The Economic Development of FILE COPY Iran Volume II (Part 1)

Report No. 378a-IRN The Economic Development of FILE COPY Iran Volume II (Part 1)

Public Disclosure Authorized Sectoral Analyses (Parts I and II)

October 4, 1974 Europe, Middle East and North Africa Region Not for Public Use Public Disclosure Authorized Public Disclosure Authorized

Document of the International Bank for Reconstruction and Development

Public Disclosure Authorized International Development Association

L J This report was prepared for official use only by the -Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. CURRENCY EQUIVALENTS

Official Exchange Rate

To February 13, 1973:

1 Iranian rial = 0.0132 US dollars

1 US dollar = 75.75 Iranian rials

From February 13, 1973: 1 Iranian rial = 0.0147 US dollars

1 US dollar = 68.17 Iranian rials

All conversions to dollars to the end of Iranian year 1972 are made at the rate of 75.75 Iranian rials.

NOTE

The Iranian year is Marah 21 to March 20. For convenience, the nearest

Gregorian year is used here. Thus 1973 is March 21, 1973 - March 20, 1974. Page 1 of 2 pages

IRAN

BASIC DATA

A. POPULATION (1972) 31.2 Milliol GROWTH (1962-1972) 3.1%

of which Urban 41.9% Birth rate 4.7% Literate 37.0% Death rate 1.6% under 15 years 47.1% Infant mortality rate 16.0% Labor Force 29.5%

B. LABOR FORCE (1972) 9.2 Million GROWTH (1962-1972) 2.7%

of which Agriculture 41.3% Eaployment growth 8.2% Manufacturing 19.8% PARTICIPATION RATE 65.7% Construction 7.7% Utilities 0.7% UNEMPLOYMENT (open) Civil Service 7.0% as % of labor force 3.5% Others 23.5% as % of active population 2.3%

C. G.N.P. PER CAPITA (1972) $ 558 GROWTH (1962-1972) 7.1%

Urba,n (estimate) $1,035 Rural (estimate) $ 215

D. INCOME DISTRIBUTION (1971): Top 20% receive 50-60% of income Lowest 20% receive 5% of income

E. GROSS NATIONAL PRODUCT (1972) $17,04 Million GROWTH (1962-1972) 10.2% of which Gross Domstio Investment 23.3% Growth 15.7% Private Consumption 57.4% Growth 7.3% Govt. Consumption 21.0% Growth 20.6% Exports (inel. NFS) 30.6% Growth 10.9% Imports (incl. NFS) 20.9% Growth 16.7:4

as proportion of G.N.P.

Gross National Savings 21.6% Growth 17. 11 Money and Quasi- Money 33.7% Growth 19.h Government Sector 30.4% Growth 23.34 Agriculture 16.1% Growth 4.2% Manufacturing 13.2% Growth 12.3%

F. CONSUMER PRICE INDEX, 1972 (1969 - 100): 113.8 GROWTH (1962-1972) 2 6% Page 2 of 2 pages

G. BALANCE OF PATMTS (end 1972):

Merchandise ]kports $4,654,.o Million Merchandise Imports *3,80.0 Million Balance of Merohandise Trade $1,074.0 Million Balance of Current Aocouit - $ 863.0 Million Balance of Long Term Capital $ 556.0 Million Basic Balance of Payments - $ 307.0 Million Overall Balance of Payments $ 518.0 Million

H. FOREIGN EXCHANGE RESERVES (Dec. 1973): $ 970.0 Million as % of 1972 Imports 26.5%

I. EXTERNAL DEBT (end 1972): Total $ n.a. Million of which Public $3,6.5 Million Private $ n.a. Million

DEBT SERVICE RATIO (1972): 17.0%

J. IBRD/IDA LUNDING (Nov. 30, 1973): IBM IDA Outstanding and Labursed $261.1 million $ million

Undisbursed $427.1 million $ million

Outabanding incl. Undiabursed $688.2 million $ million

NOTSt All growth rates are average annual rates and are in constant (1959) prices except those marked with asterisk. IBRD 1D751R ¸ аа ³ sz sr Æ,. а»ÅÁ½³о ¸ `. .1-`, 1 ', f Ã s.s.R %' ,_ , ;, i RA³v r ¼1) _ - ADMWISTRATIVED1V1S10NS _ _ - 1 ' ' `` { `` u.s.s.R tL CASP/AN5£ А о Á²³¸о¸¸³, Á ³»²¿:: о 4C j= F I º[ а¼»¸ ³¿оÈ½Áеа¼eio. u ti `r'» EAST ''' . {аnG7,Áоº³, о,: ¸оЕ¸»аЕ. .,, º ? ¸² : Ã° AZERBA¦ AN' 1 ._,,. i v ½ .+: ²о½оаº³Ï ² . Е,¸.,, о¸.аоо,о»».ЕÁ Á³Â J Р¤ º½, о .s,. - - \ . .+ " ½.,.,, :¿'³ r.,,.. . ³, , ,<, v.2 G AN ; Ë Å: о Á. ¿ьо urL²x `.- 11 ³ q ¸ ° º '9 ¸ \` ³ о,,,,,, ¼ аь¸½³ AZA1VDARAN . , о l . r..i " , ь . /' ³ KURDESTAN Å½, а о .'1J

³,º,а о . L G' ¡ ¡7 »аЕ»а« о аР ¡ Е N ¢ R А L ¸½½¸о ³ Р /1 KERMANSHAH ' , ао К , Н О R А 5 А N " ` :"° ¢ о º½о¡²¸р»::, RfÇ. ¿ о N -- / ~ ! t, Il Е s F А ½ А N AFGHANfSTAN »½ о Á.. ь,r qzfh,T¸¿¸о ¿о " - ¿¼ ¼ . Íz В Á¸» £ А Z D , KHU2ESTAN /9' Е'i ""о ! " 1 R А Q f .cor.u ` ´±' 'iy ; .,., l . 1 , а, º³,а»½а / _ Р . . . . . i / Á½½а³о К Е R М А N :. ½ЕÁ. ½о z e /KUWAIT ocxcxl ¤ PAKISTAN v.i -l ½ J' F А R 5 . ³² / Ã \."" ,, Ã, . аА»¸ Å 92 Р sis ÂArv I 5AUD1 ARABIA AND ³ !а l G BALUCH 1 STAN . а³..., Е. ss¸ . S - Р N Е , , J S'1 n аº'. »{ `^.. r5rx t ,'` ²А ½RАN ,f._ .' Г - ,., ³, 7, Г { - t , аº³ÁG? . _ »° о :, ,. ¸» vw'Ã, J/ ½. ³Á i R ´ ¸ J ' ³о¿о. ¸ Ã_ i- )/ _ Р sS³¸ / 1 I º Î iao Æо ³оо ³Î О AN l

F6r,r ^ ½ s ²£о: »¸r ÂА ÅF`* _ Г» "- Ã,-( _ J G i \! f1y 0 50 10D i5c ..fy- _ о ºÁ¼ i½[5fl5 wo, :: »:° о"" ½: ' QATAR sx so , Æ THE ECONOtiIC DEVELOPME14T OF IRAN

VOLUME I THE MAIN REPORT

VOLUME II SECTOAAL ANALYSES (Parts I and II)

VOLUME-III: STATISTICAL APPENDIX

This is Volume II of a three-volume report of the Basic Economic Mission which visited Iran in September/October 1973. The Mission consiste' d of Vinod Dubey (Chief), S. K * Bery, Julian Bharier, Peter Bowden, Walter Elkan (Consultant), S. A. Faruqi, John Foster, Norman Hicks,,.Sang Eun Lee, Jacques Nusbaumer, Vinod Prakash, Liza Shipp (Secretary). Anthony Stapleton of the IB10 Agricultural Task Force in Iran, was an associate member of the Mission. Volume I, the Main Report, was finalized and circulated in June 1974. Volume III, the Statistical Appendix, is being finalized and will be circulated concurrently.

TABLE OF 00NTENTS

(PART I) Page No.

1. AGCULTUE AND URAL DEVELORENT ...... 1 Structure of the Rural Sectort ...... 1 Performance During the Third and Fourth Plans ...... 1 The Fifth Plan ...... 23 Key Sectoral Issues ...... 28

2. INDUSTRY ...... Introduction . . . . . d. Groth and Structural Chanugee .. 5 Industrial Strategy and Policies ...... 6

3. INFRASTRUCTURE ...... 79 An Overview ...... 9 Development Plan and Priorities ...... Cost Overruns and Other Problems of Implementation of Development Plans ...... Sector Profiles ......

.. OIL AND GAS ...... 0 Impact of Petroleum on the Economy ...... 110 Institutional Arrangements ...... 113 Oil Production, Consumption and Exports ...... 118 International Oil Prices ...... 121 Natural Gas ...... 128 Petrochemicals ...... 129

(PART II)

5. DOMESTIC FINANCE: THE MOBILIZATION AND AllOCATION OF RESOURCES . . 131 Introduction ...... 131 The Role of the .Public Sector ...... 131 Financial Organization of the Public Sector ...... 13 Resources and Taxation ...... T...... h3 Resource Allocation Through.the Budet ...... Demand Management: Problems and Policies ...... 168 Monetary Policy and Demand Management ...... 176 Allocation Through the Financial System ...... , 181

6. A MACRO-EC0NOMIC MODEL OF IRAN ...... o ...... 197 Introduction .,. . . .o ...... o ...... 197 Model Projections ...... 198 Government Accounts ...... ?02 Balance of Payments ...... 20, The Model in Detail ...... Iran Model Li.sting . .? ...... *. . . . 2

List of Tables

Table No. a e

1. Official Growth Rates of Agricultural Value Added ...... 2. Rural Incomes and Expenditure ...... 2C 3. Projected Growth in Demand for Major Agricultural Commodities . . . 29 1. Livestock Production and Targets ...... 40 5. Estimated Supply of Short-Tenn Credit ...... 44 6. Estimated Supply of Medium- and Long-Term Credit to Agriculture, 1970-72 . .o ...... o ...... 5 7. Growth and Shares of Manufacturing Value Added ...... 56 8. Growth and Shares of Value Added by Broad Economic Categories . . 56 9. Manufacturing Employment by selected Product Groups, Urban Iran, 1962 and 1972 ...... 57 10. Growth of Labor Productivity by Broad Economic Categories, Urban Iran, 1962 and 1972 ...... 58 11. Distribution of Industrial Investment in the Third and Fourth Plans by Broad Economic Categories ...... 12. Gross Inflow of Foreign Private Capital and Loans to Iran by Selected Industries During Third and Fourth Plans . . . . s. 13. Public Investment in Manufacturing by Major Industries During the Fourth Plan ...... 0 . . .. . 60 14. Growth of Small and Large Manufacturing Establishments, Urban Iran, 1964 and 1969 ...... 61 15. Regional Distribution of Manufacturing Activity, 1969/70 . . . . . 62 16. Cross Output of Selected Minerals ...... 64 17. Fixed Investment in Manufacturing by Broad Economic Categories During the Fourth and Fifth Plans ...... 66 18. Sectoral Distribution of Government Development Funds ...... 75 19. Investment in New Housing Units ...... 103 20. Number and Distribution of Hospital Beds ...... 108 21. Iranian Oil Revenues ...... 22. Contribution of Oil Sector to Balaice of Payments ...... 112 23. Crude Oil Output and Disposal ...... 121 24. Projected F.O.B. Market Prices of Iranian Light Crude ...... 127 25. The Size of the Public Sector, Selected. Years ...... 133 26 . S a v i n g s P e r f o rm a n c e ...... 1 3 5 27. Stracture of Central Government Revenues (Selected years) . . . 145 28. Relative Burden of Non-Oil Revenues (Selected Years) ...... 1t- 29. Average Rates of Trade Levies (Selected Years) ...... t 30. Central Goveninent Revenue Projections ...... 1 31. Recent Budgetary Developments ...... 9 32. Structure of Iranian Income Tax ...... 33. Private Corporate Taxation ...... 34. Current and Capital Expenditure from the Budget ...... Db 35. Functional Classification of Total Central Government Expenditure . 1 8 36. Comparison of Social Services Expenditure, 1970 and 1972 . . . . 1 37. Comparison of Economic Services Expenditure, 1970 and 1972 . . . . 164 38. Price Movements: Annual Average Chages ...... 168 39. Changes in the Wholesale Price Index (Excluding Crude Oil) and Its Components ...... 169 4O. Growth in Money and Quasi-Money, Recent Years ...... 171 41. Liquidity Ratios of .the Commercial Banks ...... 13 Table No. Page

42. Minimum Reserve Requirements ...... 179 43. Distribution of Banking Units in Iran ...... 184 W4. Assets of the Commercial and Specialized Banks, Selected Years . . 184 ,%et. Creit to the Public Fector by the Commercial and Specialized h . Banks ...... 185 Credit Outstanding of Commercial and Specialized Banks to the 46. Private Sector by Major Industry ...... -86 47. P r oj ec te d S ec t o r V a l u e A d d e d .. . .. * . 1 99 Il8. Expenditure on GDP ...... 200 49. A g g re g a t e R a ti o s an d P ar am et e r s . . . . 0 1 50. Alternative Growth Projection: High Investme.nt, Low Oil . . . . * 201 "1. Comparative Positions in 1987 ...... 202 c2. Government Accounts . . . * *...... * . * * * * * * 203 53. Alternative Government Projections ...... 204 54. Balance of Payments Projections ...... 205 55. Alternative Balance of Payments Projections ...... * . * 206 56. Petroleum Fector Projections . . . . . * . * . * . * * * . . . 217 $ 7 . E xo g en ou s A s sump ti on s ...... 2 1 8 $8. Tern Assumptions for New Lending . . . o ...... * * * * 221 1. AGRICULTURE AND RURAL DEVELOPMENT

I. STRUCTURE OF THE RURAL SECTOR

The Resource Base

1. Iran's population is still predominantly rural, with 57 percent of the population in 1972 living in rural areas. The recent high rate of urban migration is expected to continue, and rural as a proportion of total population is therefore projected to fall, reaching approximately 50 percent by the end of the decade. Although the growth rate is declining, the rural population is expected to rise from the current 17.9 million to about 20 million by the mid-1980's. The rural labor force is similarly .expected to grow over the next,decade, rising from a little over 5 million at the present time to around 6 million by 1980.

2. In 1966 nearly half the rural population was concentrated in the five provinces of East Azerbaijan, Khorasan, Central Ostan, Mazandaran and Gilan, i.e. very much in the northern half of the country. This was similar to the pattern of distribution of the total population. In all parts of the country a substantial part of the population is in the rural areas; only in Central (Tehran), Khuzestan (Ahvaz and Abadan) and Esfahan Provinces is more than half the population classified as urban. Nevertheless, there is a strong continuing trend towards urbanization, and the urban population increased from an estimated 32 percent of the total population in 1956 to 38 percent in 1966, 43 percent in 1973, and a projected 47 percent in 1977.

3. The rural population continues to grow in absolute terms and census data indicate that the number of villages increased from 49,100 in 1956 to 66,600 in 1966. The distribution of rural population according to village size remained fairly constant, with approximately one-quarter of the rural population in each of the following size groups: villages with more than 1,000 persons; villages with 500-1,000 persons; villages with 250-500 persons; and villages with fewer than 250 persons. In 1966, approximately 75 percent of the rural population lived in about 18,000 villages of more than 250 persons, while the remaining 25 percent of the rural population were distri.buted among nearly 50,000 very small settlements.

4. Although the share of the labor force occupied in agriculture is declining (from 56 percent in 1956 to 48 percent in 1966), this continues to be the dominant sector in terms of occupation. Agriculture engaged nearly half of the total labor force and accounted for 70 percent of all rural occupations in 1966. According to class of worker, rural activity is dominated by self-employed persons (48 percent), wage-earners (33 percent), and unpaid family workers (15 percent). Of the agricultural labor force in 1966 55 percent were self-employed, 23 percent were wage-earners, and 17 percent were family workers. -2-

5. There is little information available on the level of employment in rural areas. Census data show that rural unemployment rose from 1.8 percent of the rural labor force in 1956 to 3.1 percent in 1966, compared to national averages of 2.6 percent and 3.7 percent respectively. More recent household sample surveys indicate open rural unemployment of similar orders of magnitude, ranging from 1.6 percent to 2.3 percent of the rural labor force. Whereas these data indicate that open unemployment in rural areas is low, there is some evidence that underemployment is substantial. Esti- mates of hours worked per week in rural areas show that between 30 percent and 40 percent of the rural labor force work less than 42 hours, and that 10-15 percent work less than 28 hours per week, though, of course, seasonal factors are important.

6. Except for the narrow coastal and frontier strips, the country con- ststs of a high plateau bounded by mountain ranges in the north (the Alborz) and the west (the Zagros). The plateau in the interior of the country, with an average height of 4,000-5,000 feet, is typically semi-arid but includes a large number of village settlements and scattered patches of cultivation based o,n a local water source. The slopes of the mountains are covered with sparse ve, getation, and some of the high valleys in the mountain ranges provide excel- Ient sumer pasture. The narrow strip of land north of the Alborz mountains, rdering the Caspian, has substantially greater rainfall than the interior and consequently much heavier vegetation. Rainfall tends in general to be higher in the north-west than in the rest of the country.

7. The total land area of Iran is 165 million ha., of which approxi- iately 50 million ha. are classified as cultivable (in terms of soil condi- cions), 20 million ha. are in forest and woodland, and the remainder are deserts, mountains, and wastelands. Of the cultivable land, less than 20 million ha. have been cultivated, of which because of water constraints only 8-9 million ha. are cropped in any one year. The annual irrigated area is about 3.6 million ha., 1/ and the area under dryland crop cultivation is generally estimated to be between 4 and 6 million ha. The sample agricultural survey of 1971 made by the Statistical Center of Iran, for example, estimates that the total agricultural area in that year was 9.3 million ha. of which 3.0 million ha. were irrigated; the official Plan Organization estimates, however, ,ive equivalent figures of 8.8 and 3.6 million ha.

R. The area of land in Iran suitable for cultivation and irrigation is substantially greater than that currently cultivated. Incomplete soil studies amade to date indicate that at least 5.5 million ha. of land are suitable for irrigation, and this figure is likely to rise as field studies progress. There are problems of salinity in certain areas, and topographic features lead to the danger of erosion in some regions, but it can be stated that, in aggregate, soils are not a major constraint to agricultural development or land use in Iran.

/ Of which 0.7 million ha. is estimated to have an optimal water supply -- see para. 12 below. - 3 -

9. By far the greater part of Iran's land area is subject to frost and this limits the range of crops that can be grown and the timing of cultivation over much of the country. The low winter temperatures limit the growing season, and in many areas land cultivation is not possible during the winter. Consequently, double cropping or crop rotation is not practical on most of the cultivated area. On the other hand, the lack of cloud cover over most of Iran results in a high level of insolation and consequent rapid plant growth in the summer.

10. The major constraint to land use of course is rainfall; there are very large areas of the country where the volume and distribution of rainfall are insufficient to support plant growth in the absence of irrigation, and other areas where rainfall is marginal for dryland cultivation. Only along the Caspian and some parts of the south-western littoral is precipitation sufficient to support permanent rainfed cultivation. As a consequence, over most of the country it is the availability and quality of irrigation that is the major factor determining land use and the level of agricultural productivity.

11. Irrigation is widely developed over Iran, based on both surface and groundwater supplies. Surface water is utilized through a large number of small scale diversion works, often on seasonal streams. A number of large scale storage and diversion dams have also been developed over the last decade, although relatively little land is so far irrigated by them because of the lack of completed distribution systems. Groundwater is also exploited traditionally through ghanats -- underground channels conveying spring water from foothills to the cultivated area. Tubewells have also begun to be developed in recent years. The potential exploitable water supply is estimated to be around 90 million m 3 , of which 20-25 percent is groundwater. Current exploitation is estimated at 55-60 billion n3 , but of this only about half is delivered to the field, with conveyance and operational losses accounting for the balance. Virtually no canals or channels are lined, structures are few, and the uncontrolled flow of ghanats and springs results in waste of water when irrigation is not required. Field losses are also high because of lack of structures and land levelling.

12. Because of these high water losses and the seasonality and poor control of the water supply, much of the land nominally under irrigation receives only a supplementary water supply. On the basis of estimated crop consumption requirements, average effective rainfall, and irrigation distribution and conveyance losses, it is estimated that only one-fifth of the irrigated land receives an optimal water supply, that a similar area receives a less-than-optimal but a still moderate water supply, and that the remaining two million ha. are only nominally under irrigation.

Land Use and Distribution

13. The area of land cultivated in 1971 was estimated to be 8.8 million ha. Of this area, almost 80 percent was in grain crops, of which wheat alone occupied nearly 60 percent of the cultivated area. The remainder produced industrial crops (principally cotton and sugar beet), forage crops, fruits -4-

and vegetables. On the 40 percent of the cultivated area that was classified as irrigated, the proportion of land in grain crops was somewhat lower (63 percent), and the shares of industrial, forage and truck crops was correspondingly higher.

14. The north-western region, 1/ although occupying less than one- quarter of Iran's total land area, contains 44 percent of the agricultural land and 40 percent of the irrigated land area and is the major agricultural region of the country. Other important areas of agricultural production are the Mazandaran-Gorgan region on the Caspian, Khorasan around Mashhad in the north-east, Esfahan in the center, Khuzestan in the south-west and, to a lesser extent, Fars around Shiraz in the south. The distribution of irrigated land corresponds closely to the overall agricultural land distribution pattern. Rainfed agriculture is-concentrated in the higher rainfall areas, namely the Caspian provinces and the north-western region.

15. Cereals are the dominant crop throughout the country, and wheat forms the staple product from both irrigated and rainfed land in all regions except Gilan where rice is the staple. Industrial crops, which comprise oilseeds, tea, tobacco, opium and spices as well as cotton and sugar beet, are less widely distributed. Khorasan is the main center of sugar beet production, with Esfahan and Fars also major producing regions. Oilseeds, tea and cotton are grown largely in the Caspian region, although cotton is also an important crop in Khorasan. Sugar cane is grown only in Khuzestan and tobacco largely in West Azerbaijan and the Caspian provinces.

16. The distribution and ownership of agricultural land underwent radi- cal changes in the 1950's and 1960's as a result of the land reform. This commenced with the decision of the Shah in 1951 to divest himself of his private trust property by sale to, and reallocation among, his tenants. Be- tween March 1951 and April 1962 this decision resulted in the sale and transfer of more than 500 villages containing 200,000 ha. of cultivable land to 42,000 tenants. The Shah's estates were small in comparison with the number of estates cultivated by tenants in Iran, but the psychological impact of his actions were far greater than the lands he distributed.

17. It is estimated that in 1960, 3.1 million ha. of land were cultivated by 1.3 million share croppers and cash tenants. Ninety percent of these were landless tenants. The first national Land Reform Law was passed in Iay 1960, but it was unsuccessful in its attempt to break the strangle- hold of the landlords. Subsequently, an Amended Law was passed in 1962 which ushered in the land reform on a nationwide basis. It was implemented in three phases and was completed officially in 1971. It was originally based on the transfer of land to existing cultivators according to the village unit. This way the difficulties of demarcation and the need for a cadastral survey were avoided, though later physical limits were placed on land area owned.

/ Thiis incorporates East and West Azerbaijan, Kurdestan, Kermanshah, Gilan, Hamadan and Central Ostan. -5-

18. In the first phase, landlords were allowed to retain the equivalent of only one village, while in the second phase this one village had to be distributed according to one of five options. In the third phase, all private tenancies -- including those established under the second phase -- were abolished. Throughout the land reform, priority was accorded to the establishment of a just relationship between the farmer and the land. One consequence of this was that where land was cultivated directly by the landlord -- either with mechanization or paid labor -- this land was not redistributed. There are, therefore, a number of large commercial agricultural operations that have not been affected by the reform.

19. The present state of land reform in Iran may be summarized as follows:

(a) All tenancies on agricultural land have been abolished, except public charitable endowments (including religious holdings) where the tenants have leases of 99 years.

(b) The former tenants are now small landholders and have full land use rights. They will receive clear title to their land when the entire compensation due has been paid and when the specific boundaries.of lands received through land reform have been de- marcated. Until these conditions are fulfilled, the title to the acquired lands rests with the Government and no right in them can be transferred by the landholder.

(c) Exceptions to land reform legislation were orchards, small woods, estates held by public charitable endowments, large mechanized estates (exempted under the First Phase), mechanized estates up to 500 ha. (exempted under the Second Phase), and lands cultivated with paid labor up to the maximum specified for different regions under the Second Phase.

(d) Pasture lands do not come within the purview of Land Reform legislation and are the subject of separate legislation, passed in 1967, dealing with the Nationalization of Pastures.

20. The precise effects of land reform are difficult to estimate because of the paucity of data, the interdependence of land reform with the White Revolution which has aims far wider than transfers of land to actual cultivators, and the numerous legislative enactments. Nevertheless it is estimated that about 2.3 million farm families benefitted from land reform, with a distribution of around 8 million ha. of land. These figures do not include about 3.2 million ha. already owned by small landowners before land reform. The land reform, which was designed primarily as a progran to transfer land from landlords to cultivating peasants, has been generally successful. The speed of the transition and the absence of widespread opposition has been remarkable. The wide range of development programs and legislative and insti-- tutional measures now being undertaken to raise social and economic levels in rural areas would never have been possible without the fundamental structural changes that were achieved through the land reform. There are, nevertheless, some issues which land reform did not deal with effectively: the distribution -6- and use of water on the redistributed lands; the problem of credit; and the problem of transhumant pastoralists. Although subsequent legislation and programs have had some impact, these problems continue to provide major impediments to agricultural and rural development.

21. There is little information on the ownership and distribution of land in Iran. The last agricultural census has been rendered obsolete by the changes brought about by the subsequent land reform. There is little or no cadastral information and even estimates of aggregate areas of agricultural land are subject to large variations. Nevertheless, an attempt has been made to define the area of land in different size and ownership categories on the basis of estimates made by the Plan Organization and the IBRD Agricultural Task Force. About three-quarters of rural households possess land, and the great majority of these fall into the peasant and subsistence Carmer categories, i.e. with less than 10 ha. of land per household of which probably less than one-quarter receives irrigation. Of the remaining families without land, the majority, estimated at 700,000 families, are landless laborers "while about 100,000 families are migrant or transhumant pastoralists. For the ;urpose of analysis, agriculturein Iran can be divided into four broadly de- inable categories of farming unit: agri-business; peasant agriculture; colmercial farms; and transhumant pastoralists. The production structure, lovel of technology, and existing and potential productivity levels differ r(nfsiderably among these categories, and the response to Government programs also varies accordingly. In the following paragraphs, the characteristics of ;ach of these farm categories are discussed.

22. Agri-business. The production-oriented programs of the Ainistry of Agriculture include the establishment of large, technically advanced and nighly capital and management intensive production units, frequently using foreign capital or management. These units are known as agri-businesses, even though they are not necessarily integrated forward into marketing and processing. This term is also used to include meat and dairy complexes -- large-scale processing units which may or may not be linked backwards to production. Not yet of significance on a national scale, agri-businesses have been developed primarily in Khuzestan.

23. The Fifth Plan includes the establishment of a large number of agri-businesses and meat complexes over the five year plan period, to produce a wide range of commodities, including grains, industrial crops, fruits and vegetables, mutton, dairy and poultry products. It is planned that 300,000 ha. of the best irrigated land should be developed in agri-business units by 1977. In the majority of cases, the agri-business concession is granted to joint Iranian-foreign companies who provide management but who raise most of the development capital domestically, primarily from the Agricultural Development Bank of Iran (ADBI). Priority is given to agri- business in the development of land under irrigation below storage dams. Whereas high levels of output should be attainable under such systems, the rate of development has been slower and the costs of production higher than originally anticipated. The major problems have been delays in developing water distribution networks and problems of management arising from the huge size (5,000-20,000 ha.) of most of these units. -7-

24. Peasant Agriculture. An estimated 80 percent of the nation's farm families are engaged in traditional agriculture. Although these families may possess on average as much as 4 ha. of land each probably no more than onu- quarter is irrigated, and even this in many cases is limited to no more tian two or three irrigations a year. The majority of farmers in this category were traditionally service tenants or sharecroppers under the feudal land- ownership system that existed before the land reform of the 1960's. Toda- they possess the land that they cultivate, but in most cases cropping patterns and techniques have changed relatively little.

25. On most peasant holdings, irrigation is provided by ghanats or 1:y small-scale diversion works on seasonal streams. The water supply thus ol- tained is uncontrolled, erratic and subject to seasonal and cyclical fluc-ua- tions in flow. Productivity under such systems is low, and cultivation i,. concentrated on staple crops for family consumption. Increases in produc tivity through the introduction of technological improvements are limited in most cases by the water supply. Surpluses on the larger or better irr - gated units are marketed through local traders or, infrequently, cooperat-ve societies. The traditional village structure in most cases has been main .ained, and allows communal cropping patterns and utilization of water to continue. Cooperatives and other institutions have been only partially effective as channels for the supply of credit and other inputs or as marketing outlet.;, with the result that for many farmers in this category technological leve .s and productivity have improved little over the past decade. However, the predominance of wheat, pulses and dairy products as staple foods ensure t'at the average farm family enjoys a relatively high level of nutrition.

26. Wheat is by far the most important crop grown by this category if farmers on both irrigated and rainfed land, with barley also widely grown in the more marginal areas. In addition to being staple foods, these crops 'ave the advantage of being relatively drought tolerant. Being winter crops, :hey fit in well with the climatic patterns and also complement other on- and iff- farm activities in terms of labor requirements. Other crops are typicallr grown only to a limited extent, with rice, pulses, fruits and vegetables, and some industrial crops (particularly sugar beet) being the most widely cultivated. Peasant farmers will generally have one or two head of cattl and a sheep flock,.the size varying from a few head to twenty or more in areas of transhumant pastoralists. Sheep and cattle are a source of cash income in times of need.

27. Commercial Agriculture. This is defined residually as that par-: of the sector falling outside the above two categories. Commercial farme.rs are those who produce a significant surplus to their family consumption naeds. Their size may vary from one ha. or less, in cases of very intensive vege.table or poultry production, to more than 2,000 ha. As an average, it is reasonable to assume that most farms of 10 ha. or more with some irrigated land fall int. this category. Commercial farms include traditional family farms, farms exempted from the land reform, the larger farm enterprises resulting from the land reform, and recent purchases by investors and entrepreneurs. -8-

28. The level of technology and productivity on commercial farms covers a wide range, from fully mechanized, technologically advanced units to holdings still operated along traditional lines. In some of the small units growing fresh fruits and vegetables, production may be very labor intensive, whereas large areas of rainfed land are in some cases cultivated mechanically with only a minimal input of labor. However, all commercial farms produce primarily for the market and are therefore responsive to normal market forces such as prices, availability of inputs, market outlets, etc. The commercial sector is also susceptible to the overall investment climate, and development of this sector will be closely related therefore to national and sectoral policies as they affect the private sector. In particular, uncertainty regarding Government action can prove a big disincentive to private sector investment, as can changes, controls and inconsistencies in agricultural policies and programs of the Government. The rapid evolution of Government policies and expansion of public sector activities in agriculture have not, until recently, been conducive to the development of private sector activities. As a consequence, investment in the commercial sector, which presently produces about 50 percent of the value of agricultural production, has been low as has tie demand for ,development financing through banks.

29. Transhumant Pastoralists. Pastoralists are defined as those groups who obtain the greater part of their subsistence and cash requirements from their livestock holdings. They include not only pastoralists without any settled base, who probably number 0.5-1.0 million persons,'but also settled groups who practice seasonal transhumance. Transhumance occurs throughout the mountainous areas of Iran -- wherever good mountain grazing exists in locations which do not allow year-round habitation -- but the main area of transhumance is the Zagros chain, stretching from Kermanshah to Fars and into Kerman. Another cluster of transhumants are found in the Moghan area of East Azerbaijan. The majority of transhumants are tribal.

30. The importance of the tribal pastoralists lies in their control of the majority of Iran's sheep and goats. The transhumant system is the only means of exploiting the substantial areas of productive summer pastures, and the continuation of a modified form of this system is vital to the development of Iran's livestock economy. At the same time, the present transhumant system, based on a fixed (or probably declining 1/) resource base and static productivity, has not proved able to respond to the rapidly growing demand for livestock products, particularly mutton, in the urban areas. The traditional practices and life style of the tribes and their relative independence of market forces makes any increase in productivity levels (through culling, sale of animals at a lower age, improved veterinary and husbandry practices, etc.) difficult to achieve. Improvements are only likely to be achieved on a significant scale through the integration of the transhumants more fully with a settled agriculture and their consequent greater exposure to market forces.

1/ The resource base is declining because of degradation of rangelands through over-grazing and because of encroachment on traditional grazing lands (particularly winter grazing) by agricultural development. -9-

Rural Institutions

31. Rural life in Iran is still very much concentrated on the village. Although the land reform broke down, to some extent, the feudal system of landlord ownership of many villages and service tenancies, the cohesiveness of village units has continued. To a large extent, this is a reflection of the physical realities of an arid environment in which the rural population is concentrated around and dependent upon a water source. Traditionally these water sources are ghanats or diversion schemes, which have to be com- munally constructed and maintained. Although the development of large irrigation systems below storage dams and of tubewells is increasing, traditional water sources still dominate. Many of the Government or quasi-Government institutions that have been established as tools for rural development are based on the village unit. Three such institutions are of importance: rural cooperative societies and unions; farm corporations; and production cooperatives.

32. By the end of 1973, 2,700 rural cooperative societies had been established, with a membership of 2.2 million covering over 30,000 villages. Since there are about 66,000 villages in Iran, already more than one-third of the villages are covered by such cooperatives, and the target is to cover all villages by the end of the Fifth Plan. If this target is reached, a very substantial proportion of the rural population will be served by rural cooperatives. This proportion is likely to be increased as the rural cooperatives accept as members rural people who did not benefit from land reform, who are landless, and who gain their living from non-farm activities. In terms of population coverage the rural cooperative movement is by far the largest rural institution, and as such a potentially very important agent of rural development and employment. The recent reorganization of the cooperative movement -- which resulted in the consolidation of cooperative societies through amalgamation from more than 8,400 in 1972 to the present number -- should improve the potential viability of the individual societies and strengthen the movement as a whole.

33. The activities of rural cooperatives fall under four main headings: produce marketing; consumer goods distribution; development of non-farm activities; and credit operations. However, in none of these fields is the role of the cooperative particularly impressive. Sales of farm produce through cooperatives total less than 1 percent of the national value of agricultural production. The small scale of this activity reflects the relatively inefficient services provided, the lack of facilities, the inability to offer attractive prices, and the lack of sufficient credit to break producers from the hold of private traders. Nevertheless, the cooperatives are expected to play a role as buying agents in the operation of the new support prices for wheat and barley. The distribution of consumer goods is one of the largest of the cooperative movement's functions, with goods worth about Rls. 1,700 million handled annually through 3,175 rural shops. It is,expected that this activity will expand and that through direct contracts with manufacturers will continue to be competitive with the private sector. Although relatively little has been achieved to date in the field of non-farm activities (limited chiefly to the provision of facilities for carpet weaving), great importance - 10 -

is attached to expanding this activity in future to assist in increasing employment opportunities. Cooperative credit operations are handled through the Agricultural Cooperative Bank (ACB) and are discussed below (see paras. 46-47).

34. The first farm corporations were established in 1347 (1968). They are designed as a mechanism for implementing the "development" phase of the land reform, through the intensive application of investment, inputs and technical assistance in a defined geographical area. The areas are selected on the basis of small size of holding, lack of social and economic infrastructure, and the limited effectiveness of other programs in reaching or bene- fitting the area or its inhabitants. They are designed to overcome the problems of fragmentation and underinvestment, and to facilitate the development of national irrigation systems, crop specialization, and the introduction of improved techniques and management. The corporations are joint stock companies set up with the approval of the farmers of the area, in which each farmer exchanges his land use rights for a shareholding in the corporation. The corporation is then managed as a single unit, with management, current and capital financial requirements and technical assistance being provided centrally through the Ministry of Cooperation and Rural Affairs. In 1968, 14 corporations were established, and by the end of 1973, a total of 50 were in operation. The Fifth Plan foresees the establishment of an additional one hundred corporations during the Plan period.

