Iran Economic Monitor OIL-DRIVEN RECOVERY Special Focus on: Iran’s Pension System: The Need for Reform; and Towards Water Security in Iran: Challenges and Opportunities Spring 2017 Global Practice for Macroeconomics & Fiscal Management Middle East and North Africa Region Iran Economic Monitor OIL-DRIVEN RECOVERY Spring 2017 Cover photo: Lake Urmia, courtesy of Mojtaba Esmaeilzad TABLE OF CONTENTS Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Chapter 1  Recent Economic and Policy Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Output and Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Jobs and Labor Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Public Finances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Monetary Policy and the Financial Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 External Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Chapter 2  Outlook and Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Special Focus 1 Iran’s Pension System: The Need for Reform . . . . . . . . . . . . . . . . . . . . . . 19 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 Pension System in Iran – Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Main Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22 Policy Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Annex 1. Pensions Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32 Special Focus 2 Towards Water Security in Iran: Challenges and Opportunities . . . . . . . . . . 35 Iran’s Long Tradition in Water Resource Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35 Symptoms of Extreme Water Scarcity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Drivers of a Potential Water Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 Looking Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 List of Figures Figure 1: Real GDP Level and Growth Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 Figure 2: Oil Production, Exports and Prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Figure 3:  Contribution of Expenditure Components to Growth (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2 Figure 4: Potential GDP and the Output Gap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 Figure 5: Youth Unemployment, Iran and other Upper Middle Income Countries (% of Total Labor Force Ages 15–24): 2013–2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 iii Figure 6: Labor Force Participation, Employment Ratio and Unemployment Rate . . . . . . . . . . . . . . . . 6 Figure 7: Gender-Based Legal Restrictions and Female Labor Force Participation (%) . . . . . . . . . . . .7 Figure 8: Central Government Budget Components (% of GDP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Figure 9: Oil Dependence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 Figure 10: CPI, Goods and Services Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Figure 11:  Official and Market Exchange Rates ($) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 Figure 12:  The Current Account Surplus Rebounded in 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Figure 13: The Lifting of Sanctions Has Quickly Affected Iran’s Exports Destinations . . . . . . . . . . . . . 11 Figure 1.1: Growth Rate of GDP Per Person Employed (constant 2011 PPP Dollars), 2005–15 . . . . . 14 Figure 1.2: Female Labor Force Participation (% of Female Population Aged 15–64), 2005–15 . . . . . 14 Figure 1.3: Simulations of Real GDP Per Capita Under Benchmark and Take-Off Scenarios . . . . . . . .15 Figure 14: Pension Spending vs Population Over 65 (as % of Total Population) . . . . . . . . . . . . . . . . . . 23 Figure 15: Accrual Rate: International Comparisons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Figure 16:  Labor Force Participation Rate (% Pop 15+), 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24 Figure 17:  Pensions Coverage vs Income Per Capita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Figure 18:  Projected Population Aged 65+/15–64 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25 Figure 19: Share of GDP Produced and Population Living in Areas Where Water Withdrawals are Approaching or Have Surpassed Sustainable Resource Use . . . . . . . . . .36 Figure 20: GDP Produced in Areas Where Water Withdrawals are 40% or More of Surface Water Resources Availability, by Country and Economy, Middle East and North Africa, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Figure 21: Reduction in the Area of Lake Urmia (88% in the Last Three Decades) Over the Past Three Decades as a Result of Intensive Upstream Abstraction . . . . . . . . . . .37 Figure 22: Total Water Productivity, Selected Middle Eastern and North African Countries and Economies, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39 Figure 23:  Combined Water and Wastewater Bill Per Cubic Meter, Selected Cities in the World . . . . 40 List of Tables Table 1: Islamic Republic of Iran: Selected Macroeconomic Indicators (2013–16) . . . . . . . . . . . . . . . 4 Table 1.1: Assumptions for Long Term Growth Simulations, Values for 2030 . . . . . . . . . . . . . . . . . . . . 15 Table 2: Pension Schemes in Iran: Active Members, and Retirees, 2014 . . . . . . . . . . . . . . . . . . . . . . 21 Table 3: Pension Schemes SSO and CSRF Design Features in Iran . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Table 4: Current Policy Parameters and, Desirable Policy Parameters Based on first Principles and Best Practice, Slow and Fast Reforms . . . . . . . . . . . . . . . . . . . . . . 28 List of Boxes Box 1: Iran’s Long-Term Growth Prospects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 iv IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY PREFACE The Iran Economic Monitor provides an update on key (Lead Economist), Edoardo Borgomeo (Consultant) economic developments and policies over the past six and Irene Rehberger Bescos (Analyst) under the months. It examines these economic developments guidance of Steven Schonberger (Practice Manager). and policies in a longer-term and global context, and Janet Minatelli (Senior Country Officer) provided assesses their implications for the outlook for the helpful comments. Muna Abeid Salim (Senior Program country. Its coverage has ranged from the macro- Assistant) print-produced the report. The team is economy to financial markets to indicators of human grateful to the Government of Iran for its contributions welfare and development. It is intended for a wide to this publication. audience, including policy makers, business leaders, The findings, interpretations, and conclusions financial market participants, and the community of expressed in this Monitor are those of World Bank analysts and professionals engaged in Iran. staff and do not necessarily reflect the views of the The Iran Economic Monitor is a product of the Executive Board of the World Bank or the governments World Bank’s Global Practice for Macroeconomics & they represent. Fiscal Management team. This third issue was prepared To be included on the email distribution list by Kamer Karakurum-Ozdemir (Senior Economist, Task of the Iran Economic Monitor series and related Team Leader), Majid Kazemi (Economist) and Fayavar publications, please contact Nada Abou Rizk Hayati (Economist), under the general guidance of Eric (nabourizk@worldbank.org). For questions and Le Borgne (Acting Global Practice Manager) and Saroj comments on the content of this publication, please Kumar Jha (Country Director). The Special Focus on contact Kamer Karakurum-Ozdemir (kozdemir@ pensions was prepared by Montserrat Pallares-Miralles worldbank.org) or Majid Kazemi (mkazemi@ (Senior Social Protection Specialist) with inputs from worldbank.org). Questions from the media can be Robert Palacios (Pension Team Leader) and under addressed to Mona Ziade (mziade@worldbank.org). the guidance of Hana Brixi (Practice Manager), and This publication can be also found on the following the one on water was prepared by Claudia Sadoff website http://www.worldbank.org/en/country/iran. v OVERVIEW I ran’s economy recorded an impressive and investment. As Iranian banks face barriers in recovery in 2016 in line with the favorable establishing correspondent banking relationship with expectations after the removal of the nuclear large international banks, foreign direct investment related sanctions. Following a contraction of close inflows to Iran and trade relationships with the rest of to 2 percent in 2015, GDP grew by an estimated 6.4 the world are restrained. Still, recent developments percent in 2016, the fastest since 2010.1 While there suggest non-oil sector and investments are likely are some recent signs of a spillover into the non-oil to play a bigger role in the next few years, bringing sectors of the economy, this growth performance was growth to an average of 4.1 percent in 2017–19. This driven primarily by the bounce back in oil production positive growth outlook hinges on the assumption and particularly in oil exports, despite lower oil prices. that some of the agreements between Iran and major Iran’s ability to increase production despite the cuts foreign companies in the oil and gas and other key agreed to by the rest of the OPEC members helped sectors, including manufacturing, will materialize. production near its pre-sanctions levels. The surge This would create renewed confidence, validating the in exports led to a sharp improvement in the current very positive expectations generated in the immediate account surplus, to 6.5 percent of GDP in 2016, as aftermath of JCPOA implementation in January 2016 growth in imports remained stagnant. As oil revenues and leading to gradually improving medium to long gained pace, the budget performance also improved, term growth dynamics as potential output starts to and the deficit shrank to 1.5 percent of GDP in rise as well. 2016 from 1.9 percent a year ago. Notwithstanding There are significant downside risks to the achievement of single digit inflation in 2016, this moderate outlook. The major risk in the near inflationary pressures have resurfaced towards the future is the political uncertainty around the full end of the year, as liquidity rose, the Iranian Rial implementation of JCPOA. This is likely to continue continued to depreciate and economic activity influencing consumer/investor confidence and may picked up. Against this background, the Central Bank lead to a further weakening in private consumption postponed the unification of the official and market exchange rates to the end of 2017. In the medium-term, growth rates are 1 The years in this note refer to Iranian calendar year, which runs from March 21 to March 20 of the following expected to retreat to slightly above 4 percent, Gregorian year. For example, 2016Q1 in this text refers in the absence of structural reforms and a major to the first quarter of the Iranian calendar year 1395 change in the pace of reintegration in trade (April-June). vii and investment. Under this scenario, GDP growth them. This would involve tackling the structural would remain below 3 percent. Furthermore, lower reform agenda that will boost non-oil sector growth, than projected oil prices could put pressure on through creating a level-playing field for existing and government revenues and undermine growth. new firms, improving the business environment and Going forward, implementing the the efficiency of labor markets. In the long-term, domestic reform agenda is likely to bring the the primary determinant of Iran’s growth prospects highest growth dividend in the medium to long is likely to be how effective it utilizes its resources term, even if the external conditions remain beyond oil and gas. Growth simulations for Iran’s the same. The challenge faced by the recently re- long-term growth prospects conducted for this report elected President Rouhani and his government suggest there is great potential to be exploited in will be to prioritize the reforms outlined in the 6th moving towards the technology frontier and better five-year development plan and steadily implement utilizing Iran’s abundant educated labor force. viii IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY 1 RECENT ECONOMIC AND POLICY DEVELOPMENTS Output and Demand each quarter, on the back of the oil sector while the expected benefits have so far not appeared as In line with the positive expectations in the strongly in the other sectors. Consequently, overall aftermath of the implementation of the JCPOA, growth in 2016 is estimated to have reached 6.4 output growth in 2016 underwent a strong percent, following a 1.8 percent contraction in 2015. rebound. The real GDP level in 2016 is expected to The major pillar of non-oil growth initially envisioned return to its historical peak of 2011 after remaining after the JCPOA implementation was a strong inflow of below this value in the previous five years (Figure 1). foreign investment into the Iranian economy. However, Initial data for the first three quarters of 2016 suggest a surge in FDI did not materialize due initially to high that the growth rate has continually increased in transaction costs for foreign businesses of fully FIGURE 1 • Real GDP Level and Growth Rate 3,000,000 15 Real GDP (2004 prices) – billion rial 2,500,000 10 Real GDP growth (%) 2,000,000 5 1,500,000 0 1,000,000 –5 500,000 0 –10 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Real GDP (2004 prices) – billion rial Real GDP growth (%) Source: Government data and World Bank staff calculations. 1 FIGURE 2 • Oil Production, Exports and Prices. 4.0 120 3.5 100 3.0 80 2.5 USD per barrel mbpd 2.0 60 1.5 40 1.0 20 0.5 0 0 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 Oil output (LHS) Oil exports (LHS) Oil price (RHS) Source: CBI and World Bank. complying with the remaining US sanctions and later annual growth in 2016 suggests that oil-driven exports complicated by increased uncertainty about possible contribution to growth of 7.7 percent dominates the –1.7 new sanctions on Iran. and 1 percent contributions of investment and private Despite challenges, oil output and exports consumption (Figure 3). continued to recover, returning to pre-sanctions The output gap has recently been closing. peak and spearheading overall growth. Oil output The recent spur in economic growth is estimated to has already increased to around 4 mbpd. This means have contributed to the narrowing down of the output that compared to the output in the first quarter of 2016, gap from –6.6 percent in 2014 to –2.3 percent in 2015 Iran has been able to increase production by 700 (Figure 4). This is in line with the increase in credit thousand bpd in only nine months. Oil exports equally received a boost, reaching 2.1 mbpd in the second quarter of 2016, up from 1.5 in the same quarter of the FIGURE 3 •  Contribution of Expenditure previous year. The quick recovery of oil production was Components to Growth (%) achieved as a result of a combination of both political and technical planning by the Ministry of Oil even before 15 the implementation of JCPOA. On the political front, the 10 Ministry managed to successfully negotiate with OPEC an 5 increase in Iran’s production quota, regaining its market 0 share by bringing its output to pre-sanctions levels and –5 secure its traditional position at the organization. This –10 coincides with the rest of the OPEC members agreeing –15 to an output cut to counteract the falling global oil 2000 2003 2006 2009 2012 2015 2018 prices. On the technical front, Iran managed to recover Gov. cons. Exports GFCF Inventories production levels in the existing fields to pre-sanctions Private cons. Imports Statistical disc. GDP levels, following an abrupt drop in extraction due to sanctions. As a result, the decomposition of estimated Source: Iranian authorities. 