deal with IAEA at the end of October, a confirmation that this group is trying to emerge as a protagonist of Iran's relations with the rest of the world. Their profile was raised, but at the price of deepening the split between them and the hardliners.

A mixed economic picture
The government remains committed to market reforms, as showed in may 2003 by the appointment of a pro-reform new head of central bank, who was welcomed by analysts. The government also appears to be becoming increasingly conscious of the damage that inflationary pressures could cause to the economy. There is also a growing awareness in government circles that the government does not spend its money in a balanced way. On the one hand there are a lot of subsidies, on the other Iran spends little in crucial sectors like health, where its expenditure reaches just 5.7% of GDP and lags behind that of other oil states. The announcement at the beginning of May of a US$21 billion 4-year plan to greatly expand the telephone and cellphone networks also represents an answer to the recognised need for increased investment in infrastructures. 
Unfortunately, from the point of view of the man in the street, the government has little to show. At the beginning of May president Khatami had to acknowledge that his plan to create 765,000 jobs a year is lagging well behind, with just over 530,000 created on average in the last three years. Whether the reforms accelerate or not, political and social tensions are not going to die down in 2003. Faster reforms will in any case mean more hardship for some sectors of the population. The latest estimate of the inflation rate in 2002/2003 was 15.3%, up four percentage points on the previous year due at least in part to the abolition of privileged currency exchange rates for some Iranian institutions, which was one of the reforms of the Khatami government. By some estimates, inflation could exceed 20% in 2003/2004, due to the growing budget deficit and price hikes in a number of commodities. 
Despite the improved economic performance of 2002/2003, it appears obvious that it will be difficult to achieve significantly higher growth rates without attracting massive foreign investment. The forecast of the Economist Intelligence Unit for 2003/2004 is 5.3%, lower than in the previous year, although still comparatively good. Even in this regard, a successful compromise among moderates could play an important role in reducing the opposition among conservatives against foreigners playing a much larger role in Iran's economy. The Iranian government is quite optimistic, as shown by its 2003/2004 budget. The assumption that oil revenues will maintain the level reached in 2002/2003 (around US$15 billion), when the Iraqi and the Venezuelan crises combined to push oil prices upwards, appears doubtful indeed. By April, the Iranian state oil company itself was expecting oil prices to fall soon to US$18/19 a barrel. The government, however, has the option of drawing resources from its stabilisation fund, which is expected to stand at US$7 billion by the end of the current fiscal year (20 March) and which is meant to compensate the fluctuations of oil prices. 
The government confidently predicts GDP growth at 6% next year, which would confirm the performance of 2002/2003. The Economy and Finance Minister Mahazeri also predicts that Iran will finally be able to attract significant foreign direct investment next year, in the range of US$4 or 5 billion, as opposed to the less than US$500 million invested in 2002/2003. Iran also plans to expand its oil production to 5 million barrels a day by 2004, up from the 3.6 million of 2002. The government is making natural gas available to most of the urban areas, in order to reduce internal consumption of oil and have more available for export. Moreover, the Khatami administration is going to borrow money to fund its many projects. It is authorising the issuing of bonds over the 2003/2004 financial year for a value of 5,400 billion rials (US$676 million), a 125% increase over the current year. The good news for the economic prospects of Iran is that the government also authorised the private sector to issue its own bonds as a way of making up for the inability of the banking sector to provide adequate funding. The level of foreign debt is at a relatively modest US$23.4 billion and the country's hard currency reserves are higher than ever. During 2003 there was a growing optimism among international observers, concerning the future prospects of the Iranian economy. In December Fitch Ratings upgraded its outlook on Iran's currency ratings from Stable to Positive, on the basis of positive forecasts for the economy and in particular for foreign earnings. The agricultural sector, which has long been a source of headaches for Teheran, was also sending positive signals. In December the government claimed that Iran is finally self-sufficient in wheat, following the end of a drought that lasted from 1999 to 2001. 
During March the first signs emerged that the Khatami administration is trying to tackle the issue of the excessive subsidies to consumption, that are undermining the Iranian economy. After an official of the oil industry admitted that Iran will have to import 5.8 billion litres of gasoline this year to meet internal demand, up 2 billion on 2002/2003, the government increased in April the price of gasoline by 30%, from US$0.06 to US$0.08 per litre. While the latter would still be a very low price by any standard, there is opposition even among reformist parliamentarians, who fear a backlash among the population and an upsurge in inflation. On the other hand, the uncontrollable increase in internal gasoline consumption represents a growing burden for Iran's economy and contributes to erode the country's oil exports, which fell by 7.6% in 2002, to just over 2 million barrels a day. Efforts to put some order in Iran's chaotic economic system continued in September. The government announced at the end of August that there are plans to introduce value added tax, which is widely seen as a positive step since it will be easier to implement than any overhaul of the direct-taxation system. The Teheran stock exchange was reformed in September, to bring its regulations more in line with those of developed countries and to introduce control mechanisms that limit the danger of a crash.