35. A variation on the farm corporation as a mechanism for implementing the development phase of the land reform is the production cooperative. Like the farm corporations, these are also conceived as a means of raising productivity in depressed rural areas through capital investment, supply of inputs and technical assistance. They are, however, designed to be more flexible and less centrally controlled than the farm corporations, and are intended as a mechanism for areas where the physical and social problems are less severe than areas selected for farm corporations.

36. Established under the Production Cooperative Law of February 1971, production cooperatives provide for their members to retain individual land use rights but to undertake joint production, establishment of irrigation facilities, construction of access roads, etc. The cooperatives are intended as a means of overcoming the disadvantages of small and fragmented land holdings by the use of machinery pools, adoption of a communal cropping pattern, joint cultivation and marketing, etc. The first production cooperatives under this law were established in 1972, and the Fifth Plan includes the establishment of 60 production cooperatives over the five year period.

Government Institutions

37. Government activity in agriculture and rural development is chan- nelled through three ministries: Ministry of Energy (ME), which is responsible for irrigation and water resource development; Ministry of Agriculture and Natural Resources (MANR), which is responsible for the implementation of most production programs and the provision of a range of agricultural services (technical assistance, veterinary services, input supply, etc.); and - 11 -

Ministry of Cooperation and Rural Affairs (MCRA), which is responsible for the implementation of the land reform, the socio-economic development of the peasant sector, the progress of the cooperative movement, the provision of marketing assistance, and the operation of certain commodity programs. There are, in addition, several regional development authorities with multi-sectoral responsibilities within a given region. 1/ 38. The Ministry of Energy- controls all water development in Iran following the nationalization of water in 1968. ME is responsible for the construction of dams and the primary and secondary distribution network below dams. It regulates groundwater development through the issue of licences for private well-drilling, and also drills and operates wells directly. Groundwater surveys, test drilling and measuring, and other related activities are also the responsibility of ME, although some of these operations can be performed by the private sector under licence from ME.

30. The activities of the Ministry of Agriculture and Natural Resources are very wide ranging. MANR is responsible for the development of all livestock and all crop development except tea and tobacco. The agencies operating under MANR include the animal husbandry and veterinary divisions, the machinery and plant protection units, the fertilizer company, all research activities, range management and all natural resource evaluation and control operations, and a nationwide network of representatives at the provinces and county levels. Probably the three most important agencies with MANR, however, are the Depart- ment of Agri-businesses and Meat Complexes; the Agricultural Development Bank of Iran; and the extension service.

40. The Department of Agri-businesses and Meat Complexes is responsible for identifying large-scale investment possibilities in agricultural production and processing, attracting private investors -- foreign and local -- and encouraging them to develop these possibilities either independently or as joint ventures, and providing the services, inputs and other facilities needed by the enterprises to operate successfully. At the present time about 100,000 ha. of land have been allocated for agri-business, and about 20,000 ha. have been developed to date. The Fifth Plan calls for the development of a further 300,000 ha. in agri-businesses by 1977, in addition to the several meat and dairy complexes that have been proposed. A large number of letters of understanding have been signed with interested companies and in a few cases contract negotiations have been completed or initiated. There will undoubtedly be a significant increase in the area to be developed in agri-business over the next five years.

41. The Agricultural Development Bank of Iran (ADBI) was established in 1967 to provide long-term credit and risk capital to large commercial agricultural operations and agri-businesses. Its funds are provided in the form of capital contributions from the development budget plus three IBRD loans. Its

1/ In a government reorganization in May, 1974, the Ministry of Energy replaced the former Ministry of Water and Power. It is expected that some or all of the responsibilities for irrigation development will be transferred to the Ministry of Agriculture and Natural Resources. - 12 -

lending policy is directed by MANR, which is its sole shareholder. It has ex7anded its operations gradually while maintaining fairly high technical and financial standards. It has acted as the principal arm of MANR in financing agri-businesses, but in the past two years it has also developed a joint lending program with Bank Melli designed to provide loans to medium-size commercial farmers. It is expected that its lending to this category of borrower will increase in importance in the next few years. ADBI lends only for medium and long-term purposes, and the interest it charges to its borrowers ranges from 8 to 9 percent.

42. Iran's extension service possesses a wide coverage but has been relatively unsuccessful in its task of introducing new techniques and atti- tudes in rural areas. It has been hampered in this by the lack of a strong research program and by the low priority that has traditionally been accorded to low-profile, long-term programs such as agricultural extension. As a consequence, the extension personnel are often poorly motivated as well as being generally inadequately trained and supported. However, with the emphasis now being given to the development of private commercial agriculture through production improvement programs, investment grants and other incentives, it can i-e expected that the role of the extension service will become more important. The production improvement programs, which are a package of improved seed, fertilizer, pesticides and technical assistance, promise to become of major importance in agricultural development in the next few years, and the recently announced range of grants and soft loans also has the potential for developing into a major program with requirements for a substantial technical assistance component.

43. The Ministry of Cooperation and Rural Affairs (MCRA) was established in 1971, combining the functions of the previous Ministry of Land Reform and Rural Cooperatives and the Ministry of Agricultural Products and Consumer Goods. It is responsible for all aspects of rural development and village agriculture, including rural and urban cooperatives, farm corporations, handicrafts and rural industries, agricultural product marketing, community development, and some aspects of agricultural pricing policy. It controls a number of organizations and dependencies, of which the most important are the Organization of Farm Corporations and Production Cooperatives, the Central Organization of Rural Cooperatives, and the Agricultural Cooperative Bank.

44. The Organization of Farm Corporations and Production Cooperatives is responsible for the planning, establishment and operation of these units. It was set up in 1968 to implement the program of farm corporations. The Organization bears the major part of the planning, management and technical operation of these corporations in their early years. To assist in this task it is establishing a number of regional advisory and supervisory centers. The program of production cooperatives is more recent and still in the forma- tive stage. Again, however, the Organization plays a large role in the actual operation.

45. The Central Organization of Rural Cooperatives (CORC) was established in 1963 as a supervisory body regulating credit and trade and promoting the development of rural cooperatives. It possesses a network of regional offices - 13 - at the province and county level. Supervision of cooperatives is at the county level, where trained supervisors with supporting staff each control 10-12 cooperative societies. In the period 1963-1969 CORC also served as the financial institution responsible for providing credit to cooperatives. In 1969, this function was transferred to the Agricultural Cooperative Bank, although CORC has retained responsibility for preparing and assessing the credit requirements of individual cooperatives. The relationship between these agencies is as follows:

Ministry of Cooperation and Rural Affairs (MCRA)

Agricultural Cooperative Bank (ACB) Central OrganAation of Rural Cooperatives (CORC)

Rural Coo)erative Unions

Rural Coop rative Societies

Cooperitive Members

46. The Agricultural Cooperative Bank (ACB), which has been established more than 40 years, now works primarily with the cooperative sector. It lends only for agricultural purposes, and is represented in rural areas by 170 branches, 38 agencies and 170 mobile units. It has a staff of more than 3,000, of which 180 are graduates. Since 1969 it has been the sole channel distributing production credit to cooperatives. Credit is given to cooperatives directly, but on the advice of and under the supervision of CORC. Interest is at 4 percent to cooperatives and, through the cooperatives, 6 percent to the members with a 12 percent penalty rate for overdue loans. Repayment records appear good, being generally over 90 percent, but some refinancing is included in the portfolio. Loans may be granted up to five times the share capital of the member, with an upper ceiling of R1s. 30,000 (recently raised from Rls. 20,000), and to the society up to five times the capital and reserves. In practice, however, funds are insufficient to meet the needs of the cooperatives and the amount of money a member gets as a loan is nearly always con- ditioned by the amount of money available to the cooperative. The loan per cooperative averages about Rls. 900,000, and the average loan taken by each member is in the region of R1s. 4,000. This is quite insufficient to meet the.current expenses of his production activities and hence his reliance on other, non-institutional forms of credit.

47. From 1970 the ACB has been implementing a supervised credit program. Under this some technical assistance is given to borrowers in the preparation and implementation of projects. Supervision is provided by a corps of 70 agricultural graduates and supporting staff. The program has brought abouL some improvement in the utilization of funds, and has expanded from 8,000 loans totalling Rls. 240 million in 1970 to 48,000 loans totalling Rls. 2,500 million, representing 16 percent of the ACB's activities, in 1973. It is planned to expand this program during the Fifth Plan period. - 14 -

48. A number of regional development authorities have been established over the past decade, of which the Ghazvin Development Authority and the Jiroft Development Authority are probably the most important. In addition, the regional water authorities in some localities have multi-sectoral responsibilities similar to those of the regional development authorities. The Khuzestan Water and Power Authority (KTPA) is the best example. These authorities have the great advantage of being able to formulate, coordinate and implement activities at a regional level, thus avoiding some of the problems that arise from centralized sectoral ministries. To date, however, this regionalization has been only partial to the extent that the authorities are still regarded only as regional arms of the central ministry. There has been little local participation -- the Governor-General, for example, has played only a nominal role -- and consequently little has been achieved in creating a regional planning and executive capability. It can be expected, nevertheless, that regional development authorities will become increasingly important as executive Government institutions in the future.

II. PERFORMANCE DURING THE THIRD AND FOURTH PLANS

49. Any analysis of the past performance of agricultural and rural development in Iran is limited by the availability of accurate data. There is no recent census, no survey of farm size or distribution, and no systematic collection of production or farm-gate price data. Even import and export statistics are poor and inaccurately classified. The major sources of data in agricultural and rural development are production estimates made by MANR, production surveys by the Statistical Center of Iran, expenditure surveys and price series by the Central Bank of Iran, and elaboration of these data by the Plan Organization and the Central Bank. The following analysis is based primarily on these sources.

Agricultural Output

50. The national accounts prepared by the Central Bank of Iran (CBI) are based on the production estimates by the Ministry of Agriculture and Natural Resource (MANR) for the major commodities and household expenditure survey statistics for the minor commodities. According to this source, value-added in the overall agricultural sector in constant prices grew from R1s. 85.4 billion in 1959 to Rls. 134.4 billion in 1972. This was equivalent to a growth rate of around 3.5 percent annually. A breakdown of this sectoral value-added shows that crop production grew at more than 4 percent annually over the 14 year period while livestock output increased at little above 2 percent per annum. Fisheries production grew much faster - at 8 percent - 10 percent annually - while forestry output increased only around 2 percent annually; thse subsectors, however, make up less than 2 percent of the sectoral value-added. These growth rates are summarized below: - 15 -

Table 1: OFFICIAL GROWTH RATES OF AGRICULTURAL VALUE-ADDED 1959-72 (percent per annum at constant prices)

Third Plan Fourth Plan 1959-72 1963-67 1968-72

Agriculture 6.0 4.0 4.4 Livestock 1.1 3.5 2.0 Forestry 6.6 2.2 1.7 Fishery 4.6 8.8 8.0

Total Sector 4.6 3.8 3.7

Source: Bank Markazi Iran.

51. According to these data, growth in agriculture has been uneven. The Third Plan saw a. significantly faster growth in sectoral value-added than the Fourth Plan -- 4.6 percent per annum compared to 3.8 percent per annum. 1/ However, livestock production grew much faster in the Fourth Plan (3.5 percent per annum) than in the Third Plan (1.1 percent per annum), whereas the rate of growth of crop output declined from 6.0 percent per annum to 4.0 percent per annum over the two plan periods. The relatively rapid growth in crop output over the Third Plan reflected the substantial increase in cropped area (largely dryland wheat and barley) that occurred in parallel with the land reform.

52. The nature of this growth in agriculture and livestock is illustrated by the trends in output of the major commodities according to MANR estimates. The following observations can be made on the basis of the official statistics:

(a) Over the period 1959-72, the highest growth in the crop sub- sector was achieved in industrial crops (particularly sugar beet and cane), forage crops, and citrus.

(b) The staple food crops - wheat, barley and rice - grew only slowly over the period as a whole. With a population growth of 3.0.perc ent per annum, production per head of wheat and barley declined.

(c) The rate of growth of production of the staple food crops declined substahtially over the Fourth Plan period. Barley output fell, and production of.wheat grew at only 1.0 percent per annum.

1/ It should be noted, however, that the Plan Organization, in the Fourth Plan document, referred to the disappointing rate of growth of agriculture of only 2.6 percent annually during the Third Plan. - 16-

(d) Output of livestock products accelerated in the Fourth Plan, largely due to the rapid growth in output of poultry products.

(e) If poultry products are excluded, growth in the livestock sub- sector has been negligible. Output of wool has declined, milk production has grown at little over 1 percent per annum, and red meat production at less than 3 percent per annum.

(f) As with crops, output of the staple animal protein foods (red meat, milk) has grown more slowly than population. The high income elasticity of demand for animal products has meant that consumption of red meat and milk has been growing perhaps as fast as 10 percent per annum compared to the growth in output of 2.7 percent and 1.1 percent per annum respectively for red meat and milk over the period 1959-72.

53. The above analysis of output is based on the official estimates of production made by MANR and elaborated by CBI. There is, however, consider- 1ble evidence that these official data significantly overstate the actual Performance of the agricultural sector over the past decade. This evidence -s provided through the analysis of three related indicators: expenditure, as provided by the household expenditure surveys, imports, and prices.

54. A detailed analysis of the household expenditure surveys from the point of view of the implications on production trends was made by IBRD in conjunction with the Plan Organization in 1970, 1/ on which the following paragraphs are based. Food consumption per head in urban centers was first investigated by the Central Bank in 1959, in connection with a revision of the cost of living index. Since 1965 surveys have been made yearly. The results indicate that urban food consumption per head has declined markedly for a substantial number of major commodities. For total milk products consumption, the indicated decrease was over 40 percent between 1959 and 1968, a trend that might be explained by a substitution of vegetable oils for the relatively more expensive animal oil produced from milk. The data show a slight increase in beef and poultry consumption, but much too small to compensate for the nearly 20 percent decline in mutton consumption. Data on wheat, rice, pulses, sugar and tea also indicate considerable reductions. The figures for a number of commodities (notably milk and mutton) suggest that a low point occurred in 1965-66 and that consumption has been increasing slightly in more recent years.

55. Since Iran's economy, especially income per head, had improved substantially during this period, questions arise regarding the reliability and interpretation of the results of the surveys. Differences in sample size (3,200 households in 1959, 1,600-1,800 thereafter) or sampling techniques could possibly explain the results. However, no analysis from this standpoint

1/ IBRD: 'Agricultural Sector Survey: Iran', October 5, 1970; Washington, D.C. - 17 - has been made; the Central Bank took a pragmatic attitude toward the results and simply concluded that they were not "plausible". In estimating changes in private consumption expenditure, its solution was to lower to the 1966 level any figure that appeared higher in the 1959 survey. 1/

56. Figures for food consumption per rural inhabitant show in general larger year-to-year variations than the urban figures, with no discernible trends, except that mutton declined consistently. Wheat consumption shows remarkable stability. On the whole, these surveys cast some doubt on argu- ments that reduced food supplies in urban centers in recent years are largely due to increased consumption by producers induced by increases in farm incomes following the land reform.. Implementation of the reform only started in 1962 and it is unlikely that any appreciable effects on incomes and food consumption would have made themselves felt by 1963. The surveys, however, show no clear consumption increases in later years, especially of products with relatively high income elasticities of demand.

57. It has not been possible to update the analysis made in 1970. The Plan Organization states, however, that there was little increase in average household expenditure during the Fourth Plan. In projecting growth in demand during the Fifth Plan, an annual increase in household expenditure of 2.5 percent was used.by the Plan Organization. However, wages in the construction industry -- which are one indicator of income levels -- have risen steadily over the past five years in real terms. This suggests that food consumption per head has probably increased over this period.

58. Data on imports into Iran are also weak. Nevertheless, it appears that agricultural imports (largely food items, i.e. excluding fibers, wood products, rubber products, skins or hides) grew at an average annual rate of 10 percent between 1957/8 and 1971/2, from Rls. 4.9 billion to Rls. 20.9 billion. The rate of growth was higher for animal products (19.1 percent per annum) than for crop products (9.3 percent per annum).

59. The trend of imports over this period has not been even, however. Imports rose slowly over the first part of the period, actually declined over the Third Plan period, and accelerated very rapidly over the Fourth Plan per_w, at 25 percent per annum. Disaggregation of imports by commodity is also re- vealing. In 1957-58, agricultural imports were dominated by the "traditional" deficit items -- sugar, tea, and coffee -- which together made up 77 percent of food imports. By 1972, these items represented only 13 percent of the total, and the major imported items were wheat and flour, vegetable oils and seeds, and animal products. The fastest growth in imports occurred in commodities in which Iran has been traditionally self-sufficient: rice, feedgrains, wheat, meat, oilseeds and dairy products. For some of these (meat, dairy products) the deficit is a function of a rapidly growing demand. For others, however, such as.wheat, the deficit is caused by stagnant production and slowly growing demand.

1/ Central Bank of Iran: 'National Income of Iran 1962-67', September, 1969; pp. 106-107. - 18 -

60. Analysis of price trends suffers from the generally accepted belief that the wholesale and consumer price series published by the Central Bank consistently understate real price trends. This is particularly true of food prices where a wide range of price controls exist and where the price used in calculating the index is the official price, even if only a negligible proportion of the supply is actually traded at this price. For example, the CBI data show only relatively small increases in the consumer price index for foods in 1973 even though many food items (sugar, eggs) were in very short supply and were hard to obtain at any price. The index for meat rose 20 percent in 1973, compared to actual increases in the official wholesale price for sheep of nearly 50 percent; in fact, mutton was virtually unobtainable for several months as a result of Government efforts to impose fixed prices on traders.

61. Nevertheless, the CBI price series still shows an accelerating upward trend in both consumer and wholesale prices. The average annual rate of increase of the consumer price index rose from 1.5 percent in the Third Plan to 4.0 percent in the Fourth Plan; the increase in 1972 was 6.3 percent. A similar trend has occurred with the wholesale price index: the food price index grew at 2.0 percent annually in the Third Plan, 3.9 percent in the Fourth Plan, and 6.4 percent in 1972. Prices of all the major food items grew faster in the Fourth Plan than in the Third, except for meat, poultry and fish products for which prices rose very fast at the start of the Third Plan. It is clear, even from the official price statistics, that there has been considerable upward pressure on food prices -- despite wide-ranging controls on wholesale and retail prices.

62. The above indicators suggest that the performance of the agricultural sector in terms of output over the period 1969-1972 was as follows:

(a) Over the period as a whole, agricultural output grew at about the same rate as population; in the Fourth Plan, however, the rate of growth of agricultural output was probably slower than population growth.

(b) The very rapid rate of growth of GNP has led to some increase in real incomes over the Fourth Plan period, and this has led to a rate of growth in demand for food higher than the rite of population growth.

(c) The resultant divergence between demand and production trends led to a very rapid growth in agricultural imports over the Fourth Plan.

(d) The greatest growth in imports was for staple foods in which Iran has been traditionally self-sufficient -- red meat, dairy products, wheat, feedgrains and rice. - 19 -

(e) Despite the rapid growth in imports, food supplies in urban centers have been insufficient. This has been reflected by prolonged shortages of certain staple foods -- meat, sugar, dairy products -- and by strong upward pressure on wholesale and retail prices.

(f) Despite broad-based price controls, consumer food prices rose faster in 1971 and 1972 than at any time in the 14 year period under review. This rise in food prices accelerated greatly in 1973 and 1974.

(g) There is reason to believe that the official agricultural output statistics overestimate actual trends in production, particularly for those commodities for which income elasticities of demand are relatively low and for which demand would therefore have risen rather slowly even if a significant growth in real incomes is assumed. This applies particularly to wheat, and to a lesser extent, to sugar. It is therefore probable that actual growth in agricultural output over the Fourth Plan was in the range 2-3 percent annually rather than 3-4 percent implied by the official statistics.

Rural Income and Expenditure

63. Estimations of either the level, distribution or rate of change of rural incomes is difficult as direct statistical information does not exist. Estimates can be derived from two sources: disaggregation of the value-added in the agricultural and livestock sectors estimated by the Central Bank of Iran; and the family expenditure surveys made annually by the Central Bank and the Statistical Center of Iran. Disaggregation of the value added in agricultural and livestock has the advantage of measuring income rather than expenditure, but suffers from the disadvantages that it excludes non-agricultural income and that information on the distribution of production among categories of farmers is not available. However, an attempt has been made to estimate income levels using the value-added estimates of the Central Bank of Iran and an estimated breakdown of land-holdings and production among the rural population according to size of land-holding made by the Plan Organiza- tion and the IBRD Agricultural Task Force.

64. On the basis of these estimates, income derived from agriculture, livestock, forestry and fishing in 1972 was distributed among the rural population is given in Table 2. - 20 -

Table 2: RURAL INCOME AND EXPENDITURE

Income Category Mean Income Percent of Rural Population ------(US$ per capita)------

More than 400 1,000 1.2 (farmers with more than 50 ha.) 200 - 400 302 19.2 (farmers with 11-50 ha. and pastoralists) 100 - 200 131 32.9 (farmers with 3-10 ha.) Less than 100 70 46.7 (farmers with less than 3 ha. and landless laborers) 100.0

Expenditure Category

More than 395 2.2 296 - 395 2.2 211 - 316 6.9 123 - 247 30.3 89 - 148 33.6 Less than 133 24.8 100.0

The overlap in categories results from the conversion of the original data, which were on a household basis, to a per capita basis. According to this source of information, therefore, 47 percent of the rural population receive an annual imputed income from agriculture of less than US$100 per head, with a mean of US$70. And 80 percent of the rural population receive less than US$200 per head, with a mean of US$96.

65. A breakdown of expenditure by categories among the rural and urban populations in 1971 shows that average expenditure per household amounted to Rls. 60,700 (US$809) in rural areas and Rls. 112,700 (US$1,503) in urban areas. These were equivalent to Rls. 11,700 (US$156) and Rls. 21,700 (US$289) per head in rural and urban areas respectively. At least 60 percent of the rural population have an average annual expenditure per head of less than $150. Although both these estimates are only approximate, they are fairly consistent and together probably give a reasonable picture of income distribution.

Regional Development

66. The major regional emphasis of Government programs in agriculture or rural development in the Third and Fourth Plans was through large-scale dam construction and irrigation development programs. By far the largest of these (in terms of agricultural and regional impact) was the Mohammad Reza Shah dam and the ambitious below-dam land development program at Dez in Khuzestan. Although the dam was completed in 1962, the major land development program was scheduled for the Third and Fourth Plans. Other major dams were the Farah dam in Gilan, the Aras dam in East Azerbaijan, and the Shah Abbas dam in Esfahan, while a number of smaller dams were also completed. - 21 -

67. Of the major projects, the Farah dam in Gilan has primarily benefitted rice production along the Caspian littoral. It has played a major role in the expansion and improvement of irrigated rice cultivation which led to an increase of 33 percent in rice production in Gilan over the period 1958-71. Domestic demand for rice has been strong, prices have been good, and the farmers of the Gilan area have enjoyed a steady growth in incomes despite the small size of the average holding.

68. Although the Shah Abbas dam in Esfahan was completed in 1970, development of the distribution network below the dam is still in the initial stages. Consultant engineers are engaged in designing the reticulation system, but it appears likely that the rapid growth of industrial and domestic demands for water in the environs of Esfahan will absorb the incremental water supply from the dam, and that there will probably have to be a decrease in the agricultural area under irrigation. On the other hand, there has been a rapid growth of the Esfahan region -- particularly over the past five years, and particularly in the environs of the city of Esfahan - due to the expansion of the industrial sector. This in turn has created a demand for high-value agricultural products -- fruits, vegetables, animal products - which has enabled farmers to intensify production and so raise incomes even on small holdings. Many farm families are in the process of becoming only part-time engaged in agriculture as other employment opportunities develop. Increas- ingly, the development of Esfahan can be expected to take place in the non- agricultural sectors. It appears, however, that the recent growth has been concentrated heavily on the environs of Esfahan, and that the remainder of the province continues to be largely dependent on agriculture and has developed little over the past decade.

69. The Aras dam on the Russian border in East Azerbaijan was also completed in 1968, and again the development of land below the dam, in the Moghan region, has not yet been completed. The area commanded by the dam is a tribal one, traditionally used as winter grazing land by the Shahsavan, with little tradition of cultivation. With the availability of controlled water supply, major structural changes in the economy of the area are being introduced. Development will take place along two lines: the establishment of farm corporations by MCRA; and the establishment of a large state farm and meat complex by MANR. A total of 40,000 ha. is expected to be developed in farm corporations, while the agri-business will control a further 55,000 ha. Under both patterns of development, forage crops will be cultivated to fatten store sheep and weaned lambs raised by the Shahsavan under a traditional system of transhumant grazing. Two large meat complexes are proposed, to process the output of the farm corporations and the state farm. Both programs are still at the early stage, but major problems can be expected to arise from the displacement of the Shahsavan from their tribal homelands (particularly by the state farm), and from the disruption of the sheep breeding cycle resulting from the loss of the winter grazing lands.

70. In terms of agriculture, the greatest effort at regional development over the past decade has been made in the Khuzestan region. The completion of the Dez dam in 1962 resulted in the control of sufficient water to irrigate - 22 - around 95,000 ha., and a comprehensive program was drawn up for the development of land below the dam. Following the success of the large-scale sugar enterprise that began operation in 1960, the Government made a decision to proceed with land development through very large agricultural units -- agri- businesses and, in the last couple of years, farm corporations - with the purpose of maximizing the speed of land and water development and introducing advanced technical and managerial methods. This inevitably led to the displacement of large numbers of the existing farmers in the area by capital- intensive agri-businesses and has consequently caused considerable social disruption which has been only partly alleviated by the introduction of farm corporations. Four agri-businesses have begun operations over the past five years, eventually to cultivate a total of 80,000 ha. The area currently under irrigation, however, is only about 20,000 ha.

71. Despite the slow progress in development to date, the establishment of agri-business has the potential to have a significant impact in the Khuzestan region. New technology, new cropping patterns, and mechanization on a scale and sophistication not before experienced in Iran are to be introduced. The effect of this enormous capital inflow has made Khuzestan one of the more rapidly growing regions of the country over the past decade. Most o7f this growth, however, has occurred outside the agricultural sector, derived from the considerable industry-and petroleum-based urban development in Abadan id Ahwaz which has contributed to the capital inflow, creation of employment, and development of markets for high-value agricultural produce.

72. Whether the heavy investment in agricultural development in Khuzestan has been successful in economic and social terms is not clear. The increased agricultural production has been achieved at the cost of colossal capital investment, of financial losses to date by the agri-business corporations, and of major loss of revenues to the Government through concessions granted on rents, import duties, water charges, low interest loans, and other subsidies to the agri-businesses. The fact that, ten years after completion of the dam, only one-fifth of the commanded agricultural area has actually been brought under improved irrigated cultivation (and this mostly in extensive, low-yielding cereal crops) has significant implications for the economic viability of the investment in the dam. From the social aspect, the mass of the rural population has benefitted little from the agricultural development of the area - farmers have been displaced from 50,000 ha. of land to date, and considerable displacement of agricultural labor by mechanization has occurred. The decision to establish farm corporations on some of the below-dam land will rectify some of the disruption; however, the farm corporations have only recently been established, and have therefore achieved little as yet. - 23 -

III. THE FIFTH PLAN

73. The original Fifth Plan as approved and published has been substantially revised to take account of increased public revenues. The original Fifth Plan also based its production targets for agriculture on what are now unrealistically low projections of demand for agricultural products. It is probable that these projections were too low even at the time they were made (1971), but in any case the much higher expectations of growth in production and income following the increase in oil revenues ensure that demand for food will grow faster than assumed in the original Fifth Plan.

74. Details of the revised Fifth Plan have not yet been made available. It is interesting, however, to examine briefly the balance and emphases of the original Plan as an indication of Government strategy and priorities. Agri- culture was allocated Rls. 267 billion, water Rls. 111 billion, and rural development R1s. 36 billion. The allocation to agriculture and water (Rls. 378 billion) is three times greater than the original allocation to these sectors in the Fourth Plan (Rls. 114 billion), although it represents a smaller proportion of the total budget (19 percent against 24 percent). Allo- cations to agriculture have been raised substantially in the revision of the Plan, however, and it can be assumed that financial resources will, as before, not be allowed to constrain agricultural programs over the remainder of the Plan period. 1/

75. The objectives of agricultural development in the original Fifth Plan were: optimal utilization of resources; an increase in agricultural production of 5.5 percent annually; and a reduction in rural underemployment. Production increases were to be achieved through the introduction of advanced technology to raise labor productivity through cooperatives, farm corporations, agri-businesses and meat complexes. Major emphasis was to be placed on cooperatives and farm corporations as mechanisms for working with beneficiaries of the land reform. Greater investment in mechanized private farms was to be encouraged, and agri-businesses were to be established on 300,000 ha. Government investment was to be directed to infrastructural operations, the provision of services, and marketing improvements. The Government was to finance agri-businesses in the form of joint ventures, establish demonstration operations where necessary, and initiate some enterprises for transfer to cooperatives or the private sector. Supervised credit was to be available for up to 60 percent of the cost of investments, and efforts were to be made to refinance existing loans from non-institutional sources.

76. The 5.5 percent annual growth rate was to be achieved through a 4.8 percent annual growth in crop production and a 6.6 percent annual growth in livestock. In particular, rapid growth was forecast for fodder crops,

1/ Fixed investment in agriculture has been described to a level of Rls. 240 billion in the revised Fifth Plan compared to Rls. 121 billion in the original. Fixed investment allocations for water resource development (including power and domestic supplies) have been increased from Rls. 106 billion to R1s. 160 billion, and in rural development from Rls. 36 billion to Rls. 60 billion. - 24- cereals, industrial crops, red meat, milk, and poultry products. Agricultu- ral exports were to continue to be predominantly cotton and dried fruit, while high levels of imports of feedgrains and vegetable oils were forecast. The major means of increasing production were to be an increase of 390,000 ha. in the land under irrigation, expansion of double cropping to 150,000 ha., an increase of 130 percent in the use of fertilizer (to 800,000 tons by 1977), and improved pest control and extension. Livestock production targets were to be achieved with expansion in the feed supply through increased cultivation of fodder crops and improved range utilization, by improvements in breeding flock birth rates, by improved disease control, by the establishment of large, modern dairy and meat complexes utilizing imported pedigree cattle, and by the expansion of intensive poultry operations.

77. Efforts to improve the marketing of agricultural products through the elimination of middle-men were to include the provision of loans to prevent forward sales, the establishment of marketing facilities, technical assistance in quality control, and the development of cooperatives as marketing institutions. Guaranteed minimum prices for major agricultural products were to gradually to be introduced, taking into consideration world market prices so that Iranian products would be competitive internationally. It was intended to double the grain silo capacity so that four months' urban consumption could be stocked. Improvements in meat marketing were also to be introduced, including the introduction of grading and quality control.

78. A basic objective of the Fifth Plan was to ensure a more balanced is- tribution of personal income between rural and urban areas by raising agricultural incomes through higher production, reduced production costs and higher employment. Underemployment was to be reduced through the intensification of agriculture using advanced technology, expansion of processing industries at the village level, development of handicrafts and other non-agricultural activities, and greater integration of livestock and agricultural activities.

79. Emphasis was to be given to efficient large-scale agricultural operations. Farm corporations and production cooperatives were to be increased so as to cover about 8 percent of the irrigated land, and agri-business were to occupy about 8.5 percent of the irrigated areaby 1977. About 10 percent of the irrigated land would be under privatemechanized agriculture, and the remaining 73.5 percent of irrigated land would be in private farms. The bulk of these would be in rural cooperatives, whose membership was expected to increase to 3.0 million in 1977. Amalgamation of cooperatives into more efficient units would be continued.

80. The objectives of the original Fifth Plan for the development of irrigation was to increase the irrigated area by 390,000 ha. to 3.89 million ha. by 1977. This was to be achieved by: completion of reservoir dams started during the Fourth Plan (these dams control 9.5 billion m 3 of water per year); completion of major (primary and secondary) irrigation and drainage canals started during the Fourth Plan to provide a distribution system for 387,000 ha. of land; completion of tertiary and quaternary irrigation ditches started in the Fourth Plan sufficient to serve 140,000 ha. of land; construction of new reservoir dams of moderate size that would control 0.4 - 25 -

3 3 billion m of water; diversion of 0.1 billion m3 of water from one watershed to another; construction of major canals sufficient to serve 455,000 ha. of land; construction of tertiary and quaternary ditch networks sufficient to serve 455,000 ha. of land; and installation of facilities to utilize 1.12 billion m3 of groundwater (the private sector was expected to invest capital for utilization of another 1.01 billion m3 of ground water). Of the total budget for water development of R1s. 111 billion over the Fifth Plan Rls. 52 billion was allocated for irrigation networks.

81. In the field of rural development, the original Fifth Plan had the basic objective of providing infrastructure and welfare services as widely as possible within rural areas, in such a manner as to reduce the number of villages and lay the foundations for the future development of towns; and to expand comprehensive educational programs in rural areas. These programs were to be decentralized, with most of the planning made at a local level. Civil works were to be designed in such a way as to utilize to the maximum local labor -- an estimated 100,000 new jobs were to be provided. The program was to be implemented through the designation of rural development areas, within which one village would be selected as the core village (on the basis of its resource base, size, growth prospects, and access to communications), and a number of other villages would be designated as satellite villages. A wide range of services and infrastructural facilities would be provided to the core village, and a smaller number to the satellite villages. Some 1,200 development areas consisting of 14,000 villages and about 10 million people were to be covered in the Fifth Plan. The program was to include a heavy training component.

82. These programs -- of agriculture, irrigation and rural development made up the main thrust of the original Fifth Plan in the rural sector, but the emphasis given to the rural population was also reflected in the other sectoral programs. Within the industrial development program, for example, emphasis was being given to rural industries, and feeder roads occupied a larger share than before of the program of transport development. When the rural components of these other programs were taken into account, the proportion of the total planned expenditure allocated to the rural sector was of the order of 30 percent. Although the details of the revision of the Fifth Plan have not been completed, the balance and content of the revised Plan is not expected to differ greatly from the original. It is believed that higher priority will be given to irrigation development, and that further emphasis will be given to the importance of the private sector in agricultural development. The target growth rate for agricultural production has been raised from 5.5 to 7.0 percent.

Other Legislation

83. Two major new sets of legislation/policy affecting agricultural and rural development have been announced subsequent to the formulation of the Fifth Plan. A massive program of investment incentives was included in the - 26 -

1973 Budget Law, and substantial increases in the guaranteed minimum prices of several major agricultural commodities have been announced. These are discussed briefly below.

84. Investment Incentives. The Budget Law for 1973 authorizes a wide range of investment incentives in agriculture. The recipients of these incentives are divided into three categories: individuals or groups of farmers with more than 25 ha.; rural cooperative societies and unions; and farm corporations and production cooperatives. Incentives are provided in two forms: grants and low-interest loans. While the terms offered are highly concessionary for all three groups of beneficiaries, they are softer for cooperatives than individuals and softest for farm corporations.

85. The incentives are to be provided for the following purposes:

(a) Studies, design and other preparation for on-farm irrigation and land levelling will be paid by the Government to the extent of 85 percent of costs for projects to benefit private farmers or cooperatives, and 100 percent for farm corporations. In cases where he development of on-farm canals and ditches represents the completion of a public-sector irrigation network, 100 percent of the costs of studies and design will be met by the Government.

(b) Of the actual construction costs for on-farm irrigation and drainage, the Government will pay 50 percent in the case of private farmers and cooperatives, and 100 percent for farm corporations. The balance will be met hrough 15-year supervised loans carrying 6 percent interest (in the case of private farms) or 4 percent interest (in the case of cooperatives).