2 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY FIGURE 4 • Potential GDP and the Output Gap 2,400,000 14 12 2,200,000 Real GDP (2004 prices) – billion rials 10 2,000,000 8 1,800,000 6 4 1,600,000 2 1,400,000 0 1,200,000 –2 –4 1,000,000 –6 800,000 –8 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Output Gap, % (RHS) Potential GDP (LHS) Actual GDP (LHS) Source: Government data and World Bank staff calculations. expansion and the increase in liquidity, which would More recently, the non-oil sector growth support the expected recovery in private consumption has started to show moderate signs of recovery. and gross capital formation shown in Figure 3. The Central Bank data for the first nine months of 2016 Investment levels continue to remain indicate that non-oil output has grown by 1.9 percent weak—a drag on future growth. Gross capital which is a considerable improvement compared to –3.9 formation figures report an 8.9 percent contraction in percent non-oil growth in the same period in 2015. The the first three quarters of 2016.2 This trend has been figures show that quarterly non-oil GDP has improved the most important ongoing legacy of the nuclear consistently, reaching 4.6 percent in the third quarter. sanctions in which investment performance has The engine of non-oil growth in this quarter seems to continued to remain bleak with a trough of 19 percent be services and agriculture that grew by 5.6 percent contraction in 2012. Out of the two subcomponents and 5 percent respectively. At the same time, growth of gross fixed capital formation, machinery investment in the output index for large manufacturing firms in the growth reached 5.3 percent in the first three quarters— first nine months of 2016 is reported to be 6.8 percent driven by a 10.1 percent increase in the third quarter. year over year which is a substantial improvement However, investment in construction shrank by 14.4 in comparison to the 3.5 percent contraction in the percent during this period. Although the contribution of similar period of the previous year. This improvement oil to growth is expected to diminish, as Iran reaches its was led by growth in chemicals and the automotive OPEC quota, the outlook for growth contribution of gas sectors that experienced growth rates of 7.7 and 35.6 is promising. Despite the importance of investment-led percent. These two sectors combined accounted for growth, the disinvestment trend in the economy is even around 43 percent of the weighted overall index that present in the domestic component of investment. This could also benefit job creation in this period. trend reflects the weaknesses in the general business climate and outlook for the economy, in addition to the external factors. Addressing the domestic reform 2 Data based on 2011 constant prices, since the 3rd agenda would allow for a more resilient economy quarter figures for 2016 were recently released by CBI while increasing the prospects of foreign investment. after a change in the base year from 2004 to 2011. Recent economic and policy developments 3 TABLE 1 • Islamic Republic of Iran: Selected Macroeconomic Indicators (2013–16) 2013 2014 2015E 2016F* Real GDP growth, at factor cost (2004=100) –1.8 3.0 –1.8 6.4 Agriculture 4.8 3.8 3.9 4.6 Industry** –4.7 4.9 4.2 8.1 Services –0.6 1.7 –6.3 5.4 Real GDP growth, at market prices (2004=100) –1.9 4.3 –1.8 6.4 Private Consumption –9.3 3.1 0.8 2.0 Government Consumption 1.6 2.7 –8.3 1.7 Gross Fixed Capital Investment –6.9 3.5 –9.8 –7.3 Exports, Goods and Services 0.0 12.0 7.1 35.0 Imports, Goods and Services –18.7 –5.7 –5.2 6.4 Prices Inflation (Consumer Price Index) 34.7 15.6 11.9 9.0 Current Account Balance (% of GDP) 6.3 3.8 2.7 6.5 Fiscal Balance (% of GDP) –0.9 –1.2 –1.9 –1.6 Sources: Government data and World Bank staff calculations. * Iranian calendar years, running from March 21st to March 20th of the following year. **Industry includes the oil and gas sector. A number of new agreements have billion joint ventures with domestic firms. Furthermore, been signed between Iran and international progress beyond initial agreements and MOUs has partners but renewed uncertainty regarding stalled as foreign investors have been cautious or full implementation of the JCPOA has hindered often hesitant to start projects in an environment of project initiation. According to the Iranian Foreign heightened uncertainty regarding sanctions on Iran. Minister, more than 84 political delegations and numerous economic missions have visited Iran in 2016 while in the same period Iranian delegations Jobs and Labor Market visited 57 countries.3 These comprised of a number of high-level visits including one in January by the The unemployment rate has continued a rising French foreign minister along with a 60 member team trend and reached 12.5 percent in the last quarter consisting of officials and businessmen, where a of 2016 despite strong economic growth in this number of agreements were signed and the Minister reaffirmed France’s commitment to JCPOA’s full implementation.4 Since January 2016, the total value 3 Interview with journalists, reported by ILNA, available at: https://goo.gl/t0eL3N. of the agreements signed between Iran and potential 4 http://www.al-monitor.com/pulse/originals/2017/01/iran- investors is estimated to have reached between $8 french-foreign-minister-ayrault-trump-nuclear-deal.html. to 12 billion.5 However, even the higher estimates 5 h t t p : / / d o n y a - e - e q t e s a d . c o m / n e w s / 10 9 3 2 3 6 , fall short of the authorities’ targets for the medium- https://financialtribune.com/ar ticles/domestic- term. According to the recently approved 6th five-year economy/57154/iran-approves-118b-of-fdi-post- development plan, annual FDI inflow is projected to sanctions and https://www.ft.com/content/f342b558– increase to a high of $15 billion in addition to $20 0a37–11e7-ac5a-903b21361b43. 4 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY FIGURE 5 •  Youth Unemployment, Iran and other Upper Middle Income Countries (% of Total Labor Force Ages 15–24): 2013–2015 70.0 60.0 50.0 40.0 MENA average 29.1 30.0 Upper middle income average 20.0 10.0 0.0 Thailand Kazakhstan Cuba Malaysia Peru Mexico Paraguay China Ecuador Angola Panama Equatorial Guinea Belarus Azerbaijan Russian Federation Brazil Venezuela, RB Suriname Fiji Turkey Colombia Costa Rica Algeria Turkmenistan Lebanon Mauritius Belize Guyana Romania Maldives Bulgaria Albania Iran, Islamic Rep. Jordan Dominican Republic Jamaica Botswana Iraq Georgia Gabon Namibia Montenegro Libya Serbia Macedonia, FYR South Africa Bosnia and Herzegovina Source: Find My Friends using the World Development Indicators. period.6 This increase is largely a reflection of an percent respectively in the fourth quarter of 2016, increase in the labor force participation rate to 38.9 from 10.2 and 19.7 percent in the same period of percent from 37.7 percent in the same period of 2015, 2015, with the gap slightly narrowing. The gender gap mainly owing to inflow of some discouraged workers in Iran’s labor force participation is one of the highest who restarted seeking jobs. The number of job seekers in the region. Participation rate for men stood at 63.7 increased by 1.07 million over the last 12 months as of percent in 2016Q4, as opposed to 14.2 percent for March 2017, significantly higher than the 766,292 new women. While more women entered the job market, jobs created, bringing the number of unemployed up by the employment rate did not rise concomitantly; an more than 311,000. At the same time, underemployment indication of challenges facing women not only in remains high at 10.9 percent of the total employed participating in the labor force but also in finding jobs. population. Unemployment in urban areas, at 13.4 While the demographic window of percent, remains significantly higher than in rural areas opportunity remains open, increasing labor force (10 percent). Unemployment is higher among youth, participation would be critical to ensure Iran is at 29.1 percent. High youth unemployment rates are a prepared for the aging challenge ahead. Due to the common feature of many MENA countries though the remarkable drop in fertility during the 1980s and 1990s, situation is considerably better in some countries such from 7 in 1984 to 2 in 2000, the age-dependency ratio7 as Lebanon, Algeria and Morocco (Figure 5). Recent research has emphasized the importance of demand 6 The labor force in Iran is defined by the Statistical Center side factors in addressing the challenges of job creation of Iran as the population 10 years of age or above. in the region (see, World Bank, 2014). 7 Age dependency ratio is the ratio of dependents—people A wide gender gap continues to prevail younger than 15 or older than 64—to the working-age in the Iranian labor markets. Male and female population—those aged 15–64. Data are shown as the unemployment rates increased to 10.8 and 20.1 proportion of dependents per 100 working-age population. Recent economic and policy developments 5 FIGURE 6 • Labor Force Participation, Employment Ratio and Unemployment Rate 42 17 40 15 38 13 36 11 34 9 32 7 30 5 2009Q2 2009Q4 2010Q2 2010Q4 2011Q2 2011Q4 2012Q2 2012Q4 2013Q2 2013Q4 2014Q2 2014Q4 2015Q2 2015Q4 2016Q2 2016Q4 Labor force participation rate (LHS) Employment-population ratio (LHS) Unemployment rate (RHS) Source: SCI labor force survey. was more than halved between 1980 and early 2000s. identify determinants of the gender gap in labor force Although life expectancy steadily increased, the ratio participation in Iran and to assess the extent of these will remain at this low level for the next three decades, legal restrictions and the degree to which they affect when it will start to climb back up—due to increasing participation of women in the labor force. However, aging of the population. If current trends continue, Iran cross-country data shows that there is a strong negative would start to age drastically by 2050 with the share of correlation between the number of legal restrictions elderly (65+) reaching a quarter of the total population. and labor force participation (Figure 7). There also Only a limited portion of the working age population exists cross-country research that suggests that legal joins the labor force in Iran, hence, until now it has not rights such as guaranteed equality and other economic been able to take full advantage of the “demographic rights such as being allowed to head households are window of opportunity.” associated with smaller gender gaps in labor force It would be critical to raise labor force participation (IMF, 2015). A regional study on gender participation rates in the coming years not only equality and development in Middle East and North to propel economic growth but also to prepare Africa (World Bank, 2013) also argues that legal and for the aging challenge ahead. Relaxing labor social barriers limit women’s labor force participation. market rigidities, through for example improving labor market regulations that may affect hiring (such as severance payments that tend to protect tenured Public Finances workers) and improving relevance of skills is critical to take full advantage of the demographic window The estimated central government fiscal deficit of opportunity. A potential deterrent to women’s narrowed in 2016, with the rise in revenues more participation in the labor force is the restrictions in than offsetting the increase in expenditures. the legal framework. According to the World Bank’s Government revenues in the first ten months of 2016 2016 report “Women Business and the Law”, Iran has reached about 66 percent of the amount envisaged in the the third highest number of legal gender differences. budget. Expenditures on the other hand, was equivalent More country-specific research would be needed to to 64 percent of the approved budget, reducing the 6 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY FIGURE 7 • Gender-Based Legal Restrictions and $43 per barrel in 2016, down from $51 in the previous Female Labor Force Participation (%) year. Direct taxes slightly reduced from 3.7 percent of GDP in 2015 to 3.6 percent of GDP in 2016, with weaker 100 economic activity in non-oil sectors. Similarly, indirect Labor force participation rate, female (% of female population ages 15+) 90 taxes fell slightly from 3.2 percent of GDP in 2015 to 3 80 70 percent of GDP, though VAT rates were kept constant 60 at 9 percent. On the expenditure side, government 50 expenditure is estimated to have also increased y = –1.2906x + 59.536 40 30 incrementally to 17.7 percent of GDP compared to 17.5 20 percent in 2015. The marginal increase in expenditure 10 Iran was a result of increase in capital expenditure, from 2.4 0 0 5 10 15 20 25 30 35 to 2.6 percent of GDP in 2016 which signals the greater Legal gender differences emphasis by the government on the lagging investment Source: World Bank (2015) Women, Business and the Law. and World Development performance of the country. Indicators. The budget’s dependence on oil income has recently moderated, but still remains high. The role of oil in government finances has been driven by FIGURE 8 • Central Government Budget recent political developments. The share of oil in terms Components (% of GDP) of both government revenues and GDP started falling with the implementation of sanctions from 2011, leading 20 0.0 the government to take measures towards resilience 15 –0.2 10 –0.4 against external shocks. Since 2013 elections, the 5 –0.6 government of Iran has also aimed to stabilize and –0.8 0 gradually reduce the role of oil in the budget, with the –1.0 –5 help of increased VAT rates. Despite the increase in –1.2 –10 –1.4 the share of oil sector in GDP in 2016 following the –15 –1.6 JCPOA, the share of oil revenues is estimated to further –20 –1.8 –25 –2.0 decline to 32 percent, before recovering in 2017. This 2010 2011 2012 2013 2014 2015 2016 represents a significant diversification of government Other Revenues Tax Revenues Other expenditure revenues, as oil accounted for more than 50 percent of Expenditure on Goods and Services Fiscal deficit (RHS) total revenues in 2010–11. Source: SCI labor force survey. In March, the Iranian Parliament approved the 2017 budget. The main assumptions of the $100 billion 2017 budget are that the economy will grow at 7.7 fiscal gap for the period to around a half of the budget percent, inflation will be around 7.6 percent, oil exports proposed value. In line with this budget performance, will accrue at an average price of $55 per barrel in 2017 the fiscal deficit for the full year is estimated at 1.6 and around 35 percent of government revenues will percent of GDP, down from a deficit of 1.9 percent of consist of oil revenues. On the structural side, the new GDP in 2015 (Figure 8). In 2016, it is estimated that total budget law improves public financial management by government revenues increased to 16.1 percent of GDP mandating the transfer of all government accounts in 2016, up from 15.6 percent of GDP in 2015, in line from the banking sector to the Central Bank of Iran with the continued rise in other revenues which includes (CBI). Crucially, the legislation includes not only the contribution from oil income. Oil revenues slightly central government funds but also all State Owned increased by 0.2 percentage points to 6.0 percent Enterprises (SOEs) and other public entities that of GDP, mainly as a result of an increase in oil export receive governmental budgetary allocations. This will volumes despite the drop in oil prices to an average of allow real time control to the CBI and the Supreme Recent economic and policy developments 7 FIGURE 9 • Oil Dependence beverages price index increasing by 12.8 percent. This is in line with the inflationary trend observed since July 30 60 2016 as global non-oil commodity prices witnessed 25 50 an accelerating inflationary trend. Between July 2016-February 2017, the main drivers of this rising trend 20 40 were food prices and housing prices. The declining 15 30 trend in core inflation (excluding fuel, electricity and 10 20 food and beverages) halted in August 2016 and the 5 10 rate stabilized at around 9 percent during this period. The downward trend in the services inflation 0 0 2010 2011 2012 2013 2014 2015 2016 also came to an end in October 2016, hinting the building up of inflationary pressures in the non- Oil revenue % of government revenues (RHS) Oil sector % of GDP (LHS) tradable sectors as well. In February 2017, services price index increased by 11.5 percent compared to Source: Government data and World Bank staff calculations. the same period of the previous year, continuing a persistent inflation rate of around 11 percent since October 2016 and down from 20 percent in April Audit Court on transactions to or from these accounts 2015. As of February 2017, the biggest contributors to and minimize financial mismanagement. This measure inflation in services came from health and education along with the ongoing securitization of government components, with annual price increases of 17.1 and arrears through provision of Islamic treasury bills to 11.2 percent respectively. As shown in Figure 10, the the banking system are all positive steps in improving decline in service prices had joined the sharp decline not only the government fiscal accountability but also in food prices in bringing down the headline inflation the overall health of the banking system. Continued during the past two years until mid-2016. securitization of government arrears would require The increase in consumer prices can also efforts to develop the government debt market, while it be attributed to the surge in producer prices to would be important to factor into the budget the impact around 6.8 percent in December 2016, more on the interest bill of the issuance of additional new than twice the rate in the same month of the debt (of 3,500 trillion rials) and coordinate this process previous year. While agriculture prices increased with monetary policy (IMF Article IV, February 2017). by 4.9 percent, services PPI increased by 7.6 percent and manufactured goods PPI was 7.1 percent higher Monetary Policy and the Financial in December 2017 than a year before. The rise in Sector manufacturing prices can mainly be attributed to a sharp rise in prices of basic metals, the sector’s The Iranian economy experienced its first year third biggest component, by around 12.5 percent. of single digit headline inflation in a quarter of Furthermore, prices in the automobile sector grew a century, though upward pressure on prices marginally by 0.2 percent year-over-year which was have resurfaced. Monthly CPI inflation was largely a result of commitments by the Competition successfully kept at under 10 percent for 13 months Council to limit price increases of newly manufactured between December 2015 and January 2017. However, motor vehicles by the two main producers Iran Khodro inflationary trends picked up since November 2016 and Saipa.8 The increase in minimum wage by 14.5 and the headline rate moved into double digits (10.6 percent) in February 2017, on the back of oil income entering the economy. The main contributor to the 8 For instance, prices were promised to stay the same surge in inflation in February 2017 came from prices between November 2016 and May 2017. See: http:// of goods, which rose by 9.6 percent, with food and www.car.ir/news/Iran-Company/increase-car-prices. 