Foreign businesses express a strong interest in the Iranian internal market, which at present is underdeveloped, due to restrictions to imports, which the government tries to maintain at around $15 billion, and to the inability of the domestic industries to meet demand. After achieving the first modest successes in attracting foreign investments in 2002, the Khatami administration hopes that 2003 will finally see the beginning of a massive inflow of foreign investment into Iran's industry and services. This might be rather optimistic, but there were some signs of growing interest in January and February. After FIAT and Peugeot had showed up in earlier months, in February it was the turn of DaimlerChrysler and Chinese manufacturer Chery to announce their plans for the Iranian car industry, whose annual sales of 300,000 are estimated to cover only half of potential demand. It is expected that in the foreseeable future most investments in the non-oil sector will come from Arab countries, but already some European companies are beginning to invest small sums. The government expects its privatisation program to finally take off in 2003. Before the end of the current fiscal year (20 March), several state companies are expected to be floated on the stock exchange, as a prelude to privatisation. Banks in particular figure prominently in the list of state firms to be privatised. At present, there is just a single genuinely private bank in Iran and its network of branches is still very limited. There are, however, a number of obstacles towards a successful privatisation campaign. State banks are largely overstaffed, often have been operating at a loss for some time and are burdened by bad debts granted to state firms, the foundations and privileged individuals. The overall approach to economic reform remains cautious. This caution is sometimes dictated by genuine political concerns, as in the case for example of the planned reduction of tariffs on imports. At the beginning of February the deputy minister of commerce stated that the elimination of tariffs on imported goods would be eliminated gradually, in order to safeguard the interests of consumers and producers. However, in other cases this "caution" is the consequence of divisions within the government and the state administration. The complex web of interests which grew over the Iranian economy over the past quarter of a century makes reforms objectively difficult. The laws and regulations of the Central Bank of Iran, for example, encourage investment in unproductive activities, such as import businesses, which benefit from tax holidays, while production goods are subjected to high tariffs and taxes. 
The economic impact of 'regime change' in Iraq was on the whole modest. The US might veto a participation of Iranian firms in the reconstruction and in the medium/long term the opening of the Iraqi oil market might draw away potential investors in Iran's oil fields, especially if, as it is likely, conditions offered were better. In this case, Iran could at least count on US determination to favour US companies, which cannot invest in Iran anyway due to the embargo. But Iraq's more economical oil fields are shared with Iran, so that improved production there would affect Iran's production negatively in any case. Oil minister Zanganeh showed his awareness of the situation when he called for Iran to act quickly to attract foreign capital to develop its oil fields. Indeed, the national Iranian oil company claimed in May to be planning to sign contracts worth between US$5 and US$7 billion during the current year, with the aim to expand production by one million barrels. However, in the past the optimism of Iranian officials with regard to signing contracts with foreign investors has often proved unjustified. There is on the other hand capital looking for some employment in Iran, especially after at least US$7 billion returned to Iran mainly from the US, to which a growing tide of Saudi investments have to be added. The Teheran stock exchange has been growing so quickly this year that in August the government had to intervene and impose a two-week block on stock prices, fearing an imminent crash and the subsequent repercussions on the wider economy. Investors will however likely continue to prefer the stock market, given the lack of transparent investment opportunities in industry and the low returns of the agricultural sector. The government appears intent to capitalise on the trend towards the return of capital from abroad and a bill is being discussed in the parliament, which will reinstate the nationality of those Iranians who have left the country. The law that requires the sale of property belonging to people stripped of Iranian nationality is also being abolished. 
Some signs have been emerging in recent months that Iran might be willing to offer better terms to foreign investors in its oil industry. These developments continued in September, as a deputy minister hinted that new types of contract are under consideration to attract investors to the Caspian Sea, possibly including production sharing agreements.
The IMF reported that non-oil GDP has been growing at the average rate of 7.9% in 2000-2003, that is faster than GDP as a whole, confirming that the economic reforms are stimulating the economy to some extent. However the IMF pointed out that price subsidies and controls and limitations to free enterprise remain a major problem. For example, the very low price of gasoline is leading to a boom in consumption, which increased by over 26% in the March-August 2003 period alone. Production of gasoline, on the other hand, increased by just 2%, forcing Iran to import massive quantities of it, a paradox for such a big producer of oil. Fuel subsidies are a major problem for Iran and cost each year 10% of GDP. In November the oil ministry came out in public for the first time with plans to ration the distribution of gasoline, which the country imports at the rate of 13 million litres per day. 
Another source of worries is the fiscal balance, which is now negative, with a deficit of 2.3% of GDP. The government is aware of the problem and is considering measures to contain the fiscal deficit, hoping to contain the inflation rate at no more than 18%. The government is also aware of the increasing social tensions and is carrying out a number of schemes aimed at reducing unemployment. One of them foresees the replacement of "foreign workers" with Iranian ones and according to the minister of labor and social affairs it will be enforced firmly. The government is also spending money on job creation schemes and it claimed in September that the official unemployment rate fell by two percentage points over the last 12 months, to 11.2%. It is not clear, however, how sustainable these job creation efforts are in the medium and long term, while replacing foreign workers will only create unskilled and low-pay jobs, which will make few Iranians happy. Besides, official unemployment figures are not considered very reliable by economists and the actual impact of these schemes is uncertain.
Towards the end of the year, the government renewed its efforts to convey the idea to the public, that the program of privatization is still on track. It announced at the beginning of December that Khuzestan Cement Company will be privatized at 96%, the largest proportion of shares ever sold by the state in Iran since the revolution. 