(c) Costs of land-levelling will be assisted by the Government. On private farms, the Government will pay 60 percent of costs on areas up to 25 ha., 40 percent of costs on areas 25-50 ha., 20 percent of costs on areas 50-100 ha., an1O percent of costs on areas above 100 ha. On areas above 50 ha., 50 percent f the balance will be met through 15-year supervised loans carrying 6 percent interest. On cooperatives, the Government will finance 60 percent of the costs in the form of grants and the balance as 15-year supervised loans carrying 4 percent interest. All land- levelling costs on farm corporations will be financed through grants.

(d) All rural industries will be eligible for Government support. This will take the form of a loan to cover 60 percent of costs over 15 years at 6 percent interest in the case of private investors. In the cases of cooperatives and farm corporations the Government will provide 20 percent grants and 80 percent loans over 15 years at 2 percent interest.

(e) Contractors providing inputs or services to the agricultural sector will be eligible for Government assistance provided - 27 -

that the standards and prices of their services are subject to Government control. Financial assistance will be in the form of loans over 15 years at 4 percent interest to cover 60 percent of capital costs in the case of private operators and 80 percent of capital costs in the case of cooperatives.

(f) All improved livestock for milk of meat production imported either directly or through the agricultural ministries will be eligible for reimbursement of all transport costs incurred in their importation.

(g) The construction of all offices, stores, workshops and related buildings on cooperatives and farm corporations will be financed in the form of grants.

(h) Members of farm corporations will be eligible to receive loans up to a prescribed maximum over 15 years carrying interest at 2 percent for the construction of private housing.

(i) All expenditure on machinery, livestock, and current inputs on farm corporations will be financed through loans at 4 percent. The maturity of the loans will be 10 years for machinery purchase, and five years for all other items.

(j) An amendment added to the 1973 Budget Law adds to these incentives by authorizing the Government to finance also current inputs and by giving the executive ministries discretion to reduce further the share of costs to be borne by the farmer, cooperative, etc.

86. Evaluation and approval of investments to be financed under this program lies with the Ministry of Agriculture and Natural Resources (MANR), Minis- try of Cooperative and Rural Affairs (MCRA), and Ministry of Energy (ME). ME will only be involved where investment in irrigation is concerned, and MANR only where investment by the private sector is concerned. Projects up to a specified level of cost will be approved by ministry representatives at the local level, and larger projects will pass to Tehran for approval.

87. Once a project has been approved, it will be financed through one of the three agricultural banks: the Agricultural Development Bank of Iran, the Pasture Development Fund, or the Agricultural Cooperative Bank. In each case, the bank will be given managed funds to finance the approved projects. At the present time, it is intended that the banks will serve purely a financing role and will not be concerned with evaluating the investments. The banks will be authorized, for the funds managed under this program, to accept chattel mortgages as sufficient guarantee.

88. Price Supports. The Government recently announced new guaranteed minimum prices for wheat (R1s. 10,000 per ton compared to the previous price of Rls. 6,000), barley (Rls. 7,500 per ton compared to the previous price of Rls. 5,000), and maize (R1s. 9,500 per ton -- no floor price had previously existed). It is also expected that a price will soon be announced for sugar beet of Rls. 1,800 per ton compared to the previous price of Rls. 1,350. - 28 -

89. These prices will be implemented through the existing institutions -- i.e. the Cereals, Sugar and Tea Organization (previously MCRA but transferred to the new Ministry of Commerce) for wheat, barley, and sugar, and the Pasture Development Fund (MANR) for maize. These agencies will be responsible for purchasing at the guaranteed price all produce offered to them. Coope- ratives will be authorized to act as buyers where relevant. Although cooperatives have marketed less than 1 percent of agricultural output in recent years, it is considered that the much higher prices plus the introduction of marketing contracts will succeed in expanding the marketing operations of cooperatives. Under these contracts, the farmer receives a cash advance against his crop and in turn signs a contract to market his crop through the cooperative. Any trader who then purchases that crop is liable to prosecution.

IV. KEY SECTORAL ISSUES

90. Planning for agricultural and rural development in Iran is in a state of flux. The considerable importance of these sectors to the nation's social and economic progress is fully recognized by the Government. His Imperial Majesty hasin recent years constantly emphasized the need to accelerate the socio-economic development of rural Iran, and agricultural and rural development was again accorded high priority in the formulation of the Fifth Plan. In both financial and political termsstrong support has been given to those agencies responsible for implementing.the Government's programs in the rural sector. Despite this considerable shift in emphasis of Government policy, however, at the start of the Fifth Plan there were nevertheless a number of misgivings about the Government's programs for agricultural and rural development. It appears that the support given to these programs was still inadequate, that the performance targets were too optimistic, and that Iran's development strategy still retained its urban bias. In particular, it appeared that the programs of rural development were unbalanced, with emphasis being placed on programs that would benefit only a few and leave untouched the mass of rural poor. The agricultural target of a 5.5 percent annual growth in output seemed similarly unrealistic, with Government programs concentrated heavily on large-scale operations while the private commercial farmers who contribute the bulk of the nation's agricultural output received little in the way of support or incentives.

91. The first year of the Fifth Plan, however, has seen many of these doubts eased. There cannot now be any doubt about the Government's determina- tion to accelerate growth in rural incomes. Nor is there now likely to be any shortage of funds with which to implement the Government's programs in the rural sector. Perhaps most important, the recent legislation offering investment grants, soft loans, and price incentives indicates that the Gov- ernment has now recognized the vital role to be played by the private sector in the field of agriculture. Problems undoubtedly remain, and a number of obstacles still have to be overcome before the ambitious programs now on paper can be converted into action. But Iran now is committed fully to a strategy of accelerated agricultural and rural development, and has the - 29 -

policy framework and programs with which to achieve this. In the following paragraphs, the major obstacles and bottlenecks that still need to be overcome for the effective execution of this strategy are discussed.

Agricultural Strategy

92. Demand for foodstuffs in Iran is expected to grow rapidly over the next five years, at rates ranging from a little over 3 percent annually for wheat to more than 13 percent annually for poultry meat. The average growth in demand is estimated to be around 8-9 percent annually. If the Government is successful in its objective of improving income distribution through faster increases in the incomes of lower-paid persons, then the demand for food could grow even faster. At the same time, 70 percent of the rural population depend directly on incomes derived from agriculture as their main source of liveli- hood. While improvements in rural living standards can also be achieved through other sectors, it is clear that increases in rural incomes over the next 5-10 years will continue to depend largely on increases n agricultural output. Demand projections for the major agricultural commodities are summarized below:

Table 3: PROJECTED GROWTH IN DEMAND FOR MAJOR AGRICULTURAL COMMODITIES, 1977 AND 1982 (percent per annum)

1972-77 1977-82 Low Assumption High Assumption

Wheat 3.1 2.4 3.1 Meat - red 8.9 5.2 9.5 - white 13.3 8.7 14.3 Rice 7.8 5.3 13.6 Sugar 5.5 3.8 5.5 Vegetable oil 6.6 4.7 6.7 Fresh milk 8.4 Yougurt 4.3 Butter 11.4 Cheese 7.5 Eggs 7.6 5.5 8.3 Pulses 6.6 4.5 6.6 Feedgrains 10.5 8.3 10.6

93. The major constraint to expansion of agricultural output is that, because of the low rainfall over most of the country, there is little surplus productive capacity that can be readily exploited. Over most of the country the area of cultivation under rainfed conditions is close to -- if it has not already exceeded -- the technical and economic limit. There is therefore little scope for expanding the area of dryland cultivation. Be- cause of the constraint on productivity imposed by limited and erratic precipitation, there may also be limited scope for raising yields and output on - 30 - the rainfed area. 1/ The prospects for raising output therefore depend heavily on the rate at which the area and yields under irrigation can be increased. Official statistics state that Iran's irrigated area at the present time is around 3.6 million ha. However, the mission estimates that of this area only about 700,000 ha. are adequately irrigated, a further 800,000 ha are moderately well irrigated, and the remaining 2.1 million ha. are poorly irrigated, receiving in effect only supplementary irrigation in spring and early summer. In other words, the water supply is absolutely limiting on 2.1 of the 3.6 million ha. of irrigated land, and partially limiting on a further 0.8 million ha., as well as being absolutely limiting on the great majority of the 5 million ha. of rainfed land.

94. Because of the water constraint, which limits the response to fertilizers and other inputs, the productive capacity of the majority of agricultural land is limited. To raise the productive capacity considerable investment in improved irrigation facilities is necessary. Here, however, the second major constraint to agricultural development is met: nearly half the cultivated land is in holdings of less than 10 ha. and of an enterprise size that fails to generate significant, if any, surplus over family consumption. For these farms it is almost impossible to generate the level of savings necessary to finance investment in improvement of irrigation. And, because the majority of these farms lack title to their land, it is generally not possible for them either to raise long-term credit or to receive licences for the development of groundwater. To these difficulties must be added the traditional nature of agricultural production on these, as well as on some larger farms, with a strong subsistence element, a least-risk approach to agricultural operations, a low level of farmer education, and a lack of familiarity with improved techniques.

95. The Government, therefore, is faced with the formidable task of raising substantially the level of output from a large, traditional sector faced with major physical production constraints and pervasive structural weaknesses. On the positive side, however, one of the greatest obstacles to agricultural development -- that of absentee landlords and tenant farmers and sharecroppers -- has been overcome through the land reform. There is no overall financial constraint facing the country, and the Government, having recognized the priority needs of agriculture, has made ample financial allocations to this sector. What is needed, therefore, is a clear strategy for the development of the sector, a balanced mix of production programs, consistent policy measures, and competent institutions to formulate and implement these policies and programs.

1/ The Caspian area, where rainfall is significantly higher than the rest of the country, is an exception to this argument. While there is undoubtedly potential for raising yields in this region, the area under cultivation cannot be increased significantly. In the other dryland areas with higher precipitation, in the north-west, there is probably some long-term potential for yield increases with the introduction of dryland cultivation techniques and increased use of inputs. - 31 -

96. Agricultural development strategy in Iran is in a state of flux, and considerable changes in approach and emphasis have taken place following the initiation of the Fifth Plan. The Fifth Plan itself increased substantially the financial allocations to agriculture and water development, but continued much the same mix of programs as had failed to achieve the targets of the Fourth Plan. Thus, the Fifth Plan continued to place heavy emphasis on agri-businesses, farm corporations, and rural cooperatives as the institutions through which production increases were to be achieved; the private sector was to be assisted by transfers through credit institutions.

97. Since the start of the Fifth Plan period, however, there has been a very basic shift in the Government's agricultural strategy. This shift has been in response to considerable pressure on the relevant agencies, from both within the Government and outside. It reflects the growing awareness within the Government that past agricultural performance was worse than generally realized, that substantial improvements in agriculture and rural development are essential for the continued development of the national economy, that existing programs in these sectors although useful were inadequate, and that a much greater effort has to be made to mobilize private sector resources in agriculture. Greater emphasis is now to be placed on farm-level irrigation and the development of processing and other rural industries. The Government has now recognized that the nature of Iran's agricultural and rural problems is such that every possible channel for improvement has to be exploited, and that isolated programs and projects will not be sufficient.

98. The shifts in emphasis and new policies and programs formulated over the past few months have done much to clear the major inconsistencies and gaps in agricultural strategy that existed at the start of the original Fifth Plan. I/ In particular, the acceptance of the importance of the private sector and the formulation of comprehensive supports and incentives for private investment offer real hope that such investment be forthcoming and that the stagnation of commercial agriculture -- and therefore of total agricultural production -- of the past decade may be ended. It is now important, therefore, that the remaining obstacles to the implementation of the agricultural program are removed. At the level of agricultural strategy, there are two weaknesses that threaten the effectiveness of the Government's agricultural and rural programs.

99. The first is that no clear set of priorities has been established for production policies and programs. Given the rapid growth in demand for foodstuffs and the agricultural resource constraints, it is clear that Iran is likely.to be a substantial and growing importer of agricultural products for the foreseeable future. 2/ It is important, therefore, that production

1/ This shift in emphasis has been formalized in the revision of the Fifth Plan.

2/ Acceptance of this probability marks one of the changes in attitude over past ten months. Whereas the Fifth Plan had agricultural self-sufficiency by 1977 as its target, Government officials now talk about 80 percent self-sufficiency as the planning objective. - 32 - policies are designed to maximize the use of the limited production capacity. Taking account of physical constraints, expected world market trends, labor requirements, etc., a production strategy should be formulated setting priorities among the different agricultural commodities. Production policies and programs can then be designed so as to be consistent with each other and with the overall strategy. Such a situation does not yet exist in Iran. Differ- ent programs are aimed at promoting different crops while competing for the same scarce resources. This planning weakness is discussed further under pricing policy, below.

100. The second major gap in Iran's agricultural strategy lies in the confusion over the roles to be played by the public, private and cooperative sectors. This problem overlaps considerably with that of institutional weaknesses, but differs in that it could be resolved relatively quickly if its importance were realized. There has, over the past few months, been considerable clarification of the roles of these sectors. The very high degree of reliance placed on public sector activities in the original Fifth Plan has been compensated in part by subsequent changes recognizing the role of the private sector, and there has been some progress towards defining a more realistic approach to the complicated problem of cooperative development. But still the set of policies and programs that comprise Iran's agricultural development strategy contains inconsistencies and gaps. This lack of a clear strategy becomes apparent when any policy issue is examined in detail, and will be further discussed below in the context of the more important of these issues.

101. Of the two deficiencies noted above, the first -- the failure to appreciate fully the resource constraints and consequently to set priorities for the use of these scarce resources -- is likely to cause the most problems in the short- and medium-term (the recent decision to raise wheat prices by 65 percent, for example, is likely to lead to upward pressure on consumer prices and, at the same time, to result in a reduction in the area planted to competing field crops over the next few years). In the longer term, however, the failure to demarcate the areas of public, private and cooperative sector activity in agriculture is likely to have serious repercussions on the development of the rural economy.

Production Programs

102. While progress has been made in relating agricultural strategy to the needs of the economy, some major obstacles to the effective mplementa- tion of production programs in this sector still remain. The most important of these -- water development, pricing policy, credit mechanisms, livestock development -- are discussed in some detail below. There are, however, a number of other issues related to the implementation of Iran's agricultural production program, and these are discussed briefly in the following paragraphs. - 33 -

103. The lack of surplus production capacity in agriculture 1/ means that investment is essential if output is to expand. However, the private sector has been unwilling to invest in agriculture in the past decade due to the unsuitable investment climate. To a certain extent this has been corrected through the recent announcement of the wide-ranging program of investment grants and soft loans for agriculture and the substantial increases in some crop prices. Whether these incentives will be sufficient to attract investment when high profits at low risk are still available in other sectors remains to be seen. There continues to be, however, considerable unease among private commercial farmers regarding the long-term security of land ownership by the private sector. Although the land reform was completed officially in 1971 and there had been no large-scale transfers for several years preceding that, the continued expansion of public sector activities carrying powers of compulsory acquisition still threatens the long-term security of private landowners. These activities include the farm corporations program, the establishment of agri-businesses, and the development of land below dams.

104. Although the area of land affected by these activities is small, the threat they pose applies throughout the sector. This has been compounded by the increasingly tight control exercised by the Ministry of Energy over water resource development and by the plans of MANR to concentrate agricultural development on high-potential areas (poles) through large-scale farm enterprises. Discussions with landowners indicate that this uncertainty is widespread. Clearly, any long-term program of agricultural development that is going to incorporate private sector activity will depend to a large extent on the success of the Government in allaying.the fears of potential private investors. This could be achieved through a combination of measures, including the reconfirmation of private titles, the announcement well in advance of plans to establish farm corporations or agri-businesses and the proposed locations, the declaration of certain areas to be unaffectable, i.e. free of Government intervention, for a stated number of years, or a clear statement by the Government of the roles to be played by the private and public sectors. So far, none of these measures have been taken, and the Government therefore runs the risk that private investment will again in the future, as in the past, fall short of that needed to achieve the nation's objectives in agriculture. A strong, progressive commercial agriculture cannot develop while the threat -- real or supposed -- of Government acquisition exists.

105. The corollary of adequate incentives for private investment is the introduction of disincentives for lack of investment. In other words, it may be necessary not only to offer private farmers the "carrot" of good prices and long-term security; but also to use a "stick" to penalize individuals who fail to invest or to utilize scarce resources (particularly irrigated land) efficiently. This "stick" could most easily be fiscal in nature, through the introduction of a land tax or the levy of a fixed charge against

1/ In terms of individual holdings -- in national terms, of course, the existence of large areas below dams that have not yet been brought into production represent a very substantial potential capacity that is not being exploited. - 34 - the supply of irrigation water, 1/ irrespective of the crop grown. This form of taxation could, if sufficiently heavy and suitably progressive, provide a strong incentive to farmers to maximize the exploitation of their land and and water. 2/ It is interesting, for example, to speculate what the rate of land development by the agri-businesses in Khuzestan would have been if a land tax had been applied, or a fixed charge for water made on a per ha. basis irrespective of actual use, or even if a realistic rent on the land had been charged.

106. There are, however, two major obstacles to tht implementation of such a tax. The first is that the Government does not yet have a clear idea of what pattern of resource use -- what kind of land exploitation -- it is seeking. The recent substantial increase in the wheat price, for example, is inconsistent with other programs designed to intensify agricultural land use. The introduction of a land tax as a policy tool when no clear policy yet exists would clearly be premature. The second obstacle would be that of efficient imposition and collection of such a tax in the absence of cadastral information and any tradition or discipline of direct taxation in rural areas.

107. A third issue relevant to Iran's agricultural production programs is the quality of agricultural research. Iran has a number of well-trained and highly competent research scientists, but many of them are being used well below their potential. The research program is poorly structured and administered, with a large number of stations executing uncoordinated and often low priority programs. As a result, the research service has contributed little to Iran's agricultural development in terms of introducing and adapting new inputs and technology. No improved genetic material has been produced for the major crops, improvement of indigenous livestock breeds has been negligible, and even basic information on optimum seeding rates, fertilizer application, or timing of operations is not generally available. With the emphasis that is now being given to agricultural development in Iran, a complete restructuring and upgrading of the research program (especially of an applied nature) should be given high priority.

108. Following on from and related to the research program is the supply of improved seeds. Good quality genetic material is essential if the improvements in productivity needed in Iran's agriculture are to be achieved. At the present time good material is not available. At least part of the

1/ A combination of fixed and variable charges would be necessary to prevent excessive water use or the unnecessary cultivation of crops with high water requirements.

2/ The only such "stick" to have been applied to Iranian farmers in recent years was the exemption given under the land reform to land under mechanized production. As a result, the area of rainfed wheat increased from 2.6 million ha. in 1960 to 3.7 million ha. in 1971. - 35 - problem stems from the failure of the research program to produce many improved varieties adapted to local conditions. Nevertheless, the facilities for the certification, multiplication and distribution of the varieties that are available are inadequate for the needs of the sector. An FAO/IBRD team 1/ investigated Iran's seed program in 1971 and identified a project for the expansion and upgrading of the program. No action was taken by the Government, however, and the situation continues to be unsatisfactory. Because of the long-term nature of a seed improvement program, priority should be given to initiating such a program as soon as possible.

109. Also related to the above two points is the quality of the extension service. Although the coverage of the extension service is comprehensive in terms of the number of offices and staff assigned throughout the country, the effectiveness of the service has been limited. To a large extent, this inef- fectiveness is due to the low priority given to agricultural development in recent years and, within agriculture, the low priority given to long-term, gradual programs of the kind implemented by an extension service. As a consequence, the motivation of the extension personnel is poor, their training is inadequate, and they are not supported by an adequate research network. They are therefore in a weak position to respond to the priority now being given to agricultural development.

110. The remaining issue relating to the Government's production programs -- and one which affects also other programs in rural areas -- is that of the institutional capacity of the public sector. Because of the failure of the private sector in agriculture to respond to the needs of the economy, there is a tendency in the Government to place increasing emphasis for future progress on public sector operations. This also applies to the cooperative sector, which has .failed to develop a technical or administrative capacity of its own and therefore remains heavily dependent on Government support. The recent legislation offering investment grants and soft loans for agriculture is a good example: while the legislation is designed to support the private and cooperative sectors, much of the responsibility for designing, evaluating, processing, channelling and supervising investments rests with the agricultural ministries.

111. The rapid expansion of agricultural programs and the substantial increase in funds allocated to this sector inevitably place a huge burden on the existing agricultural institutions. These consist primarily of the three agricultural ministries (MCRA, MANR, and ME) -- particularly their planning and executive departments -- and the two aagricultural banks (ADBI and ACB). Despite the generally high quality of top level management, these agencies are understaffed and lack sufficient trained administrative and technical personnel to execute their increased responsibilities. Heavy use is made of consultants, yet because of the work load on the ministries, terms of reference are often poorly drawn up and selection and supervision procedures are inadequate. Consequently, much of the input provided by consultants is of poor quality and is ineffectively used.

1/ FAO/IBRD Cooperative Program: Report 20/71 IRA. 3; September 1971; Rome. - 36 -

Rural Development Strategy

112. The extremely rapid economic growth experienced by Iran over the past decade has made the problem of rural development both more important and, in some ways, more difficult than in other countries. Rural development is particularly important because the majority of the population is rural, because the sectoral emphasis of recent economic growth (petroleum plus industrialization plus construction) has concentrated the benefits of this growth in urban areas, and because income differentials have been increased by the extremely rapid growth in urban wealth. At the same time, economic expansion makes the problem of rural development more difficult because it creates income aspirations that cannot be met within a traditional peasant agriculture and it sets a time constraint on the alleviation of rural poverty that precludes conventional, long-term programs of rural development through improved peasant farming, expanded extension services, small-scale self-help programs, etc. On the other hand, of course, the high rate of economic growth removes the most immediate constraint -- the financial one -- to the implementation of rural programs. The problem then becomes that of identifying programs and establishing institutions for injecting capital and expertise rapidlv into programs or projects that offer employment and income prospects comparable to those enjoyed in urban areas.

113. It is really only within the last year, since the formulation of the Fifth Plan, that rural development has received heavy emphasis and high priority within Iran's development program. Before that, Government efforts were relatively small and lacked balance -- a combination of low-key, broad- based programs through the cooperative movement, with a few inputs and little impact, and a small number of very intensive "maximum package" projects (particularly the farm corporations) which achieved considerable impact but benefitted only an insignificant proportion of the rural population. Little in the way of integrated intersectoral programs had been introduced, and Govern- ment inputs were largely concentrated on agricultural production and education. On the other hand, although little was achieved in improving socio-economic conditions in rural areas, the past decade saw a major upheaval of the structure of rural society through the land reform and the greatly expanded education program. These reforms have created a framework within which the ambitious rural development program of the Fifth Plan can be implemented with some hope of success.

114. Rural development in the Fifth Plan is concentrated on five major programs: 1/ a maximum package program of land consolidation, investment and intensive managerial and technical assistance through farm corporations and production cooperatives; a conventional program of supervised agricultural credit on soft terms through the ACB; a restructuring of the cooperative movement with emphasis on technical assistance, marketing, and the development of non-agricultural activities; the initiation of a program for the development of small-scale industries in rural areas; and the development of rural infrastructure through the establishment of rural development

I/ These are programs operated by the Ministry of Cooperation and Rural Affairs. There are, of course, also the rural components of the national programs of other executive ministries in the fields of communications, education, utilities, health and welfare. - 37 - centers (RDC's). These programs taken together represent a comprehensive and ambitious attempt to tackle the problems of the rural area. They are particularly interesting because of the emphasis being placed on non-agricultural development in rural areas -- directly through the farm corporations and rural industries programs, and indirectly through the RDC's which are designed to aggregate the rural population into small towns and to provide the infrastructure for the development of secondary and tertiary sectoral activities. Given the structural changes in rural areas achieved over the last decade and the strong political and financial commitment by the Govern- ment to their implementation, these programs should result n substantial improvements in socio-economic conditions in rural areas over the next few years.

115. There are, however, three major obstacles that still need to be overcome if the Government's efforts in this field are to be successful. The first is the lack of coordination that still exists among these different programs -- not only between the several ministries involved but also between the different departments of MCRA. All the programs are formulated on a national scale according, in each case, to different priorities. Al- though some coordination is achieved -- between, for example, the farm corporations and rural industries programs and the farm corporations and RDC's program -- this is not typical. The greatest problem is likely to be the lack of coordination between the production programs and the purely infrastructural programs. The RDC's, for example, in most cases are not linked with programs that will generate increased production in parallel with the improved infrastructure and services to be provided by the RDC's.

116. The second factor likely to limit the effectiveness of the rural development effort is the continued centralization of project conceptualiza- tion, preparation, implementation and supervision. To a certain extent this reflects the relative capacities of MCRA at the central and regional levels -- certainly any delegation of authority to the region would have to be gradual and accompanied by an intensive training effort. But the existing centralization of responsibility is already causing major problems. The most obvious is the over-burdening of central ministerial staff, with the consequent delays and deteriorating standards. Perhaps more important, however, is the danger that programs designed in Tehran will frequently be inappropriate for the locality or region in which they are to be implemented -- this is already apparent with some of the farm corporations, and is likely to emerge as a major problem as well in the newer programs. The third danger is that an aggregation of independently-formulated program is likely to lead to regional imbalances in the mix of project and programs. Regions with potential and political clout such as Fars, Khorasan and Azerbaijan, for example, receive priority in all the MCRA programs, whereas regions such as Sistan and Baluchistan, the south coast, or Chahar Mahal Bakhtiary are in danger of being neglected, even though their rural problems may be greater.

117. An increased regionalization of planning and execution is formalized in the Fifth Plan, and the Plan Organization has a rudimentary program for the establishment of regional planning offices operating under the Governor- Generals at the ostan level. A small proportion of the development budget is allocated to the Governor-Generals. The executive ministries, however, continue to plan, execute and supervise their programs centrally. If the - 38 - desired expansion of Government programs is to be achieved and if insurmount- able logistical and bureaucratic obstacles are to be avoided, an explicit program of regionalization of planning and executive functions appears essential. This applies particularly to MCRA which is the most over-centralized of the agricultural ministries and for which the development of a regional capability in program formulation and implementation would appear to have the most advantages.

118. The third major constraint applies throughout Iran's development program -- that of understaffed institutions and lack of trained personnel. This is particularly important in rural development where staff often need to be highly motivated and willing to live and work in difficult, isolated situations. This, for example, has been probably the most outstanding achievement of the farm corporations program -- the success in getting relatively well-trained managers and technicians to live in remote rural areas. Clearly, the great expansion of MCRA's activities is going to create a demand for such persons greatly in excess of the present supply. Suitable training of staff is therefore going to be of critical importance to the effectiveness of MCRA's operations over the next 5-10 years. At the present time, however, MCRA's staff training programs appear to be inadequate in coverage and quality, particularly as the level of education provided by the universities and technical schools also leaves much to be desired. Although there is much in common between the training needs for the different programs (e.g. farm corporations, rural cooperatives, supervised credit) there is a lack of coordination and consequent duplication of effort among the different ministry departments. This also applies to training programs of other ministries -- for example, MCRA has established its own Management Training Institute in Fars even though three similar institutes are operated by other agencies in Tehran and Karaj. The shortage of qualified teachers increases the importance of having a coordinated training program for MCRA if not for all the agricultural ministries. Such coordination.seems essential if the problem of staff shortages is not to become acute.

Irrigation Policy

119. Improvement of irrigation supplies is essential for any sustained growth in agricultural output. The area nominally under irrigation has increased from 3.2 million ha. in 1967 to 3.6 million ha. in 1972. It is estimated, however, that on no more than 0.7 million ha. of this total are the water requirements of the crops fully met, while on a further 0.8 million ha. the crop requirements are probably moderately well but not fully met. On the remaining 2.1 million ha. the water supply is inadequate and no significant increase in output can be expected until the irrigation supply is improved. Yields on these lands are no higher than on the better rainfed land, and are close to the ceiling imposed by the limited availability of water.

120. ME has a long-term program to tackle this critical matter of total water supply through the construction of large storage dams and through the control of groundwater development. Six major storage dams have been completed over the past ten years, commanding a net irrigable area of about - 39 -

800,000 ha., but less than 100,000 ha. of these are currently under improved irrigation. The Fifth Plan calls for priority to be given to the development of distribution networks below these dams, and has as a target the completion of such networks on 300,000 ha. 1/ of land for which the water is already available (i.e. the target would result in less than half the commanded area being brought under improved irrigation). However, delays in the execution of ME programs and the failure of MANR and MCRA to reach decisions over the type of land use on the land to be irrigated indicate that a maximum of 200,000 ha. of land will be brought under improved irrigation below dams during the Fifth Plan.

121. Groundwater development is controlled by ME following the nationalization of water resources in 1968. As a result, tubewells can now legally be sunk only with a licence from ME; licences are only granted to titled landowners (only 20 percent of the nation's farmers possess title to their land) or approved cooperatives or farm corporations, only in areas where ME groundwater surveys have been completed, and only where it can be ensured that no significant lowering of the water table will result. This "safe-yield" con- cept of groundwater utilization is far more conservative than that practiced in many other countries. Exploration of groundwater is progressing only slowly, and is limited to areas already known, and it seems unlikely that more than 100,000 ha. will be developed with groundwater during the Fifth Plan under existing policies. Given the importance of the agricultural sector in the Fifth Plan and the key role played in this by water development, there is a strong case for increasing the emphasis on groundwater exploration and development.

122. If Iran's agricultural production is to expand at a rate significantly faster than that of the past decade, an expanded program of irrigation development is essential. The recent legislation authorizing investment grant:; and soft loans for on-farm water development is to be welcomed, but responsibility for the execution of major irrigation works rests with the public sector. 2/ If the present programs are continued unchanged, it is difficult to see that more than half of the Fifth Plan target of an increase in irrigated land of 390,000 ha. will be achieved. There is, nevertheless, considerable potential for increasing the availability of irrigation water in the short- and medium-term if ME would concentrate its activities in this direction. Priority should therefore be given to the following in the field of water resource development:

1/ Some of this land is already irrigated under traditional systems, so that the incremental area of irrigation resulting from the completion of distribution networks would be somewhat less than 300,000 ha.

2/ ME is responsible for construction of dams, diversion works, and primary and secondary canals; MANR is responsible for tertiary and quarter- nary canal construction. - 40 -

(a) A crash program of completion of distribution networkA below dams already constructed.

(b) A crash program of groundwater exploration.

(d) A nation-wide program for improving on-farm irrigation systems through increased control structures, canal lining, and land levelling.

(e) The establishment of an extension program in water control and management to work at the farm level.

Livestock Policy

123. Iran's deficit in the production of animal products has grown rapidly over the past five years as a function of rapidly growing demand and slowly growing or stagnant supply. Iran now imports considerable quantities of live sheep, mutton, dairy products and wool. Only in poultry and egg production has supply kept pace with demand. A continued rapid growth in demand is expected over the Fifth Plan, ranging from 6.5 percent annually for red meat to 15.7 percent annually for white meat. To help meet this demand, the original Fifth Plan target growth rate for livestock products was set at 6.6 percent per annum, to be reached as follows:

Table 4: LIVESTOCK PRODUCTION AND TARGETS, 1971 AND 1977 /1

Average Annual 1971 1977 Growth Rate % --('000 tons)---

Red meat 305 445 6.5 White meat 50 120 15.7 Fish 32 60 11.1 Raw milk 1,900 2,800 6.7 Eggs 55 100 10.5

/1 These projections are taken from the original Fifth Plan report.

A wide range of programs and policies have been introduced or proposed to meet these ambitious targets. There appear, however, to be a number of weaknesses in most of these programs which suggest that the production targets may be o7ver-optimistic. These problems are discussed below for each of the major products. - 41 -

124. Red Meat. Red meat will continue to be the major source of animal protein in Iran. The Plan is to keep imports to their recent level -- 13,000 tons per annum 1/ -- and shift some demand towards white meat and fish. About 65-70 percent of the red meat supply comes from sheep and goats. Of these, it is estimated that about 35 percent are held by transhumants with no settled agricultural village base, about 15 percent by villagers who migrate season- ally, and about 40 percent by non-migrant villagers. In other words, 90 percent of the sheep and goats are owned by small farmers or pastoralists in the lower income bracket of the rural population. Despite this important correla- tion between sheep ownership and rural poverty, however, the production programs of MANR for red meat concentrate heavily on the fattening, slaughtering and marketing of sheep and goats, particularly through large-scale agri- businesses and meat complexes. The programs neglect the breeding end of the production chain although it is here that the greatest long-term potential for increased productivity (through increased lambing, decreased mortality, improved nutrition, etc.) are to be found.

125. It is estimated that no more than 30-40,000 tons are likely to be added to the annual production of red meat through fattening operations alone. Clearly, a considerable increase in the off-take from the breeding flock will also be necessary if the production target is to be met and if sufficient numbers of animals are to be available for the fattening operations. It seems essential, therefore, for the Government to develop programs to improve the productivity of the breeding flock, preferably through integrated agriculture- livestock programs 2/ as at the village level these two operations are inter- dependent. To break the traditional production cycle injection of increased feed into the system is essential. This will inevitably be more difficult than the simple construction of centralized feed-lots -- it will have to incorporate a wide range of technical and financial inputs and appropriate incentives, and will have to be adapted to the socio-economic structure of each area -- but it is essential if a continued expansion of livestock production is to be achieved.

126. The Fifth Plan envisages the major expansion in the beef supply to be associated with development of the dairy industry, in which male progeny and cull animals will be fattened and slaughtered for meat. However, the amount of beef which could be supplied annually based on 200,000 high producing milk cows would be less than 40,000 tons if the female progeny were not retained for breeding, and only about 28,000 tons if females were reared for milk production. In practice, there will probably not be as many as 200,000 high producing milk cows by 1977, and the incremental beef production would be correspondingly lower.

1/ Imports of live animals and meat in 1971 were equivalent to 13,000 tons of meat. About 20,000 tons were imported in 1972, and imports in 1973 are running higher still.

2/ Along the lines of the pilot project being prepared jointly by thae Gov- ernment and the IBRD Agricultural Task Force in the Kermanshah region. - 42 -

127. Poultry Products. White meat and egg production has grown very rapidly over the last decade, largely owing to the development of capital- intensive commercial operations (these now supply an estimated two-thirds of the white meat and half of the eggs). There is no reason why production of poultry products should not increase to meet the expected rapid growth in demand provided that good quality feed is available (this is likely to be supplied increasingly through imports) and that prices are maintained at levels which offer the producer an attractive return on his investment. The more important question is, given the diverging trends of supply and demand for red meat, to what extent is it possible to substitute white for red meat in the urban diet?

128. Although red meat is the traditionally preferred protein, it appears that substitution by white meat will occur fairly readily if the price differential is right. It would therefore seem sensible for the Government to use the price mechanism as a tool for shifting the demand pattern for meats towards white meat. At the present time, poultry meat retails at about Rls. 110 per kg., and mutton at about Rls. 130-150 per kg., after payment of a Rls. 30-40 per kg. subsidy. At the same time, costs of feed for poultry are very high owing to the high costs of grain and the high mark-up of the feed industry. It would be relatively simple administratively for the Government to shift some or all of the subsidy currently given to red meat consumers (which already exceeds Rls. 2 billion per annum and is expected to grow very rapidly) to the poultry industry, 1/ either directly to the consumer or through the feed industry, and to create a sufficient price differential to achieve a significant shift in demand towards white meat. This would have the twin benefits of reducing the cost in foreign exchange to Iran of meeting its urban meat requirements, and of stimulating the development of a local industry (broilers) in place of importing a finished product (sheep or mutton).

129. Milk. It is estimated that of a total cattle population of 6 million, there are fewer than 30,000 pure-bred milk producers of imported origin and up to 100,000 cross-bred cattle not all of which are commercial milk producers. About 40 percent of the total supply of milk products originates from sheep and goats, with the balance provided largely by improved local cows. Consumption of milk in rural areas is largely in the form of fresh milk, butter oil, yogurt and yogurt products and cheese. Fresh milk, cream, butter and cheese are also widely consumed in urban centers.