8 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY FIGURE 10 • CPI, Goods and Services Inflation industries had been contracting under the sanctions due to the shrinking of correspondent banking. This 25 helped the recovery of large manufacturing firms (by 6.8 percent) in the first three quarters of 2016. The 20 CBI has indicated that these funds are only temporary 15 measures to allow firms to sustain their operations and create room for growth, which would enable them 10 to tap into other funding sources. However, these 5 measures have also contributed to an accelaration in liquidity growth; in January 2017 liquidity grew by 26 0 percent year-over-year. Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Notwithstanding these challenges, the CBI has shown commitment to reform and embarked Goods (%, YOY) Services (%, YOY) CPI (%, YOY) Core inflation (%, YOY) on implementing a wide range of measures to improve the banking sector operations. As part Source: CBI. of the commitment of the Central Bank to address the issues of concern listed by Financial Action Task Force (FATF), new financial reporting based percent for 2017, a rate higher than the expected on international financial reporting system (IFRS) is inflation, may put additional pressure on inflation. being implemented. Adoption of IFRS is an ongoing Despite the narrowing down of the output process and if implemented appropriately, it would gap, unemployment rates above the non- be an important step for the country to be removed accelerating inflation rate of unemployment permanantly from the FATF blacklist. This would be a (NAIRU) suggest absence of inflationary pressure clear signal of readiness for hosting foreign investment. from the labor markets. The recent growth in GDP Furthermore, the recently approved reforms in the has not been accompanied by strong employment transfer of all government accounts to the Central generation, which can be attributed to the dominance Bank, not only increases fiscal transparency and of the capital-intensive oil sector. At the same time, prudence but could reduce the stress of government estimates of NAIRU using a multivariate Kalman arrears on the banking sector and increase efficiency Filter suggests a declining NAIRU in recent decades. in intragovernmental transactions. It could also greatly While the NAIRU reached 11 percent in 2016, actual mitigate systemic liquidity risk across the financial unemployment rate remains above the NAIRU, system. The CBI has also taken other measures such indicating limited inflationary pressures stemming as scaling up a vibrant and transparent interbank from any tightness in the labor market. market, as the unique platform for all banking The Central Bank has boosted provision of transactions, and issuing permits to banks to open trade finance by commercial banks for imports accounts for foreign nationals. of intermediate goods, especially for enterprises Correspondent banking relations have in the industrial sector. The CBI has overseen the gradually restarted with smaller international expansion of lines of credit by the banking system to banks but remain as an important challenge the real economy by 37 percent in the first 11 months of with major international banks. One of the main 2016. The mining and manufacturing sectors received impediments to short run growth in the non-oil sector almost 30 percent of all loans which is the biggest has been the lack of change in the stance of major share relative to their contribution to GDP, out of international banks in reinitiating correspondent which 82 percent were directed towards their working banking relations (CBR) with Iranian banks. This capital requirements. The role of these directed loans reluctance of reengagement of the big banks is based was key in overcoming the long period in which on the uncertainty around dollar transactions and the Recent economic and policy developments 9 Official and Market Exchange Rates FIGURE 11 •  both rates (Figure 11). However, the exchange rate ($) premium has increased slightly in the third quarter of the year due to the seasonal increase in demand 45,000 and expectations for a sharp depreciation after the US 40,000 elections, driving the market exchange rate to above 35,000 the 40,000 rial mark for a few days. At the time, the CBI 30,000 was quick to react and brought the rates back down. 25,000 The government also allowed the banks to clear funds 20,000 at the market exchange rate in order to reduce pressure 15,000 on the foreign currency reserves. Subsequently, in mid- 10,000 March the official and parallel rates stood at around 5,000 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 32,400 and 37,000 rials respectively. However, the full unification of the rates was postponed by a year, Official rate Parallel market rate under pressure from the recent increase in inflation to avoid the potential pass-through from a further Source: CBI. depreciation of the rial. Reestablishment of a well- functioning correspondent banking relationship would also support the unification of the rates. The Tehran Stock Exchange (TSE) index so-called U-turn transactions9 especially since some has experienced a slight downturn due to of these banks were hit with hefty fines prior to JCPOA implementation. The unification of the official and market 9 The U-turn dollar denominated transactions were exchange rates has been postponed by a year transactions of Iranian funds that were previously allowed to be cleared through US financial institutions on the to the end of 2017. The gap between the two rates condition that the recipient and issuer of the transaction fell from a recent peak of 192 percent in June 2013 were non-Iranian banks that are not in the US or under to 15 percent on average in the first three quarters of US jurisdiction. However, the exemption allowing such 2016/17, accompanied with a much lower volatility in transactions was revoked in 2008. The Current Account Surplus Rebounded in 2016 FIGURE 12 •  160 12 140 10 120 8 100 USD, Billions 6 % of GDP 80 4 60 2 40 20 0 0 –2 2000 2002 2004 2006 2008 2010 2012 2014 2016 Current account balance (RHS) Imports (LHS) Exports (LHS) Source: World Bank. 10 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY external factors influencing the future of JCPOA. FIGURE 13 • The Lifting of Sanctions Has Quickly After the stock exchange index reached a historical Affected Iran’s Exports Destinations peak of 81,537 in April 2016, there was a correction through June 2016. The volatility in the index has Iran’s exports of goods (Quarter, USD million) declined after this sharp swing and as expectations Germany for attracting investment and the longevity of the France JCPOA were partially revised. The overall index Japan has hovered around the 77,000 mark since August Korea European 2016, with mid-March levels 6 percent below the Union December level peak. At the same time, the top 50 India China or 30 index displays a more negative performance of Advanced big companies which were more likely to benefit from Emerg Developing improvement of international trade and finance. 0 2,000 4,000 6,000 8,000 10,000 2015Q2 2016Q2 External Position Source: IMF DOTS. Iran’s external position strengthened in 2016 following the six-year low in the current account surplus in 2015. The surplus is estimated to have rebounded from 2.7 percent of GDP in 2015 to 6.5 compared to a year ago, while exports to India soared percent of GDP in 2016, with higher oil production, by 57 percent over the year. lifting of sanctions and improved oil prices FDI and portfolio investment remained low (Figure 12). According to government sources, oil in 2015 at 0.2 percent of GDP but is estimated to exports increased by one-third, up to 2.1 mbpd in the have more than doubled in 2016. FDI and portfolio second quarter of 2016, compared to 1.5 mbpd in equity is estimated at only $0.8 billion in 2015, but the same quarter of the previous year. Net exports, have quickly ramped up in 2016 to $2.0 billion.10 as a share of GDP, more than doubled from 2.4 to 6.1 The lifting of sanctions has drawn investor interest to percent of GDP in 2016, as exports recovered while the hydrocarbon sector along with automobile and imports remained close to the 2015 level. telecom sectors. As Iran’s reintegration with the global The pick-up in exports was driven by financial system speeds up, even larger increases in exports to advanced economies, particularly to FDI are expected. Europe and Korea. Exports to Europe are almost Foreign reserves were estimated at 10 times higher at 2 billion dollars in the second $134.3 billion at the end of 2016, which was quarter of 2016 compared to one year prior when the equivalent to 21 months of imports. The high sanctions were still in force (Figure 13). The largest import coverage reflects Iran’s continued difficulties increases occurred in France which went from only $6 to access international payment systems and low level million to $658 million between March and September of imports. Since the implementation of JCPOA, Iran in 2016. Korea and France were both oil importers has increasingly sought to conduct trade transactions, from Iran prior to the sanctions and are amongst the particularly for oil, in euros to avoid the challenges it most active countries since lifting of the sanctions in faces with holding US dollars. seeking out FDI opportunities on top of the already active trade agreements relating to the automotive sector. China and India remain Iran’s most important export destinations. Exports to China did see a small fall of 4 percent between second quarter of 2016 10 Based on 2016 IMF Article IV Staff Report. Recent economic and policy developments 11 2 OUTLOOK AND RISKS I ran’s medium-term growth prospects are pressures started to build up through food and housing expected to moderate to around 4 percent in prices and the closing output gap. Under the baseline the baseline scenario. While the 2016 economic scenario, inflation is projected to be slightly below 11 performance was stronger than initially envisaged on percent in 2017 and ease marginally to 10.2 percent the back of a stronger bounce-back in the oil sector, and 9.6 percent in 2018 and 2019, respectively. As medium-term growth outlook is somewhat weaker. a result, continued tight fiscal and monetary policies Continued uncertainties regarding Iran’s reintegration would be crucial to keep inflation under control. with the global banking system and global economy Similarly, the sharp recovery in the constrain both foreign and domestic investment and current account surplus in 2016 is unlikely to keep a cap on growth. As the growth dividend from oil be sustained beyond 2017. The current account weakens, growth is expected to moderate to 4 percent surplus is estimated to have surged to 6.5 percent in 2017 with the help of a recovery in gross fixed capital of GDP in 2016 from 2.7 percent in 2015. While still investment, following two years of contraction (Annex considerably smaller than the pre-sanctions peak 1). Iranian economy is expected to grow by 4.1 and of 10 percent of GDP in 2011, this level is expected 4.2 percent in 2018 and 2019, respectively, lower than to ease to 5.5 percent in 2018 and further to 4.6 projected in the Fall 2016 issue of the Iran Economic percent in 2019. This would be driven by the expected Monitor (IEM). This positive growth outlook still hinges slowdown in oil exports and stagnant non-oil exports, on the assumption that some of the agreements combined with a pick-up in imports. between Iran and major foreign companies in the oil Improved public finances and structural and gas and other key sectors, including manufacturing, fiscal reforms would help maintain macroeco- will materialize. This would create renewed confidence, nomic and fiscal stability. While fiscal balances in validating the very positive expectations generated in the last few years suffered from low oil revenues, in the the immediate aftermath of JCPOA implementation medium term spending pressures would dominate, in January 2016 and leading to gradually improving given the expected rise in interest payments from medium to long term growth dynamics as potential securitization of government arears and the continued output starts to rise as well. In the long-term, the primary pressures from the pension system. Improved tax determinant of Iran’s growth prospects would be how collection and prudent management of spending effective it utilizes its resources beyond oil and gas. would help achieve a budget surplus in 2018–19. Box 1 provides growth simulations for Iran’s long-term There are significant downside risks growth prospects with a focus on key policy areas such to this baseline scenario. The major risk in the as productivity and labor force participation. near future is the political uncertainty around the Sustaining the downward trend in inflation full implementation of JCPOA and the possibility of may prove challenging. Following a substantial new sanctions. This is likely to continue influencing decline in CPI inflation in the last two years, inflationary consumer/investor confidence and may lead to 13 a further weakening in private consumption and government revenues and undermine growth. Going investment. Under this scenario, GDP growth forward, the main challenge still facing the economy is would remain below 3 percent. Furthermore, lower channeling the ‘oil proceeds’ towards benefitting the than projected oil prices would put pressure on broader population. In order to optimize the returns BOX 1  •  Iran’s Long-term Growth Prospects Iran’s growth prospects would increasingly rely on its effective use of resources beyond the oil sector. As the oil production capacity reaches pre- sanctions levels, further sizeable growth dividends are unlikely to be driven by the oil sector. Instead, the country would need to rely more on its other abundant resource, its educated labor force and focus on bringing its productivity levels up. Iran does not compare favorably with its peers in terms of productivity and the use of its labor force. Preliminary analyses for long-term growth simulations benchmarked Iran against a set of comparators in terms of its efficiency of production. The group of benchmark countries are those that are oil exporters, upper middle-income and with a population of over 20 million. As shown in Figure 1.1, the growth rate of Iran’s GDP per worker fell short of the upper middle- income countries’ average in 2005–15. The more striking difference between Iran and its set of comparators is in the level of female labor force participation. At only 17.8 percent, Iran is among the countries, along with a few of its MENA peers, with the lowest female labor force participation rates (Figure 1.2). FIGURE 1.1 • Growth Rate of GDP Per Person Employed (constant 2011 PPP Dollars), 2005–15 7 6 5 4 Upper middle income average 3 2 1 1.9 0 –1 Algeria Mexico Iraq Venezuela, RB Iran, Colombia Malaysia Russian Angola Islamic Rep. Federation Source: Find My Friends using WDI. FIGURE 1.2 • Female Labor Force Participation (% of Female Population Aged 15–64), 2005–15 80 70 60 Upper middle income average 50 40 30 20 10 17.8 0 Iraq Algeria