Oil industry
Iran also needs to unblock the development of the oil industry. Iran will need to invest $30 billion over the next 8-9 years to maintain its share of world oil exports. The ageing Iranian fields have lost production capacity at the rate of 250,000 barrels per day, 6.4% of annual production. At least $1 billion are needed every year to maintain production at the current levels. To maintain the level of exports in the face of rising internal consumption and to increase them to satisfy the needs of a growing population, much more than that amount will be needed. However, the Iranian oil industry continues to be starved out of investments and progress has been recorded recently only in the development of the manufacturing of liquid natural gas. Several large Western multinationals, such as Royal Dutch/Shell and Total, are reported to have lost faith and to be already scaling back their presence in Iran. Japanese companies like Japex and Inpex maintain some optimism, although the Azadegan project too, for which the two have bidden, had not yet been signed by its stated deadline of end June and appears likely to be delayed further. As always, the source of the delays is the political sensitivity of foreign investments in Iranian oil industry. A Deutsche Bank study estimated that the profit margin in Iran is about 15%, compared to a world average for the oil industry of 20%. Moreover, the deals tend to last only about half of what they last elsewhere. This difference would not be enough to discourage investors, but the long queues imply extra costs and uncertainty. The awareness that the availability on the market of the Iraqi oil fields over the next few years could represent a major blow for Iran's chances to impose its own terms has not succeeded in accelerating the pace of the oil ministry. Some industry experts say that unless Iran speeds up investments in the oil fields, its production could fall to 3 million barrels per day over the next few days, from the current 3.6 million. At this rate, the goal of attracting US$16 billion in foreign investment in the oil and gas industries by 2010 does not seem to have many chances to succeed. 
In the strategy of the Khatami government, gas is supposed to make up for the shortcomings of the oil industry. Since Iran has huge reserves of gas, which at present are largely under-exploited, it would make good sense to move the focus of the investments in that direction. After the blow of the re-negotiation of the deal with Turkey, which could have cost Iran as much as 20% in discounts on the previously agreed price, Iran will be looking east, having identified China and most of all India as potential major markets of the future. 
Nonetheless, in the second half of 2003 it began to emerge that the recent discovery of three new oil fields in July was having an impact on Iran's development strategies. After having focused on its gas sector until the summer, the Iranians began now to show a renewed interest in oil, for example by trying to accelerate the signing of some oil deals, like the Bangestan and Azadegan fields. In November the National Iranian oil Company invited bids for 16 new exploratory oil blocks, with a new and more attractive type of contract, which covers both exploration, description and development of the fields. Iran's wariness of OPEC cutting oil production can also be seen as a sign of a renewed desire to attract more investment and expand its production. Investors too seemed to be finding some new optimism about doing business in Iran. Total and Petronas, for example, seem set to finally make a profit this year in Iran, a fact that might encourage others to sign, despite the strict conditions. It is known that Petrobras, never previously active in Iran, is considering to enter this market. Despite US pressures, which apparently played a role in keeping Italy's ENI and Royal Dutch/Shell from accepting the invitation to bid, the negotiations on the Azadegan oil fields seemed finally to have reached an advanced stage, in which French company Total appeared to be in a favourable position to win. 