130. Government plans are for the Fifth Plan target of an additional 900,000 tons of raw milk by 1977 to be met through the import of high-quality pure-bred cattle so as to have 200,000 of these in production by 1972. The aim is for Iran to be self-sufficient in all dairy products. Incremental

1/ Politically this would be more difficult, and any such shift would have to be gradual. It could be made acceptable if poultry meat was available at a substantially reduced price. As an interim measure, it would be possible to retain some subsidy on the cheaper cuts of red meat.

2/ In its revision the Fifth Plan projects a greater degree of substitution of red meat by white than did the original. - 43- production is to be through an intensive system based on roughage and high concentrate rations in housed conditions. This system is very costly and, in realization of this, the Government has set a new factory delivered price of R1s 15 (US$0.22) per liter of milk of 3.3 percent butter fat.

131. Of the projected increment in demand, only about one-quarter will be for high-value dairy products, namely liquid milk, high fat yogurt, cream and ice cream. About 50 percent of the incremental demand will be in the form of butter, and the balance as butter oil and cheese. Currently, butter is produced by factories as a by-product of pasteurized liquid milk, in which milk received at 3.3 percent fat is reduced to 2.5 percent fat for sale. If the demand for butter is to be satisfied through local production, however, then butter will have to be produced from raw milk as the main product, with dry skim milk powder as a by-product. The resulting products will inevitably be very high cost; at a conversion ratio of 24:1, the cost (delivered factory) of the raw milk alone required to produce a kilo of butter will be 360 rials. This compares with a cost of imported butter that has ranged from Rls. 35 to Rls. 100 per kg. over the past three years and that retails at Rls. 140-160 per kg. and local by-product butter that retails at Rls. 180-200 per kg. The extra cost of producing butter through this high cost method is estimated to reach about Rls. 6 billion per annum by 1977, compared to by-product local butter and about Rls. 7 billion per annum compared to imported butter. This will have to be met either by the consumer or by the Government in the form of a subsidy. Consequently, although the strategy of using imported cows and intensive high cost production systems to meet the incremental demand for dairy products is appropriate for the high value products, it appears to be excessively costly as a source of supply for butter and butter oil.

132. A more appropriate strategy for the dairy sector would be to limit the expansion of high cost milk production based on imported cows to the growth in the market for high value products. This would reduce the need for imported animals from the currently-projected 200,000 to around 40-50,000 over the Fifth Plan period, In the short- and medium-term, the deficit between supply and demand for butter and butter oil would be met through imports -- there are not expected to be major problems of price or availability of these commodities on the world market in the foreseeable future. In the medium- Ond long-term, appropriate Government action now could succeed in shifting some of the demand, particularly for butter oil, towards lower-price vegetable oils, and at the same time investigate the possibility of developing a lower-cost supply of milk using cross-bred cattle and cheap roughage in the Caspian area. These changes, however, will require major shifts in the production and pricing policies now being pursued by the Government.

133. In summary, therefore, it must be concluded that the Government's objective of approaching self-sufficiency in animal products by 1977 appears to be over-optimistic, and that some of the programs designed to achieve this objective are potentially of very high cost to the nation. It would seem preferable therefore to develop production programs along lines in which Iran can expect to be moderately efficient (long-term improvement of the sheep breeding flock, intensive poultry production, and intensive milk production for high-value products), to use the price mechanism to shift demand -44-

towards those items that can be produced domestically at a reasonable cost (e.g. poultry meat), and to adopt a planned import policy (preferably through long-term contracts) in order to obtain those items that cannot be produced efficiently nationally in a manner that will reduce Iran's exposure to cycles in world commodity prices and availability.

Agricultural Credit

134. In Iran, as in most other countries, it is difficult to estimate the importance of non-institutional sources in the total credit supply in agriculture. If it is assumed that the total short-term credit requirements in agriculture are around 30 percent of the gross value of agricultural production, then non-institutional credit can be estimated residually. On this assumption, non-institutional sources supply more than two-thirds of all short-term agricultural credit as shown in Table 5.

Table 5: ESTIMATED SUPPLY OF SHORT-TERM CREDIT TO AGRICULTURE, 1971 AND 1972

1971 1972 Rls. billion Percent Rls. billion Percent

a.stitutional ACB 7.8 12 10.2 14 ADBI - - - - Pasture Development Fund - - - - Production programs 3.8 6 4.6 6 Commercial banks 8.1 12 n.a. n.a. LMDBI - -_-_-

Sub-total 19.7 30 n.a. n.a.

Non-institutional 43.3 70 n.a. n.a.

Total 67.0 100 75.0 100

135. In estimating the supply of medium- and long-term credit in agriculture, it has been assumed that there is no non-institutional credit on these terms. Although this assumption is almost certainly too strong, it is probable that non-institutional sources are far less important than they are in the supply of short-term credit. On this assumption, the supply of institutional medium- and long-term credit has increased from about Rls. 2.7 billion in 1970 to about Rls. 5 billion in 1972 as shown in Table 6. - 45 -

Table 6: ESTIMATED SUPPLY OF MEDIUM- AND LONG-TERM CREDIT TO AGRICULTURE, 1970-72

1970 1971 1972 R1s. % R1s. % R1s. %

ACB 583 21.2 930 26.5 1,600 32.1 ADBI (disbursements) 384 14.0 632 18.0 1,213 24.4 Pasture Development Fund - - - - - IMDBI 376 13.7 253 7.2 210 4.2 Machinery bongah 1,150 41.8 1,250 35.6 1,350 27.2 Farm corporations 256 9.3 448 12.7 600 12.1

Total 2,749 100.0 39513 100.0 4,973 100.0

136. The estimate of total short-term credit needs as a percentage of the value of agricultural production is at best very crude, particularly as a substantial proportion of production (particularly of grains and animal products) is in the hands of subsistence producers, whose credit needs are related more to consumption than production requirements. Nevertheless, this estimate does illustrate what a small proportion of this demand -- less than one-third -- is met through institutional sources. The importance of this lies both in the very high interest rates charged by non-institutional credit sources (equivalent to 25-50 percent per annum compared to 6-12 percent per annum from credit institutions), and in the frequent loss of independence in marketing and procurement on the part of the farmer.

137. If the supply of and demand for agricultural credit is disaggregated, the same conclusion is reached, i.e. that institutional sources of short-term credit are grossly inadequate for the needs of the sector. It can be assumed, for example, that the two major institutional sources of short-term credit -- ACB and the commercial banks - respectively service the peasant sector (through the cooperative movement) and the commercial sector. The rural cooperative movement had about 1.8 million members in 1971, and if it is assumed that each member represented one family and that every member utilized credit from the ACB, then the mean loan was only Rls. 5,000 per family -- a figure clearly inadequate to meet that family's needs for production credit, however defined (the International Labor Organization quotes a figure of Rls. 75,000 as the short-term credit needs of the average cooperative member). The inadequacy of this sum appears even greater when it is realized that most cooperative members also have to make annual amortization payments on their land acquired under the land reform and that they have no alternative institutional source for consumption credit.

138. An estimate of the increase in short-term credit needs through 1977 can be made on the basis of the Fifth Plan's target growth rate for agriculture and livestock production of 5.5 percent per annum. Assuming an annual price inflation of 6 percent and using the same rule of thumb of 30 percent of gross value of production to be financed, then there will be an incremental - 46- annual demand for R1s. 54 billion of short-term credit by 1977, and an aggregate incremental demand over the five year period of R1s. 150 billion. Merely to maintain the current (inadequate) ratio of institutional lending to total credit needs (0.3:1), therefore, it will be necessary to inject an additional Rls. 50 billion into the institutional credit mechanism for short-term credit needs alone. This compares with the original Fifth Plan projections of a total transfer through credit mechanisms of Rls. 50 billion over the plan period, for both short- and long-term credit.

139. On the above assumption -- i.e. an increase in institutional credit sufficient to maintain the present share of institutional in the total credit supply -- an increase of more than 70 percent in the total lending of these institutions would be needed by 1977. On the other hand, the input of the commercial banks, which contributed a little over one-third of agricultural institutional credit in 1971, has declined in absolute terms over the past few years. If the credit situation is not to deteriorate seriously over the next five years, therefore, it will be necessary to induce commercial banks to expand their lending to agriculture and/or to increase very substantially (by more than 250 percent) the operations of Government financing agencies in this field. In practice, both changes will probably be essential.

140. It is more difficult to estimate both the current and the future demand for medium- and long-term agricultural credit for two reasons. First, there is always the possibility that long-term investments are being or will be financed by rolling over short-term credit. And second, the level of demand for medium- and long-term development credit is dependent on a much wider range of factors than is demand for production credit. These factors include the overall investment climate, the specific sectoral investment climate, alternative investment opportunities, pricing, import and taxation policies, and a wide range of direct and indirect Government influences. Where these factors act against agricultural investment, then there is the likelihood that the effective demand for development credit will be less than the potential demand as defined by resource or market criteria.

141. There is considerable evidence that both these situations occur in Iran -- that short-term credit is used to finance investments, and that the effective demand for development credit is substantially below the potential demand. The first is largely a function of the bureaucratic, procedural and legal obstacles to utilization of existing institutional sources of medium- and long-term credit. ACB and ADBI are the major financing institutions in this field and both have had only limited effectiveness. ACB, which works largely with cooperatives and with short-term credit, has limited funds and staff for financing investment in the commercial sector. It is, in addition, an extremely bureaucratic institution with a reputation for cumbersome procedures. ADBI is designed to provide development credit to commercial farmers, but has been impeded until recently by its lack of branch offices, strict technical and collateral requirements, and a reluctance to promote the use of its funds. - 47 -

142. The relatively low effective demand for long-term credit, however, is very largely the result of Government policies which, until recently, have created a climate highly unattractive for investment in agriculture. In the Third and Fourth Plans, agriculture received few of the supports enjoyed by other sectors to encourage private investment or to .compensate for an exchange rate that was unrealistically low for the non-petroleum production sectors. Although imports of agricultural products are controlled and some prices are supported, these controls and supports have been operated in an haphazard, short-term manner, offering little long-term security to potential investors. Unlike policies for other consumer goods, food pricing policy has generally been decided in the consumers' interest - it is only in the past year that the Government has been willing to introduce subsidies on a large scale. Al- though neither land reform nor the nationalization of water resources need, per se, prove a major deterrent to private investment, the manner of their operation in Iran has ensured that they do. In the case of land reform, the failure to establish land titles, the continuing addition to the legislation twelve years after its enactment, and continued extension of the Government's power of compulsory acquisition, together create substantial insecurity in the commercial agricultural sector. Similarly, the nationalization of water has been used as a mechanism for controlling and limiting private sector development without a compensating improvement of public sector operation, either in the storage, diversion and distribution of surface water or in the exploration and development of groundwater.

143. Consequently, it is probably correct to say that the availability of medium- and long-term credit has been sufficient to meet the existing effective demand for.such financing. This is supported by the failure to utilize all the funds allocated for this purpose in the Fourth Plan, and by the lei- surely growth of ADBI operations compared to the performance of similar institutions in other sectors. However, the current utilization of medium- and long-term funds of less than Rls. 5 billion annually in a sector with a gross value of production of more than Rls. 250 billion annually is exceptionally low by any standards. It would not be unreasonable to assume that this very low level of private sector investment has been a major reason for the slow growth of agricultural output in the Fourth Plan (2-3 percent per annum).

144. There are a number of constraints to the improvement and expansion of the institutional credit system in agriculture, some of which have already been mentioned. These differ with the various credit institutions, and with the various categories of farmers. The following is a list of the more important of these constraints:

(a) Sectoral .and national policies. Sectoral and national policies that have combined to deter private investment in agriculture are probably the greatest obstacle to an expansion of medium- and long-term credit. - 48 -

(b) Alternative investment opportunities. This effect is felt primarily through the commercial banks which are steadily reducing their lending in the agricultural sector because of the lack of security and incentives in that sector compared to the greatly mbre attractive opportunities and lower risks offered in manufacturing industry, construction, trade and services. The value of banking system credit to agriculture has remained about constant over the past five years, and agriculture's share of total banking system credit declined from 11.5 percent in 1968 to 6.3 percent in 1971. As the Government agricultural banks increased their lending over this period, the decline in commercial bank lending was even more pronounced.

(c) Institutional and bureaucratic inadequacies. These apply particularly to Government banks, and have been outlined above. The inflexibility of the Government banks means that they are in a weak position to respond to the priorities now being given to agriculture. Both ACB and ADBI have recently undergone changes in management with a view to improving their capacity to handle increased responsibilities. Both are faced with major tasks -- in ACB because of the sheer size of the bureaucracy, in ADBI because of its lack of a regional network and small number of staff. Recent changes in legislation should enable the banks to operate with more flexibility in the future, but it appears that if the desired rapid injection of capital into private agriculture is to be achieved, then the capacity of the banking system will have to be expanded. In the medium-term, this inevitably means utilization of the commercial banking network to channel funds to agriculture.

(d) Collateral requirements. Most of the beneficiaries of the land reform do not have clear title to their land -- payment, over 15 years, is not finished, and cadastral surveys have not been made. As all institutional sources of long-term credit (except the supervised credit program of ACB) currently require fixed asset guarantees, the majority of peasants and small farmers are effectively excluded from such financing at present. The recent legislation authorizing banks to accept chattel mortgages for long-term loans made with managed funds will go a long way towards removing this constraint.

(e) Shortage of skilled manpower. Little of the institutional credit available to farmers carries with it adequate supervision or technical assistance. Given the absence of an effective extension service this defect in the credit system becomes doubly important. Probably only ADBI of the major institutions per- forms an adequate analysis and supervision of loans, and only the supervised credit program of the ACB attempts to provide technical assistance together with credit facilities. There does not seem to be any reason why the technical, supervisory - 49

and administrative capacity to operate a greatly expanded package credit plus technical assistance program could not be built up, probably within ACB. This would take time, however, and would require a much stronger training program than currently exists. In the short term, therefore, there can be considered to be a skilled manpower constraint to improvement of agricultural credit facilities.

(f) Shortage of funds. Of the major credit institutions, probably only ACB is limited by a shortage of funds. The demand for short-term, and possibly for medium- and long-term, credit from ACB is much greater than the current supply, despite a more than doubling of ACB's operations over the past four years. The large distribution network through the cooperative system, the low interest rate (6 percent), and the bank's considerable experience indicate that a substantially greater volume of funds could be moved by the ACB. Because of inflexibility regarding interest rate charges and very high operating costs, however, ACB is unwilling to borrow from the Central Bank. Increases in its resources are therefore largely limited to increases in capital provided through budgetary transfers. In the context of Iran's present fiscal position, however, this does not present major difficulty.

Pricing and Marketing

145. Pricing policy cannot be discussed separately from agricultural strategy as a whole, pricing policy being one -- and often the most important -- tool for implementing an overall strategy. As discussed above, major inconsistencies still exist in Iran's agricultural strategy, and these are inevitably reflected in current pricing policy. For example, major price increases have recently been announced for wheat, barley, maize and sugar beet, at the same time as cotton prices are at exceptionally high levels; these commodities inevitably compete for the same limited area of irrigated land. Major subsidies are paid out on mutton but little or nothing is done to encourage improvements in productivity in the sheep breeding flock. The subsidies on red meat allow consumption to grow far faster than supply whereas prices of poultry -- for which no significant supply constraints exist -- receive no subsidy. Other examples are common. As has already been argued, self-sufficiency in agricultural products is not an imminent prospect for Iran. The question that therefore needs to be answered before a consistent pricing policy can be formulated is not whether Iran can become self-sufficient in foodstuffs during the Fifth Plan, but to what extent and how can the accel- eration of agricultural imports (which rose from Rls. 6 billion in 1967 to Rls. 21 billion in 1972) be contained?

146. In defining the role of pricing policy within an overall agricultural strategy, three factors need to be taken into consideration. First, for many commodities, including most of the staple foods, there are major physical or structural constraints to increases in output -- i.e. the supply is price inelastic. As an example, crop production is limited throughout most of the country by inadequacy of water supply which restricts the cropped area, - 50 - the use of inputs and the variety of crops that can be grown. Similarly, most mutton production is derived from partially nomadic tribal flocks utilizing fully existing rangelands. Price policy per se can therefore have only a limited impact on overall crop or mutton production.

147. Second, Iran is a deficit producer of all major agricultural commodities except cotton and dried fruits, and thus relies on imports to supplement the domestic supply. In no single commodity is Iran a major world importer, however, with the result that Iran is both a price-taker internationally and is able generally to procure without difficulty the relatively small volumes of imports needed (a possible exception is the import of live sheep). More- over, Iran does not face shortages of foreign exchange with which to purchase food imports, nor are such shortages likely in the foreseeable future. In sum, even though increasingly dependent on imports to meet the domestic demand for food, Iran need not feel seriously vulnerable to world supplies and prices provided a logical, long-term import policy is adopted.

148. The third factor is that Iran's currency, based on the petroleum- dominated export sector, is extremely strong. This means that for some sectors of production that do not feature strongly in Iran's foreign trade, such as agriculture, the currency is over-valued, which in turn makes Iranian production appear to be high cost when compared to world levels. This applies even today when, although world prices are cyclically very high, Iran can still import most agricultural commodities more cheaply than they are being produced domestically. Consequently, imports can be used not only to supplement domestic supplies but in many cases also to reduce costs to the consumer. While such price differentials have considerable advantage as anti-inflationary tools, they can also, if not carefully controlled, act as deterrents to domestic producers. This again emphasizes the need for a comprehensive and integrated policy that relates food imports to domestic production and demand.

149. The formulation of an agricultural strategy for Iran therefore requires specific acknowledgement of the role to be played by imports. With acceptance of the fact that Iran is likely to remain a deficit producer of agricultural products for the foreseeable future, it is necessary to establish priorities for the use of the country's limited agricultural resources, and to formulate appropriate production programs and policies (including pricing policies) in relation to these priorities. These should take into account not only projected domestic demand, supply constraints, and estimated trends in world prices, but also the employment and income effect of domestic production of different commodities and the social and economic impact of different price levels to consumers. These factors are discussed in the following paragraphs.

150. If supply and demand projections are calculated for the major agricultural commodities, it appears that, in addition to Iran's traditional deficits in vegetable oils and sugar, substantial deficits can be expected to emerge over the next five years for some or all of the following major commodities: red meat, wheat, dairy products, feedgrains and rice. On the basis of Fifth Plan production targets, net imports of these commodities can - 51 - be expected to increase from Rls. 8.5 billion in 1972 to about Rls. 30 billion (US$440 million) in 1977 1/ -- an increase of 250 percent. Under somewhat less optimistic production projections, the need for imports would be even higher, growing by about 380 percent to Rls. 40 billion (US$590 million).

151. Clearly, therefore, every effort is needed to promote domestic production of these staple foods in order to reduce expenditure of foreign exchange, to reduce the dependence on external sources for the supply of strategic commodities, and to ensure an adequate supply of food to Iran's urban centers. It would appear that incentive prices to producers should have a major part to play in Iran's agricultural policy. It must be noted, however, that the role prices can play is limited. In the case of mutton production, for example, the full utilization (or, in many areas, over-utilization) of the rangelands means there is little or no under-utilized production capacity that can be tapped by the offering of incentive prices. While some improvement can be obtained through fattening operations, increases in breeding can be achieved only by long-term improvements in the productivity of the existing flock; 2/ this will not be brought about primarily or even largely by changes

1/ Based on IBRD projections of world commodity prices. As these projections probably underestimate the likely level of world inflation, the import bill in 1977 may be very considerably higher. 2/ Two levels of supply response in the production-of mutton can be expected. A favorable ratio of feed: meat prices will encourage the fattening of animals and so will raise the average carcase weight of slaughtered sheep and goats. This supply response is currently being developed with some success by the Government. A theoretical maximum increase in supply by this means would be an increase in carcase weight of 5 kg. for all sheep and goats slaughtered and could add about 60,000 tons to the annual mutton supply. In practice, about 40 percent of animals slaughtered at the present time are already fat, so the incremental production would be no more than 30-40,000 tons. At the second level, supply increase can be achieved by increasing the off-take from the national breeding flock. Currently, off-take is estimated at about 30 percent and this could be raised to close to 40 percent by increasing the percentage of lambs reared and by encouraging the fattening of lambs before one year of age (by improved nutrition), improved natality, and reduced mortality. Complete adoption of this system could lead to an increase of about 110,000 tons of meat (30 percent increase) even without any increases in average carcase weight. To achieve this increased off-take, however, it will not only be necessary to provide fattening operations but also to increase the feed supply through the integration of range and low- land pastures and village agriculture, by control of range grazing and by the provision of supplementary feed and improved husbandry. Price incentives per se would play only a limited role in achieving this necessary shift in the present system of sheep breeding and fattening. A third level of production -- that of intensive sheep breeding based on irrigated forage production and supplementary feeding -- does not appear to be feasible at foreseeable meat prices (a model of a confined 500 ewe flock illustrates that a price of more than R1s. 300 per kg carcase weight would be needed for the enterprise to be financially viable). - 52 - in prices to producers. In the case of rice, the area that is suited physically to this commodity is limited and is already largely exploited; production increases will depend primarily on improvements in yields. Wheat, feedgrains, sugar beet and oil seeds all compete for irrigated land, so that substantial increases in the area cultivated of each of them is not feasible given the slow projected expansion of irrigated land in Iran. Prices, therefore, will be important in a relative sense and will decide shifts between crops, but they are not likely, per se, to induce increased output overall from irrigated field crops.

Demand and supply projections indicate that it is in red meat that Tran will experience the most rapidly growing deficit over the next five years, aind chat this could be Iran's largest agricultural import, in value terms, by 1977. It would appear desirable to maximize domestic production of red meat but, as discussed above, the basic constraints to expansion of the sheep breed- ig flock suggest that even the Fifth Plan target of a 6.5 percent annual growth ;i output will be difficult to achieve. The nation can therefore adopt one of two general policy measures: to import sufficient red meat to cover the deficit between demand and domestic production; or to shift consumption away from .e imat towards white meat. In fact, both measures will probably be neces- :2.iy., Production of poultry can be increased very rapidly if the price sig- als are right and if the necessary inputs are available. Poultry production uy about 12 percent annually during the Fourth Plan, and there is little eason to believe that this expansion could not be accelerated during the Fifth Plan. Even at present retail price relationships demand for poultry meat is expected almost to double over the next five years, to around 120,000 ,ons annually, but a further expansion to substitute some of the expected 150,000 tons increase in demand for red meat may also be possible.

153. The desirability of accelerating the substitution of white meat for red is increased by the expected rise in world red meat prices. At the same time, it is probable that Iran will not be able to import sufficient live sheep to meet its requirements and will therefore have to develop consumer acceptance of chilled or frozen mutton. If substitution of red with white meat is to be encouraged, it will be necessary to reduce the consumer price of white meat relative to red meat (at present, official consumer prices are is. 110 per kg. for poultry meat and Rls. 130-150 per kg. for mutton). As sc costs make up around 55-60 percent of the production costs of poultry, : subsidy on feed costs would be needed to achieve this reduction. At the arae time, it would appear reasonable to raise the price of red meat to the cnsumner nearer to its market level by reducing the present subsidy. 1/ !Learly, this would have to be done in stages.

1/ The introduction of increases in the red meat price together with a reduction in the white meat price would be desirable financially and economically (the present subsidy of Rls. 30-40 per kg. is ineffective and costly) and would be acceptable socially provided that adequate supplies of white meat at lower prices were available. - 53 -

154. The availability of feedgrains and other feedstuffs will be the most critical factor in development of livestock production in Iran over the next five years. Even without any changes in price relationships between red and white meat, and assuming a substantial increase in alfalfa and forage crop production, the demand for feedgrains is expected to increase by 80 percent over the next five years. Any additional expansion of white meat production would raise this demand even further. Even if all the incremental feedgrain has to be imported, however, at expected world prices it would be substantially less expensive to import feedgrains for poultry production than to import red meat. 1/ Domestic production of feedgrain is effectively limited to barley, more than half of which is produced under rainfed conditions. It is not reasonable to expect any significant increase in barley production from the existing dryland cultivated area over the next five years, and expansion in domestic feedgrain production is likely to be achieved largely through extension of the irrigated cultivation of maize or sorghum. This can only be achieved at the expense of other field crops -- primarily wheat, sugar beet, cotton or oilseeds. Calculations indicate that, in terms of import costs, it would be preferable for Iran to substitute to the extent possible consumption of white meat for red meat and cultivation of feedgrains in place of wheat where this is feasible.

155. The basis for a pricing policy is now beginning to become clear. In straight financial terms, it will benefit Iran to maximize white meat and feedgrain production domestically, to maximize red meat production within the present production systems (i.e. mutton based on extensive breeding flocks and beef produced primarily as a by-product of the dairy industry), and to cultivate wheat on rainfed and poorly irrigated land, but only residually on the better irrigated land when the demand for other major field crops has been met. On these assumptions, chilled or frozen mutton and wheat would be imported as needed to meet supply deficits. In terms of probable availability of world supplies, this strategy also appears acceptable. It is possible to argue that such a policy would be strategically unacceptable because it would increase Iran's dependence on the world market for its staple food, wheat. If a conscious policy decision is taken on this, however, there is no reason why Iran should not be able to negotiate a long-term wheat contract with a major producer -- Australia would seem to be the most suitable -- to ensure a regular supply of wheat for the foreseeable future. Iran will not after all be a major importer in world terms -- imports are unlikely to exceed 1.5 million tons annually within the next five years -- and will not therefore affect significantly world trade. A decision to import a significant proportion of the country's wheat needs would have the possible added advantage of reducing the average price to the consumer. It would also facilitate the Gov- ernment's efforts to procure and hold a strategic reserve stock.

156. The main disadvantage with the approach outlined above is that wheat is the major product of Iran's small farmers, the rural poor. Implicit in the above approach is that producer prices for wheat should not be at a level to

1/ The CIF price of chilled or frozen mutton can be expected to be around R1s. 75,000 per ton in 1977. The equivalent cost of imported feedgrains and other feed components to produce one ton of white meat would be around Rls. 40,000. - 54 - encourage a shift out of other crops into wheat on the better irrigated land, and that a potentially favorable income distribution effect of pricing policy would therefore be lost. There is little reason to believe, however, that higher farmgate prices would improve significantly the real income of subsistence and semi-subsistence farmers. Experience in other countries suggests that pricing policy is not usually very effective as a means of redistributing rural incomes, and that other policies and programs of the Government are more likely to be successful in this aim.

157. The above scheme, however, contrasts severely with price policies currently operated in Iran. In addition to the lack of a clear overall policy for either producer prices or imports of agricultural commodities, a number of recent increases in producer prices have been announced which run contrary to the above argument. 1/ The raising of the support prices of wheat and barley to Rls. 10,000 and R1s. 7,500 per ton respectively is likely to lead to a shift in cultivated area out of other field crops (sugar beet, cotton, oil seeds) towards these extensive cereals even on better irrigated land. As argued above, this must be against the long-term objectives of agricultural development in Iran. The continuation of substantial subsidies on red meat also seems to run counter to the economic and technical realities of the Iranian situation. Another problem will be to improve, expand, and staff the necessary institutions to formulate, review and evaluate price policies and to implement price support programs. Although a centralized pricing committee has now been established, it lacks the technical and statistical support to work effectively other than in the short-term. And the substantial increase in wheat prices is likely to strain to excess the capacity of the Cereals, Sugar and Tea Organization to purchase, store and distribute wheat.

158. In summary, therefore, there seems to be an urgent need for the following changes if an effective agricultural pricing policy is to be formulated:

(a) The formulation of a clear, long-term agricultural production strategy, based on realistic estimates of production potential and expected world price trends. One such strategy, as argued above, would concentrate on the production of feedgrains, higher value industrial crops and white meat in Iran, with wheat and red meat to be imported residually.

(b) The establishment of a Price Review Committee supported by a competent Statistical Bureau and linked closely with an import and Marketing Board authorized to enter long-term import contracts where necessary.

(c) The establishment of a program of price supports and appropriate implementational mechanisms to offer producers guaranteed minimum prices for selected commodities in line with the priorities set within the production strategy. These mechanisms should utilize, to the extent possible, existing or potential private sector capacity.

1/ Further potential complications may arise as a result of the government's announced intentions to invest in agricultural production abroad in order to ensure Iran's "self-sufficiency" in staple commodities. - 55 -

2. INDUSTRY

I. INTRODUCTION

159. Iranian manufacturing until the early 1960's was dominated by cot- tage industries, particularly carpet weaving, and non-durable consumer goods industries. During the 1960s, however, Iran made remarkable industrial progress. The output of the industrial sector increased at an average rate of 12.9 percent-per annum, slightly below the rate of grwoth of the oil sector, and much faster than the growth of the agricultural sector. Most of the production increase occurred in consumer goods but the structure of manufacturing was deepend by investments in capital goods industries, motor vehicles and other consumer durables, chemicals, construction materials, steel, and aluminum. The share of manufacturing and mining in gross domestic fixed investment during the decade was about 17 percent. The sector contributed about 38 percent to additional employment opportunities created in the country.

160. The growth of manufacturing has not been without its problems. The early import substitution stage led to high prices for finished products domestically, and an enlarged import bill for intermediate and capital goods. Concentration on the middle and upper income end of the domestic market, together with the encouragement of excessive entry into some industries, led to fragmentation of production. Lack of agricultural raw material supplies has always been a problem, and so has the shortage of skilled labor and management. Currently booming domestic demand and restrictions on competitive imports have reduced the incentive to export. If this trend continues, manufacturing will increasingly become inward oriented. A lagging capital market has been a problem in the past and is likely to be more so as Government policies push manufacturing towards decentralization. Institutional support, in the form of vocational education, remains weak. These difficulties, however, are not unique to Iran. Most of the rapidly industrializing countries, such as Korea, and Turkey are experiencing similar problems.

II. GROWTH AND STRUCTURAL CHANGE

161. Value Added. Gross value added in manufacturing increased at an average rate of 12.3 percent during 1962-72 in real terms. 1/ The pace of growth in real value added accelerated slightly towards the end of the 1960's averaging 12.6 percent per year during 1968-72 while the share of manufacturing activity in Gross Domestic Product increased from 12.4 percent in 1962 to 14.1 percent in 1972. The direct contribution of manufacturing to overall economic growth was over 15 percent in real terms in the past decade (see Table 7).

1/ These figures exclude oil refining. - 56 -

Table 7: GROWTH AND SHARES OF MANUFACTURING VALUE ADDED

1962-67 1968-72 1962-72

Gross Value Added 11.8 12.6 12.3 (rate of growth, 5) Share in GDP (%) 12.6 13.8 13.3 Share in incremental GDP (%) 15.3 15.1 15.2

162. Production Structure. Manufactures of consumer, intermediate, and capital goods have grown at steady rates in terms of gross value added and value of output at current prices, yet as one would expect in an economy which was initially dominated by the manufacturing of nondurable consumer goods, the growth of intermediate, durable consumer and capital goods has begun outstrip the growth of nondurable consumer goods (see Table 8).

Table 8: GROWTH AND SHARES OF VALUE ADDED BY BROAD ECONOMIC CATEGORIES

1962-72 Annual Share in Growth Incremental Rate Value Added

Total: All Industries 15.7 100.0

Non-durable Consumer Goods (%) 10.7 33.2 Intermediate Goods (%) 19.3 31.3 Durable and Capital Goods (%) 21.0 41.0

163. Most of the growth of nondurable consumer goods occurred in processed food, wearing apparel and textile industries. Among these, the apparel industry expanded rapidly, at an annual rate of about 25 percent in real terms. The intermediate goods industry also grew rapidly during the decade. In particular, the contribution of the basic metal industries to value added increased from 100 million rials in 1962 to more than 8 billion rials in 1972, while there was a tenfold rise in value added in printing and publishing and rubber products.

164. Value added in durable and capital goods industries increased from three billion rials in 1962 to 20 billion rials in 1972. More than half of this was contributed by the motor vehicles industry with a further third by manufacturers of electrical equipment. Several new products, such as paper, fertilizers, steel pipes, aluminum, automotive diesel engines, electric fans, and insulated cables were produced in Iran for the first time. Production of several other commodities such as detergents, sheet glass, iron profiles, - 57 -

gas stoves, television sets, refrigerators, and passenger cars increased phenomenally, though admittedly from a low base.

165. Changes in the structure of Iranian manufacturing, therefore, have been substantial during 1962-72. The increasing sophistication of the sector and its decisive move towards a vertical integration of production augurs well for future growth. Emphasis on capital goods industries reflects the need to furnish a solid base for integrated industrial growth as well as a diversified economy.

166. Employment. Employment in manufacturing industry in the urban areas increased from about 380,000 to about 940,000 during 1962-72 at an average annual rate of 9.5 percent. Employment opportunities were created in all industrial product groups, with textiles contributing most by providing 160,000 or 29 percent of newly created urban jobs during the decade, and processed food, wearing apparel and metal products creating another 43 percent (see Table 9).

Table 9: MANUFACTURING EMPLOYMENT BY SELECTED PRODUCT GROUPS, URBAN IRAN, 1962 AND 1972

Annual Employees (000) % Share Growth 1962 1972 1962 1972 Rate %

Processed Food 68.0 160.0 17.9 17.1 8.9 Textiles 80.3 239.8 21.2 25.6 11.5 Wearing Apparel 70.9 145.2 18.7 15.5 7.4 Paper and Paper Products 0.9 4.6 0.2 0.5 17.5 Metal Products 36.5 111.2 9.6 11.9 11.8 Basic Metals 2.0 19.6 0.5 2.1 26.0 Electrical Machinery 3.5 30.1 0.9 3.2 24.0

All Manufacturing 379.0 936.0 100.0 100.0 9.5

167. Information on employment is incomplete, however, in modern manufacturing activity or in factory-type manufacturing establishments it may be approximated by the number of paid employees in the urban areas. Their number increased from 250,000 in 1962 to 530,000 in 1969 at an annual rate of 11.4 percent during these seven years. The remaining industrial work force increased from 780,000 to 1,040,000 at a rate of 4.2 percent in the same period. The distribution of employment by status varies considerably from industry to industry. The tobacco industry is at one extreme where the entire employment consists of only paid workers, and wood products and furniture is at the other extreme where half of the workers are unpaid. The fast growing industries such as machinery, basic metals, and rubber products have a high proportion (more than 85 percent) of paid workers. - 58 -

168. Output per worker . The value of output per worker increased from 90,000 rials in 1962 to 140,000 rials (at current prices) during 1962-72, at an annual rate of 4.7 percent. According to available data output per worker in nondurable consumer goods remained fairly constant during the decade, while it increased at an average annual rate of 8 to 10 percent in intermediate, durable and capital goods (Table 10). The inter-industry variations in output per worker are large. At one end of the scale are textiles, apparel, wood products and furniture, leather and leather products, metal products, and non-electrical machinery industries. Output per worker in these industries varies between 45-90,000 rials. At the other end is the tobacco industry where output per worker is in excess of 1,400,000 rials. It is followed by beverages, chemicals and chemical products, and basic metals where output varies between 440-540,000 rials.

