Why Iran must shake up its approach to state-owned enterprises

Al-Monitor – A year ago, President Hassan Rouhani’s budget proposal for the next Iranian year (beginning March 21) sparked a heated internet debate among Iranians. The main cause of their anger was the lavish funds allocated to certain state agencies and institutions. However, what was left unnoticed and indeed in need of much more public attention was the draft budget’s section on state-owned enterprises.

A litany of problems in Iran are thought to be the byproducts of budget decisions, including high liquidity growth, abnormal bank interest rates, costly business activity, money laundering, capital flight and smuggling of goods, to name a few.

With that in mind, in the forthcoming Iranian fiscal year, the state budget will total 17,032 trillion rials ($405.5 billion). Of that amount, state-owned enterprises are expected to garner around 12,747 trillion rials ($303.5 billion), while the government’s general budget will total considerably less, at 4,786 trillion rials ($114 billion). Although the bulk of Iran’s state budgets is routinely allocated to state-owned enterprises, the books of such enterprises are not scrutinized by parliamentarians, either due to a lack of time, or perhaps due to media outlets focusing more on the government’s general budget.

Shockingly, according to the audit compiled by the Supreme Audit Court for 2016-17, a total of 162 state-owned enterprises were deemed economically unviable. Originally, under the 2016-17 budget law, a mere nine state-owned enterprises were categorized as loss-making enterprises. But the audit increased that amount eighteen-fold. Of note, that same audit reports that 75% of the revenues of such entities over the same period were spent on current expenditures and a meager 25% allocated for investment purposes. Despite these tremendous losses, 15.5 trillion rials ($475 million) were taken from the state budget at the time to prop up these state-owned enterprises rather than fund feasible infrastructure projects to enhance economic growth.

Currently, Iran has 377 state-owned enterprises. Of those enterprises, the Big Four — the National Iranian Oil Company, National Iranian Gas Company, Central Bank of Iran and Arak Oil Refining Company — are expected to constitute around 94% of the total net margins of state-owned enterprises in Iran’s 2019-2020 fiscal year. In stark contrast, the remaining companies contribute approximately 13% of total net margins. Put another way, the majority of state-owned enterprises are in the red, eating away at their budgets without being held accountable for poor performance or inefficiency.

As could be anticipated, 79% of the government’s tax revenues also stem from the sectors of the Big Four: oil, banking, insurance and, to a lesser degree, electricity. Following in the course of preceding years, the Big Four are expected to be chiefly responsible for the main share of tax receipts. This, nevertheless, underlines the fact that a majority of businesses owned by the state are illiquid and operate below their break-even point.

Being able to pay taxes is a proper indicator of a typical company’s financial position. This denotes that a company is able to maintain a profit. Nevertheless, this is different for Iranian state-owned enterprises. For most of them, a forecast of profitability is not conducted through the mechanisms of a board that can approve and oversee finances. Moreover, the payment of taxes and dividends by these companies over the course of the year generally leads to a sharp decrease in their activity and liquidity. Consequently, this discourages their CEOs from providing accurate data on their respective firms while the budget bill is under review by lawmakers. That being said, it is no surprise that there exists obvious differences between the real performance of state-owned enterprises and what parliament voted on as their financial plan.

As such, these companies affect the business environment in a number of ways. First, they negatively impact government funding. Altogether, these firms will pay about 166 trillion rials ($3.9 billion) in taxes and dividends during the next Iranian year. This seems to be unrealistic compared with the average rise of the enterprises’ budget deficits over the last four years, as well as the amount of tax income that has not been realized in the current year, as projected. Since state entities are slated to receive 169 trillion rials ($4 billion) in government aid in the form of cost credits and credits for the acquisition of capital assets, they risk unsettling the sustainability of the state budget.

Second, state-owned enterprises influence the business climate by spiking the volume of debts to the financial system. As such, these enterprises are assumed to be borrowing about 1,191 trillion rials ($28.3 billion) in domestic and foreign credit facilities next year. They are also projected to repay $24 billion to service their debts of past years. This will substantially increase demand for loans on the money market. How these enterprises will be able to cover their obligations with such poor balance sheets is anybody’s guess.

With that in mind, it is now more vital than ever to assess the impact and role of state-owned enterprises in Iran’s economic landscape. To improve the poor business environment in the country, the sustainability of their budgets must be examined and approached so that government spending moves in parallel with revenues. Furthermore, the efficiency of state-owned enterprises should be boosted to help stabilize the government budget.

To this end, corporate governance with respect to state-owned enterprises must be rigorously revised to allow financial resources to be more freely channeled to competitive companies in the private sector. In this equation, preparing the ground for the government to divest from unproductive state-owned enterprises and focus on empowering the real private sector in addition to revising bankruptcy laws appear to be the long-term answers to improving the unfavorable business climate in Iran.