Are falling oil prices pushing Iran to make risky economic choices?

Iran may bring back a controversial policy of selling military exemptions to help fill government coffers emptied by lower oil prices and nuclear sanctions.

Iranian officials are adamant that the precipitous drop in global oil prices that has slashed domestic spending across the oil-producing world will not bring the country to its knees.

But the latest state budget reintroduces a controversial program to sell exemptions from mandatory military service – an indication of just how hard the oil-dependent economy has been hit by falling prices and years of sanctions over its nuclear program. Indeed, for President Hassan Rouhani, the economic hit comes amid delicate nuclear negotiations, and makes the potential economic boon from any deal that much more attractive.

Military exemptions haven’t been sold in more than a decade, and critics say the policy risks deepening a social divide in Iran between haves and have-nots.

But for one square-jawed, 34-year-old Iranian, at a party with friends in north Tehran, the provision brings deep relief.

“We buy back two years of our life,” says Shayan, as several other military-age men within earshot nod approvingly. All of them would qualify for the controversial measure, and say they’re willing to pay the necessary thousands of dollars.

But while Shayan and upwards of 2 million young men may rejoice at being given the option to bypass their military service, the plan speaks to Iran's current economic stress.

President Rouhani’s government recently slashed the basis of its new budget from $72 per barrel of oil to $40, and the oil minister last week defiantly declared that Iran can withstand further falls to $25 per barrel.

Rouhani even asserted that his government had drafted Iran’s “least oil-dependent” budget, and warned that other oil-producing countries like Saudi Arabia and Kuwait “will suffer more than Iran.”

But GDP growth, which has been steady for a decade at about 5 percent a year, is expected to be at least halved in the coming fiscal year, to 2 or even 1 percent. And earlier hopes in Tehran of a doubling of oil revenues to $60 billion in the coming year are being dashed, with the figure likely to remain, like last year, just $30 billion.

That is a fraction of the $100 billion per year enjoyed by the government of Mahmoud Ahmadinejad, the arch-conservative former president, before Rouhani was elected 1-1/2 years ago with the promise of fixing an economy damaged by sanctions.

'Wind out of Rouhani's sail'

“In terms of expectations, this is a huge shock to the government,” says Djavad Salehi-Isfahani, an economist at Virginia Tech, on the decline in oil prices.

The tight new budget, he says, “means the government will not be doing development expenditures, which have always been the mover and shaker of Iran’s growth process.”

Rouhani’s political future rests in many ways on improving the economy. That may require a nuclear deal with six world powers that would ease years of crippling sanctions on oil, trade, and banking. The final deadline for three years of talks is June 30.

“The oil price going down has taken the wind out of Rouhani’s sail,” says Mr. Salehi-Isfahani. But a nuclear deal that released $20-30 billion back into Iran’s economy could raise the GDP growth rate back up to 4 or 5 percent.

“That’s where the balance hangs on these negotiations, whether Rouhani can generate economic growth in the next 12 months, or he’s going to just have to say, ‘Sorry guys, wait a little longer,’” says Salehi-Isfahani.

On paper, World Bank figures show that Iran’s dependence on oil is just 22 percent of GDP, compared, for example, with more than double that for Saudi Arabia or Iraq. But those numbers can be deceptively low, because in Iran the oil industry affects so many other sectors.

'Difficult' but not a 'disaster'

Already government projects are on the chopping block, and government salary increases will be half what they were last year. Ministries have been tasked with raising cash on their own with measures from higher post office fees to enforcement of traffic fines.

The resulting economic strain means the “temperature of social affairs … will be much higher,” says Saeed Laylaz, a reform-minded economist in Tehran.

“If they reduce the projected budget of the government, it means less economic growth, less employment, and less satisfaction among the people,” says Mr. Laylaz. Still, he notes that even with both low oil prices and sanctions, Iran is still likely to import $60 billion in foreign goods in the coming year, nearly twice the level of 2004.

“The situation will be difficult but it is not disaster … not beyond controllability,” says Laylaz.

The budget bill has not yet passed, but explicitly states that up to $289 million in income from selling military service must be spent strengthening Iran’s defenses. Officials in mid-December rejected any connection between the budget deficit and the new measure, but the tactic was used in decades past.

A similar plan was first approved in 1991, and in 2001 the government of then-President Mohammad Khatami voted to allow families to buy military exemptions. Between 2000 and 2001 – the last year young men could benefit from the policy – some 360,000 purchased their military service, reports the online Tabnak news.

Billions at stake

"One of the reasons to sell military services was collecting liquidity,” Abdollah Ramazanzadeh, the former government spokesmen for Khatami, told Shargh newspaper last August. “That [collecting cash] was one of the most important economic objectives of Khatami's government.”

In the past, the fee was the equivalent of several hundred dollars. Today it starts at roughly $6,500, and can run to more than double that.

Abbasali Mansouri, a member of parliament’s National Security Commission, estimated that government revenues from the program could range from $2.9 billion to $5.8 billion.

Some complain that such a high cost will have a negative social effect.

“Such acts prioritize the government's financial objectives over citizens' rights and would make members of society tools ... for economic objectives,” said the Nasl-e Farda daily. 

Laylaz also opposes the practice, saying it enables the well-to-do to pay for exemptions, while poorer Iranians can’t afford that option.

Words vs. deeds

In the meantime, the belt-tightening measures contrast with brave official statements. When Finance and Economy Minister Ali Tayyebnia announced the reduction of oil price estimates to $40 per barrel for Iran’s next fiscal year, which begins in March, he said “we plan to turn [the drop] into opportunities.”

At a petrochemical conference in Tehran, Mohammad Reza Nematzadeh, the industry, mining and trade minister, criticized former President Ahmadinejad's frequent defiant statements that sanctions had no impact, saying they got in the way of dealing with the problem today.

“Why should we abandon logic and swear instead or have empty gestures?” Mr. Nematzadeh asked from the podium. “Do you think the world doesn’t get it that our gestures are empty? That our remarks are empty?”

“Our educated youth can tell if you’re lying,” he said.