Warnings About Inflationary Budget for 1404; Iran's Income and Expenditure 'Under the Shadow of War and Pressure'

The government of Masoud Pezeshkian has submitted its first budget bill since taking office to the parliament; a budget that has been likened to a 'war budget' due to a 200% increase in military expenditures. The general outlines of this budget have been approved under conditions where the Islamic Republic is facing unique economic and security challenges. The likelihood of continued conflict between Iran and Israel, increased sanctions pressure with Donald Trump's return to the presidency, and an unfinished list of economic imbalances turn the 1404 budget into a deep challenge for the government; a challenge in which the government has been forced to try to balance its expenditures through 'reducing subsidies,' 'increased borrowing,' and 'increased inflationary pressure.' One of the most tangible effects of these conditions on the government's income and expenditure can be traced in the '200% increase in military budget.' The rial amount for this budget line has not yet been announced, but evaluations from Radio Farda indicate that '47% of the country's oil export revenues' are set to be directly allocated to the armed forces, similar to this year. This amount is equivalent to 561 trillion tomans, while the government's share of these resources is only 43% and equivalent to 509 trillion tomans. Accordingly, economic actors and analysts say that 'the footprint of war' is evident in the 1403 budget. Meanwhile, budget resources, excluding military expenses, had already faced significant deficits in previous years. The Pezeshkian government claims it will increase Iran's military budget by '200%.' Increased withdrawals from the Development Fund as a solution based on 'borrowing' has become a more prominent tool for the government to cover budget deficits in the proposed bill compared to previous years; it is expected that in 1404, about 540 trillion tomans of the budget deficit will be covered by borrowing from the National Development Fund. This is the first time a government has relied so heavily on borrowing from the National Development Fund in a budget bill. Pezeshkian, who always emphasizes his deep relationship with the Supreme Leader of the Islamic Republic, in one of his first actions, with Ali Khamenei's permission, withdrew from Iran's foreign exchange reserve fund to pay the government's immediate debts and also reduced its share of oil revenues. Abdolnaser Hemmati, the Minister of Economy, also recently stated that funds had been withdrawn from the National Development Fund to cover the budget deficit, and permission had been obtained from the Supreme Leader for this action. Abbas Argon, a member of the Tehran Chamber of Commerce's board of representatives, said regarding this: 'The most significant aspect of the 1404 budget is related to the issue of borrowing from the National Development Fund, which did not exist before. From a revenue perspective, this volume of borrowing, especially in the area of bonds, is a form of selling the future.' Another part of the budget deficit is expected to be compensated through borrowing from the capital market and issuing treasury bonds. However, the debts of previous governments have become so heavy that the government's borrowing from the debt market will put more pressure on the capital market. According to government estimates, in next year's budget, more than 700 trillion tomans of various bonds will be transferred with a 175% increase compared to 1403, while the government's current revenues have only increased by 42%. Accordingly, the government faces a serious challenge in settling past debts. The government's attempt to cover the budget deficit from targeted subsidy resources has already hit a wall. According to the Minister of Economy, the budget shortfall was supposed to be compensated from targeted subsidies, but this sector also faces a significant deficit, leading to the allocation of part of the general budget to targeted subsidies in the first half of this year. Therefore, next year, the government will not only be unable to rely on targeted subsidy resources but will also have to allocate part of the general budget to cover subsidy deficits. The inflationary nature of the budget is expected to be the most probable consequence of increased borrowing in next year's budget, as the government strengthens the liquidity creation cycle by putting pressure on the debt market. Inflationary drivers in the 1404 budget are based on two pillars; one is 'eliminating government subsidies' and the other is 'liberalizing energy prices.' Parliament representatives expect that 'reducing the currency for essential goods from 15 billion dollars to 12 billion dollars' in next year's budget will increase the prices of goods and inflation. As a result of this change, several essential goods will be removed from the preferential currency basket. In addition to the elimination of subsidies, the increase in the NIMA exchange rate, which has been continuously rising in recent months, is another driver that exacerbates the increase in commodity prices. For example, one-third