Iran, Mexico Malaysia Venezuela, RB Colombia Angola Russian Islamic Rep. Federation Source: Find My Friends using WDI. (continued on next page) 14 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY from these oil proceeds, an effective sovereign wealth priority. These reforms would need to be supported by management architecture would need to ensure fiscal connecting Iranian banking sector with the rest of the sustainability and address development challenges. world and through improved trade linkages facilitating Moreover, tackling the structural reform agenda that the much needed job creation especially for the would boost non-oil sector growth remains a key country’s young and highly educated population. BOX 1  •  Iran’s Long-term Growth Prospects (continued) Simulations of Iran’s long-term growth path show the abundant potential from moving closer to the frontier. To assess the impact of changes in three key parameters on Iran’s per capita GDP by 2030, three scenarios are constructed. The three parameters used are: investment to GDP ratio, total factor productivity growth and female labor force participation. The scenarios include a status quo (baseline), benchmarking to comparators and a take-off scenario. The three variables that are exogenously shocked are selected as those most likely to be affected by reforms in Iran. The status quo scenario assumes all the parameters remain at the same levels as their 2005–14 average (Table 1.1). The benchmark scenario is based on the average outcomes of Iran’s selected comparators (Algeria, Angola, Colombia, Iraq, Malaysia, Morocco, Russia, and Venezuela). Take-off scenario assumes very strong improvements on Iran’s present condition. Investment rate is assumed to increase from 26 percent to 35 percent of GDP (top 10th percentile in the world), female labor force participation improves from 17 percent to 57 percent and TFP growth of 1.1 percent, highest levels among the comparator set. Finally, two combined scenarios assume all the benchmark assumptions occur simultaneously and all take-off scenarios occur simultaneously. TABLE 1.1 • Assumptions for Long Term Growth Simulations, Values for 2030 Status Quo Benchmark Take-off Investment Rate (share of GDP) 26.0% 26.0% 35.0% Female Labor Force Participation Rate 17.7% 46.9% 57.0% Total Factor Productivity growth rate 0.3% 0.9% 1.1% Combined scenarios are illustrative of the potential for Iran’s economy to move to a superior growth path (Figure 1.3). Under the assumption that Iran’s female labor force participation rate increases to 47 percent and the rate of increase in its TFP increases to 0.9 percent, both averages of its set of comparators for this exercise, the real GDP per capita will be close to two thousand dollars higher than in the baseline in 15 years time. More strikingly if the three parameters used for this simulation reach the highest levels observed in the set of comparators), Iran’s real per capita GDP is more than 40 percent higher than its baseline level by 2030. FIGURE 1.3 • Simulations of Real GDP Per Capita Under Benchmark and Take-Off Scenarios 15,000 14,000 13,000 12,000 11,000 US$, 2010 10,000 9,000 8,000 7,000 6,000 5,000 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Baseline Benchmark Take off Source: WB staff calculations using Long-term growth simulation model. OUTLOOk and risks 15 Annex 1 IRAN: SELECTED ECONOMIC INDICATORS (2014–2019)* 2014 Act. 2015 Est. 2016 Proj. 2017 Proj. 2018 Proj. 2019 Proj. Real sector (annual percentage change, unless otherwise specified) Real GDP at factor cost 3.0 –1.8 6.4 4.0 4.1 4.2 Total oil production (million barrels/day) 3.1 3.2 3.7 4.2 4.3 4.4 Crude oil, average price (US$) 96.2 50.8 43.0 55.0 60.0 61.5 Money and prices (annual percentage change, unless otherwise specified) CPI Average Inflation (p.a) 15.6 11.9 9.0 11.5 10.9 10.6 Investment & saving (percent of GDP, unless otherwise specified) Gross Capital Formation 26.2 24.6 23.2 24.0 25.2 26.5 Gross National Savings 30.0 27.3 29.7 30.5 30.8 31.1 Government finance (percent of GDP, unless otherwise specified) Total revenues 14.6 15.6 16.3 17.5 18.2 18.8 Tax Revenues 6.4 6.9 6.7 6.6 6.4 6.1 Direct Taxes 3.3 3.7 3.6 3.6 3.5 3.3 Indirect Taxes 3.2 3.1 3.0 3.0 2.9 2.8 Total expenditures 15.8 17.5 17.7 18.1 17.9 17.6 Current 13.0 15.1 15.0 14.9 14.8 14.6 Net lending/borrowing (overall balance) –1.2 –1.9 –1.5 –0.6 0.2 1.2 External sector (percent of GDP, unless otherwise specified) Current Account 3.8 2.7 6.5 6.5 5.5 4.6 Net Exports 3.5 2.4 6.1 6.0 5.1 4.2 Export of Goods and Services 23.1 19.7 25.0 26.9 27.5 27.9 Import of Goods and Services 19.6 17.3 18.4 20.0 21.5 22.9 Total International Reserves (Billion US$) 126.2 128.4 134.3 147.2 166.1 as Months of Imports (number of months) 18.5 22.9 21.1 21.2 22.2 Total Gross External Debt Stock (US$ bln) 5.5 4.5 8.3 10.1 8.5 3.3 Total Gross External Debt Stock (% of GDP) 1.3 1.1 2.0 2.4 2.1 0.8 Memorandum Items: Nominal GDP (Billion IRR**) 11,033,666 11,502,510 13,119,439 14,996,331 16,826,804 18,955,294 Sources: Government Data and World Bank Staff Calculation. * Fiscal year ends March 20. For example, 2015 corresponds to the fiscal year of 2015/2016. ** IRR: Iranian Rial 16 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY References IMF. 2015. Fair Play: More Equal Rules Boost Female World Bank. 2015. Jobs and Privileges: Unleashing Labor Force Participation, IMF Staff Discussion the Employment Potential of the Middle Note, Washington, DC. East and North Africa, MENA Development IMF. 2017. Islamic Republic of Iran 2016 Article IV Report,Washington, DC: World Bank. Consultation—Press release; Staff Report; and World Bank. 2015. Women, Business and the Law Statement by the Executive Director for the Islamic 2016: Getting to Equal. Washington, DC: World Republic of Iran, IMF Country Report No. 17/62. Bank. doi:10.1596/978–1-4648–0677–3. License: World Bank. 2013. Opening Doors: Gender Equality Creative Commons Attribution CC BY 3.0 IGO. and Development in the Middle East and North Africa, Washington DC: World Bank. OUTLOOk and risks 17 SPECIAL FOCUS 1 IRAN’S PENSION SYSTEM: THE NEED FOR REFORM11 Introduction employees), and CSRF (Civil Servants Retirement Fund). Together both schemes cover around 90 This special focus chapter provides an overview percent of all contributors. While SSO covers 83 of the Iranian pension system, its main challenges, percent, CSRF covers only 7.1 percent. With respect to and preliminary guidance towards a series of beneficiaries, CSRF is already covering more than 28 policy interventions with the objective to improve its percent of all beneficiaries. The Armed Forces Pension coverage, equity and fairness, incentives, economic Organization, and the Rural Pension Organization are and administrative efficiency, as well as its financial the other two relatively sizeable schemes, covering sustainability. 6 percent and 3.3 percent of the total number of The chapter is organized in three parts. Section insured, respectively. Around 50 percent of the elderly 2 presents some background of pensions in Iran population in Iran today is not receiving a pension against general fundamental principles of pension from any of the contributory schemes and has to rely systems based on international best practices, as well on other sources of protection, from family, social as a general overview of the Iranian pension system, assistance, or others. including institutional structure, and parametric The pension system in Iran is currently facing features. Section 3 presents the main challenges various challenges. In addition to the ones on coverage, faced by the current pension system in Iran. Section important challenges remain on administrative aspects; 4 presents some policy considerations, and general particularly the need to improve the management of discussion on the way forward, by drawing on some reserves. Current investment policies are complex, and fundamental principles and international experiences. not necessarily in the best interest of plan members. The pension system in Iran is highly Appropriate investment regulations are not in place. fragmented, composed of 18 contributory pension The pension system in Iran is also currently facing schemes. Based on the latest information, 76 percent economic inefficiencies due to fragmentation (which of the employed population is registered with one of these schemes. The two largest ones are SSO (Social 11 This chapter was prepared by Montserrat Pallares- Security Organization, which covers private sector Miralles, with inputs from Robert Palacios. 19 represents an obstacle to labor market mobility). Servants Retirement Organization and Social Security The system has also various features that lead to Organization (which covers private sector employees). increasing inequities.12 Also, in spite of the generosity Among other sizeable schemes are the following: of the system by design, in practice adequacy seems Folad Co. Pension Organization,13 Bank’s Pension to be another challenge. Pension benefits received Organization, Oil Industry Pension Organization, by 77 percent of the pensioners from SSO and by 35 Armed Forces Pension Organization and Rural percent of those from the CSRF, are below the poverty Pension Organization. SSO includes voluntary line. Finally, the pension system in Iran is also under enrollment for the self-employed (which represents significant fiscal stress. Revenues from contributions 44 percent of all insured). All the schemes in Iran are do not cover pension expenditures. Investment returns designed as contributory, PAYG (Pay-As-You-Go)14 are very low, and reserves are depleting. Deficits of and DB (Defined Benefit),15 and are facing the usual all schemes together represented 425.3 trillion rials in challenges of system demographics. The support 2014 (around 4 percent of GDP). ratio—number of contributors divided by the number The challenges and opportunities of the of beneficiaries—is falling significantly in many of pension system in Iran are indeed considerable. these schemes. As indicated in Table 2, except for the This chapter presents only a very general overview. insurance fund (scheme) for farmers, villagers and All challenges and opportunities would need to be tribes and the lawyers support fund (scheme), which tackled with very careful and in-depth quantitative are new and recently established funds, the rest of analysis and policy discussions. Reforming pension the schemes are already showing unfavorable system models or building new ones that will work for demographics. In the case of SSO, the support ratio individuals and governments alike is an incredible is still relatively favorable but decreasing rapidly (less challenge. Most governments worldwide are currently contributors for more beneficiaries). reforming or in need of reforming their pension Table 3 presents the main design characteristics systems, and international experience shows clearly of the two biggest schemes, SSO, and CSRF. that there are no easy solutions for pension reform. A Contribution rates in the private sector (SSO) are lower simple model for pension reform cannot be uniformly than in the public one (CSRF). Eligibility conditions applied to all countries. However, what is quite clear, for retirement are diverse, and generous. Retirement and further described in the last part of this chapter, is ages basically range between no minimum (females the fact that a multi-pillar or multi-dimensional pension with 20 contribution years in the CSRF, and males system is required, in order to meet and balance the and females with 35 contribution years in SSO) and multiple and sometimes conflicting objectives of a 65 years (males and females in CSRF). pension system. Basically, no single pillar or tier can The statutory retirement age in SSO is 60 for bear all the weight of delivering adequate income men and 55 for women (with 10 years of contributions). with broad coverage in a sustainable, efficient and The scheme does not provide formal early retirement, secure manner. There is no example of a country however it has implemented generous exceptions to globally that manages to achieve high levels in each the statutory rule. In the following cases retirement of these outcomes with only one pillar. In addition to parametric reforms, consideration for other pillars (social pensions), as well as the integration of pension 12 Various design features lead to some members to schemes, is also recommended. contribute the same as others but take out disproportionally more from the system. 13 This fund is not accepting new entrants. Pension System in Iran – Overview 14 Financing mechanism where current contributors pay for current beneficiaries (see annex glossary). The pension system in Iran is composed of 18 15 Pension is calculated according to a formula (see annex pension schemes. The two biggest ones are Civil glossary). 20 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY TABLE 2 • Pension Schemes in Iran: Active Members, and Retirees, 2014 Organization/Fund Number of active members Number of retirees Support Ratio Social Security Organization 13,344,498 2,179,572 6.1 Civil Servants Retirement Organization 1,135,000 1,244,000 0.9 Insurance Fund for Farmers, Villagers and Tribes 660,000 22,697 29.1 Armed Forces Social Security Organization 580,000 650,000 0.9 Oil Industry Staff Fund 96,700 — — Steel’s Staff Support Fund 11,552 74,564 0.2 Ports and Marine Organization Staff Fund 1,304 2,088 0.6 Banks Fund 164,000 103,000 1.6 Lawyers Support Fund 30,000 780 38.5 Ayandesaz Fund 10,920 4,172 2.6 Other Exclusive Funds ( 8 Funds) 63,060 56,510 1.1 TOTAL FUNDS 16,097,034 4,405,995 3.65 Source: MoCLSW, Ministry of Cooperation, Labor and Social Welfare. TABLE 3 • Pension Schemes SSO and CSRF Design Features in Iran DESIGN CHARACTERISTICS SSO (national scheme) CSRF (civil servants) SOCIAL SECURITY CON TRIBUTIONS Total contribution rate of employer and employee (as % of covered wage) 18% (7% employees, 11% employers) 22.5% (9% employees, 13.5% employers) ELIGIBILITY CONDITIONS Different Eligibility Conditions (years): 1. Statutory Retirement Age 60/55 (men/women) 65 (60 at employer’s request) with required length of service of 10 30 2. Any age with 35 years of experience Yes No  0 consequent years or 25 years of experience for arduous and 3. 2 Yes No hazardous job  0 years old male with 25 years of experience—with employer’s 4. 