Forecast and summary 2004

Internal policy
The parliamentary elections of 20 February 2004 were undoubtedly a major defeat for the reformists, not only because the Parliament will now have a conservative majority, but also because the participation rate was not as low as originally predicted, although it was still much lower than in the previous elections. The inability of the reformers to campaign as a single block and to present to the voters with a single proposal likely confused them and damaged the prospects of a successful boycott of the elections. The reformist front approached the parliamentary elections in a state of disarray and could not but lose. While the defeat of the reformists is not debatable, the victory of the conservatives is not so clear-cut, however. The largest group among them is the pragmatic Developers of Islamic Iran, whose positions differ little from those of the most moderate component of the reformist coalition, the Executive of the Reconstruction. Both groups are sponsored and encouraged by former president Rafsanjani, whose efforts to re-enter the political scene have received a major boost. Interestingly, Rafsanjani criticized the exclusion of many reformists from the electoral lists. The Developers, who won all the seats in Teheran, are quite tolerant of the new social attitudes which emerged in recent years and attract the wrath of the stricter conservatives. They focus on economic and development issues and their main promise during the electoral campaign was to end unemployment and cut inflation. They will open the country to foreign investment, but will not allow political dissent. They already control the Teheran city council and are applying a similar strategy there, where they launched a large scale program of public works aimed at reducing unemployment and improving the quality of life in the city. President Khatami appears likely to accept to work with them and has already been offered the olive branch by leading conservatives. President Khatami started already during April to replace the ministers deemed to be least compatible with the new parliament. The ministers of road and transport and education and training were the first targets, but soon the minister of the interior too was added to the list of the undesirable ones. He actually resigned on 8 April. They seem ready to work with what is left of the reformists on a number of issues and many among them long to isolate the radical conservatives who want to push a conservative agenda which has no support in society.