of the production cost of chicken, an important item in the household food basket, is supplied with preferential currency, and the rest with NIMA and free currency. Meanwhile, the NIMA exchange rate has increased by more than 30% compared to last year, and the preferential exchange rate has also seen a 30% increase. Hossein Samasami, a member of the Economic Commission of the Islamic Consultative Assembly, has predicted that the reduction of preferential currency in the 1404 budget bill will increase inflation by at least 20%. The government officials have made contradictory statements regarding the increase in gasoline prices. Mr. Pezeshkian, in defending the budget bill in parliament, announced the production cost of gasoline to be eight thousand tomans; statements that implicitly indicate his willingness to increase gasoline prices. However, government officials do not fully defend the increase in gasoline prices 'for now' due to security implications and the likelihood of public protests. With these circumstances, some parliament representatives believe that an increase in gasoline prices next year is inevitable, but there is no complete consensus among parliament representatives regarding the increase in gasoline prices. Hossein Samasami stated, 'Based on our predictions, the budget bill for next year includes an increase in gasoline prices of up to 40%, as more than 20 trillion tomans have been allocated for it.' Farshad Ebrahimpour, another parliament representative, claimed that 'the parliament is strongly opposed to increasing gasoline prices and will definitely not accept gasoline price hikes during the review of next year's budget bill.' Meanwhile, Mehrdad Lahouti, the deputy chairman of the Planning and Budget Commission, stated, 'With changes in the budget figures, it is clear that the government is likely to want to increase gasoline prices next year.' At the same time, it seems that there are no security considerations regarding the increase in prices of other energy sectors like electricity, as the Minister of Energy explicitly stated on November 7 that electricity prices will increase. According to Abbas Aliabadi, the government will no longer play a role in providing the rial cost of electricity, and people will have to purchase the electricity they need from the free market. Faramarz Tofighi, a labor activist, reacted to Aliabadi's statements by saying, 'When the Minister of Energy has liberalized electricity and asks people to buy it from the free market, a livelihood crisis should be expected.' Changes in the dollar-to-rial conversion rate for calculating the value of imported shipments are also among the decisive developments in the budget. This rate has been calculated at 28,500 tomans this year but will be determined 'at the rate of the gold and currency exchange center' for next year, which is currently around 50,000 tomans. Accordingly, the cost of imported goods will increase; this development has also been interpreted by currency market traders in recent weeks as a 'government signal to increase in the currency market.' The government estimates the oil export figure in the budget bill to be two million barrels per day. This is while Iran's oil sales have been limited due to international sanctions, and Trump's return to the United States may intensify international pressures on Iran's presence in international markets. According to the Financial Times report, Iran sold an average of 1.56 million barrels of crude oil per day from January to March 2023. This level of sales - if the figures are accurate - has been achieved under conditions where Western governments have been less strict about Iran's oil sales. Accordingly, government critics say that after the onset of Middle Eastern conflicts and Trump's re-emergence, achieving the figure of two million barrels per day seems ambitious. 'Optimism' regarding oil production has also been evaluated as another ambitious aspect of the budget. Based on the budget bill table for 1404, the daily oil production is estimated at three million and 750 thousand barrels, while before the imposition of sanctions, Iran's operational oil production was three million and 838 thousand barrels per day. Accordingly, the government intends to increase operational production to about 98% of pre-sanction levels. The estimate of two million barrels of oil exports indicates that the government is counting on increased oil exports to bear the heavy burden of debts and budget deficits. Meanwhile, tax revenues, which could cover part of the expenses, are under pressure this year due to 'increased exemptions.' The Research Center of the Parliament in its review of the budget situation has stated that the government's action to increase the ceilings of tax exemptions will reduce tax revenues by '48 trillion tomans.' However, in the announced statistics in the budget bill, it is stated that the government's revenues, which mainly include tax revenues, have increased by 44%. The Research Center of the Parliament in another part of this report has evaluated 'high reliance on oil export resources' in the shadow of potential external shocks as a fundamental weakness of the budget.