5 No Yes permission 5. Female with 20 years of experience—with employer’s permission No Yes PENSION BENEFIT CALCULATION Benefit formula for old-age pensions: Basic Replacement Rate 33.3% 99.9% Incremental Replacement Rate 3.3% 3.3% Maximum Replacement Rate 116% 100% Number of Last Years for Wage Base Calculation 2 2 Post-Pension Indexation Discretionary Discretionary Source: MoCLSW, Ministry of Cooperation, Labor and Social Welfare & WB pensions database. Special Focus 1 Iran’s Pension System: The Need for Reform 21 ages can be lower: i) individuals with at least 35 years under-declaration, evasion, and early retirement. of contributions can retire at any age; ii) individuals In practice, adjustments of pensions in-payment working in hazardous jobs who have worked at least (indexation) are subject to discretion by government 20 consequent years or 25 years as a whole, even officials. Hence, beneficiaries are at risk of their discontinued, can also retire at any age without purchase power being eroded due to inflation. penalties. In the case of CSRF, at various points in time, the scheme provided additional incentives for early Main Challenges retirement as a mechanism to reduce the size of the civil Financial sustainability and affordability16 service. In 1988 and 1992, the SSO also implemented two generous early retirement programs. Over the The pension system in Iran is currently facing the years, there has been a fast increase in the number usual challenges of system demographics, with the of beneficiaries, attributed in part to the government’s support ratio considerably decreasing, in addition to efforts to control wage expenditures by reducing the the challenges of very generous17 parameters. The size of the civil service. Hence, the statutory rules system is also plagued by low returns to investments.18 have quite often been overruled. As a result, the schemes’ deficits have been rapidly Today in CSRF men can retire at age 50 if they increasing. A main concern of the Iranian policy have contributed for at least 25 years (and with the makers at this point is the financial sustainability employer’s permission). Female employees who have since the current system heavily relies on the general contributed continuously for 20 years can apply for budget, especially in the case of the Civil Service and retirement at any age (with the employer’s permission), Armed Forces schemes. Government contributions however, the minimum pension in this case does not to the civil service and military pension schemes apply. represented 2.8 percent of the public budget in Both benefit formulas (in SSO, and CSRF) 2005 rose to 14 percent in 2014 and is expected use the average of the last two years as the base for to increase to 28 percent in the next 7 years. Total pension calculation. In the SSO, with an accrual rate deficits reached 425.3 trillion rials in 2014 (around 4 of 3.3 percent per year and only the last two years percent of GDP). used to compute the base salary for the pension, Figure 14 illustrates the high correlation that statutory replacement rates for full-career workers exists worldwide between pension spending and are equal to 116 percent, while for those who have the percentage of population over 65. Iran is well only contributed for 10 years (the minimum length of above the predicted line, it has higher spending when service) the replacement rate is 33.3 percent. comparing with other countries in the world with In the case of CSRF, the basic replacement rate similar percentage of elderly population. This fact is (for an individual who has contributed the minimum due to various reasons, including pensions generosity length of service of 30 years) is 99.9 percent. It is also important to note that in CSRF both contributions and pensions are actually computed on a base of 75 16 While the concept of affordability looks only at the percent of total income, hence effective replacement costs of pension benefits, the concept of sustainability rates for full career workers is 75 percent when compares the retirement benefits with the contributions paid to earn the pension rights. Most contribution rates considering the entire remuneration (or 100 percent of the current pension schemes in Iran cannot sustain when considering only the pensionable income). the promised pensions. As explained in part 3 below (main challenges), 17 See next paragraphs and Figure 15. the current design features of the pension system 18 No specific data on investment returns was made are creating inequities and distortions in the labor available at the moment of writing this chapter, however supply. In particular, the benefit formulas and it was mentioned that the current investment policies are eligibility conditions in SSO provide incentives for complex, and with low returns. 22 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY FIGURE 14 • Pension Spending vs Population Over pensions19 include increased retirement ages (to 65 (as % of Total Population) respond to the increase in life expectancy), and revision of benefit formula and eligibility conditions (particularly 16 considering the highly generous provisions for early 14 Italy retirement). Basically, pension schemes in Iran have Pension spending (% GDP) 12 Hungary a fundamental misalignment between the contribution 10 rate and benefits paid at various retirement ages. 8 A key parameter of the benefits of such Tunisia 6 Iraq IRAN Algeria schemes is the accrual rate, which is the proportion of 4 Palestine Lebanon Australia Kuwait Egypt Morocco China earnings paid in pension for each year of contributions. 2 Jordan Djibouti y = 0.5992x–1.032 Mexico Yemen India Dominican Republic R² = 0.7116 Multiplying the number of years of contributions by 0 0 5 10 15 20 25 the accrual rate gives the gross replacement rate Population over 65 (% Total population) (benefit paid), a standard and important indicator Source: WB pensions database. in the analysis of these types of retirement-income provisions. Figures 15 illustrates how generous pension accrual rate is in Iran when compared with of most of the schemes (particularly civil servants and European and other OECD member countries. In other special schemes) as well as the widespread Iran, the difference between what many individuals early retirement programs and also survivorship contribute into the schemes and how much they pensions. take out from such schemes is huge, leading to the Benefit promises of the current pension challenge of the current unsustainability. schemes in Iran are not in line with the contribution rates and the retirement ages. While parametric 19 Ideally, and as much as possible, the present value of all alignment to the overall sustainability objective is contributions of an individual should be equal to the present neither simple nor univocal, potential reforms to value of the pension payments to the same individual. High improve the alignment between contributions and internal rate of returns make the system unsustainable. FIGURE 15 • Accrual Rate: International Comparisons IRAN Turkey Italy Poland Sweden Switzerland Finland Portugal France Czech Republic Austria Canada Belgium Germany Netherlands USA Japan Mexico United Kingdom Ireland 0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 Source: WB pensions database. Special Focus 1 Iran’s Pension System: The Need for Reform 23 Labor Force Participation Rate (% Pop 15+), 2014 FIGURE 16 •  90 75.04 76.73 74.00 80 68.88 70 49.46 59.60 60 50.90 49.46 50.29 50 45.40 40 30 21.85 20 16.70 10 0 MENA region World OECD members IRAN Male Female Total Source: WDI/ILO. In addition to problems of financial sustainability specific programs for self-employed such as drivers as explained in the previous paragraphs, challenges or construction workers have instead been recently on managing reserves, as well as challenges regarding increasing. Many in the informal sector and/or small the accumulation of arrears by the government to business do not contribute at all. More than 6 million the pension schemes for its due contributions and employed people in Iran today are not covered by the late fees, are also very important to consider. The pension system. government arrears to the pension funds has been An important consideration of the coverage increasing from 100 billion rials in 2001 to 700 gap in Iran is the fact that its total labor force billion rials in 2012. The Government annual debt participation rate is one of the lowest worldwide, repayments have been between 0 and less than 250 particularly because of the low female participation billion rials in the same period. rate (as indicated in Figure 16). Less than 17 percent of women (aged 15+) are part of the labor force. Also, Coverage according to 2014 administrative data, more than 40 percent of contributors are self-employed and more Historically, the coverage of pension schemes in than 20 percent of the employed is informal.20 Iran has been increasing. In the mid-1970s only It is not clear that the future expansion of the around 29 percent of the total population in the working age population in Iran will be accompanied country were covered by pension schemes (including by an expansion of employment, particularly in the dependents). In 2014, this indicator represented formal sector and therefore, an expansion of the around 69 percent of the total population. When social insurance and pensions covered population. not including dependents, but only contributors as The informality phenomenon involves the majority percentage of the number of employed, the coverage of workers in the private sector, particularly in rural ratio is 76 percent. Coverage is high, however, there is still an important coverage gap. One of the main challenges is the lack of appropriate mechanisms to 20 Total labour force in Iran was more than 27 million in cover the self-employed. Also, voluntary coverage is 2014. Among them 21.3 million were contributing to very irregular (mostly villagers and self-employed do pension schemes; of which 11.9 million employed and not contribute regularly), despite the fact that some 9.4 million self-employed. 24 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY Pensions Coverage vs Income Per FIGURE 17 •  Projected Population Aged 65+/15–64 FIGURE 18 •  Capita 50% 120% 45% Population aged 65+/15–64 Active members (% Labor Force) 40% 100% 35% Algeria IRAN with covered self-employed included 30% 80% Tunisia 25% 60% Egypt Jordan 20% Morocco IRAN 15% Iraq 40% Djibouti 10% Yemen 5% 20% Lebanon y = 0.016x +0.0956 Palestine R² = 0.7401 0% 0% 2015 2020 2025 2030 2035 2040 2045 2050 0 10 20 30 40 50 60 World Iran (Islamic Republic of) High-income countries Income per capita (Thousands) Source: WB pensions database. Source: UN population projections/WDI WB. sector, self-employed, and female population. Many population aged 15–64) in Iran is still very low, the countries worldwide are also facing the problem projected ratio into the future would be higher than the of informality, and evidence suggests the need to average worldwide. Unless reforms are implemented rethink policy making, especially concerning labor soon, the ageing population would not only aggravate markets and social security reform, because many of further the financial problem, but also the inequities, the intended beneficiaries operate beyond the reach and the labor market structure. of legislative reform. As indicated in Figure 17, there is a high Equity/fairness; predictability/ correlation worldwide between income per capita and transparency; adequacy, and economic coverage of social insurance/pension systems. Most efficiency countries in the MENA region, including Iran, have higher coverage rates than would be predicted by Equity and fairness: Iran’s retirement-income regimes their income.21 This indicates that it would be difficult treat contributors differently, particularly favoring to expect the coverage to expand substantially early retirees who receive benefits for longer, relative through conventional mechanisms over the medium to workers who keep going until the normal pension term, and particularly since most of the uncovered age. The problem of early retirement, however, is not population are in the private sector (including self- only due to the design of the pension system per-se employed, rural, etc). but mostly because of the wide set of jobs defined as When looking at the coverage of beneficiaries, “arduous and hazardous”. Early retirement provisions more than half of the population above age 60 has are both inequitable and distortionary. They are to rely on informal care (mostly family) or social leading people to leave the labor force (or at least the assistance. It is important to point out that with formal sector) before they would have otherwise. In falling birth rates, rising life expectancy, changes in addition to the generous early retirement conditions, urbanization, migration, and family structures, the the required minimum length of service and basing reach and scope of informal arrangements have the pension calculation on only the last years of also been weakening during the last few years and wages encourages evasion and underreporting of are going to weaken even further unless some new wages in SSO. policies to protect the old are implemented. Figure 18 indicates that despite the fact that the elderly dependency ratio (population aged 65+ to 21 Source: pensions database, World Bank. Special Focus 1 Iran’s Pension System: The Need for Reform 25 Iran’s practice of basing pensions on a limited Adequacy: Also, in spite of the generosity of the system sub-set of years (the best or final years in the career), by design, in practice adequacy seems to be another used to be a common practice internationally, but this challenge. Pension benefits received by 77 percent of is no longer the case. In Iran the pensions law in this the pensioners from SSO, and by 35 percent of those respect has been slightly amended, and pensions from the CSRF, are below the poverty line.22 are supposed to be based on the last five years, however this measure has not yet been enforced. Economic efficiency: Another challenge of the Some countries have already moved from the final current system is fragmentation. Particularly the five years, fifteen, or even twenty to lifetime average. difference between public and private sectors is also This convergence towards lifetime-average salary an important policy issue because it impedes the for pension calculation is a best practice, explained mobility of the labor force within and across sectors, because of the following: the contribution base for increases administrative costs, and generates an pensions is the lifetime salary, because payments unequal treatment of different categories of workers. are made each year. When the base for calculating An increasing number of countries worldwide are pensions differs from this—with a limited set of best or merging its different pension schemes. final years—and benefits can be unfair, open to abuse and have perverse incentives on economic behavior. For example, basing pensions on a limited number Policy Considerations of best or final years tends to be regressive, because Looking forward, policymakers in Iran would need to the people with final or best years substantially above create awareness among the population regarding their career-average earnings tend to be those that the problems facing the pension system while earn the most. generating commitment to reform. This requires Considering lifetime-average salary for pension framing discussions within a long-term horizon to calculation is particularly relevant for Iran, given its make explicit the tradeoffs between the potential relatively large informal sector, and self-employment. social and economic costs of today’s policies with the Final-salary measures give a large incentive to future benefits. under-report earnings in earlier years and artificially When creating a road map towards pension boost pay in the years which are used to calculate system reform, it is recommended that policy benefits. Empirical evidence from many middle- makers in Iran consider the following three points, income countries confirms that such gaming of the and ask themselves about the principles based on pension system is widespread. Such behavior is most international best practices: acute among self-employed workers, where verifying incomes is extremely difficult. 1. Parametric reforms that mitigate inequities, distortions and financing pressures Predictability and transparency: Another policy 2. Consideration of alternatives for redistribution, issue of pensions in Iran is the fact that there is such as social pensions currently no automatic mechanism of indexing 3. Consolidation of multiple schemes (merging pensions in-payment. Adjustments are subject to the current fragmented system) the discretion of Government officials. This is not good practice as this can lead to erosion of the living In addition to these three points directly related standards of retirees by inflation. Price-indexation of to pension design, other aspects related to labor force pensions in-payment is the most common policy. Indexing pensions in-payment to prices guarantees the purchasing power of pensions during retirement. 