Foreign policy
Even if Iran's foreign policy will still reflect a substantial degree of factional infighting within the regime, in the longer term a parliament dominated by the conservatives will at least offer the advantage of Iran speaking with a single voice in matters of international relations and might make reaching some sort of settlement easier. The attempt to find an accommodation with the US in its own terms will also continue, as reformists and conservatives mainly differ on what precise type of settlement they want, rather than on the idea itself of dealing with the "Great Satan". On 30 January a breakthrough in US-Iranian relations seemed to be about to happen, as it was announced in the US that a 10 member congressional delegation trip to Teheran had been agreed. Interestingly, it was the Iranians who dashed any hope, denying that such a deal existed. The electoral climate in Iran certainly contributed to prevent the delegation's trip. What could be the last attempt of the reformists to establish a benchmark in foreign policy for a while took place in April, when an Iranian mission sponsored by the reformists traveled to Iraq to start a mediation between the US and the Shiite insurgents. Paradoxically, increasingly confident of their forthcoming victory in the parliamentary elections, the conservatives are already proposing themselves to the US as the only negotiating partner for improving relations between the two countries. The international position of Iran appeared compromised again in February by substantiated allegations that it is not complying with the UN resolution which demands that it fully declare its nuclear program. First there were revelations that Teheran failed to declare to having acquired drawings for an advanced uranium-enrichment centrifuge, then such a centrifuge was found in a base of the Iranian air force. It is now believed that Iran is continuing to assemble centrifuges, despite the agreement. Following this development, a senior official of the state department stated that the US government might even consider the use of force to prevent Iran from developing nuclear weapons. 
Although the relations of Iran with the surrounding countries are in general expected to continue to improve, it is difficult to forecast what type of relationship will be established with the new Iraq. There is little doubt that the Iranian regime will try to develop a stake in the future governments and given the difficulties experienced by the occupation forces led by the US it might well succeed in obtaining a settlement quite favorable to its own interests, at least in the short-medium term. Iran scored some positive developments in its international relations during January. Egypt and Iran finally announced that they will soon re-establish diplomatic relations.

Economy
Inevitably, the economic performance of Iran will depend in 2004, as in the past, from the trend of oil and gas prices. The growing awareness of the need to attract more foreign investment might finally begin to translate into the signature of more contracts, but not necessarily, especially if the factional conflict remains obviously undecided. The buyback system, deeply disliked by the oil multinationals, remains in place, although now investors can now tender for up to 25 years, compared to 7-8 years previously. Moreover, investors will not need to re-bid after exploration work has been carried out. Despite Iranian claims that even US companies have expressed interest in the tenders, however, most potential investors are disappointed, also because the major oilfields have been excluded from the new buyback deals. Still, a major Iranian success was the signature on 18 February, after protracted delays of the Azadegan oil deal with the Japanese, worth US$2 billion. By 2020 the government would like to raise production of oil to 7 million bpd, up from the current 4 million bpd. Iran is also trying to expand its gas production. The plans are ambitious, as gas exports should rise to 20 billion cubic metres by 2010 and 60-80 billion by 2020, up from just 3.5 billion last year. Exports to Turkey are planned to increase to 10 billion cubic metres by 2007, while negotiations are being held with Kuwait for a further 4 billion cubic metres.
In any case, the benefits of new oil contracts will not directly affect the economy during 2004. The efforts to develop the non-oil sectors of the economy are likely to produce some results in 2004, in part due to the growing number of joint ventures with foreign companies. On the whole, however, the impact of these initiatives will remain limited, except for some specific sectors, like communications. Significant benefits might derive from a partial return of capital from abroad, which already began in 2003, but there are few signs at the moment that this capital is going to be invested in productive activities. Creating employment for the mass of young Iranians who every year join the job market will remain a daunting task. The economic liberalization will continue. In March, for example, new rules were approved which will allow foreigners in invest in Iran's stock exchange. They will have to keep their money in Iran for at least three years and their share of the total value of the market will have to be no more than 10%. 
The 2004/2005 draft budget features a 10.5% increase on the previous year, to reach US$127 billion. The budget aims at achieving a 7.3% economic growth, based on the assumption of an average price of oil at US$19.5 a barrel. The Guardian Council however rejected the new state budget, on the ground that it conflicts with the constitution and with Sharia law on several points. The new budget once again confirms Iran's proclivity to spend to stimulate the economy. Even during the current year, the government admits that it will have to draw US$500 million from its Oil Stabilisation Fund, despite oil earnings US$6 billion higher than expected. The Fund will therefore drop to US$7.7 billion, a negative development in a year of oil revenue windfall like 2003/2004 has been. The conservatives supported a better balanced budget and are closer to the positions of the government, although they might just want to save the money, which will come from the reserve fund, for their own projects once they are in power. 