Table 10: GROWTH OF LABOR PRODUCTIVITY BY BROAD ECONOMIC CATEGORIES, URBAN IRAN, 1962 AND 1972

1962/63 1972/73 Annual (000 rials) Growth Rate

Total Manufacturing 90 142 4.7

Nondurable Consumer Goods 92 107 1.5 Intermediate Goods 91 204 8.4 Durable and Capital Goods 90 229 9.8

169. Domestic Investment. Tndustrial investment increased from 5 billion rials in 1962 to 65 billion rials in 1972. Even when adjusted for price rises, the resulting ninefold increase in real terms is still very large. Net fixed investment during the Third Plan was 63 billion rials; it was 250 billion rials in the Fourth Plan. The changes in the structure of investment by broad economic categories and product groups are even greater (Table 11). Investment in nondurable consumer goods was 63 percent of net fixed investment during the Third Plan, with more than half being in food processing and textiles and a further 10 percent in transport equipment (motor vehicles) manufacturing. In the Fourth Plan the combined share of these three industries in investment outlays was reduced to 25 percent, though the amount of investment increased from 39 billion rials to 63 billion rials. Investment in basic metals rose from a negligible amount of 1.4 billion rials in the Third Plan to 60 billion rials during the Fourth Plan largely because of the Esfahan Steel Mill. Investment in chemicals and chemical products also rose sharply from 2.7 billion to 34 billion rials. Other important manufacturing industries were non-electric machinery, paper and tobacco. - 59 -

Table 11: DISTRIBUTION OF INDUSTRIAL INVESTMENT IN THE THIRD AND FOURTH PLANS BY BROAD ECONOMIC CATEGORIES

III Plan IV Plan

Total manufacturing 100.0 100.0

Non-durable consumer goods (%) 62.7 29.3 Intermediate goods (%) 20.4 57.5 Durable and capital goods (%) 15.1 12.7

170. Foreign Private Investment. Foreign private investment in Iran excluding the oil sector, was 3 billion rials in the Third Plan and 9.7 billion rials in the Fourth Plan, of which approximately 80 percent was in manufacturing and 12 percent in mining. Petrochemicals, rubber products, phar- maceutical and chemical industries received almost half of the total gross inflow of foreign private capital and loans (Table 12).

Table 12: GROSS INFLOW OF FOREIGN PRIVATE CAPITAL AND LOANS TO IRAN BY SELECTED INDUSTRIES DURING THIRD AND FOURTH PLANS

III Plan IV Plan m.,rials Percent m. rials Percent

Petrochemicals 120 4.0 2,200 22.7 Rubber products 750 25.4 1,230 12.6 Pharmaceuticals and chemicals 680 23.0 1,210 12.5 Metallurgical industries 220 7.5 960 9.9 Mining 510 17.1 960 9.9 Others 690 23.2 3,120 32.2

All economic activities 2,970 100.0 9,680 100.0

During the past decade, United States enterprises have been important foreign investors in Iran, accounting for almost half of the entire gross inflow of foreign funds. Germany and the United Kingdom also increased their already substantial investments in Iran, while investment by Japanese enterprises increased dramatically from 20 million rials in the Third Plan to 425 million rials in the Fourth Plan. - 60 -

171. Public Investment. The Government invested more than 100 billion rials in manufacturing industry during the Fourth Plan 1/ (Table 13). This was concentrated in two industries - basic metals and petrochemicals - which received almost 85 percent of local public investment in manufacturing.

Table 13: PUBLIC INVESTMENT IN MANUFACTURING BY MAJOR INDUSTRIES DURING THE FOURTH PLAN

Billion rials %

Basic metals 59.5 58.7 Petrochemicals and chemicals 24.2 23.9 Capital and durable goods 10.7 10.6 Food processing and tobacco products 5.9 5.8 Others 1.0 1.0

All manufacturing 101.3 100.0

1/2. Industrial Loans. The Industrial and Mining Development Bank of Iran (IMDBI) and the Industrial Credit Bank (ICB) are the two leading institutions which give long-term loans for industrial investment. 2/ Loans given by either institution are subsidized by the Government to stimulate industrial development. IMDBI approved loans worth 7.5 and 27.0 billion rials, respectively, during the Third and Fourth Plan periods. The ICB approved industrial loans worth 1.7 and 7.2 billion rials respectively during the same periods. These two institutions together disbursed 29 billion rials to private industry during the decade, out of which almost six billion rials were paid by ICB. Most of the loans of IMDBI were for manufacturing, though during the Fourth Plan IMDBI advanced one billion rials of loans for non-manufacturing activities as well. Almost 45 percent of the loans in manufacturing were committed for three industries: textiles, motor vehicles and construction materials while electrical machinery, food processing and paper shared more Lhan one-fourth of IMDBI's loans. IMDBI has been quite responsive to changing economic conditions. For instance, in the early 1970s when the shortage of construction materials became apparent, it increased its lending considerably to these industries. Both ICB and IMDBI have been concerned with the need for regional dispersal of industries. Consequently, only one-fourth of loans approved by ICB during the Fourth Plan were for the Greater Tehran area

1/ In addition, the Government spent 1.9 billion rials on mining, 1.3 billion rials in technical assistance, and 8.5 billion rials in loans or equity to private investors.

2/ Short-term loans to finance working capital including inventories are provided by Bank Melli and other commercial banks, as well as by ICB. These loans are not discussed here. - 61 -

as compared with one-half during the Third Plan. Both these.institutions, particularly IMDBI, have generally financed large plants; almost two-thirds of loans committed by IMDBI were in excess of 75 million rials, each with five year maturity.

173. Establishment Size. Information on manufacturing activity by size of establishments is fragmentary. It appears that the benefits of rapid industrial growth to small-scale enterprises have been limited, particularly when measured by growth of value added per enterprise or per person engaged (Table 14).

Table 14: GROWTH OF SMALL AND LARGE MANUFACTURING ESTABLISHMENTS, URBAN IRAN, 1964 AND 1969

Annual 1964 1969 Increase (%) Small Large Small Large Small Large

Establishments (000) 109.0 3.2 172.6 5.1 9.6 9.5 Persons engaged 328.2 164.9 499.9 256.9 8.8 9.3 Paid employees (000) 181.0 158.0 292.0 239.0 10.0 8.7 Wages & salaries (billion rials) 4.2 6.7 9.0 14.8 16.2 17.3 Gross value added (billion rials 19.6 25.0 31.2 56.1 9.8 17.5 Wages & salaries per paid employee ('000 rials) 23.0 42.0 31.0 62.0 5.7 7.9 Gross value added per person engaged ('000 rials) 60.0 152.0 63.0 218.0 0.9 7.6 Gross value added per establishment ('000 rials) 180.0 7,000.0 181.0 11,070.0 0.14 7.3 Paid employees/All persons engaged (%) 55.2 95.9 58.4 93.3 - -

Small establishments employ two-thirds of the manufacturing work force and contribute just over one-third of value added and gross output in manufacturing. However, the actual contribution of small establishments is likely to be more than reported because of poor survey coverage.

174. Regional Distribution. Manufacturing activity is largely concentrated in the Central Province, which includes the Tehran and Ghazvin area. Almost 60 percent of value added in manufacturing is estimated to originate in this province although it has only 40 percent of employees, 35 percent of establishments, 20 percent of population, and 6 percent of land (Table 15). Regional concentration is further accentuated if one considers establishments employing 10 or more persons. During the 1960s the Government has pursued a policy of regional diversification of industries. For example, the Govern- ment prohibited new industrial enterprises within a 120 kilometer radius of - 62 -

Tehran to avoid further concentration; this led to the development of Ghazvin as a new industrial center. The Government is also undertaking investment in infrastructure and social sectors to provide the needed incentives for location of new industries away from the Central Province.

Table 15: REGIONAL DISTRIBUTION OF MANUFACTURING ACTIVITY, 1969/70

Establishments Value Added Output Large Total Large Total Large Total

All Regions 100.0 100.0 100.0 100.0 100.0 100.0 Central 45.9 35.5 70.0 61.2 70.2 59.8 Esfahan and Yazd 8.0 16.1 7.2 10.2 7.5 10.7 Khuzestan 4.0 6.0 4.1 6.0 3.6 5.0 Others 42.1 42.4 18.7 22.6 18.7 24.5

The regional variations in average establishments size, earnings and productivity are quite significant. Manufacturing establishments located in the Central Province tend to be relatively large, and the labor employed there tends to be more productive and well paid as compared to the national average. For instance, the average value added per establishment in the Central Prov- ince was 850,000 rials against the national average of 500,000 in 1969. All other provinces were below the national average; the average size of establishments in Azarbaijan West, Azarbaijan East, Kermanshahan, Khorasan, and Sistan and Baluchistan was less than half the national average. Similarly, average labor productivity was highest in the Central Province - 175,000 rials against the national average of 115,000 rials, whereas it varied between 38,000-60,000 rials in the above mentioned five provinces.

175. Manufactured Exports. During 1962-71 Iran's exports increased by 13 percent per annum, but manufactured exports increased at only half that rate. Hence, the share of manufactured exports in merchandise exports decreased from 29 percent in 1962 to 17 percent in 1971. Exports of oil were mainly responsible for this trend, since the value of these exports weighed heavily in the overall export performance of the economy. The composition of manufactured exports has changed significantly during the decade. The dominance of handwoven carpets in non-oil exports is gradually declining, as the exports of modern manufactured products, such as canned fish, rubber tires, clothing and knitted fabrics, etc., increase rapidly. The rate of growth of these exports during the Fourth Plan was 18.6 percent per year and is expected to be higher during the Fifth Plan.

176. Imports. Iran's merchandise imports increased at 16.5 percent per year during 1962-72, and were worth US$2.5 billion in 1972. During the decade the composition of merchandise imports changed considerably in favor of consumer durables and capital goods, whose share increased from 32 percent to 43 percent, while the share of non-manufactured products declined. In particular, capital goods imports increased rapidly because of the fast pace - 63 -

of industrialization and the overall growth of the economy. Imports of capital goods accounted for almost half of the increase in imports during the Third Plan, and somewhat less than half during the Fourth Plan. Machinery imports increased from 100 million dollars in 1962 to 600 million dollars in 1972, while the Iranian motor vehicle industry, which has largely relied on imported components and parts, caused a large increase in the imports of automobile chassis and parts. Imports of intermediate goods, including basic metals and metal products, increased at an annual rate of 15 percent per year; most of this increase was due to imports of iron and steel, although imports of aluminum and copper also increased substantially. Domestic production of some of these items did not begin until the early 1970s. Almost the entire increase in imports of nondurable consumer goods was contributed by textiles (60 percent) and processed food (30 percent). Textile imports increased from US$40 to $130 million during the decade, while imports of processed food rose from a negligible amount in 1962 to US$50 million in 1972. Since domestic production of processed food did not rise fast enough, an increasing proportion of domestic demand had to be met through imports.

177. Import Substitution. Like many developing countries in the 1960s Iran's industrialization strategy was dominated by import substitution. A good indicator of this process is the ratio of total imports to market availability which decreased from 28 percent in 1962 to 25 percent in 1972. For intermediate goods the ratio of imports to market availability decreased from about 48 percent in 1972 to about 36 percent in 1972 with import substitution dominant in paper and paper products, printing and publishing, rubber products, and in chemicals and chemical products. Although the full effect of import substitution on capital and durable goods imports is not apparent from the aggregate data, the example of electrical machinery can be taken. Iran's output of electrical machinery rose remarkably, from 500 million rials to 20 billion rials over the decade. The industry entered into new products such as switchboards, copper cables and wires, telephone receivers and equipment, storage and dry batteries. Output of refrigerators, television sets, coolers and other electrical appliances increased substantially, and imports of those items was reduced. In 1962 imports of electrical goods supplied 87 percent of the total demand, in 1972 only 50 percent.

178. Mining: Value added in mining increased from 0.8 billion rials in 1962 to 3.5 billion rials in 1972 at an average annual rate of 15.0 percent. The increase in the output was faster in the latter half of the decade. Pro- duction of coal and iron ore increased significantly and together contributed about 37 percent of output in 1972. Availability and exploitation of these two minerals augurs well for the industrial development of Iran. It will substantially aid the country's effort in establishing a steel industry. A beginning in this direction was made with the construction of Esfahan Steel mill, and there are plans to create additional iron and coal combines to increase indigenous production of steel. Estimates of mining output for 1962 and 1972 are given in Table 16: - 64 -

Table 16: GROSS OUTPUT OF SELECTED MINERALS

Value (m. rials) at Quantity ('000 tons) 1968 prices 1962 1972 1968 1972

Coal (incl. coke, briquette and bitumen) 227 1,000 216 560 'ad and zinc ore 40 220 389 457 Iron ore 30 980 1 319 Limestone 636 5,200 157 260 Sand and gravel - 9,500 92 157 Chromite 110 180 165 123 Chalkstone 723 2,400 67 106 Copper ore 6 1 35 50 Other minerals - - 232 333

Jto al 1,354 2,365

III. INDUSTRIAL STRATEGY AND POLICIES

179. Industrial Strategy: The import substitution strategy followed by Iran has involved backwards integration from simple processing, fabrication or assembly of final goods to their intermediate products - components, parts, and raw materials - and finally, to the capital good industries. 1/ So far import substitution has taken place in a large number of consumer goods, including durables, and also to a substantial extent in the intermediate goods needed for them. During the Fourth Plan, import substitution began in capital goods, such as machine tools, tractors, buses and telecommunication equipment. Iran is now entering into a more complex phase of import substitution involving sophisticated products such as fertilizers, aromatics and other petrochemicals, industrial boilers, compressors, electric motors, ships, etc.

130. The Government's main policy objective has been to create an industrial sector based on modern technology. Economic efficiency was, in the first instance, not a prime consideration. The Government encouraged import substitution by means of high tariff protection, quantitative import restrictions and generous fiscal incentives. By the early 1970's the administration of the protection system had become so flexible and the manipulation of quantitative restrictions so effective, that domestic production costs could be

1/ For a detailed analysis of the industrial strategy followed in the 1960's see IBRD: Industrial Policies and Priorities, Iran, Report No. SA-27a, March 1972. - 65 - brought down to international prices for many products; in some cases they were even lower.

181. In recent years, however, the increasing complexity of the industrialization process has made new demands on policy. The import substitution potential in consumer goods has been largely exploited. There was excessive fragmentation of production, and the incentive structure had to be modified to encourage the production of capital goods. The slow growth of agricultural output was limiting the growth of agro-based industries and the scarcity of raw materials in Iran was exacerbated by international shortages and rising prices. By 1972 a booming domestic demand based on rising real incomes was making inroads into the exportable surplus of non-traditional materials.

182. The salient features of the new industrial strategy adopted for the 1970s include a fuller exploitation of natural resources and the development of mineral-based industries for the domestic market and for exports; the use of modern technology to provide maximum possible quality and efficiency; continued import substitution with emphasis on backward integration towards capital goods; greater attention to small and medium size establishments; and progressive decentralization of industry away from the Greater Tehran area. In accordance with this strategy, Iran is exploiting its long-term comparative advantage, particularly in petrochemicals, petroleum refining, copper, iron and steel. The Government's policy is to develop as much processing of natural gas and crude oil as possible. The same applies to forward integration of minerals which is to be undertaken whenever it is economically viable.

183. The domestic market for petrochemicals has so far been somewhat limited and their prices in international markets are most volatile. The National Petrochemical Company of Iran (a Government monopoly) has therefore stressed the importance of guaranteed export markets, especially in negotiating joint ventures, as well as an adequate supply of technical expertise by foreign collaborators. In the near future, Iran will be exporting aromatics, chemical fertilizers, plastics and other petrochemical products. Investment in these industries in the Fifth Plan is likely to exceed the present allocation of 60 billion rials. The Plan also envisages establishment of two oil refineries, largely to meet increased domestic demand for petroleum products. These refineries would increase the refinery input of crude oil from 240,000 barrels a day to 490,000 barrels.

184. Considerable investment in mineral (non-oil) resource-based industries is also expected to take place. About 20 billion rials (or two-fifths of total mining investment) is presently allocated for the development of the Sar Cheshmeh copper mine and smelter. It is expected that the value of concentrated copper ore output will increase from 50 million rials in 1972 to 9,600 million rials in 1977 (at 1972 prices), while production of blister copper will rise to 160,000 tons annually. This program will stimulate ecu- nomic development in Kerman Province, one of the most backward parts of the country, as well as contribute to non-oil exports. Value added in mining - 66 - during the Fifth Plan is expected to rise at a real annual rate of 25 percent although it is envisaged that mineral exports will rise at only eight percent, because domestic demand of the growing metal processing industry for iron, copper, bauxite and other minerals will be met first, and only the surplus will be exported.

185. Iran's industrial policies remain closer to the "Japanese model" than to "free trade" patterns of development. In the early phase of industrialization the Government was directly involved in industrial production. In the 1960s private entrepreneurs were encouraged, although the Government still led in backward integration. Public investment in the principal capital- intensive heavy industries - steel, aluminum, petrochemicals, machine tools, tractors - was undertaken during the Fourth Plan. Towards the end of this plan, private entrepreneurs were showing interest in these fields, therefore, emphasis on private initiative in industry has been renewed. The Fifth Plan originally envisaged that 540 billion rials would be invested in fixed assets in manufacturing (excluding oil refining but including petrochemicals and agro-industries). The largest increase in investment during the Fifth Plan is envisaged for capital and durable consumer goods (Table 17).

Table 17: FIXED INVESTMENT IN MANUFACTURING BY BROAD ECONOMIC CATEGORIES DURING THE FOURTH AND FIFTH PLANS (in billions of rials)

Fourth Plan Fifth Plan

Total manufacturing 249.0 537.0 Nondurable consumer goods 68.2 145.9 Intermediate goods 148.0 333.4 Capital and durable goods 32.8 88.7

186. Protection and Trade Policy: The incentives provided by the protection system have been by far the most powerful in Iran's industrial development. The protection system is flexible and complex - consisting of a customs duty, commercial benefits tax, quantitative import restrictions, registration fees, compulsory deposits on import orders, and miscellaneous minor taxes and charges on imports. A wide-ranging system of exemptions from the basic protection measures further adds to the complexities and administrative difficulties. The administration of protection has, in spite of its complexities, become more effective over the years.

187. Throughout the sixties the protection system was liberally administered to encourage industrial development. By the end of the decade, however, the need for a thorough evaluation of the industrial incentive system was recognized, and the Government sought a new foreign trade policy to promote exports and to supply the domestic market. As Iranian industry was able to expand without cost inflation, the need for protection declined. In general, protection has been highest on most durable and non-durable consumer goods, - 67 -

moderate on intermediate goods and lowest on capital goods. However, during the early 1970s tariffs have been reduced on some foodstuffs such as sugar, non-alcoholic beverages, edible oil, rice and breads; textiles such as woolen cloth, cotton fabrics, and handwoven carpets; wardrobes, and chests of drawers, sole leather and hides, paper and paper products, samovars, cement, mosaic tiles, aluminum sheets and wares, and trailers. Moreover, quantitative restrictions on imports of industrial products such as edible oil, bread, weighing scales, passenger and sports cars, and silverware have been relaxed. On the other hand, tariffs appear to have gone up on several manufactured products such as wheat flour, hydrogenated vegetable oil, wooden doors and windows, leather casing and guts, water pumps, automobile batteries, and cars costing more than 250,000 rials each. In addition, in the recent annual review a large number of commodities were transferred from the unauthorized to authorized list, special permission requirements were abolished for many authorized imports, and commercial benefit taxes were drastically reduced on others.

188. It may be noted that even high customs tariffs sometimes fail to provide adequate guarantees to domestic producers, since quality differences between imported and domestic products tend to offset price differentials, and consumers may show strong preferences for imported products. The high customs tariffs - above 500 percent ad varorem - on passenger and sports cars, particularly on luxury and semi-luxury models, are said to be largely because of the "irrational" consumer preferences for foreign goods. Further, the exemption from import prohibitions and tariffs for almost all Government imports results in a significant erosion of protection. The pervasiveness of protection is further weakened by the exemptions granted to firms, including those engaged in production for exports, on the plant and equipment and intermediate inputs needed by them, though often only for a limited period. There is still some tendency toward "tailoring" the commercial benefit tax to meet the needs of a new producer, though the policy of prohibiting imports to meet the needs of a new product line has by and large been abandoned in recent years.

189. Past experience in Iran, as in some other countries, shows that prices of import replacing goods tend to decline as new industries improve their efficiency and economies of scale become effective. This latter factor is likely to be of even greater importance for the intermediate and capital goods now being introduced, as economies of scale are generally more significant in these producth; it is often economic for only one or two firms to meet the domestic demand. Quantitative import restrictions can be, and have been, used to assist in this, but a vigorous exports promotion policy would also be helpful. Efficient import substitution and export promotion often go hand in hand. Currently while Iran has little need for manufactured exports on balance of payments grounds, consideration of an efficient scale of production may be an important reason for encouraging production for export. As the prices of intermediate and capital goods enter into the costs of other products, particular care in ensuring efficiency is required. This is not to deny that some protection may be essential to encourage domestic production of intermediate and capital goods. At present, however, some manufacturers of capital goods are penalized by negative protection: they pay customs tariff on their inputs while their outputs have to compete with goods exempt from duties. The administration of the protection system thus requires continuous vigilance. - 68 -

190. Industrial Licensing and Location. The objectives of the licensing system are multifarious and have undergone significant changes as industrialization has deepened. Until the late 1960s, the main objectives of the industrial licensing system were essentially to stimulate investment flows into selected manufacturing industries while ensuring the financial, technical and managerial soundness of the enterprise. Granting of a license virtually ensured access to generous Government incentives, including protection. The Ministry of Economy utilized the licensing system for promotion as well, and frequently issued licenses to the development finance institutions, IMDBI and ICB, which then put together a business proposal based on this privilege.

191. These objectives were considerably modified in the late 1960s. The new emphasis was on the shift from the production of consumer goods to intermediate and capital goods, on the economic viability of the project without excessive Government support, on the minimum economic size for an industry, on the use of domestic resources by a project, on the curbing of concentration in the Greater Tehran area, on the net effect of the project on the balance of payments, and on the need for managerial control of foreign investment in Iran. Some of these objectives were further refined in 1969 and 1970, when minimum limits were imposed on the extent of domestic value added in manufacturing (35 percent) and use of domestic resources (65 percent of unit cost). A maximum limit of 35 percent was imposed on nominal protection, and a res- triction was imposed on the location of new industrial plants within 120 kilometers from Tehran.

192. Until recently, virtually every new industrial establishment, except carpet weaving, required a license or "commencement permit" from the Ministry of Economy. After the establishment was completed an "operation permit" was required. The Ministry of Economy recognizes the problems of licensing and has recently liberalized licenses for production outside the Greater Tehran area. These relaxations particularly relate to construction materials and consumer goods, and include cement, ceramics, glass, shoes, textile fabrics and knitwear. Industries have been categorized into seven groups, depending on the nature of their market, as follows: Groups 1-3: local industries, Group 4: provincial industries, Groups 5-6: national industries, Group 7: international or export industries. Before this liberalization, new entrants to Groups 1-3 industries had to obtain a permit from the provincial office of the Ministry of Economy, and new entrants to other groups had to obtain a license from Tehran. Since the liberalization, entrants to groups 1-4 can obtain a license from the provincial offices. Only a few provincial offices are, however, adequately staffed, and the results of this liberalization have not yet been fully felt.

193. The Ministry of Economy's response to raw materials shortages, which have been accentuated by similar shortages in international markets, has been to liberalize licensing still further, allowing excess capacity since imports could not be relied upon as a safety valve to meet unanticipated domestic demand. The Ministry recognizes that licensing should mainly be concerned with large projects, particularly where economies of scale are significant to regulate foreign investment and to influence plant location. Further, a - 69 -

limited use of the licensing system would enable a careful and thorough economic evaluation of a project than could be undertaken if licensing continued to be general. Such a thorough evaluation would help in establishing an appropriate level and duration of protection and other incentives needed for "infant industries", as well as in strengthening the follow-up system essential for implementation of projects.

194. The Government's policy of regional decentralization of industry and, in particular, moving industry away from Tehran, raises the following issues:

(i) The policy of a total ban on the expansion of plants in the Greater Tehran area may have to be reviewed in the case of multiple-product plants. It can be argued that a firm should be eligible for the tax incentives even when it does not move out its entire plant but transfers plants of only selected product lines. Such flexibility would enable a firm to exploit fully its economies of scale while simultaneously not aggravat- ing industrial congestion around Tehran. The suggested modifi- cation in the present policy does not necessarily imply a firm- by-firm decision, though it might complicate the administrative decision process.

(ii) Regional decentralization should not necessarily lead to a wide dispersion of industrial plants, otherwise manufacturing enterprises will be unable to take full advantage of external economies generated by industrial concentration. The pace of industrialization could be dampened by such a dispersion and the cost of infrastructure - human and physical - could be excessively high.

(iii) An appropriate regional decentralization policy should focus on a limited number of "growth poles". However, as recognized by the Government, a rapidly growing new industrial center may pose problems of industrial congestion unless advance planning of the physical and social infrastructure is stressed. Land policies could be used to stimulate regional decentralization.

195. Export Promotion. Exports of manufactured goods are unlikely to be significant in Iran's balance of payments situation in the next 10 to 15 years. Oil and mineral-based manufactured exports will continue to remain major export items. Indeed, Iran's long-term comparative advantage lies mainly in exploiting the full potential of its mineral resource-based and capital-intensive industries, and also in taking advantage of its proximity to European, Middle-Eastern and South Asian markets. Export diversification would take place through exploitation of forward and backward linkages of the oil industry and minerals such as copper, bauxite and iron ore. Iran is expanding its oil refining capacity at an accelerated pace, and will soon enter into oil-product marketing, and second and third generations of petrochemicals It seems that the backward integration of the oil industry would also be socially profitable. For example, Iran could become internationally competitive in oil and gas pipes, and other equipment needed for refineries and petrochemical plants. As the domestic market for industrial machinery grows and - 70 -

the industrial work force acquires the higher skills, it may be economically viable to produce and export these types of machinery in the next decade. Iran may also capture a substantial portion of neighboring markets for motor vehicles in the near future.

196. The Government had recognized the significance of increasing non-oil and non-traditional manufactured exports by the mid-1960s and established the Export Promotion Centre in 1967. The Centre undertakes various activities including market research and feasibility studies, the preparation of advertis- ing campaigns, the organization of trade missions, participation in trade fairs and exhibitions and the administration of an export incentive scheme. It ad- ministers export incentives such as reduced port charges, reduced freight rates, elimination of municipal taxes, credit facilities, protection against financial risks (excluding exchange fluctuations) through the establishment of the Export Guarantee Fund, reduction in or exemption from direct and indirect taxes payable on export receipts or profits and drawback of import duties paid on directly imported inputs by exporters. In recent years, the Centre has diversified its promotional activities and it expects to stimulate exports of several non-oil, non-traditional manufactured products during the Fifth Plan period. These products include printed and finished cloth, knitwear, canned vegetables and fruit, shoes, particularly with leather tops and plastic soles, buses and minibuses. Nevertheless, the export promotion drive still faces some obstacles. These are:

(i) Enforcement of international standards on export and quality control is problematic and sometimes constrains the maneuver- ability of Iranian exporters to take advantage of the changing international market conditions.

(ii) Until recently, every export consignment was physically inspected by the Customs authorities; this was often causing inordinate delays in loading. Appropriate corrective measures are now being adopted to avoid such delays.

(iii) The ban on the expansion of industrial plants in Greater Tehran is tending to inhibit the exports of several products including shoes, consumer durables, knitwear, textile fabrics and biscuits.

(iv) The import duties are not reimbursed whenever an imported intermediate product is locally purchased by an exporter. Absence of a full reimbursement procedure discourages exporters from using domestic inputs, and tends to deny small producers, who are not direct importers of their inputs, a chance to take full advantage of the drawback system.

(v) Booming domestic demand is making inroads into the exports of manufacturers. Domestic profits are frequently so high that even the liberal export incentives scheme fails to induce entrepreneurs to penetrate (competitive) markets abroad. - 71 -

197. Taxation and Tax Incentives. The granting of an industrial license to an enterprise automatically carries with it an attractive package of tax incentives. The exact nature of the package depends on a number of considerations, including the location of the plant, the type of ownership, corporate structure, reinvestment of profits, and export promotion. Company profits are usually exempted from corporate taxation for a period varying between five to 15 years, provided plants are located at least 120 kilometers' distance from Tehran. 1/ All companies listed on the stock exchange are allowed a 15 percent deduction from taxable profits provided their shares are widely held. Profits reinvested within three years are exempted from income taxation provided reinvestment exceeds five percent of a plant's fixed assets and is made beyond 120 kilometers from Tehran. Firms engaged in developing export markets are also eligible for some tax-exemptions. The effectiveness of these tax incentives in achieving their objectives has rarely been carefully studied in any developing economy, and Iran is no exception to this general rule. In particular, tax exemptions granted to a foreign investor can be questioned, be- case, unless a tax "sparing" provision has been negotiated with the foreign government, the beneficiary is likely to be the foreign government and not the investing firm. The tax system provides substantial premiums for large corporations registered at the stock exchange and having widely diffused ownership of shares on the assumption that this fosters the development of the capital market and widening of industrial ownership. But the effects of such incentives and the extent to which they lead to the stated objectives needs further study.

198. Recent changes in the system of excise and sales taxes show that the Government is blending revenue and protection aims with the social objective of more equitable distribution of income. Excise taxes have been gradually increased on de luxe models of domestic cars, television sets, and beverages. Such taxation helps to prevent excessive profits by domestic producers and either discourages the consumption of luxury and semi-luxury goods or contributes to revenue.

199. Industrial Credit and Capital Markets. The sponsors of an industrial project supply on average 40 percent of fixed investment in the private sector, while suppliers' credits and other foreign funds amount to 35 percent, IMDBI and ICB to approximately 15 percent and four percent respectively, with the remainder coming from commercial banks and the bazaar. Because IMDBI and ICB provide on average one-third of the overall capital requirements of the projects financed by them, they are directly involved in almost 60 percent of private industrial fixed investment. Both IMDBI and ICB have played a very important promotional role in the industrialization of Iran. In particular, IMDBI occupies a unique position in this respect - as an innovator. IMDBI has brought together entrepreneurs and interested foreign participants, negotiated agreements, assured technical assistance, worked as mediator between all parties, and through technical, financial and managerial advice ensured

1/ For those in the Esfahan area, only 50 percent of profits are exempted. - 72 - that projects were implemented and operated in accordance with modern business practices. 1/

200. IMDBI utilizes almost 95 percent of its resources in supporting manufacturing industries, essentially catering to the long-term needs of large enterprises. The average size of loans committed during 1972/73 was 115 million rials and only 10 percent of the resources were committed for loans below 50 million rials. ICB uses almost 90 percent of its resources for industrial enterprises, but approximately one-third of the amount is given for working capital. It caters to the needs of both large and medium size enterprises, although the bulk of industrial loans are given to relatively large firms. The average size of loan has varied considerably from year to year - it was 19, 51, and 31 million rials respectively during 1970, 1971 and 1972. ICB pays special attention to labor intensive industries; 87 percent of the amount of industrial loans approved in 1972 was for food processing, construction materials, metal products, and textiles. IMDBI, on the other hand, committed only 44 percent of its lending to these industries during the same period, and approximately 36 percent to capital goods and consumer durable industries.

201. The Agricultural Development Bank of Iran (ADBI) is an autonomous government corporation founded in 1968 to encourage and assist large-scale private investment in agriculture, animal husbandry, and agro-industry. A new privately owned development bank, the Development and Investment Bank of Iran (DIBI) was established in June 1973. It specializes in long-term lending, equity investment, and underwriting of large industrial enterprises, and gives preference to "priority" industries suggested by the Ministry of Economy. Preference is also given to those enterprises which have gone public and have therefore implemented the program of widening industrial ownership. In recent years, Iranian industry has been growing so rapidly that the need for an alternative source of funds was felt both in the Govern- ment and business community; IMDBI had reached a virtually monopolistic position, and the demands for industrial finance and promotion of new industrial enterprises were increasing continuously. Hence, DIBI will hopefully both compete with and complement the innovator's and financier's roles of !ODBI.

202. In recent years, medium and long-term capital borrowing have not posed any serious problems for large industrial enterprises. Small to medium size firms, however, have faced an acute scarcity of capital, primarily because of their apparent lack of "creditworthiness" as perceived by money lenders or bankers; the rigorous - generally 200 percent or more - collateral requirements of immovable property - land and buildings - imposed by banks, makes it

1/ For details, see IBRD: Appraisal of the Industrial and Mining Develop- ment Bank of Iran, Report 259a-IRN, January 1974, pp. 4-6. - 73 -

almost impossible for most small enterprises to borrow. I/ Availability of working capital or short-term funds is more uncertain and depends, inter alia, on the "tightness" of monetary policies. Whenever credit is tightened small firms are generally among the first casualties. The working capital problem is likely to be exacerbated as the industrial structure continues to move toward durable and capital goods.

203. For small and medium-size firms there is a considerable overlap among the sources of supply and demand for working capital (short and medium- term), and fixed capital (long-term loans and equity). In the absence of adequate sources of long-term finance, many firms "roll over" short-term borrowings for long-term financing. The cost of borrowing capital by small and medium size firms thus goes up, and at the time of a credit squeeze, the problems of these firms are accentuated. To the extent this practice is common in Iran, as it is in several other developing economies, the available statistics on industrial financing present a distorted view of shortages of short-term and long-term funds. Banks have recently been supplying almost 50 percent of the short-term capital for industry. About 20 percent of short-term capital is supplied by self-financing from cash flows, and the remainder is supplied by suppliers' credits, the bazaar, and distributors who purchase a factory's production in advance.

204. The share and bond market is very limited in Iran. The Tehran Stock Exchange, sponsored by the IMDBI, was established in 1968, and is still in its infancy, despite the attractive exemptions for a company listed on the Exchange. For instance, any company whose shares are listed is entitled to a 15 percent exemption from total taxable income. If at least 33 percent of new equity is open to the general public, then the exemption limit is raised to 20 to 25 percent depending upon the extent of public participation. Profits earned in selling shares are completely tax-free. 2/ Moreover, a company, whose capital is divided only into registered shares, and whose number of shareholders exceed 100 with no one holding more than 10 percent of equity, is exempted from 10 percent of the corporate income tax payment. Only 23 industrial and banking companies, with a paid-up capital of 12 billion rials, were listed on the Exchange at the end of 1972 and the total paid up capital of listed industr4d companies was 6.5 billion rials. The annual turnover at the Exchange in 1972 was just above one billion rials, of which nearly 70 percent was in Government bonds, earning more than nine percent tax-free dividends, and about one-third of a billion was in share transactions. The very slow growth activity on the

1/ Sometimes movable property - plant and equipment - is acceptable to the banks, but only at greatly undervalued prices. Inventories, if exceptionally accepted as collateral, are usually stored under lock and key with access jointly by the Bank and the firm.

2/ Dividend taxation in Iran is withheld upon distribution of dividends. Fifteen percent of dividends distributed to local shareholders is withheld, and a graduated scale is applied to dividends remitted abroad. Undistributed profit is subject to a flat 25 percent tax. - 74 -

Exchange can be attributed to a variety of factors. For instance, tax incentives may be ineffectual when there is tax evasion. The financial disclosures required for listing purposes may result in assessment for "back taxes". High rates of profitability make self-financing easier and reduce the need for external financing. High and risk-free returns from Government bonds, and time and savings deposits as well as their liquidity considerations tend to make the equity market less attractive. Finally, there seems to be widespread aversion to breaking up family control of companies, and consequent lack of public confidence in companies under tight family control.

205. The Government recognizes the serious socio-economic implications of concentration of industrial ownership in the hands of a few families. It has set the continuation and expansion of sale of shares in private industrial concerns to their workers and employees as an important income distribution objective during the Fifth Plan. Large industrial enterprises are persuaded to allow workers, white collar employees, and the general public to buy one-third or more of the shares of a company. Workers and employees are eligible to buy shares equivalent to up to two months of their wages and salaries at the issue price of the shares of companies in which they work. They can buy even more shares, but then they have to pay the market price. In the absence of a well-organized stock exchange it is difficult to evaluate the market price of a share, but the program is itself a part of building up the stock exchange.