22 Schemes are generous by design, however, given the fact It makes retirement incomes predictable and that so many people retire early (with very few years of transparent. contribution) many individual pensions are actually low. 26 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY structure, rules and definitions would also need to benefit accrual rate, pension age, and contribution be considered when creating the road map towards rates. Table 4 present a few examples of current vs a pension system reform. Labor force aspects to be desirable policy measures. Policy makers would also considered would include, among others, female need to decide on the pace of reform, from slowest labor force participation, and particularly modifying to fastest type of reforms (with their pros- and cons-). the process of defining arduous and hazardous jobs. In order to gain support from the public and Until recently many type of ordinary jobs have been minimize resistance for pension reform, it would be defined as “arduous and hazardous” for political very important to emphasize other challenges beyond reasons, in order to allow people to retire early. These the financial sustainability/affordability ones and easy early provisions have considerably increased communicate them appropriately and effectively to the gap between life expectancy and the effective the public. During the pension reform process, policy average retirement age.23 makers in Iran might want to also consider important lessons learnt on communication aspects from other Parametric reforms that mitigate inequities, I.  countries worldwide, and particularly from the OECD. distortions and financing pressures There are relevant good but also bad practices in As mentioned in the previous section, several of this respect, and various surveys, and lessons learnt the current practices of the pension system in Iran to improve pension information and communication. have put the system on an unsustainable trajectory. The goal would be to create awareness among In general, people contribute only for short periods the public, and particularly among all relevant of time but get benefits for long periods. Current stakeholders (social partners, and others) during policies also damage and distort the way the labor the reform process, about the challenges facing the market works, it creates inequities, as well as adverse pension system and the options for reform. incentives. Early retirement opportunities create adverse Consideration for redistribution: social II.  incentives for the labor-market. Such early retirement pensions and other potential mechanisms measures seem reinforced and institutionalized. When talking about redistribution it is actually There are two areas where damaging norms seem to important to distinguish between redistribution toward have been established: the core elderly poor, who are usually (but not always) outside the contributory system, and redistribution • It becomes the norm to contribute for a short within the contributory scheme, ideally from high- period; income workers to low-income workers. • It becomes the norm to retire at the earliest Redistribution toward the elderly poor involves possible opportunity (in the civil service social assistance programs (and/or non-contributory scheme a man can retire at 50 with only 25 social pensions when recipients are only elderly years of service if employer decides, and a population), in-kind or in-cash transfers, that should woman can retire at any age with only 20 years be financed directly from the central budget. The of service, if the employer decides). elderly poor, and those individuals likely to become poor during old age, face liquidity constraints and It is important to assess and analyze the short-term risks that outweigh the risk of longevity. current system with regards to such damaging norms. Noncontributory schemes need to be in place to It is also crucially important that policy makers subject the current scheme—and any proposals for reform—to detailed actuarial modeling and analysis to properly 23 In 1988 life expectancy at birth was 60, and effective set the individual parameters of the reformed scheme. average retirement age 55, while in 2005 life expectancy The financial modelling will set out a range of pension increased to 70, but on the other hand the effective possibilities, emphasizing the trade-offs between the average retirement age decreased to 48. Special Focus 1 Iran’s Pension System: The Need for Reform 27 TABLE 4 • Current Policy Parameters and, Desirable Policy Parameters Based on First Principles and Best Practice, Slow and Fast Reforms Feature of the pension Desirable policy (from first system Current policy principles and best practice) Slowest reform Fastest reform Accrual rate structure Linear: 3.3% Linear: 2% 2% for future accruals 2% for all retirees, even those who have accrued rights (at the previous 3.3%) Qualifying period for 10 years in private Longer period (depending on other pension parameters) 30 years in public Earnings measure last two years for private sector Lifetime average Lifetime average salary All accrual from the reform and last month for the public used to calculate benefits point on lifetime average sector only for new entrants. salary, meaning pension in two parts (final salary and All existing workers average salary) for existing remain on current rules workers Benefit adjustment: Discretionary Inflation-adjustment Inflation-adjustment for Inflation-adjustment for new ‘indexation’ new retirees and existing retirees Normal pension age 60/55 in most schemes Increase to reflect longer life Start to increase in line Increase in pension age expectancy with life expectancy to 65 (and then link to life expectancy) Early pension age Various conditions Gradual increase to reflect longer Curtail 50–55 retirement Gradual abolition of early life expectancy window over a 10-year retirement so that early period; increase 55 early age catches up with the pension age with life normal age expectancy Benefit adjustments for Zero Actuarially neutral Phased increase Immediate use of 6% for all early retirement 2–3–4–5–6% over a new retirees five-year period Contribution rate 18% in private sector, and 22.5% Labor-market policy should avoid in public sector further increases protect these individuals. These programs need minimum pensions) directly from the central budget. to be implemented in a way that does not create In the case of a DB-PAYG system, transfers can be negative incentives for working and for joining the regressive, meaning that low income individuals contributory system. receive lower rates of return than high-income Many countries also pursue another form of individuals; furthermore, future generations usually redistribution, from high- to low-income workers within receive lower rates of return than current generations. the contributory system (usually a DB-PAYG scheme, In the case of SSO and the CSRF, for instance, a like the ones in Iran). The costs of this redistribution given individual’s rate of return from the DB-PAYG mechanism, however, can outweigh the benefits. system is determined by two main factors: the average Whether redistribution from high- to low income growth rate of the real wage; and life expectancy. workers in the contributory system is desirable or Individuals whose wages grow faster and who live not is a matter of social preferences. If it is, however, longer, thus receiving pensions for longer periods of policy makers ought to consider the less-distorting time, have higher rates of return. These individuals redistribution mechanism. Achieving the redistribution are often educated and healthy workers, more likely through the pension system involves taxing labor to belong to middle- and high-income households. In and thus distorting labor markets. An alternative principle, the system could be designed instead so is to finance the transfers (e.g., guarantees on that low-income individuals receive higher rates of 28 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY return than high-income individuals (for instance by the policymaker in this context is to deal with the introducing minimum pensions), but progressivity tradeoff between sustainability and adequacy is not an inherent feature of the DB-PAYG system. as the population ages. In New Zealand for Another characteristic of the DB-PAYG system is instance, there has been an increase on that the sustainable rate of return that the system voluntary retirement savings to reduce the can pay decreases over time. The implication is that burden of the increasing spending on social new generations receive lower rates of return than pensions, and maintain or increase adequacy. old generations. Thus, there is an implicit transfer • Scenario 2: The second case is the one of resources from the young to the old. Even if the of some higher income countries, where system is designed with some degree of progressivity social pensions are meant to supplement within generations, high income members of the “old” a contributory pension scheme with high generation can still receive implicit transfers from low- coverage. It is designed to address gaps at the income members of the ‘‘young” generation. margin—those individuals that have accrued In recent years, a large number of countries insufficient pensions due to short periods in worldwide have introduced cash transfers for the employment. In contrast to New Zealand’s elderly population. These programs—sometimes universal coverage for example, only 1 percent referred to as social pensions—come in a wide of the elderly in the United States receive a variety of shapes and sizes. The appropriate role of social pension. these programs within the overall pension and social • Scenario 3: The third case and most common protection system is an increasingly important policy scenario is observed in the growing number of question that Iran could consider in their policy developing countries opting for social pensions discussions for pension system reform. While the due to frustration with stagnant coverage in current contributory pension system is increasingly contributory schemes. This is the case in much receiving transfers from the Government, such of Latin America and increasingly in Africa transfers are only benefitting those who are covered. and Asia where between 10 and 70 percent On the other hand, social pensions could benefit of the labor force (and even smaller share of either everybody (above a certain age) or, if well the working age population) contribute to a designed, those who need it the most. pension scheme. There are at least four scenarios that could • Scenario 4: Finally, a new group of countries characterize the situation facing a policymaker in the Europe and Central Asia (ECA) region considering the role of social pensions (scenarios 2, may be heading towards a greater role for and 3 might be the most relevant for Iran, but other social pensions. In these countries, the shift scenarios might also have relevant lessons learnt): to a market economy means that for the first time in decades, cohorts will soon be • Scenario 1: the first case of social pensions is reaching old age with little or no contributory one in which there is a well-established social pension income. Moreover, their pay-as-you- pension scheme that is seen as a major element go financing models are collapsing in the face of the overall social protection system. This is of the dual challenge of aging and informality. the case in a handful of countries ranging from As a result, most pensioners receive the New Zealand to South Africa. Unlike Iran, both minimum pension while large deficits must of these countries made a choice early in their be covered by the budget. When Georgia, history to rely on social pensions rather than for instance, faced this situation in 2008, it mandated contributory pensions. While this decided to give up the fiction of a contribution- path dependence does not preclude a shift based pension system and became the first towards savings or insurance, it does reduce country to convert a social insurance program the need for such a mandate. The challenge for to a social pension. Special Focus 1 Iran’s Pension System: The Need for Reform 29 The appropriate advice on the role of social conducting a viability study for the implementation of pensions must take into account these varied starting social pensions in Iran. points. In the case of Iran, when deciding whether to introduce a social pension program, the following Consolidation of multiple schemes: III.  questions should be asked: towards integration of the pension system • What are the tradeoffs? Given limited fiscal Finally, another important policy consideration on space, will other social protection programs pension reform in Iran should be the integration of receive less funding if budget is allocated to current schemes. Around twenty countries worldwide social pensions? are currently in the process of considering the • Are poverty rates higher among the elderly integration of separate schemes. Particularly regarding population than other groups? separate schemes for civil servants, and private sector • To what extent do other safety net programs employees. These countries can be found in all already address the problem of poverty among regions, and include such countries as Mexico, Cape the elderly, especially if there is evidence that Verde, Djibouti, Bahrain, and Brazil. Others such as the poor elderly co-reside? Morocco are planning to merge separated schemes • Could the social pension lead people to save for civil servants and employees of SOEs (state owned less for old age including fewer contributions enterprises). to mandated schemes? Given the growing fiscal burden of many civil • Could social pensions lead to higher service pension schemes and the degree to which informality? they discourage labor mobility, compelling arguments • What is the counterfactual for the overall exist for having a single national scheme for both pension system? For example, would a social the public and private sectors. Moreover, there is pension allow Iran to have a smaller contributory no compelling public policy rationale for mandating scheme and therefore, lower payroll taxes? different levels of consumption smoothing over an individual’s life cycle or for establishing different Another important suggestion on the topic retirement ages for public and private sector workers. of redistribution would be to conduct appropriate Consequently, a number of countries have introduced surveys to estimate the coverage gap and its causes. reforms to integrate their civil service and national The objective of this activity would be to identify pension schemes. Arguments for eliminating separate the specifics of the population groups that are not pension schemes include: covered by the system, including their geographic and socioeconomic characteristics. At the end, • Dualism discourages labor mobility and only on the basis of this information it is possible to exacerbates unjustified differentials in define specific activities to expand contributory and compensation between the public and private noncontributory schemes. sectors, and It would also be a key activity to conduct a • Dualism adds administrative costs because it review of the current social assistance programs for the typically results in the duplication of services elderly-including estimates of costs, benefits provided, already performed by the administrators of number of beneficiaries, and their socioeconomic national pension schemes. characteristics. The review would assess management, targeting, and monitoring mechanisms and would If not complete integration, at a minimum, present recommendations in terms of the need to it would be important for policy makers to create expand, eliminate, and or design additional programs. mechanisms that provide easy portability of benefit The review would be recommended to include detailed entitlements across the various schemes in Iran so estimates of financing needs. This could also include that workers are not penalized when moving between 30 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY different sectors, particularly between the public and workers in the reform (sometimes with provisions to private sectors. partially or fully recognize their accrued rights), and a Portability can be provided by establishing few countries have given current workers a choice of procedures to value the accrued rights of workers who being included or excluded. elect to move between the public and private sectors To conclude this chapter, international for instance, and to recognize and respect those experience shows clearly that there are no easy rights in their new pension scheme. Conceptually, the solutions for public pension reform. A simple model process would involve the computation of the present for pension reform should not be uniformly applied value of rights earned in one scheme as a result of to all countries. However, there are the mentioned qualifying contributory service and then giving credit principles, based on international best practices that for this service in the other scheme. can provide useful guidance to policy makers in Iran However, full integration is more often as they struggle with crafting solutions which are recommended than portability of rights. Many countries appropriate in light of the country’s culture, political that have integrated pension schemes (particularly for system, economy, and labor force structure. Together, public and private sectors) have generally chosen to these principles should be carefully considered. The exclude all current workers from the reform (leaving fiscal, financial, welfare and behavioral implications them covered by the rules of the legacy pension of potential reform options should also be carefully scheme), other countries have included all current considered, and quantified. Special Focus 1 Iran’s Pension System: The Need for Reform 31 Annex 1. Pensions Glossary Commutation factors. Mathematical factors used to determine the amount a pension needs to be This glossary provides practical definitions for key reduced in order to provide an associated lump terms used in the diagnostic assessment of pension sum benefit. systems. It is based on the work of both the World Contribution base. The reference salary used to Bank and the OECD. calculate the contribution. Contributory pension plan (scheme). A pension plan Accrual rate. The rate at which pension entitlement where the employer or the members have to pay is built up relative to earnings per year of service into the scheme to receive pension benefits. in a defined-benefit