Can Iran reduce its reliance on oil?

Travel around Pakistan’s Balochistan province, and there’s a good chance you’ll find someone savouring an Iranian yoghurt drink spiced with mint - called the laban. 

“Everyone is drinking it these days,” says Sardar Shaukat Popalzai, who runs a think tank in Quetta, the provincial capital. 

Balochistan borders Iran’s Sistan-Baluchestan province, and for decades traders have shipped goods between the two countries with little hindrance. 

This balance of trade, which for the most part has remained in Iran’s favour, takes place in the informal sector where government’s reach to tax and regulate the flow of goods is limited. 

From shampoos, skincare products to detergents and electronic appliances, Iranians products have long lined store shelves in the border regions of Pakistan. 

Popalzai says Iran has managed to carve out a market despite stifling US sanctions. 

“A lot of that has to do with the Iranian culture. I have not met a single Iranian businessman who complains about his problems. They just try to find a way around it.” 

But a lot of it also depends on Tehran’s policy to wean reliance away from oil and on to other sectors such as automobiles.  
Violent street protests eclipsed recent reports that Iran aims to eliminate dependence on oil revenue to finance its next budget. 

Demonstrations swept across Iran after the government increased petrol prices 50 percent to thirty US cents per litre, at a time when people find it difficult to find jobs and inflation is expected to hit 35 percent this year.  

Since US President Donald Trump reimposed sanctions last year, Iran’s economy has shrunk. The IMF estimates that Iran’s GDP will contract by more than 9 percent compared to what it was just two years back. 

Washington has introduced sanctions that inflict maximum damage on ordinary Iranians by making it difficult for the Islamic republic to export oil, its major source of foreign exchange. 

Over the past year, Iran’s oil exports have come down drastically to around 500,000 barrels per day from 2.8 million bpd before the sanctions. 

While the sanctions, which target a host of other industries as well, are having an impact, Iran says it’s no longer taking into account income from oil sales to make its budget. 

So how is that happening?

A shift that was a long time coming 

Between 2009 and 2019, Iran’s reliance on oil revenue to finance its budget has come down from 60 percent to just 30 percent, says Mohsen Tavakol, a senior non-resident fellow at the Atlantic Council’s Middle East Programme. 

“Iran’s plan to reduce its overall economic dependence on oil revenues was a strategic approach that goes back to 1950,” he says. 

As part of that strategy, it encouraged the development of mining, petrochemical and food processing industries. 

“The growing and expanding diverse industries have immensely contributed to Iran’s GDP during the past decades and thereby to the government’s budgets through taxes as well as direct and indirect shareholding,” says Tavakol. 

Oil still plays a major role in the economy, and it made up 17 percent of Iran’s GDP in 2017, according to the World Bank. Oil’s contribution to the economy fluctuates depending on its prevailing prices in the international market. 

Every year the government prepares its budget on the projected sale of oil. For instance, in the current 2019-2020 fiscal year, which ends next March, it has set eyes on shipping 300,000 bpd to make up for its $40 billion spending plan. 

Around $25 billion of that is supposed to come from oil exports. 

The envisaged budget for next year that doesn’t include oil revenue will mean the government has fewer resources to spend. And the easiest way to make up for the lost oil revenue is to increase taxes or a steep reduction in subsidies. 

The country spends around $69 billion on energy subsidies every year and wants to cut that bill. But the recent decision to rationalise the petrol price that resulted in violent protests has highlighted the risks involved. 

Tehran’s confrontation with the US has cut it off from international financial markets, drying up foreign direct investment and making cross-border trade difficult. 

The Iranian currency, the rial, has lost substantial value since the sanctions were reimposed last year, stoking up inflation, which has added to grievances against the government.

Large state-owned companies and banks dominate the landscape, and the government takes out money from the national vaults to finance military expeditions in countries such as Iraq without much scrutiny. 

Deep-rooted corruption, complex regulations, and an ineffective banking system have also become a drag on the economy, says Tavakol. 

The feared Islamic Revolutionary Guard Corps, the military force that is answerable to Iran’s Supreme Leader Ali Khamenei, has ventured into businesses such as real estate to international trade, crowding out the private sector. 

And reducing the dependence on oil comes at a cost.

“Removing domestic subsidies on certain products and services – recently on petrol as an example – isn’t really a way for the Iranian government to compensate budget shortfalls,” says Tavakol.