206. Small-Scale Industries. The Government has been emphasizing the development of labor-intensive small and medium industries, particularly in the backward regions over the last decade. This program is intended to meet several objectives simultaneously. Development of modern small- and medium- scale industries will lead to the regional decentralization of industries. This will generate greater employment opportunities both in rural and urban areas. Labor productivity will be improved in these regions and consumer demand will expand. The industrial ownership base will be broadened so that the benefits of industrial progress may be more equitably shared. However, to date, despite several steps taken by the Government, the growth of medium- and small-scale industry has been limited. The Government established the Organization for Small-Scale Industries and Industrial Estates of Iran (OSSI) in 1968 as an autonomous body affiliated with the Ministry of Economy. I/ The Organization - located in Tehran - is assisted by a UNIDO team of experts, and provides technical and commercial advisory services to small industries. Its main focus is on the small industries with a potential for becoming modern. The five-year development program for small industries prepared by OSSI, as incorporated in Iran's Fifth Plan, proposes, inter alia, loans and credits to

1/ An Industrial Estate Authority was established as early as 1965 to support a UND Special Fund Project. It was, however, soon realized that establishment of a demonstration Industrial Estate by itself would not be adequate to promote growth of small industries. The Government then decided to replace the Industrial Estate Authority by OSSI. - 75 -

some 10,000 small industrial enterprises. 1/ The Plan further emphasizes the interdependence between small industries and other sectors of the economy, and proposes to ease general credit facilities for small industries.

207. The availability of finance is an important obstacle to the improvement of productivity and growth of small enterprises, whether modern or traditional. When the same interest rate is institutionally fixed for lending to both large and small enterprises, the latter are often denied the funds, because of higher risk as perceived by the lending institutions. As a means of minimizing risk, the lending institutions also insist on collateral, particularly in the form of immovable property, and on detailed financial and technical information about the enterprise. The capability to meet these demands is most lacking in small enterprises, and hence, small enterprises end up borrowing in the bazaar at exorbitant rates. Because the Government has been aware of such obstacles, it has initiated several schemes to alleviate the financial hardships of small entrepreneurs; none have yet been operating for a sufficient time to be effective.

208. The Industrial Guarantee Fund (IGF), based on counterparts of the USAID funds, was established in 1961 to supply capital for small-scale industries. During the first six-seven years, the Fund's program moved very slowly and administrative expenses exceeded investment income. In 1968, the Fund's administration was transferred to Bank Omran; since then its activity has accelerated considerably and loans granted to small industries amounted to 177 million, 152 million and 128 million rials respectively during 1970, 1971 and 1972. These loans are essentially, though not exclusively, for fixed capital and they have gone to handicrafts, hotels, restaurants, dry cleaning establishments, etc., besides manufacturing industries. The maximum amount of a loan is 5 million rials. Interest charged is eight percent per annum up to three million rials, and 10 percent on higher amounts. The Fund has served some small enterprises, but the resources available to the Fund have not been fully utilized because authority is centralized in Tehran. Commercial bank policies are generally followed in operating the Fund, and little promotional work has been done to inform and assist potential small entrepreneurs.

1/ The definition of a small enterprise adopted by the OSSI is quite different from the one followed in statistical surveys. According to the OSSI definition, a small unit must satisfy five conditions: (i) its fixed assets should not be more than 7.5 million rials and not more than 25 percent of such an investment should be on land and buildings; (ii) its employment should not exceed 50 persons on a single-shift basis; (iii) it should not have any specialized management; (iv) its items of production should not pertain to artistic goods (e.g., carpet weaving); and (v) it should have no financial participation by a foreigner. The OSSI has been considering raising the fixed investment limit to 15 million rials. - 76 -

209. The Industrial Credit Bank (ICB) commenced a scheme to provide up to one-half million rials to small enterprises at eight percent interest in 1972. Since this is the first time the ICB has dealt with small enterprises, the scheme is confined only to the provinces of Fars and Khuzestan, and is administered through four commercial banks - Bank Melli, Bank Tehran, Bank Bazarganin, and Bank Etebarat Iran. During the last five months of 1972, ICB approved, under this scheme, nearly 400 loans amounting to 120 million rials. ICB has earmarked seven percent of its lending during the Fifth Plan for this scheme. The collateral requirements seem to be somewhat less strin- gent under this scheme because any business assets and/or personnel guarantees of the third party are acceptable.

210. In early 1973, the Bank Melli agreed to act as agent for OSSI to provide loans varying between one and three million rials to small enterprises at eight percent per annum. Both the Plan and Budget Organization and the Bank Melli have provided 100 million rials each for this purpose. As a safeguard against possible misuse of these subsidized loans, the Gov- ernment has refrained from publicizing that risk of non-payment or non- recovery is fully covered by the Government and Bank Merkazi - 75 and 25 percent, respectively. Bank Melli still prefers real estate as collateral, but in special cases, as a last resort, a branch manager may consider movable assets such as machinery and equipment as collateral at his own discretion and responsibility. Collateral has to be equivalent to 150 percent of the amount of the loan. This scheme can be a potential major step toward credit liberalization because the normal commercial banking practice in Iran is to accept only non-movable property, such as land and buildings as collateral in amounts equivalent to 200 percent of the loan amount. In particular, some mechanism has to be devised to compensate a branch manager for the risk and innovative steps undertaken by him in his endeavor to reach the disadvan- taged, poor people. If the subsidized funds, when channeled through a commercial bank, remain beyond the reach of small, poor entrepreneurs, the Bank may have to modify the existing arrangements and/or devise new institutions.

211. Some important characteristics of the credit facilities for the poor, small entrepreneurs, are the immediate availability of funds, no collateral requirements, longer maturity of loans, and "reasonable" interest rate. The difficulties in mitigating the inherent problems in meeting these conditions are recognized by the Government. The experience learned by the Govern- ment through the steps taken in recent years will assist it to bridge the gap between the policy formulation and implementation. In general, simplified administrative procedures, decentralization of authority, development of a well-designed system of checks and balances, and a commitment to the cause of alleviating poverty are required. The Government has thus recently established a regional development bank in Ahwaz to provide credit facilities for small enterprises in the southern region, and it is considering establishment of more regional development banks. 1/

1/ As a supplementary measure, hire-purchase schemes could be worked out to facilitate the availability of fixed capital to small enterprises. - 77 -

212. The need to obtain commencement and operation permits, even though they are not legally required in a strict sense, is another obstacle for small enterprises. In practice, access to tax incentives, credit from Government- assisted institutions, exemption from duty on imports of intermediate and capital goods, commercial rates for public utilities, etc., are all dependent on such permits. The bureaucratic procedures, delays, and administrative requirements sometimes tend to dissuade small entrepreneurs from starting a new business or new production line, or to compel them to operate or expand their small business without the Government's full knowledge. The situation becomes accentuated for small entrepreneurs living away from the national or provincial capitals. The OSSI is working on a proposal to abolish licensing requirements for "small" industrial establishments to complement the Ministry of Economy's recent liberalization. Replacement of licensing requirements by registration for statistical purposes would be an appropriate measure.

213. The bias against small enterprises also exists in some of the tax incentive policies affecting manufactured exports. Exporters of non- traditional products are eligible for exemption from customs duty and commercial benefit tax on the imports of their inputs. A small entrepreneur engaged in manufacturing export goods can rarely afford to import his inputs directly from abroad, because of the small size of his order, lack of resources, and unfamiliarity with foreign markets. He has to buy imported inputs locally at a cost which includes high trade margins and import duties. Thus, he is unable to take advantage of the tax exemption policy and ends up paying a considerably higher price than a large producers. The OSSI, in conjunction with the Exports Promotion Centre, is currently working on a bill to remove this bias from the tariff policy.

214. Some small industrial enterprises require technical, managerial, and marketing assistance. The OSSI is actively engaged in providing these and other promotional services with the assistance of the UNIDO. The UN experts and their Iranian counterparts from OSSI visit small industries periodically, mainly in the Greater Tehran area, for this purpose. Moreover, industrial consulting engineers through factory visits and training courses in specific subjects are organized for the benefit of small industrialists. The OSSI is also assisting the promotion of new units in the field of consumer goods and service industries, by conducting feasibility studies, preparing model schemes, providing technical guidance in the selection of machinery, training workers, and sponsoring applications for industrial licenses and loans.

215. It is clear from the experience of the Industrial Estate in Ahwaz, that promotion of small industries through industrial estates is likely to be very slow, and supplementary ways must be found to accelerate the development of small industries. Consequently, the OSSI is giving high priority to the promotion of new, modern, small industries which have linkages with large-scale establishments and with other sectors of the economy. The OSSI proposes to organize a network of modern, small industries to produce parts and components needed by large industries on a sub-contract basis. It appears that modern, small factories will continue to play an important role - 78 - as the industrialization continues at an accelerated pace during the 1970's. The Government would thus continue its policies of minimizing, and if possible of eliminating, inadvertent discrimination or overt bias against small enterprises. It would also reserve product lines for small-scale industries and prohibit production of those products in large establishments unless a very sound case is made by the large establishment.

216. Handicrafts: In the mid-1960s, the Government decided to preserve and develop traditional handicrafts and established the Iranian Handicrafts Centre affiliated with the Ministry of Economy in Tehran in 1965. The Centre provides technical aid and credit to craftsmen and artisans; helps them to secure materials and tools; organizes production cooperatives and work shops; establishes promotional and training centers; builds model plants and projects to improve product quality and standards; and takes a variety of steps for marketing in Iran and abroad. The Centre has more than 100 technical experts, who not only assist in production and the improvement of quality of handicrafts, but also assist in developing new product lines as well as developing new marketing channels. It has conducted a large number of field investigations which have led to an accelerated growth of several handicrafts, loaned over 100 million rials to cooperatives, assisted in producing raw materials worth 300 million rials, established 35 new workshops, modernized 140 existing workshops, set up several thousand new designs, established regional guidance centers, organized displays and exhibitions in Iran, participated in exhibitions abroad, established retail shops, and stimulated private traders' interest in handicrafts. The Center needs further encouragement and support to expand its activities during the Fifth and Sixth Five Year Plans.

217. Handicrafts can substantially supplement incomes of part-time craftsmen and artisans, because of technical flexibility, use of only simple, locally manufactured tools and abundance of the skills with little alternative uses. Promotion of handicrafts will also help in raising the incomes of full-time but low-paid artisans and craftsmen. At this time continued promotion of handicrafts is important to the basic objectives of the Iranian development program. In particular, promotion of handicrafts will help to improve the living standards of poor people; it will assist in achieving a more equitable income distribution and reducing rural-urban income disparities; it will contribute towards increasing demand for industrial products and will help to diversify export earnings. Eventually,the significance of handicrafts will decline as Iran succeeds in modernizing its economy. But that situation may arise sometime in the 1980s when the entire Iranian labor force will be engaged in modern, reasonably well paid jobs. Until then, full advantage should be taken of the cushion provided by the handicrafts in supplementing incomes of relatively poor artisans and craftsmen. - 79 -

3. INFRASTRUCTURE

I. AN OVERVIEW

218. The development efforts of the public sector in Iran during the past decade (1962-72) have been characterized by huge investments in infrastructure. A large part of the Government's resources were devoted to the construction of conventional type of infrastructure facilities, in transport, power, irrigation, etc., but considerable investments were also made in social overheads. Although Iran has adhered to the strategy of promoting economic development through an appropriate mix of public and private sector participation, the public sector has played an active role and has invested heavily.

219. During the 1960's, Government investment increased from 16.1 billion rials in 1962 to 149.4 billion rials in 1972, at an average annual rate of 25 percent per year. As a proportion of total gross capital formation it increased from 33.0 percent in 1962 to 54.0 percent in 1972.

Table 18: SECTORAL DISTRIBUTION OF GOVERNMENT DEVELOPMENT FUNDS

(million US$) Third Plan Fourth Plan Fifth Plan /1 (1962-67) (1968-72) (1973-77)

All Sectors 3,022 100.0 7,241 100.0 22,884 100.0

Agriculture 342 11.3 615 8.5 3,044 13.3 Industry and Mining 360 11.9 1,542 21.3 3,387 14.8

Economic Infrastructure 1,671 55.3 4,135 57.7 10,504 45.9 Energy Sector 462 15.3 1,361 18.8 3,112 13.6 Others 1,209 40.0 2,773 38.3 7,392 32.3

Social Infrastructure 547 18.7 941 13.0 5,378 23.5 Education 275 9.1 434 6.0 3,364 14.7 Others 272 9.0 507 7.0 2,014 8.8

Others 102 3.4 - - 571 2.5

/1 Original allocations for development expenditures in the public sector.

Source: Plan Organization, Various Plan Documents and Financial Reports.

220. As Table 18 shows, the investment priorities of the Government have undergone considerable change. During the Third and Fourth Plans there was greater emphasis on economic infrastructure and industry than on agriculture and social overheads. During the Fifth Plan, however, the proportions of development funds to be devoted to agriculture and social infrastructure increased substantially. At the same time, the absolute size of the Government's - 80 - investment program during the Fifth Plan is, in itself, a cause for concern in view of the recent problems of the Plan and Budget Organization (PBO) with project planning, implementation and cost overruns. If the quality and effectiveness of investment is to be maintained, measures to impose stricter financial discipline and closer supervision of the activities of the executive agencies must be adopted. This is all the more necessary because of the relative inexperience of the executive agencies with project planning and implementation, and also because the agencies involved will have to draw upon a limited and much sought after pool of managerial and technical skills. How the latter are eventually allocated between the private and public sectors and between various public sector agencies, will partly determine the effectiveness of public sector investment.

221. A second major aspect in infrastructure investment is the formulation of specific sectoral growth policies. In the past, and particularly during the last phase of the Fourth Plan, infrastructure investment occurred almost on an ad hoc basis. However, rapid expansion of the economy ensured that, if excess capacity was created, it could soon be absorbed. Yet the sheer size of the anticipated growth in Government investment and the increasing complexity of the economy imply that there is now a clear need for the formulation of infrastructure growth policies. At present it is difficult to discern the overall energy policy of the government, or how the transport sector is to be developed, or what structure is to be given to social services. In an economy which is faced with few financial constraints, it is this type of planning which is needed most.

II. DEVELOPMENT PLANS AND PRIORITIES

222. Iran has nearly 25 years of experience in development planning. The First Plan (1948-55) was primarily aimed at postwar reconstruction; however, many of its targets could not be achieved because it coincided with the nationalization of oil and the consequent cessation of oil revenues in the early 1950s. The Second Plan (1955-1961) focussed on creating the basic infrastructure necessary for economic development. The scale of spending, however, contributed to a balance of payments crisis. A subsequent review of the Plan identified the lack of control and coordination in most programs as a major shortcoming.

The Third Plan (1962-1967)

223. The Third Plan came under the direct responsibility of the Prime Minister and a much greater effort was made to relate the list of projects to sectoral and overall priorities. During this period, the responsibility for project execution was formally handed over to the existing agencies although in fact, the Plan Organization still retained the responsibility to prepare projects, supervise their implementation, and coordinate the development process. The Plan envisaged investments totalling 290 billion rials during the 5-1/2 year period, of which 158 billion rials was to be in the public sector and 132 billion rials in the private sector. In addition, 32 billion rials - 81 -

of recurrent expenditure in the public sector and 20 billion rials in the private sector were envisaged. Thus, the overall size of the Government's development program was 190 billion rials. This was subsequently increased to 228.9 billion rials. The initial size of the program was based on the assumption of a 6 percent growth in the Iranian economy, and the amount of gross fixed capital formation, that took place in the last year of the Second Plan (about 43 billion rials). The planners assumed that the ratio between gross fixed capital formation and GNP would remain reasonably constant, at about the level recorded during the Second Plan. Thus the required increase in fixed investment would also be 6 percent. By the end of the Third Plan, total development expenditure actually incurred by the public sector was 204.6 billion rials, a little over the original allocation of 190 billion rials and 89.4 percent of the revised allocation.

224. The thrust of the Government's investment program in the Third Plan was the expansion of economic infrastructure in communications, transport, energy, and water resources. This emphasis was further accentuated in the revised investment program which allocated 127.2 billion rials, or 55.3 percent, to the conventional infrastructure sectors. In retrospect, it seems that these priorities were well conceived. Economic growth during the Third Plan averaged 8.8 percent per annum as against the 6 percent target, and the investment in infrastructure not only contributed to this growth but also alleviated bottlenecks which would have hampered the growth of other sectors.

225. The changes which occurred between the program originally proposed and the revised program, mainly revolved around increases in the allocations for economic infrastructure. There were substantial increases in the allocations for transport, oil and gas and irrigation. Allocations for power in the original program were considered under the allocations for industry and mining, though in the revised plan separate provision was made. Further, the original program did not make any provision for housing, but in the revised program 12.4 billion rials were allocated for this purpose.

226. Development allocations for the social sectors, consisting of rural and urban development schemes, education and manpower training, and health and social welfare, were reduced slightly in the revised Plan, which did not make a specific provision for rural/regional development programs, since credits for these programs were to come from sectoral allocations. It must be remembered, however, that funds for the social sectors were also allocated from the current budget of the Government. During 1962-1967, a sum of 77.0 billion rials was allocated to education and health programs, which amounted to 28.2 percent of the total current expenditures of the Government, including outlays on security and defense.

227. The combined development rogram for economic and social infrastructure claimed almost three-fourths of public investment funds in the Third Plan. The remaining one-fourth, amounting to 53.2 billion rials, was divided almost equally between agriculture and industry. Actual disbursements for economic infrastructure sectors were about 93.3 percent of the revised allocation; and in the social sectors almost the entire allocation was disbursed. In financial - 82 -

terms, therefore, the Plan infrastructure targets were substantially achieved, as compared with industry, where only about 63 percent of the allocated.funds were disbursed.

228. Although the inter-sectoral priorities of the Third Plan were well conceived, two problems remained at the end of the Plan period. First, agricultural growth was hampered in part owing to inadequate attention paid to water distribution networks. The construction of large dams was initiated, and in some cases completed during the Plan period, but insufficient funds were allocated for distribution networks, with the result that the utilization of available water resources remained low. Second, literacy, though increasing, remained low, while shortages in educated and trained manpower began to be felt. In large measure, these shortages were due to unexpected demands generated by rapid growth of the leading sectors of economy, and the programs that were undertaken during the mid-1960s to remedy these shortages could not be expected to produce results until the early 1970s. Additionally, however, the increasing youthfulness of the population continued to put heavy pressures on available educational and training facilities. A further weakness of the Third Plan with respect to social sectors was a lack of specific programs for rural and regional development. Credits for rural development programs were specified in major sectors, but there was no coordinated effort to bring together these programs so as to have a maximum impact in a given area. Consequently, the disparities between the urban and rural centers in terms of income and civic facilities continued to widen. Similarly, the Third Plan sponsored regional development programs, but no specific allocation was made for this purpose.

The Fourth Plan (1968-72)

229. The Fourth Plan was nearly 2-1/2 times larger than the Third Plan. Initially, 480.0 billion rials were allocated of which 380.2 billion rials represented fixed investment, 64.9 billion rials recurrent expenditures associated with the fixed investment, and the remaining 34.9 billion rials fixed investment by private sectors financed indirectly from the Development Budget. The Plan was later revised to 548.5 billion rials. The priorities of the Fourth Plan showed a remarkable similarity with those of the Third Plan with respect to economic infrastructure. The emphasis in the investment program continued to be on the supply of the infrastructure facilities so as to provide a base for accelerated growth of the economy, particularly for the growth of a modern industrial sector. In the original allocation of the Fourth Plan, 52.4 percent of public sector development funds were earmarked for economic overheads. This proportion was further increased to 57.1 percent in the revised program, or close to the proportion of the disbursements to economic overheads in the Third Plan. The relative share of social overheads was reduced from 18.1 percent in the Third Plan to 13.8 percent in the Fourth Plan and there was also a cut in the share of agriculture, from 11.3 percent to 8.6 percent, while allocations to the industrial and mining sector were increased substantially, though these were concentrated on a relatively small number of major projects. - 83 -

230. Reduced investment allocations to social overheads did not imply a neglect of these sectors, because to a certain extent, they were compensated by funds from the general budget, especially for the education and health programs. Nevertheless, the neglect of agriculture proved to be a handicap in Iran's efforts to harmonize the overall pattern of development between the major sectors and contributed to a further widening of income gap between the rural and urban population.

The Fifth Plan (1973-77)

240. The development program for the Fifth Plan in the public sector was originally put at $22.8 billion. In view of increases in the price of oil and consequent increases in the Government's resources, these development allocations were increased to $29.2 billion in December 1973. It appears that the infrastructure priorities of the Government have not changed significantly. 1/ The largest portion of the public sector development funds, about $10.5 billion, has been allocated to economic overheads. The highest priority, therefore, has again been accorded to the conventional infrastructure sectors even though the relative share has declined in comparison with the Fourth Plan. At the same time, with the emphasis on improved income distribution and a wider dissemination of development benefits, the Fifth Plan has allocated a much greater proportion to the social sectors -- 23.5 percent of development funds. As in the previous years, the investment funds for the social sectors will be supplemented by annual appropriations from the current budget.

241. Immediate priority in the Government's development program for economic infrastructure has been accorded to energy, which includes the oil, gas, and power sectors. In the oil and gas sector the emphasis of the program is on the projects that would further contribute to the export ccapability of Iran, such as the direct participation of NIOC in overseas operations, mainly in oil refining, and the establishment of liquified natural gas (LNG) plants.

242. The Government has allocated relatively more funds for social overheads than it did in the Fourth Plan. The original allocations for education and manpower training programs were about 230 million rials, or about 14.7 percent of development funds, giving education high priority. Primary education programs were allocated about 40.8 percent of this amount; higher education about 26.2 percent. Allocations for health and social welfare programs were small, about 68.0 billion rials or less than 5 percent of the development funds, but these allocations were to be supplemented from the current budget. Renewed emphasis has been given to rural and urban development programs, which include water supply, rural and urban roads projects and sanitation. The emphasis in the power sector is on transmission and distribution as previously, with the generation program largely concentrated on new thermal units. Next

1/ There have been further revisions in the amount of development expenditures of the Fifth Plan since December 1973. But these revisions cannot be incorporated as they remain tentative and have not been ofificially released. - 84 -

in priority are the transport and the housing (construction) sectors. Each of the sectors have been allocated about 11 percent of the Government's development funds, which implies a relatively lower emphasis on transport and a higher emphasis on housing than in previous plans.

243. Availability of development funds for infrastructure project is not likely to be a constraint in the future. However, achievements of the physical targets of the Plan may be hampered because of the difficulties that the agencies concerned may encounter in the preparation and implementation of projects. The planned expansion in the infrastructure is crucial to future development of Iran because of the high rate of anticipated growth of the key sectors of the economy. Although the existing infrastructure seems to be adequate for the existing needs, any shortfall in the targeted expansion could create significant bottlenecks and would be costly in terms of its restraining impact on Iran's development.

III. COST OVER-RUNS AND OTHER PROBLEMS OF IMPLEMENTATION OF DEVELOPMENT PLANS

244. In the past, the Government has experienced several problems in the implementation of development plans. Notable among these have been cost overruns on certain key projects. In 1972 the Plan Organization instituted a study to analyze the project preparation and implementation with a view to determine the causes for cost overruns and to devise appropriate measures to counteract them. The concern with cost overruns grew strong during the Fourth Plan when two major upward revisions of the size of the overall investment program were undertaken. While the revisions involved inclusion of new projects in some sectors, in many instances it was occasioned by increases in the cost of ongoing projects. This has been particularly true of large-scale projects in the infrastructure program as well as in other sectors. The size of the projects, however, was not the only factor responsible for cost overruns; a number of small projects also experienced significant cost increases over the initial estimates.

245. In the industrial sector, for example, cost overruns occurred in sugar manufacturing plants, aluminum plants, car and tractor manufacturing plants and petrochemical plants. The highest cost increase occurred in the case of the Esfahan Steel Mill; the original allocation of 16.7 billion rials was increased to 28.6 billion rials in the mid-Plan revision and was finally increased to 55.3 billion rials. Expenditures on this project by 1972 were reported to be 55.0 billion rials, amounting to almost half the total investment of 113.1 billion rials in the sector.

246. In the energy sector, too, cost-over-runs occurred in a number of large-scale projects, the highest being in the case of Iranian Gas Trunk Pipeline (IGAT) Project. The original allocation of about 16 billion rials was later increased to 39 billion rials, which, by the end of 1972 and with a few elements of the project still incomplete had been spent. In the water resources sector, there were also cost increases. For example, allocations - 85 -

for the Shah Abbas Kabir dam were increased from 4.2 billion rials to 4.5 billion rials; for the Reza Shah Kabir dam from 3.1 billion rials to 4.5 billion rials.

247. During the Fourth Plan, the number of development projects undertaken was over 800 and many of these consisted of a large number of sub-projects. The Plan Organization until very recently was involved with the preparation, implementation, monitoring, and, in case of large size projects, with direct supervision, of projects. The variety and the number of projects almost inva- riably exceeded the capacity of PBO to regulate and monitor in the implementation stage. In addition, some of the large scale projects were of a complex nature, for which previous experience simply did not exist in the PBO, e.g., the steel mill, the IGAT, and the multipurpose dams. There were few precedents to these types of projects and there was no established machinery in the PBO or elsewhere to cope with the problems during implementation. In some cases, the problems that arose were simply outside the control of PBO and even the country itself.

248. In addition to the PBO, about 180 executive agencies, including independent organizations, ministries, and ministerial agencies, are involved in the implementation of development projects. Their capabilities for implementation and supervision vary according to differences in their executive capacity, technical ability and project experience. Similarly, about 150 technical service organizations, including Iranian and foreign consultant firms, technical cooperation agencies organized on an ad hoc basis, and a host of technical bureaux of Government agencies are involved. Qualitative differences among these organizations in terms of their capabilities and experience are substantial. Finally, about 470 Iranian contracting companies listed with the PBO participate in development projects and occasionally liaise with foreign firms on major contracts. (A number of other Iranian contracting and consulting firms that are awaiting formal approval of PBO, frequently obtain sub-contracts from the prime contractors.) Again, the expertise of these contracting firms in carrying out development projects ranges widely from those that are very poor to those which are of high quality and meet international standards of excellence. This applies equally to the manufacturers or suppliers of materials and equipment required for the various development projects. The project-implementating machinery as a whole, therefore, has not been uniform and has contributed to the frequent cost over-runs observed during the Fourth Plan.

249. In addition to the institutional aspects that have a bearing on the problem of cost over-runs, three other factors have been important:

(a) Inadequacies or inaccuracies in the preliminary forecasts of project costs.

(b) An unforeseen increase in the size of the project or an increase in its constituent elements.

(c) Administrative and technical weaknesses of the implementing agencies and problems faced during execution of projects. - 86 -

With regard to the forecast of the project costs, the problems clearly lie with the project appraisal procedures and methodologies. Cost over-runs in major projects can largely be traced to inadequacies in the evaluation procedures. The PBO is of the view that preliminary research and pre-investment studies have not been of a sufficiently high standard due to a lack of effort in collecting the necessary economic and technical data base, inadequate technical and advisory services, and a lack of expertise or experience on the part of the project evaluation teams. Consequently, the optimal size of projects could not be accurately determined.

250. Cost over-runs due to subsequent additions of other elements to a project underway have occurred largely due to weaknesses or deficiencies in the estimation of the real needs of the project by the project evaluation team, inaccuracies in the technical services provided by the responsible group, or inadequate expert advice on items like soil surveys, mapping, planning, or inadequate supervision of the projects.

251. Normally, three parties are involved in the implementation of a given project; the contractor, the executive agency and the PBO; though occasionally consultants may be hired to do evaluation and supervision. Contrac- tors are selected mostly on the basis of competitive bidding for construction work and procurement. In this tripartite arrangement problems have often arisen owing to a lack of clarity as to who has the responsibility for the project. Under the new system, the executive agencies, usually the infrastructure ministries, will have the sole responsibility of project implementation and supervision. The purpose of this arrangement is to promote effective and prompt decision making at the appropriate level during the implementation phase of the project and to eliminate irrelevant and often excessive regula- tions. On the financial side, there has been occasional failure to meet payments promptly due to excessive control and complicated procedures which may handicap a contractor at crucial stages. in case of procurement from abroad, a supplier may not be able to open accounts in time to purchase imported equipment and materials, due to tight conditions of credit, especially where suppliers' credits are utilized.

252. To cope with these problems, the PBO, as a first step, has initiated cost over-run studies with the cooperation of other executive agencies. It has instituted a central information system to collect and process project data. It has taken steps to improve technical and advisory services on which it draws heavily to prepare and implement projects. Further, the PBO has established procedures to evaluate the experience and capabilities of consulting and contracting firms. The latter have been graded and classified. Bidding procedures are under review, and in future, PBO is likely to insist on fixed price contracts with the usual provisions for contingencies. Efforts are being made to standardize technical specifications of materials and processes to safeguard against cost discrepancies. Cost and price estimates will henceforth be made public so that bidders will have equal access to information, and, hopefully, subsequent cost revisions will not be necessary. - 87 -

IV. SECTOR PROFILES

1. Energy

253. The central element in the dynamism of the Iranian economy for the past decade has been the rapid growth of the energy sector. More than any- thing else, the contribution of this sector, in terms of foreign exchange earnings, Government revenues, the supply of petroleum products, and the supply of gas and electric power for domestic use, has provided Iran with a strong basis for rapid growth. Iran has vast and diversified energy resources. Oil is the major resource but large gas reserves have also been discovered and there are still many coal deposits left unexploited. 1/ Though most of the electricity generated in Iran has been obtained from thermal units, and, in recent years, also from gas turbines, nearly 30 percent is now obtained from hydroelectric plants.

254. Allocations for the energy sector in the Third Plan amounted to 35.1 billion rials, of which 32 billion rials were reported disbursed at the end of the Plan period. This allocation amounted to 15.3 percent of total development funds. Nearly half the allocation, 17.7 billion rials, was for oil and gas, and the remaining 17.4 billion rials was for electricity. The Gov- ernment's direct participation in oil and gas has been through the National Iranian Oil Company.(NIOC), which, from the mid-1950s has distributed and marketed petroleum products locally. In the Fourth Plan allocations for energy amounted to 103.2 billion rials, or about 18.8 percent, of the total development expenditures of the public sector, while actual disbursements were 95.0 billion rials. For the Fifth Plan period, the energy sector has been allocated 213.2 billion rials in development funds, and it is expected that this amount will be further increased in the revision of the Plan. At its current level, this allocation amounts to 13.2 percent of the development program.

255. Transport of petroleum products within the country increased more than threefold during the past decade, from 2.0 million ton/kilometers in 1962 to an estimated 8.4 million ton/kilometers in 1972. Oil pipelines have carried about 60 percent of domestically distributed oil products, railways about 22 percent, and road tankers 18 percent.

Natural Gas

256. Public sector participation in the production, distribution and sale of gas is largely through the National Iranian Gas Company (NIGC). In the Fourth Plan, most of the development funds for gas were allocated for the Iranian Gas Trunk Pipeline (IGAT), a project which has experienced huge cost overruns. The original allocation for the project was 17.5 billion rials to construct 1,100 km of trunk pipeline to supply gas to the Soviet Union and to provide gas to Iranian villages along the trunk line through

1/ For details see Chapter No. 4, Oil and Gas, of this Volume. - 88 - additional distribution networks. This allocation was more than doubled to 40.5 billion rials in the final revision of the Plan and the auxiliary project of gas distribution to villages was postponed until the Fifth Plan period.

257. For the Fifth Plan, oil and gas have been allocated about 275 billion rials for fixed capital investment, which is four and a half times the allocation in the Fourth Plan. Of this, about 191 billion rials have been allocated for oil and 84.5 billion rials for gas. The plan anticipates that domestic consumption will increase at an average annual rate of 13.2 percent. Refining capacity for domestic consumption is planned to be increased from a current level of 242,000 barrels a day to 459,000 barrels per day. Trans- port capacity through pipelines is planned to increase by the construction of 1,100 kilometers of new lines during the Fifth Plan, and about 86,000 cubic meters of storage capacity is to be built mainly at airports and the Persian Gulf Islands to store oil products for distribution.

258. Consumption of natural gas in Iran is expected to increase threefold over the next five years, from 3 billion cubic meters in 1972 to about 9 billion cubic meters in 1977. The demand for liquid petroleum gas (LPG) is expected to double over the same period from 115,000 tons to 230,000 tons. Exports of natural and liquified gas are also expected to increase, with plans for LPG exports to rise from 200,000 tons to 4-6 million tons in 1977. An important element in these plans is the installation of new gas liquefaction plants by the NIGC, in cooperation with foreign firms, with a total capacity-of 11.2 million tons a year.

Electricity

259. The development of electricity generation and distribution during the past decade has been remarkable. In particular, achievements in the public sector, which accounts for nearly two-thirds of total power generation, distribution and sales in Iran, have been substantial. Installed capacity in the public sector increased from 440 MW in 1963 to 2,200 MW in 1972, while electricity generation increased from 742 million kwh to 6,195 million kwh over the same period at an average annual rate of 26.5 percent. Total consumption (sales) of electric power has been increasing at about 19 percent annually and per capita consumption of electricity has risen from 99 kwh in 1963 to 293 kwh in 1972 and is expected to increase to 841 kwh by 1977.

260. The present organization of the power sector evolved over the past 10 to 12 years. The participation of the public sector in the development of power in Iran, however, has intensified considerably over the last five years. During the 1950s, electric power was mainly provided by small private and municipally owned utilities or by plants operated by private industries. Most power production was from diesel generating units. Later the Plan Organization initiated a power development program based on hydroelectric and thermal stations. In 1963, the Iranian Power Authority (IPA) was created as an autonomous organization responsible for electricity. Subsequently, it was decided - 89 - that an organization at the ministerial level with wider authority and broader functions was needed. Consequently, the Ministry of Water and Power was created in 1964 to replace the IPA. It was reorganized in May 1974 and renamed as Ministry of Energy.

261. In 1965, the power industry was nationalized to permit the consolidation of the industry and large-scale expansion of generating and transmission facilities. During the Third Plan period (1963-67), a start was made on the development of a nationwide grid system through the construction of transmission facilities in Khuzestan Province and the expansion of transmission systems in the Tehran area. By 1967, all generating facilities were in the public sector except for those in industrial plants. In 1966, a 10-year plan for electricity was drawn up on the basis of a report by American management consultants who recommended consolidation of the electricity supply system through a single company. This eventually led to the establishment of the Iranian Power Generation and Transmission Company, TAVANIR, in 1969. This agency is responsible for planning, generation, transmission and distribution of power in the public sector in Iran. It controls nine regional electric companies (RECs) and the Khuzestan Water and Power Authority (KWPA), but is not involved in hydro-generation. The construction, maintenance and operation of hydroelectric power stations is the responsibility of regional water authorities under the Ministry of Energy.

262. The total gross generation of electricity in 1972 was 10,400 kWh, of which 72 percent was by the public sector and 28 percent was by private industry. Energy sales in the public sector in 1972 were distributed among domestic consumers 19 percent, commercial 19 percent, industrial 46 percent, rural 8 percent, street lighting 6 percent, and miscellaneous 2 percent.

263. The original allocation for electricity in the Fourth Plan was 33.9 billion rials, or 12.2 percent of the investment program in the public sector. In the final revision of the Plan, the allocation was increased to 41.5 billion rials but the relative share of the sector in the investment program decreased to 7.8 percent, which indicates that a relatively lower priority was accorded to this sector. Of the final allocation of 41.5 billion rials, 22.3 billion rials were allocated for transmission and distribution networks, 16.5 billion rials for generation, 1.7 billion rials to rural power programs and 1.1 billion rials to research and manpower training. Comparisons of the breakdown of the original and revised allocations in the sub-sector indicate a considerable reshuffling of the priorities. In the original allocation, 33.6 percent of funds were earmarked for generation and 59.6 percent for transmission and distribution networks. In the revised allocation, these proportions were changed to 39.7 and 53.6 percent respectively.