scheme. For example, Contribution ceiling. A limit on the amount of earnings one percent of the reference salary per year of subject to contributions. applicable service. Commutation. Exchange of part of the annuity Accrued pension (benefit). The value of the pension component of a pension for an immediate lump to a member at any point prior to or at retirement. sum payment generally calculated using actuarial Active member. A pension plan member who is methods. making contributions (and/or on behalf of Defined benefit plan (scheme). A pension plan with whom contributions are being made) and is a guarantee by the sponsor, insurer or pension accumulating assets or rights to a future pension. agency that a benefit based on a prescribed Actuarial assumptions. Various estimates that an formula will be paid. actuary makes in formulating an actuarial Defined contribution plan (scheme). A pension plan valuation. May include assumptions related to in which the periodic contribution is prescribed changes in longevity, wage, inflation, returns on and the benefit depends on the contribution plus assets, etc. a return. Such a return may be the investment Annuity. A specified income stream payable at stated return on the individual’s accumulated schemes, intervals for a fixed or a contingent period, often for a declared rate of interest or a rate tied to a the recipient’s life, in consideration of a stipulated defined index. premium paid either in prior installment payments Demographic transition. Historical process of a major or in a single payment. Within the category, change in the demographic structure of the there are period certain annuities (payable for a population of a country due to changing mortality specified period that is fixed in advance of the and fertility rates or immigration/emigration start of the annuity) and life annuities (annuities patterns. Can include a transition for any reason, which are contingent upon the survival of one or for example the transition as fertility and mortality more lives). Within life annuities, there is a further rates decline, resulting in an increasing ratio of distinction between single life annuities, joint older to younger persons. life annuities, last survivor annuities and various Dependent. An individual who is financially dependent combinations of types of annuities. on a member of a pension plan. Dependent is Annuity factor. The net present value of a stream of often a legally defined term, typically including pension or annuity benefits. spouse, children and other relatives which may Beneficiary. An individual who is entitled to a benefit or may not be financially dependent on a plan (including plan members and dependents). member. Benefit. Payment made to a pension fund member Disability benefit. A benefit payable to a plan member (or dependents) after satisfaction of qualifying who meets the qualifying conditions, typically conditions. which are certification of an inability to work for Commutation. A payout option given to a pension medical reasons. plan member to replace future payments by an Discretionary increase. An increase in a pension immediate lump sum. benefit not specified by the pension scheme rules. 32 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY Early leaver. A person who leaves an occupational potential number of individuals above the eligibility pension scheme without receiving an immediate age. benefit though is entitled to a benefit at a future Pension liabilities. Balance of the obligations of a date. pension scheme accrued to current workers and Early retirement. Retirement before reaching the retirees at a point in time based on past service pensionable age for receipt of full benefits often and contributions. with eligibility for an immediate pension, on a Pension lump sum. A cash withdrawal from a pension reduced or unreduced basis. plan generally with all or part of the benefits paid Final salary scheme. A type of defined benefit formula out in one payment. that uses the final salary at retirement to calculate Pension spending. Total spending on pension the pension benefit benefits at the national level. Usually defined as Gratuity. A term used in some jurisdictions to mean spending on old-age retirement, survivor, death, a benefit payable based on meeting some and invalidity-disability benefits including both qualifying conditions. Examples include old-age contribution based and non-contributory pension and survivorship benefits for members who have schemes. not satisfied vesting requirements in contributory Pensionable earnings. The portion of remuneration schemes. on which pension benefits and contributions are Implicit pension debt (net). The value of outstanding calculated. pension liabilities after subtracting pension Portability. The ability to transfer accrued pension reserves. rights between pension plans. Indexation (benefit indexation). Increases in benefits Public sector pension scheme. An occupational by reference to an index (typically prices, wages pension scheme for employees of a central or local or some combination of both). Government, statutory and other semi-state bodies. Old-age dependency ratio. The ratio of older persons Reference wage or earnings measure. The fund to working-age individuals. For example, the member’s earnings that are used to calculate the number of persons over 60 divided by the number pension benefit in a defined benefit plan. This is of persons aged 15–59. typically the earnings of the last few years prior to Pay-as-you-go. In its strictest sense, a method of retirement. financing whereby current outlays on pension Replacement rate. The value of a pension as a benefits are paid out of current revenues from an proportion of a worker’s wage during a base earmarked tax, often a payroll tax. period, such as the last year or two before Pay-as-you-go assets. The present value of future retirement or the entire lifetime average wage. contributions minus pension rights accruing to Can be used to describe this relationship for an these contributions. individual or the scheme membership. Pension coverage rate (active phase). The number Support ratio. The number of workers required to of workers actively contributing to a publicly support each pension beneficiary. mandated contributory or retirement scheme Survivorship benefit. Benefit provided to select during a particular period, divided by the surviving beneficiaries associated with a member estimated potential number of workers that could who passes away during his or her working life or or are mandated to contribute, e.g., the labor force retirement. or the working-age population. The same term System dependency ratio. The ratio of persons can be applied to coverage under occupational receiving pensions from a certain pension scheme plans as well. divided by the number of workers contributing to Pension coverage rate (beneficiary phase). The the same scheme in the same period. number of beneficiaries in receipt of old age System maturation. The process by which a pension pension beneficiaries divided by the estimated system moves from being immature, with young Special Focus 1 Iran’s Pension System: The Need for Reform 33 workers contributing to the system, but with few Valorization of earnings. A method of revaluing past benefits being paid out since the initial elderly earnings during the reference period for benefit have not contributed and thus are not eligible for determination under a defined-benefit scheme. benefits, to being mature, with the proportion of Reference earnings are adjusted using a factor elderly receiving pensions relatively equivalent to such as average covered wage growth in order their proportion of the population. to compensate for changes in earnings over the Target replacement rate. The targeted level of wage reference period. replacement at retirement for an average wage Vesting period. The minimum amount of time required worker. to qualify for full and irrevocable ownership of pension benefits. Vested rights. Full and irrevocable pension rights. SPECIAL FOCUS 2 TOWARDS WATER SECURITY IN IRAN: CHALLENGES AND OPPORTUNITIES 24 I n the world’s most water stressed25 region, Iran can have significant economic as well as socio- stands out as one of the most water-vulnerable political costs. Despite Iran’s long and successful countries. In absolute terms, Iran has more people history of managing water resources, old challenges and more economic production located in areas with are becoming more urgent and new challenges are high water withdrawals to availability ratios than any arising. Addressing water challenges in Iran would country in the Middle East and North Africa. Over require building on ongoing policy reforms as well as 90% of Iran’s population and GDP is located in areas on national as well as sub-national analyses to develop where water withdrawals are approaching or have and prioritize context-specific interventions. surpassed sustainable utilization and therefore where actions are needed to ensure that water availability and competition do not become a constraint to Iran’s Long Tradition in Water future well-being and growth. Despite this situation, Resource Management water productivity in Iran is low. The great majority Iran has a strong tradition of water resource of water use is in agriculture, and economic returns management, and has been historically on agricultural water in Iran are among the lowest in successful in managing the resource under a the region. Urban water prices in Iran are among the lowest in the world—failing to signal the value of water and the need for water conservation, undermining the strength and sustainability of water service providers, 24 This note was prepared by Claudia Sadoff, Edoardo Borgomeo and Irene Rehberger Bescos based on and forcing the government to pay large subsidies for secondary data analysis. Figures on exposure to water service coverage, operations and maintenance costs. stress were provided by the World Resources Institute. As water becomes ever scarcer, the environment tends 25 Water stress arises when water withdrawals for human, to suffer most. Iran’s iconic lakes and wetlands are a agricultural, and industrial uses are relatively high bellwether of this growing scarcity as each year they compared to the level of renewable water resources— are further diminished. Water crises, if left unmanaged, that is, a high water-withdrawal-to-availability ratio. 35 Share of GDP Produced and Population Living in Areas Where Water Withdrawals are FIGURE 19 •  Approaching or Have Surpassed Sustainable Resource Use Share of population living in areas where water Share of GDP generated in areas where water withdrawals are 40% or more of surface water availability withdrawals are 40% or more of surface water availability Iran 94% 94% World 36% 22% Source: Estimates for Iran estimated by the World Bank. World averages were taken from Veolia Water and IFPRI 2011. Note: High or very high water stress imply that water withdrawals are 40 percent or more of surface water resources availability. highly variable and arid climate. More than 2500 and North Africa. These estimates are based on spatial years ago Persians developed qanats, a unique analysis which only compares data on location of GDP groundwater management system used in desert production with data on water withdrawals and surface regions to abstract water from mother wells and water availability. This only provides an assessment of transfer it long distances to irrigate fields or supply exposure to water stress, without quantifying the direct towns (Hassan, 2010). Technical innovations were not impact of water stress on economic activities and people. limited to qanats. Persians built aqueducts centuries More work is needed to evaluate the impact of water before the Romans, and developed canals, dams, availability, variability, and quality on economic and social flood control and water transfer infrastructures before processes throughout Iran. most other nations. They also had a robust water The environmental symptoms of Iran’s governance system with strong regulation, monitoring water crisis range from drying lakes, rivers and market mechanisms (Madani, 2014 & Madani, et al. and wetlands to land subsidence and water 2016). However, current symptoms of extreme scarcity contamination. In the west of the country, Lake coupled with increasing demand, unsustainable water Urmia—the largest lake in the Middle East and one of use, and low water productivity among other factors, are the world’s largest hypersaline lakes—has shrunk by exacerbating Iran’s water challenges. The government about 88% its size in the 1970s as a result of frequent has recognized the need to address these issues and droughts and upstream water use, diversion, and has positioned water as a priority sector in the 6th Five storage (Fathian et al., 2014). In the East, Lake Hamun Year Development Plan (2016–2021). is also shrinking (Madani & Hipel, 2011). In the center of the country, the Zayandeh-Rud River dries up in the dry season, putting pressure on aquatic ecosystems and Symptoms of Extreme Water Scarcity the Gavkhouni Wetland (Gohari et al,, 2014). This trend is replicated in several other water bodies throughout Iran’s exposure to water stress is much higher than the country, like the Parishan and the Shadegan lakes world averages. Over 90% of Iran’s population and and wetlands, despite the commitment to protect GDP is located in areas where water withdrawals are them under the Ramsar Convention of 1971.26 Land approaching or have surpassed sustainable utilization and therefore where actions are needed to ensure that water availability does not become a constraint to future well- 26 The Convention on Wetlands of International Importance, being and growth. In absolute terms, Iran has the highest called the Ramsar Convention, is the intergovernmental levels of economic production located in areas with high treaty that provides the framework for the conservation water withdrawal to availability ratios in the Middle East and wise use of wetlands and their resources. 36 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY GDP Produced in Areas Where Water Withdrawals are 40% or More of Surface Water FIGURE 20 •  Resources Availability, by Country and Economy, Middle East and North Africa, 2010 More than 750 bn$ worth of GDP are generated in areas where water withdrawals are approaching or have surpassed sustainable resource use Iran Saudi Arabia UAE Israel Kuwait Qatar Morocco Algeria Iraq Syria Tunisia Libya Oman Lebanon Yemen Jordan 0 100 200 300 400 500 600 700 800 GDP generated in ares where water withdrawals are 40% or more of surface water availability ($ billion PPP 2010 USD) Source: World Bank. Note: These numbers are estimated using spatial analysis comparing location of GDP with water withdrawals to freshwater availability ratio. GDP is measured in terms of purchasing power parity (PPP) and is in constant 2010 U.S. dollars. subsidence and sinkholes affecting large swaths of agricultural industry is extremely sensitive to hydro- the country are other symptoms of unsustainable climatic extremes, especially drought. Estimates groundwater withdrawals. All these factors also lead suggest that even small deviations of 1 mm below to frequent water shortages for agricultural, industrial, the historical rainfall average can cause around $90 and domestic users (Madani, 2014). million in economic losses (Madani et al., 2016). Climate extremes still pose significant Despite food security being one of the country’s threats to populations and the economy. Iran’s priorities, during drought periods large amounts Reduction in the Area of Lake Urmia (88% in the Last Three Decades) Over the Past Three FIGURE 21 •  Decades as a Result of Intensive Upstream Abstraction 1972 1989 2006 2014 Source: Agha Kouchak et al., (2015). Special Focus 2 Towards Water Security in Iran: Challenges and Opportunities 37 of food needs to be imported. For instance, during 55% of the total water demand (Madani et al., 2016). the 1999–2001 drought, Iran imported close to 80% This situation is leading to groundwater depletion of its domestic wheat supply, becoming one of the and irreversible damage to aquatic ecosystems and world largest wheat importers at the time (Faramarzi, surface water bodies—for instance, the desiccation 2009). Unmanaged impacts of droughts can also of Lake Urmia. Aggressive groundwater withdrawals compromise livelihoods in rural areas, leading to rural- have also resulted in groundwater table declines, land urban migration and ensuing social development subsidence and water quality degradation. issues in urban centres (Sadoff et al., 2017). At the Despite this impending water crisis, total other end of the hydrological spectrum, Iran is also