Domestic Economy

Aftermath of NDF’s Failure

Aftermath of NDF’s Failure Aftermath of NDF’s Failure

Resource-rich nations, especially those endowed with oil, have often struggled to cope with the sharp inflow of foreign currency from the sale of natural resources.

Theories have formed around the common trends in such countries, like the decrease in price competitiveness and export, and an increase in imports—a condition named the Dutch Disease and a tendency of tying the economy to commodity price volatility.

To counter some of the negatives of natural resource exports, some countries have created funds. In Iran even that plan has been without success.

Currency inflows from commodity sales (mostly oil in Iran’s case, though the country is rich in most mineral resources) led to currency appreciation, making the country’s other products less price competitive on the export market. It also led to higher levels of cheap imports and can lead to deindustrialization, as industries are moved to cheaper locations.

Also, commodity sales have a tendency of tying the economy to their price. Commodity prices fluctuate and most economies need backup industries.

As oil prices rose in the latter part of the 2000s, Iran’s government went on a spending spree, the economy grew and inflation soared. When oil prices plummeted, the government was left cap in hand. Fiscal holes appeared, investment evaporated and recession ensued.

The cycle has happened many times throughout the past century in Iran.

  Counteractive Efforts

Efforts to counteract this trend started in 2001 by the reformist government that had to handle a dry spell. An Oil Stabilization Fund was created to iron out the effect of oil price fluctuations on the fiscal budget. The fund was to save during good times and fill fiscal gaps during hard times.

Nothing was done to keep the influx of foreign currency at bay, however. None at the time thought $100 per barrel oil a possibility.

In 2011, Iran created a Sovereign Wealth Fund to diversify revenue streams and avoid reliance on hydrocarbon sales. Iran finally wanted a cure for its Dutch disease.

The initial plan was to put a fifth of the country’s oil revenues into a fund that would invest abroad for the benefit of future generations. The National Development Fund’s share of oil sales was to grow by three percentage points each year with the final target of 35% of oil sales.

While the term Dutch Disease was coined in the 60s, Iran has suffered from it for over a hundred years. Iran was the first oil producing nation in the Middle East and its governments soon got hooked on the easy money made from oil sales.

In Iran, oil is partly responsible for the shortcomings of the taxation system, as the need to tax efficiently has been lacking. In fact, the government could afford to pay lavish subsidies on energy, food and staples.

Anyway, what took place in Iran during the presidency of Mahmoud Ahmadinejad foiled both attempts at curing the Iranian economy’s reliance on petrodollars and the oil industry. In practice, the opaque structure of the funds was exploited by the government and regulations were changed to the point of making both funds irrelevant.

The administration kept the funds’ share of oil sales steady at 20%, meaning more money went to state coffers to be spent on imports, subsidies and other populist policies.

Also, the two funds legally shared the same revenue stream and most of the revenues went to the NDF, leaving the OSF dry.

  Aim of Sovereign Wealth Fund

The aim of a sovereign wealth fund is to curb the influx of foreign currency from resource sale by investing offshore. Some even say these investments can be made strategically.

The fund can buy controlling stakes in companies and use its board position to transfer expertise and technology back to its nation. It can also lubricate trade by providing export credit, among other things.

In Iran, these aims were subverted early on by changing the clause that mandated the NDF to steer clear of giving out rial-denominated loans. Afterwards, the fund turned into the government’s piggy bank. It was used in place of the OSF to fill fiscal gaps, to lend to farmers and fund yearend bonuses and marriage loans. The latter was the doing of the parliament.

The proper management of these public funds received the least attention. Despite this, the fund’s managers were happy to take out lavish salaries, when compared to the general public.

The government of Hassan Rouhani has not broken the precedent. He has tread the path of his predecessor, keeping revenues of the fund at 20% and using its money to fill out some of the fiscal holes left behind by Ahmadinejad. His reasons have been the deep recession in Iran’s economy and the dip in crude prices during the past couple of years.

Will the new NDF chief, Ahmad Doost-Hosseini, change tactics? He should devote his efforts to making the fund transparent, avoid bringing NDF money into the Iranian economy and have his fund act as a shield against oil-related risk.