264. The overall emphasis of the Plan for electricity was clearly on the expansion and modernization of transmission and distribution networks under the management of TAVANIR. The total length of the network increased from 1,791 km in 1968 to 3,340 km in 1972. Adequate funds were allocated to generation facilities which, in view of Iran's enormous oil and gas reserves, consisted mainly of thermal units. Allocations to the rural electrification - 90 -

program were to provide electricity to areas that were not connected with the main transmission network. The total planned generating capacity in rural areas was 70,000 kilowatts, based on diesel units.

265. The outlook for electricity in the immediate future is that of substantial growth, surpassing, in some cases, the already considerable achievements of the Fourth Plan. According to the estimates of the PBO, consumption of electric power in Iran during the Fifth Plan years will increase at an annual average rate of 21 percent, from about 9.1 billion KWH in 1973 to 23.8 billion KWH in 1978. Almost 91 percent, or 21.6 billion KWH of this total requirement will be supplied by the power stations installed and operated by the public sector agencies, mainly TAVANIR, and the remainder will be supplied by private units of industrial enterprises. The growth of per capita consumption is estimated to be about 17.7 percent per annum, somewhat less than experienced in the last five years.

266. As regards the sources of power supply, about 67 percent will be obtained from thermal generators, about 28 percent from hydroelectric generators, and the remainder from gas and diesel units. Installed capacity is expected to increase threefold, from 2,200 MW to 6,200 MW. The Fifth Plan targets also call for a substantial expansion of the existing transmission and distribution networks. The total length of power transmission lines is expected to increase from about 3,340 km in 1972 to about 9,980 km in 1977. The rural electricity distribution program calls for expansion of the electricity supply network to 1,180 "rural development zone centers" which are essentially large-size villages. Priority is given to this program in view of the problems experienced with independent diesel power generating units which will continue to operate in remote areas where transmission and distribution networks will not be constructed in the near future.

2. Transport

267. There are three elements in Government investment in transport in Iran. These are:

(a) Government agencies and state-owned autonomous companies such as the Ministry of Roads, the Iranian State Railways (IRS) and the Civil Aviation Administration.

(b) State-owned companies attached to the Ministry of Finance such as the Ports and Shipping Organization (PSO) and Iran Air.

(c) The Ministry of Economy, which controls the domestic production of automobiles, the Ministry of Co-operatives and Rural Affairs, and the Ministry of Interior. Each have limited responsibilities in rural and regional transport. - 91 -

The private sector handles marine shipping with two companies, Arya and South- ern Shipping Lines, while Pars Air and Air Taxi take a small share of the internal air transport market. It also dominates road transport, both for passengers and freight, with the exception of public passenger transport within the municipalities, and there is relatively little Government control on its activities.

268. In the past there has been a lack of a coherent policy, inadequate planning, and poor coordination between the executive agencies in transport. These weaknesses have continued to persist, though efforts are currently underway to improve the situation. The thrust of these efforts lie in a proposed reorganization of the transport sector based largely on the recommendations of a Transport Co-ordination Study, conducted by a French firm, BECOM. Under the present system, prime responsibility for pre-investment studies, their evaluation and the eventual financing of transport project proposals rests with the PB0, but the PBO has so far not been able to fulfill this responsibility effectively. Its priorities often do not reflect the priorities of the operating agencies. Indeed it is largely concerned with overall sectoral allocations rather than with project planning, which has been, and continues to remain, the weakest link in the planning mechanism. Each transport agency, at present, has a planning department. These departments or divisions, unlike the autonomous agencies like NIOC or Iran Air, are short of qualified personnel. Coordination between transport modes and between transport and other activities, has in general, been poor, although some recent progress has been made with the creation of joint committees organized by the PBO.

269. In the early 1960s, the thrust of the Government's infrastructure program was to create adequate transport facilities. Accordingly, the Third Plan allocated 53.7 million rials for transport - nearly half of the funds earmarked for conventional infrastructure projects - with the emphasis being on the construction of a national highway network. In the Fourth Plan, 78.5 billion rials, or 14.3 percent of the development expenditures, were allocated for transport. A large part of this allocation was also earmarked for highways, thus continuing the intermodal priority of the early 19 60s. The Fifth Plan allocation to transport is 180.0 billion rials, or 11.5 percent of the development program in the public sector. In the ongoing revision of the Fifth Plan, the size of the sector's allocation may increase, but in view of the previous considerations regarding the absorptive capacity of the sector in terms of project planning, preparation, and implementation, it is unlikely that the new allocation will be substantially larger.

270. The intermodal priorities of the Fifth Plan show certain important changes from those in the revised Fourth Plan. Although the relative share of funds to highways has remained roughly at the same level, there is a marked increase in the relative share of ports and shipping, from 8.1 percent in the Fourth Plan to 13.7 percent in the Fifth Plan. The allocated amount has increased threefold from 8.1 billion rials to 25.7 billion rials respectively. On the other hand, the share of railways has decreased from 22.6 percent to 16.5 percent. Continued emphasis on highway construction is necessary to interlink Iranian industrial centers and towns with the main network of - 92 -

roads in the country. A vigorous road maintenance program is also needed owing to past neglect of this function, and the deterioration of newly constructed roads. An enlarged focus on ports and shipping was caused by the tremendous increase in the country's seaborne trade in the past few years, and the expected increase of such trade.during 1973-77.

Highways

271. Road transport accounts for about 80 percent of value added by all types of transport. In general, the western half of the country has an adequate network of main roads, while in parts of the eastern half, the conditions of the main road system is currently being improved. The rural road network is, however, particularly limited. The total length of highways in Iran increased from 34,500 km in 1962 to about 43,400 km in 1972 at a rate of 2.3 percent per annum. The largest increase occurred in asphalted roads; from 320 km to 11,600 km during the decade, and the total length of gravel roads also increased substantially, from 140,Q00 km to nearly 230,000 km. Many improvements were also made to existing dirt roads and motorable tracks.

272. Accurate statistics on the growth and composition of the vehicle fleet and its use of the highway network do not exist. Annual registration statistics were kept until 1964 when a new licensing system based on periodic evaluations of personal property was introduced. Countrywide traffic census counts were discontinued in 1962 and only isolated counts have taken place since then, usually in the context of a feasibility study for a road project. However, data on motor vehicle registration and gasoline consumption have been compiled by the Statistical Center of Iran; they show an average annual growth of 13.4 percent in car registration, 8.1 percent in buses, and 10.7 percent in trucks. Highway use, as reflected by gasoline consumption, has been growing at about 9 percent per annum. Improved road facilities, a rapidly growing national income and the expanding production of domestically produced vehicles has led to a greater than threefold increase in the number of registered passenger vehicles in Iran from about 107,000 in 1962 to about 364,000 in 1972, and a decrease in population/passenger vehicle ratio from 225 to 88.

273. The Third Plan allocated 27.7 billion rials for construction and improvement of major roads. The program included, among other items, completion of about 2,400 km of roads started in the Second Plan. By the end of the Third Plan period about 2,350 km of these roads had been completed and another 700 km were under construction. With regard to feeder roads, the Third Plan provided for the construction of 7,000 km of gravel roads in various regions, and preparation of projects for another 10,000 km of these roads. During 1962-1967, about 14,700 km of feeder roads were surveyed and construction work was started on 8,700 km, of which about 5,500 km were completed. Work on the remaining 2,300 km of feeder roads was expected to be completed during the Fourth Plan.

274. The Fourth Plan allocation to highways was about 43 billion rials, of which almost all was disbursed. Of the total allocation, 24.6 billion rials were earmarked for the construction and maintenance of major roads and - 93 -

about 17.8 billion rials for minor roads, including feeder roads. The original quantitative targets were the construction of about 4,700 km of new roads, including completion of construction started during the Third Plan, and the repair, asphalting and resurfacing of about 4,500 km of major roads. A mid-Plan review indicated that pace of progress was slow during the first two years of the Fourth Plan and that there were substantial cost over-runs, largely owing to inadequate project preparation and problems with implementation of ongoing projects. There has been no visible improvement in the capability of the Ministry of Roads since then with respect to project preparation and implementation.

275. The allocation for highways in the Fifth Plan is 96.0 million rials, or about 51.2 percent of the total allocation for the transport sector. Of this, 54.0 billion rials have been earmarked for major roads, 32.0 billion rials for secondary roads, and 10 billion rials for the road maintenance program. The objectives of the program are to complete the network of major roads and to establish full communication among major population centers, to provide transport links between country's major ports and towns and cities in the interior, to provide access to markets for agricultural and industrial products, and to provide transport facilities for tourist centers. The Fifth Plan targets call for the completion of about 6,500 km of new roads at a cost of 43.5 billion rials which will increase the size of major road network in Iran from about 12,500 km in 1973 to about 19,000 km by 1977. If past performance is any indicator, it seems that the program is somewhat ambitious, and shortfalls may appear by the end of the Plan period. The allocation for feeder roads in the Fifth Plan is 32.0 billion rials, which will cover about 19,500 km of secondary and feeder roads. The targets of the Plan call for completion of 11,000 km of feeder roads at a cost of 21.4 billion rials, and to undertake construction of 4,500 km of feeder roads that will be completed later. Again, it appears that this program is optimistic, particularly in view of past performance.

276. A separate allocation of 10.0 billion rials has been made for road maintenance, of which 6.5 billion rials is for re-asphalting and other repair works, and the remaining 3.5 billion rials have been allocated for purchasing road maintenance equipment by the Ministry of Roads. The Road Maintenance Department will be granted a matching appropriation of 3.5 billion rials from the general revenue budget to help keep the machinery in operable condition. Maintenance of feeder roads is a part of the feeder road program and is not funded separately.

Ports

277. Ports in Iran can be divided into three separately administered categories -- oil ports, general cargo ports and small fishing ports. The oil ports are entirely operated and financed by the oil companies and to all intents and purposes, are outside the scope of macro-planning. General cargo ports fall in two groups. The first group consists of Khorramshahr, Bandar Shahpur, Bushehr, and Bandar Abbas in the Persian Gulf, and account for the - 94 - bulk of the total port throughput. The second group consists of Bandar Pahlavi and Nowshahr on the Caspian Sea and handle only a small proportion of throughput.

278. The general cargo ports are managed by the Ports and Shipping Organi- zation (PSO), which was established in 1960 under the Ministry of Economy and transferred to the Ministry of Finance in 1966. The PSO has regulatory and operation functions for shipping, maritime affairs, and, as the national port authority, planning, constructing and operating general cargo ports. The PSO has no authority over the oil ports, but provides services such as pilotage, dredging and navigation aids. The top level management of the PSO is good and to improve the middle level management a training program is being undertaken. The PSO is also aware of the need to improve the quality of its investment program. Consequently, the use of feasibility studies is increasing and upon the completion of an ongoing Ports Master Plan Study a comprehensive development plan for ports will emerge.

279. The total volume of Iran's external trade (including all imports and non-oil exports) in 1962 was 2.05 million tons of which about 1.7 billion tons or 83 percent was seaborne. Most of the seaborne trade, about 93 percent, was channeled through the Persian Gulf Ports. By 1972, the total external trade volume had increased to about 8 million tons, of which 5.7 million tons, or 84 percent was seaborne; and Persian Gulf ports continued to handle a large portion, about 90 percent, of this. The average annual growth of 13.6 percent of seaborne trade between 1962 and 1972 has required a continuous effort to expand and modernize port facilities. In view of the overall growth of the Iranian economy and the bouyancy of its leading sectors, these trends are likely to continue, and indeed may be further strengthened.

280. The Fourth Plan allocation for ports was initially 6.8 billion rials, later decreased to 6.4 billion rials. Of the revised allocation, about 2.5 billion rials were earmarked for construction and development, 2.3 billion rials for maintenance and improvements and the remainder 1.6 billion rials were allocated for training programs, studies and surveys. At the end of the plan, 4.6 billion rials were reported disbursed; the major shortfall occurred in the maintenance and improvement program, where only about 1.1 billion rials were spent. The overall objective of the plan was to increase cargo handling capacity by 3 billion tons, representing a 75 percent increase in the capacity that existed at the begining of the Plan period. The PBO estimates that, by 1977, 9.7 million tons of port capacity will be needed implying that seaborne trade will grow at an average annual rate of 11.2 percent during the Fifth Plan period, slightly below the growth rate observed during the past 10 years.

281. In view of the rapidly growing requirements, the PBO has allocated 25.0 billion rials-to the ports program in the Fifth Plan. This is about four times the allocation of the Fourth Plan. The program calls for: - 95 -

i) Completion of Fourth Plan projects; important among these are the construction of four jetties at Bandar Shahpur, expansion of Pahlavi and Nowshahr ports on the Caspian Sea, dredging of Bushehr channel, and construction of cargo facilities at Bandar Abbas.

ii) Construction of 10 new jetties and grain sites at Bandar Shahpur.

iii) Development of small harbours in the Persian Gulf, construction of wave breakers and jetties, and organization of coastal shipping lanes.

282. The Port Improvement Program will be based on the outcome of the Ports Master Plan Study. This Study has now reached the interim report stage and will be completed by July 1974. The preliminary outcome of the study indicates the development of two premier ports for the country, both on the Persian Gulf, at Bandar Shahpur and Bandar Abbas. These ports will ultimately contain general cargo berths, container terminals and grain terminals. Addition bulk ore facilities will also be required at these sites. The remaining ports, both in the Persian Gulf and the Caspian Sea, will serve mainly as regional ports. The development of two premier ports is appropriate considering the geography of Iran and the distribution of commercial, industrial and mining centres.

Railways

283. The Iranian State Railways (ISR), though nominally having independent status and financial autonomy, are run very much as a department of Min- istry of Roads and are heavily dependent on the PBO for investment funds, as well as certain operational expenses such as for renewals and spare parts. The PBO, therefore, has a strong control on the funds allocated to the ISR. Rates and fares are also tightly regulated by the Government. The operations of the ISR are decentralized into ten regions reporting directly to the Pres- ident of the ISR who is an appointee of the Ministry of Roads. The regional manager's responsibilities are limited strictly to day to day operations, and do not include marketing, transactions and recruiting.

284. The ISR's current operations are briented towards meeting the transport needs of the Government and only marginally serve the private sector. In particular, Government freight shipments by the ISR constitute 75 percent of its total freight traffic; the remainder is largely composed of ores and heavy industrial cargo. The monopoly of the ISR in handling the Government cargo has been the subject of much criticism in the past, insofar as it shielded the ISR from pressures to improve its efficiency. A negative aspect of this monopoly is the interference of the Government agencies in the operations of the ISR. Some of these not only demand and receive privileged services but seem unconcerned about prompt reimbursement to the ISR for services rendered. Lack of commercial autonomy in combination with the present operational arrangements have impeded improvements in the - 96 -

efficiency of the ISR, a situation which has remained unchanged for a number of years. There is no commercial or marketing department to undertake market analysis or research for the type of services that may be beneficial to ISR as opposed to the services that may be efficiently carried out by other modes. Further, there still is no system of cost-accounting to analy- se expenditures for each group of rail transport and to identify operational weaknesses. The ISR has believed that increases in rates and fares as well as expansion of the network will eventually take care of these problems.

285. Passenger traffic on the ISR registered a continued decline from about 4 million in 1962 to about 2.8 million in 1967; thereafter it has fluctuated. Over the past five years, passenger traffic seems to have stabilized at around 3.5 million passengers per year. The main reason for declining passenger traffic after 1967 was competition from bus services in Iran. Compared to bus transport, rail fares were higher, travel time by rail was often longer, and train frequencies generally fewer. To a certain extent, the growth of internal air transport and the vitality shown by Iran Air has also contributed to this trend. There has not been any change in railway fares or freight rates since 1960.

286. Rail freight traffic increased from 1,874 million net ton/kilometers in 1962 to about 3,671 million ton/kilometers in 1972. During the 1960s about 70 percent of all the goods transported by the ISR related to Khorramshahr- Bandar Shahpur-Tehran line, a trend unlikely to change in the immediate future. Petroleum products are the main item in the freight traffic of the ISR. Their proportion has been declining, however, while agricultural commodities have proportionately increased. This trend is likely to continue, and may even strengthen in the future because of anticipated imports of agricultural goods, particularly feed grains and edible oils, and the development of the mining sector. The transport of minerals to the steel plant in Esfahan will probably become one of the mainstays of railway operations in the future, since the petroleum traffic will increasingly be taken over by pipelines. Provided that the ISR improves the quality of its service and adopts an active pricing policy, it should also be able to compete successfully for agricultural and industrial traffic. A factor favoring rail transport is the long hauling distance for major items. The flows of agricultural products, e.g., from the main producing areas in the north to various consumption centers, are clearly better suited for rail than for road transport. The possibility of attracting shipments of fruits and vegetables destined for the Tehran area by using refrigerator cars should also be explored. The important industrial developments presently underway at Tabriz, Ahwaz and Esfahan offer new opportunities for the ISR to increase its share in the transport of industrial products. Of particular interest for the railway will be the demand of these industries for shipments to and from Tehran. The ISR has a sound industrial sid- ing policy, which encourages the use of rail. The sidings are built by the interested industries, and then taken over by the ISR, which pays for track maintenance and shunting. To compensate the industries for their initial outlays on sidings, freight rates are discounted by about 20 percent. - 97 -

287. The Third Plan program for the development of railways was modest, involving allocations of 4.3 billion rials. Major items of the program were the replacement of 376 kilometers of existing railway lines, completion of the line which would link the Iranian and Turkish rail systems, the purchase of rolling stock and the completion of new railway terminals. Much of this program was completed.

288. In the Fourth Plan, 17.8 billion rials were allocated to the ISR of which 15.3 billion rials were reported disbursed by the end of 1972. A large part of these funds was earmarked for the construction of 1,550 kilometers of the Esfahan-Zarand main line and auxiliary lines for the Arya Mehr Steel Mill. A small amount was allocated for repair facilities and manpower training. The Plan also pledged an internal reorganization of the ISR as well as a reconsideration of ISR's financial arrangements with the Govern- ment and its agencies. However, this did not materialize. Similarly, while there were genuine concerns about the rigidity of fare and rate structures, financial accountability, and lack of commercial autonomy of the ISR, no policy steps were taken during the Plan period.

289. The Fifth Plan allocations for railways are 29.0 billion rials, and the thrust of the program is to meet the transport needs generated by heavy industry, specifically the Esfahan Steel Mill. The capacity of the steel mill is to be expanded to 1.9 million tons, which will require a proportional increase in the handling capacity of Zarand-Esfahan railway line. A sum of 5.0 billion has been allocated for doubling the railway trackage between Zarand and Esfahan. Another significant component of the program is the construction of 730 kilometers of new railway line between Zarand, Kerman and Bandar-Abbas. This will link the mineral rich area of Zarand with modern port facilities to be constructed at Bandar Abbas. The line will be used for trans-shipment of heavy ores for export and for domestic use. The capacity of the line will be about 7.5 million tons per year based on the present rolling stock and 1,000 gross ton trains. A pre-feasibility study of this project has already been completed and a full-fledged study will be undertaken shortly. The cost of the line, including supply of equipment, rolling stock, and communications equipment, has been estimated at about 14 billion rials, for which allocation has been made in the Fifth Plan.

Air Transport

290. Air transport in Iran increased rapidly during the period 1964-72. Pasenger traffic at Tehran Airport increased at an average annual rate of about 15 percent per annum, and air cargo traffic increased by about 8 percent per annum. The rapid growth of aviation in Iran is largely due to geo- graphic, demographic, and economic features of the country. Distances between Tehran and other important cities are long: for example, Tehran- Abadan air distance is 650 kilometers; Bandar Abbas 1140 kilometers; Mashhad 750 kilometers; Tabriz 530 kilometers. Surface transport facilities are costly and difficult to build because of the huge mountainous and desert areas between these towns. Also, the need to ensure quick and easy access - 98 - between provincial headquarters and the capital is important both administratively and politically. There are, in addition, strong seasonal traffic flows which can be met by the flexibility offered by aircraft rather than by heavy commitments in fixed-capacity surface systems.

291. The original Third Plan allocation to air transport was 4.0 billion rials, and was concentrated on the development of airports. Although only 2.8 billion rials were reported disbursed by the end of the Plan period, the objectives of the Third Plan - to construct 10 new provincial airports and to improve the facilities of existing airports - were largely met. In the Fourth Plan this program was continued and airport capacity was further increased. The original allocation in the Fourth Plan for these programs was 6.2 billion rials, which was later revised to about 11.5 billion rials.

292. The Fifth Plan allocation for the development of airports and aviation is 24.5 billion rials, more than double the amount allocated in the Fourth Plan. The program calls for the completion of the extension work started during the Fourth plan, the expansion of existing airports, and supply and installation of modern telecommunications equipment. An allocation of 6.0 billion rials has been made for the expansion of Tehran airport, which is expected to be completed in 1980, while about 5.4 billion rials have been allocated to Iran Air for the purchase of Concorde supersonic jets.

3. Communications

Telecommunications

293. In the Third Plan, the original allocation to telecommunications was 4.4 billion rials, of which 3.4 billion rials was eventually disbursed. The main objective of the program was to establish a reliable telecommunications network with enough flexibility to allow for short-term increases in facilities. Some of the important projects completed during the Plan period included microwave telephone and telegraph communications, expansion of postal services, reinforcement of the national radio network and establishment of the National Television of Iran.

294. The number of automatic telephones increased from about 107,000 in 1961 to 202,000 in 1967 and 14 new telephone exchanges were installed. The coverage of automatic telephone networks was increased from 9 cities to 23 cities during the same period. Long distance telephone communications, mainly consisting of new microwave networks, were expanded though some parts of the program lagged behind. Postal services in Iran were also considerably expanded during the Third Plan. The total number of post-offices increased from 870 in 1961 to about 1380 in 1967, with the largest increase occurring in the number of rural post offices, which almost doubled from 450 to 875. The volume of domestic and international mail increased by 69.2 percent over - 99 -

the same period. Facilities for radio broadcasting increased, with some delays in installation, while television broadcasting continued to rely on two television stations. In 1969 a state television agency, the National Tele- vision of Iran, was established to encourage further development of television broadcasting in the country.

295. The original allocation to telecommunications in the Fourth Plan was 20.3 billion rials; this was later increased to 44.0 billion rials. This represented a phenomenal increase in the resources allocated for the development of telecommunications facilities in the country, and indicate the high priority accorded to them. The main objectives of the Plan were to expand telephone and telegraph facilities to cope with the enlarged demand for these services and to expand radio and television networks. The priorities of the sector continued to focus on the development of telephone and telegraph facilities which primarily served the urban areas. Almost 85 percent of the revised allocation, amounting to 37.4 billion rials, was earmarked for telephone and telegraph facilities, about 10.3 percent or 4.5 billion rials for radio and television networks, and 4.7 percent, or 2.05 billion rials for postal services. In view of the vast size of the country and widely dispersed population, allocation for long distance telecommunications facilities were considered necessary, but the funds for postal services were insufficient to cover effectively the rural areas of the country. The main target for the development of radio was to increase the installed power of shortwave and medium-wave transmitters by 1300 kilowatts, to a total of 4835 kilowatts at the end of the Plan. Total broadcasting hours were also be increased to 218 hours per day. A National Radio and Television center was to be established in Tehran to centralize all activities in the country. For television programs, production centers at Rasht and Abadan, Tabriz, Mashhad, Bandar Abbas and Shiraz were to be established and television transmitters were to be constructed at Esfahan, Gorgan, Ahwaz and Kermanshah. The television network would therefore cover almost all the major urban centers and the radio network almost the entire population of the country. Programs for the expansion of postal services, however, remained minimal; they included a modest increase in the establishment of the number of post offices and equipment, though the Plan did anticipate a substantial increase in the demand for these services.

296. The Fifth Plan allocation for telecommunications is 41.2 billion rials, or about 3.4 percent of the public sector investment program. Of this amount, 7.5 billion rials has been allocated for urban telephones, 10.1 billion rials for the telecommunications network, 10.0 billion rials for' radio and television networks, and the remaining 13.5 billion rials for pdsts and other items. 1/ The Plan has given highest priority to urban telephones vis-a-vis other items in the telecommunications sector. The objective of,-the Plan is to increase the number of automatic telephones from 14 per 1000 in"-1972 to 33 per 1000 in 1977. This implies an increase in the capacity of telephone in- stallations from 430,000 to 1,130,000 automatic numbers during the Plan period. Other important targets for development of telephones and telegraphs are:

1/ These allocations refer only to development funds. A substantial investment will be undertaken by ICI, which is accounted differently. - 100 -

(i) to install local automatic-dial system in 51 cities and towns, thereby increasing the number of towns with automatic facilities to 95;

(ii) to establish long-distance automatic dial telephone service among 70 cities and towns of the country;

(iii) to increase the capacity of the microwave network by 50 percent, and

(iv) to establish an automatic telegraph network for domestic and international connections and the international switching system.

297. The allocation of 10.0 billion rials for radio and television is aimed at improvement of the programs presented and to increase the effective coverage. The PBO estimates indicate that at the end of the Fourth Plan, television networks covered about 50 percent of the country's population, but only about one-fifth of the covered population is currently benefiting from television programs. A major reason for this low utilization is the high price of television sets. The Plan recommended reduction in prices through a combination of price controls and subsidies. In addition, the Plan stresses the need for the standardization of receivers to facilitate large- scale dissemination of broadcasts. An attempt would also be made to expand the present coverage from 50 percent to 60 percent largely through the expansion of local television networks. The allocation of 6.5 billion rials for the improvement of postal services is about three times the allocation made in the revised Fourth Plan. It represents a substantial increase in the financial resources available to this sub-sector. The program includes the establishment of eight mechanized postal centers in the provinces, an increase in the number of urban post offices from 270 to 570 and village post offices from 862 to 1,182, the establishment of 30 mobile post offices, the introduction of postal money order services and post office savings accounts; and an increase in the number of postal trainees from 2,500 to 12,500 and postal staff from 6,200 to 15,400, by the end of the Plan.

4. Water Resources

298. The development of water resources is crucial in Iran's efforts to increase agricultural output and to provide adequate water supplies for its expanding cities. The generally arid climate and the pattern of rainfall in the country, except in the Caspian Sea area, is such that intensified agri-' culture is largely dependent on irrigation facilities. However, in spite of considerable investment in the construction of large storage dams during the past decade, the amount of irrigation water being supplied by these dams is presently small.

299. Large-scale development of regulated surface water supplies began in the Second Plan period with the construction of the Sefid Rud and Dez dams. This development has continued through the Third and Fourth Plan periods despite - 101 -

short-falls, delays and cost over-runs. During the Fourth Plan period, it is estimated that less than 0.5 million ha. were brought under irrigation as against the target of 0.72 million ha. This was because of a lack of sufficient diversion and distribution works below the storage dams and of on-farm development in these areas. One problem has been the difference of views on agricultural policy by various agencies of the Government. Specifically, there is a difference of opinion between the PBO, the Ministry of Energy and the Ministry of Cooperatives and Rural Affairs about the roles of agri-business, farm corporations, and traditional agriculture in the development of the agricultural sector.

300. The Third Plan targets for the development of irrigation were to bring 140 thousand ha. of land under irrigation, to improve and regulate irrigation of an additional 260 thousand ha. and to conduct irrigation surveys so as to build a data base for future years. In the implementation of this program there were considerable overlaps between the Second and Third Plan. For instance, of the 400,000 ha. of new or improved irrigated lands envisaged in the Third Plan, about 220,000 ha. were from projects started during the Second Plan. Notable among these were the Farah, Amir Kabir and Mohammed Reza Shah Pahlavi dams that were constructed for the exploitation of surface water. The remaining 180,000 ha. were to be brought under irrigation through projects initiated and completed during the Plan period. Of the total, development of surface water was expected to provide irrigation facilities to 45,000 ha., and an additional 40,000 ha. were to be supplied by small-scale groundwater irrigation projects. The Third Plan, therefore, clearly emphasized development of groundwater sources through a series of small-size projects.

301. By the end of the Third Plan about 145,000 ha. of new land had been brought under irrigation and water supply was improved for about 240,000 ha. of land. In the private sector, the constrt4tion and improvement of ghanats and water channels made arable an estimated 10,000 ha. of new land, and irrigation facilities were improved on an additional 15,000 ha. In the public sector, efforts were made towards the development of new surface water resources. Towards the end of the Plan, work had begun on large-scale multipurpose projects, such as the Shah Abbas the Great, Darius the Great, Shahpur I, and Cyrus the Great dams. These were to be completed during the Fourth Plan period.

302. The allocation for the development of water resources in the Fourth Plan was originally 37.8 billion rials and was later increased to 44.2 billion rials. Nearly 79.6 percent of this revised allocation, nearly all of which was disbursed, was allocated for the development of surface water resources through large-scale irrigation projects and multipurpose dams. The specific objectives of the Fourth Plan were to increase the supply of irrigation water from 29 billion c.m. to about 33 billion c.m., or by 15 percent. The additional water supply was expected to increase arable land by 400,000 ha. and improve irrigation facilities for another half a million ha.; to meet the water requirements of industry with due regard for agricultural water priorities; to supply water to plan designated urban and rural areas, and to carry - 102 - out essential studies on water resources with the purpose of determining the quality and quantity of available water, to prepare water balances and to prepare special projects.

303. The Fifth Plan allocation for water resources is 109 billion rials, of which nearly 81.3 billion rials have been allocated for irrigation and water supply networks, 2.0 billion rials for hydroelectricity, 14.6 billion rials for urban water supply and about 11.1 billion rials for research and studies. The major objectives of the Fifth Plan are to bring about 400,000 ha. of new land under irrigation, thereby raising the total irrigated farm- land from 3.5 million ha. in 1972 to about 3.9 million ha. by 1977; to provide water supply to towns and cities covering about eight million people. This would raise the total urban population served by reliable water supply from nine million in 1972 to about 17 million in 1977; and to increase the installed capacity of hydroelectric power stations from 792 MW in 1972 to about 1812 MW in 1977. The project content of the program was not made public in the original plan document, and in any case, is being revised. Hence, it is difficult to make any comment about the program priorities, justifica- tion and changes, if any, in the overall composition of the program. How- ever, continued emphasis has been given to irrigation programs especially the construction of distribution networks below storage dams.

5. Housing and Construction

304. Public sector activities in construction and housing have been aimed to satisfy the needs for office space and housing for Government workers. The Third Plan did not make any specific provision for a housing program, although from the beginning of the Plan period housing projects proposed by various agencies were approved by the PBO and eventually allocated 12.4 billion rials. Of the 12.2 billion rials reported disbursed to various agencies, including the Ministry of Development and Housing, which was established in 1964, almost the entire amount was spent for the benefit of the public sector. The only exceptions were the allocations made to the Mortgage Bank of Iran, and the construction of low cost housing for slum dwellers in south of Tehran and the outskirts of other provincial centers.

305. The achievements during the Third Plan, within this limited framework, were modest. About 3,000 units were constructed by the Housing Organ- ization for Government employees, including staff quarters for members of the Armed Services. This compares with about 200,000 units constructed during the Plan period by the private sector. About 4,000 dwelling units were also constructed in Tehran and Mashhad for low-income groups. The housing situation for the poor in Iran consequently improved little in the early 1960s. The average annual growth rate of urban population was about 5.0 percent and the increasing concentration of people in a few large urban centers, especially Tehran, had considerably aggravated the housing problem. At the same time, there was also a change in the type of housing required as incomes increased and modern living styles spread. The new demand favored small family houses - 103 - as against large communal houses. The increase in this type of housing in urban areas contributed to an almost uncontrolled urban sprawl, creating a heavy burden on existing urban facilities and heavy administrative problems for the municipalities. A lack of coordinated policy about urban growth and the absence of town planning further contributed to the plight of urban centers. The private sector, nevertheless, found urban real estate as one of the most desirable forms of investment. The PBO estimates that about three-fourths of private sector investment went into housing and construction during 1959-1965.

306. The housing situation in the rural areas remained unsatisfactory during the Third Plan period. Hardly any improvement occurred in the living conditions of the rural population. Facilities such as water supply and electricity were usually not available and many public services were non-existent. Iranian planners were aware of these problems at the time of the formulation of the Fourth Plan, but their attention remained focused on the housing situation in the urban areas. They estimated that 275,000 new housing units were required over the period 1968-72. However, of the total allocation of 42.5 billion rials for housing and construction, 81.2 percent was for Government buildings, including housing for the Armed Forces.

307. The Fifth Plan document reflects a more or less similar pattern in allocations of public sector funds to housing and construction. The private sector is expected to remain the dominant investor in housing. The following table gives the details of the housing program:

Table 19: INVESTMENT IN NEW HOUSING UNITS

Urban Rural Housing Units Investment Housing Units Investment (000) (billion rials) (000) (billion rials)

Public Sector 165 89.0 24 5.0 Private Sector 575 267.8 200 41.0

Total 740 356.8 224 46.0

Source: Plan Organization.

Other targets of the Plan are:

(i) To construct 53,000 housing units for Government employees both civilian and non-civilian.

(ii) to provide 8,000 housing units to Government employees engaged in agricultural development work.

(iii) to construct 25,000 housing units for workers in industrial estates. - 104 -

6. Education

308. The First and Second Development Plans paid only limited attention to formal education; instead these Plans emphasized technical and vocational training. The emphasis on formal education, especially the concern with "illiteracy", began with the Third Plan. The revised allocation to education in the Third Plan was 21.6 billion rials, or about 9.1 percent of the total public investment program. Of this amount, 3.0 billion rials were allocated for technical and vocational training programs, 11.1 billion rials for primary education, 1.35 billion rials for secondary education, 3.6 billion rials for higher education, and the remaining 2.55 billion rials on other programs. The main objectives of the Third Plan were:

(i) to provide educational facilities for 60 percent of children in the 7-12 years age group;

(ii) to provide secondary education facilities for 400,000 students by 1966;

(iii) to reduce illiteracy in the over 10 age group from 85 percent to 60 percent by the end of the Third Plan; and,

(iv) to improve the quality of higher education and to expand its facilities.

309. In the case of primary education, the target of 60 percent coverage implied that facilities should be provided for about 681,000 new pupils. At the end of the Plan, according to the estimates of PBO, 816,000 students were enrolled in ordinary schools and another 540,000 were attending literacy corps schools. Further, 582 new primary schools were built during the Plan period and 676 whose construction began before 1962 were completed. The actual number of new teachers recruited was about 36,000, and the teacher-pupil ratio was between 32 and 35, in spite of overcrowding in classes in some regions. The Literacy Campaign aimed at the over-10 age group also had notable success during the Third Plan period. According to the 1966 census, the literacy rate increased to 35 percent from 17 percent in the late 1950s. In 1964, a National Literacy Campaign Committee was established to coordinate campaign activities. Total enrollment in secondary education in 1966 was estimated at 579,000 pupils of which 90 percent were in the urban areas and only 10 percent in the rural areas. About 83 percent of students were enrolled in state schools, and the remainder in private schools. The average size of the class was about 45 in state schools and 35 in private schools.

310. There was a significant expansion of higher education; the number of students increased from 24,000 to 42,000 or about 70 percent during the Third Plan. The quality of higher education, however, showed only marginal improvements. In spite of the efforts made during the Third Plan, the education system as a whole, in the PBO's assessment, remained ill-suited to the needs of the country. The expansion of secondary education was excessive, the orienta- tion of higher education remained on traditional lines, while adult education, - 105 - vocational training and skill development remained inadequate. The Third Plan objectives of the improvement in the quality of education did not materialize; about 40 percent of primary school teachers were inadequately qualified, and school facilities continued to be poor. The PBO estimated that at the end of the Third Plan period, about 40 percent of children of primary school age and about 80 percent of adolescents were not receiving education because of these inadequacies.

311. The Fourth Plan education program was formulated against this back- ground. Within the development program allocations, priority was given to primary education with 41 percent of the funds allocated for this purpose. Next in priority was higher education, for which 26.2 percent of the funds were allocated. About 10 percent was allocated for technical and vocational training and nearly the same proportion was allocated for secondary education. In retrospect, it seems that from a social viewpoint, the emphasis on primary education was appropriate. However, the relative neglect of vocational and technical training, and the built in lopsidedness in higher education, further enhanced the pressures on the supply of trained manpower.

