Iran’s economy continued its gradual recovery in 2021/22 following the rebound in domestic and external demand.

Despite a more accommodative fiscal policy in 2021/22, higher oil and tax revenues have improved the fiscal deficit-to-GDP ratio.

Consumer price inflation accelerated due to a combination of supply-push and demand-pull factors, adding to pressures on the welfare of lower-income households. 2021/22, Iran marked its third consecutive year of annual inflation above 35 percent, driven by a rapid growth in monetary aggregates, inflationary expectations, and rising global commodity prices. Headline and core inflation climbed to 40.2 percent and 36.7 percent in 2021/22, respectively, with headline inflation registering the highest rate in a decade. The surge in food prices following the war in Ukraine added to inflationary pressures and increased the fiscal burden of subsidized food imports. In response to the growing food import bill, the authorities ended the import subsidies for some essential goods, increased the guaranteed purchase price for domestically produced wheat, and raised the administered price of certain food items to reduce smuggling. To mitigate the impact on consumers, these measures were combined with the introduction of additional cash transfers and announced plans for the deployment of electronic coupons for purchase of essential food items. These measures led to monthly inflation increasing to 12.2 percent in June 2022 month-on-month (m/m) — a record high for monthly inflation. Food prices increased by 25 percent m/m, which was felt most by lower income deciles and in rural areas.

GDP growth is projected to remain modest in the medium term, as the economy remains constrained by both global and domestic growth bottlenecks.

A more favorable global oil market outlook is projected to improve Iran’s fiscal and external balances.

Iran’s economic outlook is subject to significant risks. On the upside, further increases as well as sustained high oil prices can result in higher oil export revenues. If oil markets seek all available supply to ease price pressures, stronger demand could also lead to higher oil export volumes, thereby further improving fiscal and external balances. If economic sanctions are significantly eased or removed following a breakthrough in nuclear negotiations, this could further improve Iran’s economic prospects and curb inflationary expectations. Downside risks relate to the impact of surging global food prices, the resurgence of new COVID-19 variants, and a worsening of the climate change impact. Soaring global food prices due to the war in Ukraine, if prolonged, could heavily impact crop and fertilizer supplies and raise food security risks. Further price increases would add to Iran’s import bill and put more pressure on the government and its limited accessible foreign exchange reserves. Persistent high inflation, if unmitigated, would increase pressures on lower-in- come deciles and adds to existing social grievances.

Addressing long-term development challenges, including impending climate change shocks, requires a comprehensive package of economic reforms complemented by adequate social protection measures.

Preparing for an Uncertain Water Future Iran is a water-stressed country where consumption outstrips natural regeneration. Climate change will widen the water supply and demand gap, worsening water challenges for Iran and its neighbors. Irrigated agriculture consumes the greatest share of water (92 percent), but that water is not used well in Iran: agricultural water productivity is one of the lowest in the region. Climate change will negatively affect the gross domestic product (GDP), demand for labor, and food prices. According to the World Bank Water in the Balance report, in a scenario where water availability reduces by 20 percent and where higher temperatures negatively impact crop yields, GDP would decrease by 7 percent relative to the baseline (real GDP in 2016) or by about US$30 billion. Demand for labor would fall by up to 4.8 percent and 10 percent relative to the 2016 baseline for agricultural and non-agricultural activities, respectively. Consumer food prices would increase by up to 8.2 percent. This analysis relies on short to medium time likely changes in crop yields and water availability prior to 2050. Since reduced water availability is one of the biggest economic impacts of climate change, Iran can benefit from lessons from countries that have coped with this issue. These pathways include (i) effective water resources management, (ii) improved water use efficiency with water demand management policies, (iii) adept institutions and tailored policies, and (iv) collaboration with riparian countries.