Kevan Harris writes for the US Institute of Peace's "Iran Primer":
Iran's biggest economic problem is the growing production slump at its factories and workshops. For both workers and the business elite, Iran's domestic industrial troubles are far more pressing--and generating far more public anxiety --- than international sanctions.
The biggest danger for Iran in 2011 is the combination of higher unemployment and inflation produced by government inaction, unintended consequences of subsidy reform, and dwindling foreign capital caused by banking sanctions. The issue has been described as rokood-e tavarom,or "stagflation," by Iran's leading financial newspaper Donya-ye Eqtesad.
To stimulate the economy, Iran's Central Bank devalued the international exchange rate of its currency by 11 percent on June 8 --- a sharp reversal after years of propping up the rial. The exchange rate fell abruptly to 11,750 rials to the dollar. The bank's action is intended to help Iran's large industrial sector increase non-oil exports to its neighbors. The devaluation makes Iranian exports of cement, copper, petrochemical and agricultural products cheaper for other countries.
Yet the Central Bank's move may in fact only compound problems for Iranian businesses. Iran's industrial sector also needs to import machinery and raw materials, so decreasing the rial's value may "hurt the economy and the nation's industry" as imported goods become more expensive, noted parliamentarian Hamid Reza Fooladghar.
The government's failure to support industry after reforms in energy subsidies last year is a central cause of the slump. For the general population, the regime promised $45 per person monthly to offset increased prices of basic goods, fuel and utilities. But the government of President Mahmoud Ahmadinejad did little to aid industries. It promised the Chamber of Commerce, Industries and Mines to make loans and credits available to alleviate increased costs, but it offered no cash. It also banned businesses from increasing prices for a long list of household goods to prevent inflation. So, Iranian industries were squeezed on both sides: The government provided no tangible aid as industrial costs soared, but companies were barred from raising prices to cover those costs.
Under these conditions, Iran faces a looming crisis in an already ailing industrial sector. The irony is that subsidy reforms were designed to rejuvenate the economy. Instead, public concern is growing about just maintaining modest levels of employment and business activity, especially in provinces outside of Tehran. In June, the Food Industries Syndicate Chief in wealthy Fars Province complained, "Our capable private sector is not afraid of quality or price competition. But the targeted subsidies law, which was supposed to help the private sector achieve quality and price competitiveness, has instead been spent on helping the consumers." He essentially implied that the government is more worried about its citizenry than its industry.
But if industries continue to stagnate, unemployment is likely to increase, as businesses cut costs by laying off more employees, forego paying overdue wages and pensions to workers, and close down production lines. In an interview, a government official in Tehran explained, "I've visited industrial zones near the capital and some are now producing at 40 percent capacity because of cost increases for business after the subsidy reforms."
In a recent assessment, the International Monetary Fund warned that Iran’s main challenge will be “restructuring of enterprises through the adoption of more energy-efficient technologies, and the broader reorientation of the economy towards less energy-intensive products and services, and production technologies.” Yet even as other emerging economies--such as Brazil, India and China--are successfully retooling industries for a competitive global market, Iran’s approach is decidedly hands-off. Officials are not dealing with basic questions, including what industries will be viable without subsidies.
Sanctions by the United States and Europe--targeted at Iranian government banks, the Revolutionary Guards, and large official institutions--are also now trickling down to small entrepreneurs and industrial workers by further raising the costs of doing business. As a result, Iran is less able to compete with other developing economies in international markets. Despite a vow to help Iranian businesses upgrade infrastructure to become more energy-efficient, the government seems unaware or unsure of how to confront the growing challenges.