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Update No: 030 - (24/05/04)

A quiet transition after all
The second round of the parliamentary elections in May confirmed the outcome of the first, with a complete defeat of the reformists. The new parliament will take charge on 27 May, marking the end of the first phase of political reforms. The political climate is however quiet in Iran during this transition phase, a sign that the age of the reforms was ending and running out of steam in any case. Although the new parliamentary majority cannot be described as having a strong support among the population, some factors play its favour. Despite the initial fears, no visible backward social change has taken place yet and appears unlikely to take place even after 27 May, as the conservatives who control the parliament now are predominantly moderate ones. The business community in particular hopes that their management of the economy will be more efficient of that of the reformists. 

Some uncertainties on the shape of reforms
President Khatami is quietly changing his team to bring it more in line with the new environment. In May, he appointed a new head of the Management and Planning Organisation, which is the country's top planning body. This is the third senior economic official to be replaced after the defeat of the reformists in the elections. However, what will exactly be the shape of the new economic management remains unclear. It is unclear, for example, whether the new parliament will be ready to start cutting seriously the subsidies to consumption, which represent a major drag on the Iranian economy. The next presidential elections are scheduled for mid-2005, a fact that might reduce further the willingness to tackle such unpopular issues. Given the current trends, even if this year the oil revenue will turn to be significantly higher than estimated in the budget, lax fiscal discipline will force the government to dip into the Oil Stabilization Fund, which is supposed to kept aside for the rainy days. Subsidies aside, the conservatives will benefit from economic outlook for this year which is not too bad. The deficit spending will help stimulate the economy and low interest rates will also contribute. 
It also remains to be seen how the pro-business conservatives will deal with the growing demand for a more radical privatization program. So far the state has privatized little and even retained large stakes, for example in the form of pension funds, in the few cases of businesses which it privatized. Privatisation is mainly supported because it is expected to reduce the endemic corruption, rather than for any other sophisticated consideration of economic policy. Some reforms planned by the reformists are almost certain to go ahead, like allowing foreign banks to open branches in Iran and the reduction of the tariffs on some imported goods. A new parliamentary bill which allows new types of contracts to be used in the oil industry for deals with foreign investors is also expected to survive the change of parliamentary majority. The new bill could play a crucial role in revitalizing investment in the oil industry, which badly needs it. In particular the new law will allow foreign investors to develop fields in which they strike oil during exploration. 

US get softer, EU gets tougher
Iran's foreign policy continued to be centered around two main issues in May, the country's nuclear program and the crisis in Iraq. Significantly, US rhetoric about Iran's nuclear program has abated in May, although it is known that the Bush Administration has been working with the Russians, trying to convince them to stop helping the Iranians with their nuclear program. It is also known that hardliners within the US administration still resist any policy shift with regard to Iran, but the realists seem to be gaining the upper hand in this moment. The realists are ready to concede that the Iranians are being quite helpful in Iraq. Indeed, leading Iranian figures continue to heavily criticise Moqtada al-Sadr, the leading Shiite rebel in Iraq. Another signal sent to the US in May was the announcement by oil minister Zanganeh that US companies will be allowed to participate in Iranian oil tenders without restrictions. On the other hand, there are growing signs that IAEA is beginning to lose patience with Iran, after having initially adopted a positive stance. Pressure in May grew also from the European Commission, which is becoming more critical not only of the nuclear program, but also of the human rights record. Although this is not seen a major shift in EU policies, it does reflect the fact that Teheran will not be able to avoid giving satisfactory answers forever.

Economy
As far as gas is concerned, the negotiations with Total and the Malaysian national oil company are far from concluded, while those with Royal DutchShell are beginning to make progress only now and might still be two years away from the final deal. Moreover, Iran's relative political isolation put it at a disadvantage with its competitors in negotiating prices. The latest long-term sale agreement with China, for example, had prices significantly cheaper than those of a recent deal between China and Australia. The Iranian system makes developing gas projects even more complicated, as investors have to work with three different companies in order to get the gas out of Iran.
The price of petrol was raised by up to 23% in April, in an attempt to ease the burden of the very heavy subsidies on the state budget. The price of petrol remains at a low 10 cents per liter and this increase is unlikely to be enough to reduce consumption significantly.

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