water productivity in Iran is among the lowest very vulnerable to floods. On average, floods have in the region. Total water productivity is defined as killed more than 130 people per year while affecting the economic output (GDP) per unit volume (m3) of about 11 million people in the last two decades of the water withdrawn. The great majority of water use is twentieth century (Madani et al., 2016). The annual in agriculture, and economic returns on agricultural estimated economic impact of floods due to property water in Iran are extremely low relative to others damage alone is about 0.5% of GDP (World Bank, in the region. Increasing total water productivity is 2017). This does not include the indirect economic challenging and requires carefully designed policies damage inflicted by floods such as supply chain including water conservation, switches to crop interruptions. High spatial variability of climatic that consume less water, and reallocation to more conditions also means that water-related challenges economically productive sectors. Actual decisions on vary across the country, adding a layer of complexity improving water productivity would have to be based to water resources planning and management. on basin-scale water accounting and considerations of the social, economic, and environmental value of water, and associated distributional impacts on Drivers of a Potential Water Crisis communities and households within the basin. In an effort to diversify the economy and In the last fifty years the population of Iran has improve national food security, the government increased fourfold, adding pressure over the has supported the agricultural sector through water resources. The population of Iran has increased water and energy subsidies. Although this policy from below 10 million at the start of the nineteenth was deemed necessary during the Iran-Iraq war, century to 79 million people in 2015 (Seyf, 2009; World the agricultural sector consumes 92.8% of the total Bank, 2015). Similarly, urban population has increased water use, while providing only 23% of the jobs, from 7.3 million to 58 million over the same time period. and contributing 13% to Iran’s GDP (Madani, 2014). Nowadays, 73.5% of Iran’s population lives in urban Low irrigation efficiency (less than 32%) partly due areas (World Bank, 2015). Eight Iranian cities have to water and energy subsidies, cropping patterns a population greater than 1 million people (Madani, respondent to traditional farming rather than to water 2014). This translates into an increasing demand for availability, and guaranteed crop purchase prices potable water and water for food. make the agricultural sector one of the biggest Unsustainable water use is one of the contributors to Iran’s water crisis. Large subsidies for key drivers of a potential water crisis. Over 25% energy consumption in the agricultural sector make of water use in Iran is unsustainable. This means deep groundwater pumping and relocation of wells that 25% of the total water that is withdrawn from economically possible, contributing to large scale aquifers, rivers and lakes exceeds the amount groundwater depletion. Although some measures, that can be replenished by the hydrological cycle. such as raising energy prices and expanding Iran is currently among the countries with highest the groundwater monitoring network to control groundwater depletion rates in the world (Döll et abstractions have been established, agriculture al., 2014). It is estimated that groundwater supplies water use trends remain unchanged (Madani, 2014). 38 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY Total Water Productivity, Selected Middle Eastern and North African Countries and FIGURE 22 •  Economies, 2010 Iran is one of the least water productive in the Middle East and North Africa Kuwait Israel UAE Oman Jordan Lebanon Saudi Arabia Algeria Tunisia Morocco Libya Iran Iraq 0 20 40 60 80 100 120 140 160 Total water productivity (US$/m3) MENA data Average productivity in high income countries Average productivity in middle income countries Source: Data estimated as the ratio of constant 2010 $ GDP (from World Bank GDP estimates) over cubic meter of total water withdrawals (from FAO AQUASTAT). Note: Water withdrawals also include water withdrawn from nonconventional supply sources such as desalination and wastewater reuse. Given the different economic structure of each country, these indicators should be used carefully, taking into account a country’s sectorial activities and natural resource endowments. Iran also has some of the lowest municipal sources, mainly from the agricultural sector, lead water tariffs in the Middle East region and in the to high levels of nitrate that deteriorates tap water world. Water bills in Tehran are ten times lower than quality. Moreover, lack of treatment and appropriate in Abu Dhabi and twenty times lower than in London. sewerage networks mean that freshwater quality is Failure to properly price water services promotes low (Madani, 2014). excessive water use and undermines the financial Institutional fragmentation undermines sustainability of the water sector. Cost recovery is efforts to coordinate and innovate. The lack of essential to ensure long-term sustainability of water a robust legal framework, weak enforcement, and services and appropriate levels of investment in the inadequate institutional coordination all inhibit efforts operation and maintenance of water distribution towards integrated water resources management systems, not just in infrastructure but also in training of and slow the adoption of recent innovations such staff. Lack of financial sustainability of water services as wastewater treatment and reuse technologies can also severely undermine utilities’ capacity to treat that could help the country meet its increasing water wastewater, leading to deteriorating water quality and demands. Weak water governance, for instance in the degradation of freshwater ecosystems. form of poorly defined and enforced property rights Although most Iranians have access to over land and water, makes it difficult to regulate water water supply and sanitation, quality of access use. In the case of agricultural water management, and levels of service vary within the country. fragmented and financially constrained institutions Over ninety six percent of Iranians have access make it more challenging to improve the productivity to improved drinking water sources, and ninety of the irrigated agriculture sector. percent have access to improved sanitation, which The water sector’s operations are highly is in line with other countries in the region (WHO/ constrained by government policy. Maintaining low UNICEF, 2015). However, non-point pollution regulated water rates for social purposes has adverse Special Focus 2 Towards Water Security in Iran: Challenges and Opportunities 39 Combined Water and Wastewater Bill per Cubic Meter, Selected Cities in the World FIGURE 23 •  Iran has some of the lowest municipal water tariffs in the world London Barcelona Dubai Tel Aviv Muscat Abu Dhabi Doha Rabat Distrito Federal (Mexico city) Kuwait city Tehran 0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 Combined water and wastewater bill per m3 (2016 USD) Source: Global Water Intelligence Global Water Tariff Survey 2016. impacts on the financial performance of urban water bodies, gives it a critical role in regional water and wastewater companies. Indirect subsidies in the security and broader ecosystem sustainability. form of capital investment and of periodic government Iran shares eleven major aquifers and eight major river write-offs of unpaid accounts receivable further basins with neighboring countries, all of whom face distort management decisions and lead water service water resource management challenges. Cooperative providers further away from self-sufficiency. management of these transboundary water resources In Iran’s large and growing urban centers would therefore be essential, as recognized in the over half of the population is not connected to General Decrees on the Environment. Current efforts sewerage systems, and only 25 percent of Iran’s to develop win-win approaches amongst neighboring wastewater is treated. More than 70% of Iran’s countries would need to be strengthened, including population is urban and the increased migration mechanisms for information sharing, resource monitoring to urban centers means that this number is set and management of water quality and quantity. to increase. This poses significant challenges for water and wastewater distribution systems. Despite recent improvements, less than half of Iran’s urban Looking Forward population is connected to a municipal wastewater collection system, and not all of the water that is Iran’s long tradition of water management and collected is then treated. This means that increasing the recent General Decrees on the Environment volumes of wastewater are being generated and provide a platform to address Iran’s current 75% of this wastewater is being returned untreated and future water challenges. The General into the environment. This creates health hazards for Decrees’ focus on monitoring water pollution and people and ecosystems, and also wastes a significant climatic changes, paired with management of potential water resource that could be treated, ongoing climatic variability provides a clear line of recycled and reused for urban landscapes, industry sight to promote source protection and adaptation or groundwater recharge. to environmental change. The strong emphasis on Iran’s geographical position, at the protecting groundwater quantity and quality is also crossroads of a number of shared, freshwater a clear indication of the importance of this resource 40 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY for the country’s long-term development and well- Incentives can be targeted to local development being. The promotion of environmental diplomacy needs and situations to ensure that policies are in the Decree provides an encouraging sign of tailored to specific realities, as demonstrated by recent Iran’s willingness to manage its transboundary water government policies to support rice production in the resources in a cooperative way. A range of actions that Northern provinces of Gilan and Mazandaran or to could contribute to mitigate Iran’s water challenges promote conjunctive use of surface and groundwater are briefly discussed in the following paragraphs. resources to halt groundwater depletion. More work needs to be carried out to prioritize these Enhancing transboundary and inter- actions and tailor them to Iran’s highly heterogeneous provincial coordination, cooperation, and water reality. exchange. Given the very large share of Iran’s Modernizing irrigation systems to reduce waters that are transboundary, more coordinated losses could lead to an estimated $3 billion management of these resources would be important— welfare gains annually without increasing particularly as climate change makes water availability the total irrigated area. If all the available water less predictable. Similarly, inter provincial coordination allocated to agriculture in Iran could be stored and is also key to achieve robust and sound integrated delivered efficiently to irrigated agriculture, agricultural water resource management within the country. production would increase and variability in production Establishing effective water balances of some commodities would decrease. Under this and models which integrate socio-economic scenario, total irrigated area is fixed and groundwater considerations at the basin and municipal levels withdrawals are limited to control depletion. What to manage trade-offs and enhance investment changes is the water storage and delivery capacity efficiency. As a country with both overall, but of the irrigation systems. This could lead to an also highly variable water stress, facing increasing estimated $3 billion welfare gains annually.27 These challenges from economic and population growth gains come from standard measures of producer’s and the impacts of climate change, important trade- surplus (improved water services and availability) and offs would need to be made in terms of inter-sectoral consumers’ surplus (reduced food prices). In addition, priorities and allocations. These decisions have major half the gains would be in the form of spillover effects implications for the sectors concerned, as well as the to the nonagricultural sectors. Recent investments development of policies which align incentives and in storage infrastructure in the Ilam and Khuzestan major investments in infrastructure such as inter-basin provinces have shown the benefits of improved transfer facilities, desalination and water recycling. infrastructure on irrigation system performance. The implications and partial irreversibility of these Strengthening incentives and continuing measures highlights the need to support water sector subsidy reforms can significantly curb decision making for major basins as well as for cities, unsustainable water use by consumers. Iran’s 2010 with integrated water resource and socio-economic energy subsidy reform shows that removing subsidies assessments and modeling. is possible and that well-designed policies can shape Improving the collection, processing and consumers’ behavior. This and other experiences show reporting of water-related information to guide that effective pricing and subsidies removal policies water policies and investments. Information share common features such as well-designed tariff provides the foundation for sound decision-making structures which balance cost recovery and economic for water planning and management. This information efficiency needs with equity and affordability. Well- is gathered from multiple sources including long-term designed pricing and subsidy removal policies also continuous observations of hydrological variables, local include accurate targeting of price changes, for instance knowledge, and commissioned studies. Information is by targeting higher consumption users, and public campaigns explaining the reason for pricing changes 27 Estimated using the International Food Policy Research and the availability of compensatory mechanisms. Institute IMPACT model (World Bank, 2017). Special Focus 2 Towards Water Security in Iran: Challenges and Opportunities 41 a shared asset that underpins any credible reform or floods and droughts. For information to be of relevance infrastructure project in the water sector. Information to decision-making, it needs to be embedded within systems are also a crucial element to forecast and appropriate institutions responsible for the collection, respond in time to water-related disasters, such as organization, and processing of information. References AghaKouchak, A, et al. (2015) Aral Sea syndrome Madani, K, AghaKouchak, A & A, Mirchi (2016) Iran’s desiccates Lake Urmia: Call for Action. Journal of Socioeconomic Drought: Challenges of a Water- Great Lakes Research 41 (1), 307–311. Bankrupt Nation, Iranian Studies, 49:6, 997–1016. Döll, P, Mueller Schmied, H, Schuh, C, Portmann, F T, Sadoff, C W, E, Borgomeo & D, de Waal (2017) & Eicker, A, (2014) Global-scale assessment of Turbulent Waters: Pursuing Water Security in groundwater depletion and related groundwater Fragile Contexts. Washington DC: World Bank. abstractions: Combining hydrological modeling Seyf, A, (2009) Population and agricultural with information from well observations and development in Iran, 1800–1906. Middle Eastern GRACE satellites. Water Resources Research, Studies, 45(3), 447–460. 50(7), 5698–5720 Veolia Water and IFPRI (International Food Policy Faramarzi, M, Abbaspour, K C, Schulin, R, & Yang, H, Research Institute) (2011) Sustaining Growth via (2009) Modelling blue and green water resources Water Productivity: 2030/2050 Scenarios. http:// availability in Iran. Hydrological Processes, 23(3), growingblue.com/wp-content/uploads/2011/05/ 486. IFPRI_VEOLIA_STUDY_2011.pdf. Fathian, F, Morid S & Kahya E, (2014) Identification WHO/UNICEF Joint Monitoring Programme for of trends in hydrological and climatic variables in Water Supply and Sanitation (2015) Progress on Urmia Lake basin, Iran. Theor Appl Climatol:1–22 sanitation and drinking water – 2015 update and doi:10.1007/s00704–014–1120–4. MDG assessment. WHO, Geneva. Hassan, F A, (2010) Water History for our times. World Bank (2017) Beyond Scarcity: Water Security UNESCO International Hydrological Programme. in the Middle East and North Africa. World Bank: Madani, K. (2014) Water Management in Iran: Washington D.C. what is causing the looming crisis? Journal of Environmental Studies and Sciences (4), 315–328. 42 IRAN ECONOMIC MONITOR: OIL-DRIVEN RECOVERY 1818 H Street, NW Washington, DC 20433