312. A major aspect of the Fourth Plan Education program was to introduce a new system of education in the country. It required preparation of new curricula and text books, and rearrangement of staff and administrative structure. While the new system included expansion of education in its objectives, it was also aimed at certain structural changes. For instance, the new system provided for free technical and vocational training, in addition to free primary schooling. The planners, however, recognized that the technical training needs were beyond the capacity of the education system and that the shortages should be met by "on-the-job" training. An evaluation of the Fourth Plan achievements is not, at present, available; but the available data indicate that achievements were mixed. Primary school enrollment was 3.4 million against the target level of 3.7 million, while enrollments in secondary education and higher education exceeded forecasts.

313. Allocations for education in the Fifth Plan have been substantially increased as compared to the Fourth Plan. A sum of 230.0 billion rials has been allocated, including 103 billion rials in recurrent funds. Within the sector, the largest part of the funds has again been allocated to primary education. The Fifth Plan has also given emphasis to the training of teachers and instructors as well as technical and vocational training. The Plan calls for a rapid expansion. of vocational and technical education, as well as higher education to provide the technology base needed for the country. Iran is already experiencing a shortage of skilled and properly trained manpower. The need is particularly acute for managers, engineers and medical personnel. An increase in their numbers would remove an important bottleneck in the growth of Iranian economy.

314. The target of the Fifth Plan is to increase the number of primary students form 3.4 million to about 5.0 million by 1977. The largest increase in student enrollment is expected to come in vocational training programs, from 31,000 in 1973 to 179,000 by 1977. About 500 new vocational schools are - 106 - planned to be opened to accommodate the enlarged enrollment. The total number of graduates of the vocational school during 1973-77 would then be about 600,000. Higher education would also expand in terms of enrollment, from 108,000 in 1973 to about 190,000 by .1977,.representing an increase of about 76 percent. Guidance cycles (introductory) and secondary education programs are expected to have modest increases during the Fifth Plan as compared to primary and higher education.

7. Health and Social Welfare

315. The Third Plan marked the beginning of a planned, and centrally coordinated, effort to improve health services in Iran. In the early 1960s a number of agencies were active on the health scene; the Ministry of Health, the Imperial Organization for Social Services, the Royal Council for Health, and Ostan and Sharestan Health Offices. The basic objective of the Plan was to provide a framework for proper coordination between the various agencies and organizations responsible for medical treatment so as to make maximum use of available facilities. Another purpose for introducing planning in the health sector was to enforce a rational, and as far as possible, an equitable distribution of medical care services in the areas of their operation. Above all, the Third Plan called for the development of medical care, public health, and training centers throughout the country. The major constraint on the program was the availability of trained medical personnel to operate the medical centers.

316. The allocation of developmental expenditures for health programs in the Third Plan was originally 12.3 billion rials, and later increased to 13.3 billion rials. No specific allocation was made for social welfare programs, per se, though a small part of the health allocation was earmarked for activities which are now covered by social welfare programs. The thrust of the health development plan was in the control of communicable diseases such as malaria, smallpox, and measles. One of the important achievements of the Third Plan was the establishment of the Health Corps in 1964. Since then, the Corps has developed into a major health care organization. It consists of physicians and high school graduates who spend the period of their military service working in semi-mobile medical units, bringing medical services to the rural areas. The Health Corps has been quite effective in providing essential facilities to outlying regions not otherwise covered by medical facilities. It accounted for about 80 percent of the outpatient medical service in rural areas during the Third Plan. In addition to the 350 Health Corps units, 206 rural health clinics were established during the Third Plan. The number of outpatient facilities in the rural areas therefore increased by more than 600 during the 1962-67 period.

317. In the medical care program, the Third Plan provided for 10,000 new hospital beds of which about 9,200 were ready for use by 1967. Nearly half of these were in the private sector. Another 5,500 beds were under construction at the end of the Plan period. The program also included construction - 107 - of health clinics of which 185 were completed and 16 were under construction. Modest sums were allocated for medical reseach to be undertaken by the In- stitute for Health Research, the Iran Food and Nutrition Institute, and the Health Research Institute.

318. At the start of the Fourth Plan, however, the state of medical services in Iran, as compared to advanced countries, remained poor. Though there were noticeable improvements in preventive care, the incidence of contagious diseases remained high. The rural areas remained particularly vulnerable to communicable diseases, specifically those transmitted through infected water. The scope of the health program was inadequate compared to the needs of the country and required a greater effort, particularly by the public sector, to provide basic health facilities to a large segment of the population. There were only 12 beds per 1,000 of population and two-thirds of these were in Gov- ernment-run hospitals. Rural health facilities covered only about half of the villages and consisted of 1,050 rural health clinics and about 400 health corps units. In the assessment of the PBO, most of these clinics were below standards and were hardly suitable for good medical work. Physicians, nurses, and nursing assistants remained in short supply and were spread too thinly and unevenly. Urban areas were relatively better off in terms of the facilities available as well as medical personnel, but rural areas continued to suffer from a lack of medical facilities.

319. The purpose of the Fourth Plan program was to introduce improvements in medical care, promote campaigns against contagious diseases, and raise nutritional standards. The quantitative targets were:

(i) completion and construction of 145 health centers;

(ii) addition of 14,500 hospital beds and the construction of 20 combined medical and health centers;

(iii) addition of 500 rural clinics and 50 teams of health corpsmen;

(iv) provision of nursing and treatment facilities for 5,600 existing hospital beds and reconstruction of 2,600 beds considered beyond repair;

(v) establishment of 5 nursing schools and 13 schools for paramedical personnel;

(vi) implementation of the health and family planning program for 50,000 potentially fertile women.

320. The Fourth Plan allocation for health and social welfare prograim, originally 17.0 billion rials, was later increased to 21.4 billion rials. Of the revised allocation, 16.2 billion rials were for health programs and the remaining 5.2 billion rials for social welfare programs. The emphasis of the Plan in health programs was on the provision of medical care facilities, major elements of which were the establishment of hospitals, clinical - 108 -

units, rural health centers, and rest homes. In addition to these development allocations, 33.6 billion rials were allocated and spent from the current budget on health programs during 1962-72. This is about twice the amount allocated from the investment budget.

321. The disparity between the health facilities between urban and rural areas has continued to widen over the years. The table below highlights one dimension of this imbalance.

Table 20: NUMBER AND DISTRIBUTION OF HOSPITAL BEDS (per 10,000 population)

1967 1972

Tehran 33 40 Ten provincial capitals 25 35 Other cities 9.5 15 Rural areas 5.0 2.5

322. The Fifth Plan document does provide some clues to the future health policy of the Government. It states that, in principle, medical services should be provided under social security through the private sector. Government hospitals and medical units run by charities should concentrate on the low-income groups. The past practice of funding private medical units through loans or grants will be discontinued; instead the Government would establish its own medical units and cover their operational expenses to provide health facilities to the low-income groups. A similar arrangement will be worked out for Government workers. In the rural areas, because of low population density and distances between villages, mobile medical units would be deployed. Em- phasis would be given to the training of paramedical personnel to provide basic health care under the supervision of doctors who are in short supply. The Min- istry of Health would continue to be responsible for coordinating activities of various health organizations with a minimum of operational responsibilities for itself. This arrangement has been criticized severely in the past on the grounds that it dilutes the responsibility of medical care in the country. It over-burdens medical colleges and schools, since in addition to the primary responsibility of education and training, these institutions are also encum- bered with the task of care. The Fifth Plan nevertheless seems to continue this arrangment; indeed it declares that more hospitals will be turned over to medical colleges in the country.

323. A major preoccupation of the planners seems to have been the annual 3.1 percent birth rate, which is one of the highest in the world. Priority has been accorded to the family planning program in an effort to reduce the birth rate to 2.6 percent by the end of the Plan period. Other objectives of the Plan are: - 109 -

(i) to increase the number of hospital beds by 24,000, of which 9,000 would be in private hospitals and the remaining 15,000 in the public sector;

(ii) to establish 70 major medical centers and 340 secondary centers in urban areas; and to open 600 centers in rural areas and establish 300 medical corps groups;

(iii) to continue work on the control of contagious diseases and prevent epidemics, improve health standards for certain groups such as students, workers, women and the mentally handicapped;

(iv) to provide treatment for malnutrition to infants on a modest scale; 65,000 newborns will be covered in this program during 1973-77;

(v) to provide additional facilities for medical training which will include establishing (a) 2 medical colleges, (b) 3 schools for medical assistants, (c) 36 nursing schools, and (d) 35 schools for medical and health technicians. A small program of research would be initiated in cooperation with the health agencies and education institutions. The Fifth Plan also calls for the provision of welfare services on a modest scale. Under this program, 100 family welfare centers and 150 nurseries will be established in the low income areas and urban slums. Programs for rural welfare, and rehabilita- tion will also be initiated.

324. To achieve these objectives the Plan has allocated 68.0 billion rials in development funds, which is about 4.4 percent of the total development program. Of this amount, 52.0 billion rials have been allocated for health programs and 16.0 billion rials for social welfare. The largest part of the health allocation, 21.5 billion rials, has been earmarked for the provisign of medical care, 14.0 billion rials for health services, 3.2 billion rials for family planning and 13.1 billion rials for other programs. - 110 -

4. OIL AND GAS

I. IMPACT OF PETROLEUM ON THE ECONOMY

325. The impact of petroleum on the Iranian economy is felt in several ways, in particular on government revenues, value added, capital formation, and the balance of payments.

Government Revenue

326. Government revenue from oil is derived from income tax and dividends paid by the National Iranian Oil Company (NIOC); income tax and stated payments (royalties) by Consortium trading companies; income tax and bonus payments by joint ventures for exploration and development; domestic taxes on internal sales; and employees' and contractors' income tax. Reflecting the increases in posted price and production levels, oil revenues received by the Government in calendar year 1972 - the latest year for which a breakdown of such revenues is immediately available - amounted to 201.1 billion rials, or more than double that received in 1970. Of this amount about 83 percent came from Consortium activities in the form of (a) income tax and stated payments by the trading companies and (b) income tax paid (until March 1973) by the Iranian Consortium Operating Companies (IOOC) on their production and refining fees. The income tax is paid directly to the Treasury. The stated payment is first received by NIOC as part of the trading companies' purchase price for crude oil, which statutorily retains 2 percent of its general reserve and transfers the balance to the Treasury.

327. The joint ventures paid 9.7 billion rials in 1972 or 5 percent of total revenues. In the original joint venture the operating company SIRIP has title to the oil and is liable for income tax on its activities; in the later joint ventures the operating companies - IPAC, LAPCO and IMINOCO - do not have title to the oil, and NIOC and the foreign partners are separately liable for tax on their share of joint venture activities. In 1972, NIOC received a further $47 million in bonuses from the signature of three more joint venture agreements and, after retaining the 2 percent required for its general reserve,.paid the balance of 3.5 billion rials to the Treasury. This was a sharp increase from its payment of 75 million rials in each of the three preceding years. NIOC also paid 2.7 billion rials in income tax on its net profits, and 2.3 billion rials as dividends to the Government.

328. Oil products sold in Iran are subject to taxes, municipal dues, a price increase on products marketed internally, and a levy for charity. In 1972, NIOC paid additionally 12.2 billion rials to the Government in these levies and taxes. Income tax is also collected from the salaries and wages of employees of the different oil companies operating in Iran and paid to the Ministry of Finance, and income tax on oil industry contractors is paid to the Treasury. These taxes are accounted separately. A breakdown of oil revenues is shown in the following table: - 111 -

Table 21: IRANIAN OIL REVENUES /1

billion rials 1968 1969 1970 1971 1972

Income tax - consortium 60.2 69.9 80.7 140.9 168.4 Income tax - joint ventures /2 1.3 2.1 3.5 6.6 9.7 Bonus payments (less 2%)-joint ventures - 0.1 0.1 0.1 3.5 Income tax - NIOC 1.2 1.1 1.4 1.9 2.7 Dividends - NICO 0.8 1.0 1.3 1.5 2.3 Tax on internal sales 7.8 8.7 9.7 10.8 12.2 Employee income tax 0.7 0.8 0.9 1.1 1.2 Contractors' income tax 1.0 1.0 0.9 0.8 1.1

TOTAL REVENUE 73.0 84.8 98.5 163.6 201.1 (million US$) 963.7 1119.5 1300.3 2159.7 2654.8

/1 Does not tally with the Budget Estimates due to differences in accounting and classification between NIOC and the Government. /2 Including NIOC's share of tax payments for joint ventures.

Source: NIOC.

The amounts shown above by NIOC as total Government revenues from the Iranian oil industry differ from those shown by the Budget Bureau as Central Government revenues from oil basically for three reasons: (a) NIOC's accounting period is the Gregorian calendar year, while that of the Government is the Iranian year ending March 20, (b) the Government classifies NIOC's payments of taxes and dividends with corresponding payments by other non-oil Government corporations, and (c) the Government classifies petroleum and fuel taxes separately from oil revenues. The Central Government's oil revenues in 1972 amounted to 178.7 billion rials, or 55 percent of total tax and non-tax revenues. The percentage would be greater with the inclusion of NIOC's taxes and dividends and of petroleum and fuel taxes. Oil revenues that year were double those in 1970, reflecting the higher posted prices under the Teheran-Agreement-since February 1971 and higher production. The budget estimate for 1973 was 225.9 billion rials, but this estimate does not reflect the posted price increases of October 16, 1973 and January 1, 1974. The budget for 1974 which was presented to the Mailis in November 1973 includes an estimate of 445 billion rials for oil revenues, incorporating the effects of mid- October price increase.

Value Added

329. Gross value added by the petroleum sector derives overwhelmingly from Iranian income from the Consortium arrangement, joint ventures and NIOC exports, and foreign income from the Consortium companies and other oil companies (factor payments to abroad). They constituted 55 percent and 35 per-- cent respectively'of oil sector value added in 1972. Depreciation, employees - 112 -

compensation, and interest and rent payments made up the balance of 5 percent, 4 percent and 1 percent respectively. The contribution of the sector to GDP, measured at 1959 constant prices, increased from 20.1 percent in 1962 to 27.4 percent in 1972. During the same period value added by the sector increased at about 14 percent per annum. Since the combined output of non-oil sectors increased at only 9.4 percent per annum, the share of the oil sector in GDP rose sharply. This trend will be further strengthened in the future considering the recent increases in oil prices.

Emplovment

330. In 1973, the oil sector employed 42,400 persons or about 0.6 percent of those gainfully occupied in the economy. About 54 percent of these were employed by NIOC itself, another 10 percent by its subsidiaries and the remaining 30 percent by joint ventures. Value added per worker in the ptro- leum sector, estimated at 4.4 million rials in 1972 in 1959 prices, is extremely high cpiared with other sectors, and reflects the high level of investment per worker in the oil industry. In comparison, value added in agriculture in 1972 was only 36,700.rials; in industry, 70,000 rials, and in services roughly 125,000 rials -- all measured in 1959 prices.

Balance of Payments

331. In 1972, the contribution of the oil and gas sector to the balance of payments amounted to $2,542.5 million, of which 93 percent was paid by the foreign oil companies, including $61 million in natural gas exports. Table 16 shows almost a threefold increase in the contribution of oil sector to the balance of payments during 1967-72. The average annual rate of growth of these revenues has been about 26 percent per annum during this period. In 1972, Consortium companies paid $2,247.1 million; all other receipts amounted to $295.4 million, or 13.5 percent of total receipts.

Table 22: CONTRIBUTION OF OIL SECTOR TO BALANCE OF PAYMENTS

Million US$ 1962 1967 1971 1972 Incole tax and royalties Consortium companies 342.2 715.3 1885.2 2247.1 Other foreign companies -- 36.3 85.4 122.4 Exnorts by NIOC -- -- 24.4 29.5 Gas export -- -- 35.8 61.2 Local expenditures Consortium companies 90.5 82.5 93.0 90.3 Other foreign companies 4.5 23.3 26.1 46.7 Current account receipts 436.2 857.4 2149.9 2597.2 Imports of goods and services by NIOC 12.3 49.8 68.0 54.7 Current account payments 12.3 49.8 68.0 54.7 Contribution of Oil Sector 424.9 807.6 2081.9 2542.5

Source: NIOC. - 113 -

II. INSTITUTIONAL ARRANGEMENTS

Creation of NIOC

332. Iranian oil was first discovered in 1908 at the Masjid-i-Sulaiman field. The Abadan refinery came on stream in 1913, and exports of crude oil and refined products began that year. During the 1930's, the Abadan refinery was greatly expanded, and a smaller refinery was built at Kermanshah. By 1941 five new oil fields were discovered: Haft Kel, Gachsaran, Naft Safid, Agha Jari and Pazanun. By 1950 output by the operating company, Anglo-Iranian Oil Company (AIOC) had reached 31.8 million metric tons. In 1951 the Gov- ernment acquired congrol over the oil sector by nationalizing the AIOC's interests in Iran and by forming the National Iranian Oil Company (NIOC) with ownership of the industry.

Consortium Agreement of 1954

333. In October 1954, Iran entered into an agreement with a consortium of oil companies 1/ which carried out exploration, production, refining and transport in the Consortium Agreement Area of southern Iran on behalf of the owner of the fixed assets, NIOC. The fixed assets in the Agreement Area were owned by NIOC, but the IOOC had unrestricted use of them for the duration of the Agreement. The Agreement was to last 25 years, and the Consortium member companies had the right to extend it by three periods of five years each, subject to reductions in the Agreement Area. The Consortium member companies, generally known as the Iranian Oil Operating Companies (IO0), formed two companies: one to explore and produce crude oil and natural gas in the Agreement Area, and the other to refine such oil and gas. The IOC received their operating costs plus.a fee of one shilling for each cubic meter of oil produced and oil refined; the fee - abolished in the New Agreement - was subject to income tax. Each Consortium member company formed a trading company, registered in Iran. Each trading company bought the crude oil from NIOC at the wellhead within the Agreement Area and either resold it for export or had it refined at Abadan and sold the products for export; this arrangement still continues. Prior to the new 1973 Agreement, crude oil prices paid by each trading company to NIOC consisted of the operating cost (including depreciation) and the stated payment (i.e. royalty) at 12.5 percent of posted price (14.5 percent since July 1, 1974). The price obtained by trading companies in export sales of crude oil and products to their international affiliates is the posted price. Each trading company pays income tax which is assessed as a percentage (raised from 50 percent to 55 percent on Novem- ber 14, 1970) of profits from oil export sales based on posted prices. The actual f.o.b. price at which the international affiliate of each trading company sells such exports to third parties overseas is thus immaterial to Iran.

1/ BP (40%), Shell (14%), Gulf Oil, Mobil, Standard California, Exxon and Texaco (7% each), CFP (6%), and the Iricon group (5%). The Iricon group now consists of Aminoil, Atlantic-Richfield, Charter Oil, Continental Oil, Getty Oil and Standard Ohio. - 114 -

334. NIOC itself carried out certain ancillary services required by the IOOC for their non-basic operations and was reimbursed for the services. The distribution and sale of refined products and natural gas for internal consumption in Iran was and is reserved to NIOC; the IOOC delivers to NIOC the required products, natural gas and crude oil.

Consortium Agreement of 1973

335. Effective from March 21, 1973 NIOC entered into a new 20-year agreement with the Consortium which superceded the previous agreement. The most important feature of the revised agreement is that NIOC has become the sole owner-operator in the former Agreement area. The intention is that NIOC ex- ercises not only full ownership but also operational control of hydrocarbon reserves, assets and administration of the oil and gas sector. Further, the Consortium replaced the IOOC by a new non-profit service company, Iranian Oil Service Company (IOSCO), incorporated in Iran and subject to Iranian law. The latter carries out operations in the revised Agreement area assigned to it by NIOC; these operations are presently exploration and production but no longer refining. The service contract is valid initially for five years and continues thereafter subject to termination by either party at two years' notice.

336. NIOC now provides all capital and funds required under the Agreement, including those needed for IOSCO's operations. The Consortium trading companies each advance to NIOC, as prepayment for crude oil purchases, 40 percent of the funds needed for capital expenditure during the first five years of the Agree- ment; this is the period of major capital expansion. They can opt to vary this proportion thereafter at two years' notice. The trading companies offset these annual advance payments against their subsequent crude oil purchases from NIOC in equal installments over ten years. The capital investment necessary for the planned expansion of capacit-: has been estimated at more than $1 billion, including secondary recovery facilities.

337. Under the revised Agreement, NIOC takes crude oil needed to meet internal consumption and a stated quantity for export amounting to about 5 percent of total output in 1974, gradually rising to 13.3 percent by 1981. In years after 1981 the stated quantity of NIOC's crude oil exports is to maintain the same proportion to total crude oil exports as it did in 1981. NIOC notifies Consortium member companies how much crude oil in the Agreement area remains available for purchase by their trading companies; if the quantity exceeds the trading companies' nominations, NIOC can opt to export the surplus. NIOC also took over management of the Abadan refinery, which has a present crude oil distillation capacity of 430,000 b/d and is one of the world's largest. NIOC plans to raise this capacity to 550,000 b/d by installing a new crude oil distillation unit for an estimated cost of $35 million. It makes an extremely wide range of mainline and high value specialty products, of which it delivers about 15-20 percent to the internal market and the remainder for export, including bunkers. It is also one of the world's main balancing refineries, i.e. it has flexibility to process crude oil so as to supplement the supply of particular refined products in other countries, where the product yield from locally refined crude oil does not sufficiently - 115 - match the local market pattern of product requirements. Under the new Agreement, NIOC has the preemptive right of product offtake from the refinery for the internal market, amounting to about 100,000 b/d. It then processes on behalf of the trading companies up to 300,000 b/d of crude oil which they buy in accordance with a 20-year processing agreement. If the trading companies deliver less than 95 percent of 300,000 b/d of crude oil for processing, they still pay a processing fee on the minimum 95 percent. The processing fee is related to the refinery's operating cost and is deductible from the trading companies' taxable income. They also pay interest (non-deductible for tax purposes) on investments made by NIOC as from March 21, 1973 to maintain the refinery's existing capacity during the subsequent 20 years. However, in compensation for their investment in the refinery prior to that date, they receive from NIOC a non-cash credit equal to the yearly amount of depreciation on refinery assets unamortized on March 20, 1973; this credit is excluded from their taxable income.

338. Since March 21, 1973 the price which trading companies pay to NIOC for crude oil delivered f.o.b. tanker or at the Abadan refinery has consisted of four elements. There are the stated payment and the operating cost, including depreciation, of producing and processing crude oil and natural gas liquids (NGL). There is also an interest payment on investment by NIOC, i.e. the 60 percent of capital expenditure for which NIOC will provide funds during the Agreement's first five years; the remaining 40 percent is advanced by trading companies as prepayment for crude oil purchases. Finally, there is a balancing margin; this is the key element in assessing the financial impact of the new Agreement, as it is designed to give to Iran financial benefits no less favorable than those applicable - at present or in future - to the other countries in the Persian Gulf through the national participation which they obtained in January 1973 in oil facilities in their countries.

339. The trading companies' gross revenues are derived from export sals of crude oil invoiced at posted price, NGL, refined products invoiced at the crude oil price plus NIOC's processing fee, and trading companies' profit margin on such sales. In computing their tax liability, they are allowed to deduct the price paid to NIOC for crude oil purchases, the price paid to oth- trading companies for any crude oil and product purchases, processing fee:'. La NIOC at Abadan refinery, and the cost of processing and refining NGL and delivering NGL products. Other than income tax and non-discriminatory taxes and fees such as municipality and sanitary charges, stamp taxes, and registry, patent and copyright fees, there is no additional taxation on the trading companies, Consortium member companies, customers or transport companies or upon their dividends. Oil exports are not subject to duties. The new Agreement adopts the US dollar as the currency of account instead of sterling as in the 1954 agreement. All payments to Iran and NIOC are therefore now made in dollars, and the accounts of NIOC and trading companies are kept in dollars. - 116 -

Joint Ventures

340. Outside the Consortium Agreement area NIOC has carried out .exploration and drilling in various parts of Iran directly or in partnership with foreign oil companies. The Petroleum Act of 1957 enabled it to enter into joint ventures with foreign companies so as to expedite the development of Iranian oil reserves. Thus far four joint ventures have resulted in commercial oil production: SIRIP, IPAC, LAPCO and IMINOCO. It is also participat- ing with BP in exploration in the North Sea.

341. The Societe Irano-Italienne des Petroles (SIRIP) was NIOC's first joint venture, formed in 1957 on a 50:50 basis with the Italian AGIP group. Unlike subsequent joint ventures, SIRIP has title to the oil which it sells to its shareholders at international prices; it then pays income tax to NIOC at 50 percent of its net profit and distributes the remaining 50 percent as dividends equally to its shareholders. Thus the Government receives 75 percent of net profit, i.e. 50 percent from SIRIP through NIOC as tax and 25 percent as dividend from NIOC. SIRIP produces oil offshore from the Bahregansar/ Hendijan fields at about 55,000 b/d and the Now Ruz field at about 60/70,000 b/d. It has been testing the promising structures of Didrou and Rig in the Zagros mountains.

342. The Iran Pan American Company (IPAC) was NIOC's next joint venture, formed in 1958, also 50:50, but with the U.S. firm AMOCO. IPAC is the shareholders' operating company; it does not have title to the oil but is reimbursed its operating expenses. The shareholders sell the oil at international prices and are each taxed at 50 percent of the net profits. Thus the Govern- ment again receives 75 percent of net profit, i.e. 50 percent from both shareholders as tax and 25 percent as dividend from NIOC. Production is from the Darius and Cyrus offshore fields. The Darius field produces about 120,000 b/d of 340 API crude oil, some of which is sold under long-term contract to the 50,000 b/d refinery at Madras, India in which each party has a 13 percent interest. The Cyrus field produces about 25,000 b/d of 180 API crude oil, having high sulphur and salt content but good asphalt quality; it is sold in Far East markets for indirect burning in power stations. The field's capacity is planned to be raised to 50,000 b/d by the installation of pumping equipment. The offshore Fereidoon field is expected to begin production in mid-1974 of 33* API crude oil with an ultimate capacity of about 150,000 b/d; the structure extends across the marine border with Saudi Arabia, known there as the Marjam field. The offshore Ardeshir field is expected to begin production in about 1975 with a production of about 100,000 b/d. The offshore Esfandiar discovery is understood to be under evaluation.

343. The Lavan Petroleum Company (LAPCO) is a joint venture formed in 1965 between NIOC (50 percent) and US firms Atlantic-Richfield, Sun Oil, Murphy Oil and Union Oil (12.5 percent each). Its financial arrangement follows those of IPAC. Production is from the offshore Sassan field which started in 1968 and since mid-1972 can produce 200,000 b/d. NIOC supplies 35,000 b/d of its share under long-term contract to the new South African 50,000 b/d refinery in which it has a 17.5 percent interest. A new offshore "W" structure is under evaluation; its potential has been reported at 40/50,000 b/d of relatively low sulphur crude oil. - 1.17 -

344. The Iranian-Marine International Oil Company (IMINOCO) is a joint venture between NIOC (50 percent) and the Italian state oil company ENI, the US firm Phillips Petroleum, and the Oil and Natural Gas Commission of India (16.7 percent each). Its financial arrangements also follow those of IPAC. Production is from the Rostam and Raksh offshore fields. Production of 38* crude oil from the Rostam field began in 1968 and averages about 35,000 b/d; some wells are now on the pump. Production of 340 crude oil from the Raksh field began in 1971 and is now about 70,000 b/d. Exploratory drilling continues, and a third offshore field, Alpha, has been discovered.

345. In addition to the four joint ventures which resulted in commercial production, NIOC entered into four others in 1965 and three in 1971. 1/ Ex- ploration is continuing except in two joint ventures where the agreements are understood to have been ended.

Service Contracts

346. In 1966 NIOC initiated a new series of agreements in which the foreign oil company, at risk of its own capital, undertakes an exploration and development program as contractor to NIOC. There are provisions for minimum amounts of expenditure and for surrender of contractual areas. If oil is found and produced, it becomes NIOC's property at wellhead. Half the total recoverable reserves in all oil fields is assigned to NIOC for the national reserve. The contractorhas the right to buy a proportion of the other half of reserves subject to an agreed formula, at a price equal to operating cost plus 2 percent, and pays income tax on the realized price. The contractor loans the development cost to NIOC and is repaid, with interest, in cash or crude oil.

347. NIOC signed the first ser,iice contract in 1966 with the French group Elf/ERAP which formed a subsidiary, Sofiran, to act as contractor. Oil has been found in the Sirri offshore field and is expected to start production in about 1975 at 40/60,000 b/d. NIOC signed the second contract in 1969 with the Euro- pean group EGOCO which consists of Sofiran (32 percent), ENI (28 percent), Hispanoil of Spain (20 percent), the Belgian firm Petrofina (15 percent) and OMV of Austria (5 percent); Mitsubishi of Japan subsequently acquired 40 percent of Sofiran's interest. Its third contract was signed with Continental Oil in 1969 which subsequently assigned interests of 50 percent to Phillips Petroleum and 25 percent to Cities Service.

1/ The 1965. joint ventures were with Elf/ERAP (Farsi Petroleum Company); a US group of minor oil companies (IROPCO); Shell (DOPCO); and a West German group (PEGUPCO). The DOPCO and PEGUPCO agreements are understood to have been terminated. The 1971 joint ventures are with Amerada-Hess (BUSHCO); a Japanese group 33.3%/Mobil 16.7% (INPECO); and Mobil (HOPECO). - 118 -

III. OIL PRODUCTION, CONSUMPTION, AND EXPORTS

Oil Production

348. Proven recoverable reserves of Iranian oil are reported at about 60 billion barrels at the beginning of 1974, equivalent to 27 yeras supply at the current rate of production, 1/ using existing techniques of extraction.

349. Crude oil production in Iran began in 1913. By 1963 it has reached 74 million metric tons (1.5 million b/d). Since then, it has continued to grow rapidly to 143 million tons (2.9 million b/d) by 1968 and 294 million tons (5.9 million b/d) by 1973, an average growth of 7.5 percent p.a. during the decade. Production for 1973 is also an increase of 17 percent over that of 252 million tons in 1972.

350. Production in Iran has come predominantly from the Consortium area, where it averaged 5.3 million b/d during January-June 1973. The most recent increase in capacity was achieved by expanding existing production units and bringing in new ones - at Marun, Kharg, Ahwaz, Rag-e-Safid and Karanj - plus a new 42/48" pipeline from Ahwaz to Ganaveh on the coast near the Kharg Is- land marine terminal. Crude oil is blended for export from the Consortium area in two grades: Light (340 API) and Heavy 2/ (310 API), in the approximate proportion of 55:45 Light to Heavy. Under the new Consortium agreement the total installed capacity in the revised Agreement area is to be increased to 8 million b/d by October 1, 1976, enabling production of 7.6 million b/d. However, it is reported that a lower output may now be sought, in the order of 6.5 million b/d. It is understood that this would be achievable-without introducing secondary techniques such as natural gas injection which would enable a higher rate of oil production. The benefits and costs of investment in reinjection of natural gas rather than in delivering it for export sales is believed to be under further study by NIOC.

351. Production by the joint ventures SIRIP, IPAC, LAPCO and IMINICO began in 1960 and rose to about 24 million tons (470,000 b/d) in 1972. NIOC also produces about 0.7 million tons from its own operations at the Naft-i- Shah field in northwestern Iran. Taking into account the prospective decline in output from existing fields and the future output from IPAC's new fields, total output from joint ventures is projected by the mission to reach about 1.4 million b/d in 1980 and to remain at that level for a few years. Decline could set in thereafter unless active exploration and technogical development leads to new commercial discoveries.

1/ Oil and Gas Journal, December 31, 1973.

2/ Being renamed to Iranian Medium. - 119 -

Domestic Consumption of Petroleum Products

352. By 1972, domestic consumption of oil products had increased to 11 million tons (220,000 b/d), at an average annual rate of 11.2 percent from 1967. The latest long-range projections announced by NIOC in mid-1973 suggest, however, that domestic consumption will increase at just under 9 percent per annum during the next 20 years, from 284,000 b/d in 1973 to about 851,000 b/d in 1985, and to about 1.5 million b/d in 1993. Of the four mainline products, gas, and fuel oil account for over alYthe oal,though sales of kerosene and gasoline have been rising strongly. With the commissioning of the Iranian Gas Trunkline in 1970, natural gas consumption will be increased domestically in substitution for middle distillates (kerosene and gas oil).

353. To meet the domestic market, NIOC has organized its domestic distribution network into five main regions: northern (including Tehran),-west, east, central Iran and south. It distributes products at the retail level itself and by means of rural cooperatives and private contractors. Products are moved from domestic refineries by road, rail and coastal barge and above, all by a substantial pipeline system. As a matter of social policy, refined products are priced uniformly at the retail level, except for fuel oil which is about 38 percent cheaper in the main producing area, the province of Khuzestan. All petroleum products are taxed, with gasoline bearing the heaviest surtax.

354. Products for the domestic market are processed at the Tehran (Rey), Kermanshah, Shiraz (Fars) refineries and for the balance at the Abadan refinery. The Tehran refinery was brought on stream in 1968 with a crude oil distillation capacity of 85,000 b/d; this was raised in 1972 to 110,000 b/d byjthe expansion of existing units. It receives crude oil by pipeline from the Ahwaz field and produces a full range of products including lubricants, special products and sulphur. The Kermanshah refinery in western Iran came on stream in 1935 with a capacity of 2,000 b/d and was completely renovated in 1972, bringing the capacity to 15,000 b/d. It receives crude oil from the Naft-i-Shah field close to the Iraqi border and supplies a full range of mainline products to western Iran. NIOC plans to expand the refinery's capacity to 80,000 b/d by about 179. The refinery near Shiraz was commissioned in 1973 with an initial capacity of 40,000 b/d. It receives Gach Saran crude oil by pipeline and supplies a full range of mainline products to the provinces of Fars, Kerman and Esfahan provinces in southern and eastern Iran.

355. To meet future growth of the internal market including a 20 percent contingency, NIOC plans to complete new inland refineries in alternate future years each of about 100,000 b/d capacity. The first project is a second Tehran refinery of 100,000 b/d capacity, on which construction began in early 1973 at an estimated capital cost of $143 million. The second project is planned to come on stream in 1976 at Tabriz with an initial capacity of 84,000 b/d. It will receive Ahwaz crude oil from a line under construction which will join the main Ahwaz-Gehran line, and it will supply products to the northern province of Azerbaijan. The third project is understood to be planned for completion in 1978 near Gorgan on the Caspian shore; it would supply products - 120 - to northeastern Iran. Meanwhile the joint venture LAPCO is building a topping plant on Lavan Island with a capacity initially of 6,000 b/d and ultimately of 20,000 b/d. It will receive Sassan crude oil and supply products, particularly-diesel oil, mostly to the mainland for the internal market and the balance.-zfor exports including ships' bunkers.

Oil Exports.

356.. In 1972, Iran exported 240 million tons (5 million b/d) of crude oil and refined products. Of this amount, 94 percent (4.6 million b/d) was in the form of crude oil and 6 percent (300,000 b/d) in refined products. These'.exports. have grown strongly in recent years, at an average annual rate of 16 percent. Consortium companies accounted for 89 percent of crude oil exports in 1972. However, exports by NIOC both from joint ventures, and from its:entitlement of Consortium area output, and by foreign partners in joint -ventures, have shown significant growth in recent years. Crude oil exports are mainly to Japan and Western Europe, but sales to North America have,been growing during the last 5 years and accounted for 5percent in 1972,-Exports of refined products are made by Consortium companies from the Abadan refinery and have not grown in recent years.

357. Exports of crude oil from the Consortium area are made via the deep- water marine port on Kharg Island, which is now the world's largest offshore crude oil loading terminal. Following completion of the fourth construction phase in November 1972 the terminal now has twin berths at the Kharg IV sea island, one able to load 300,000 d.w.t. tankers and the other 500,000 d.w.t. tankers. .Refined products are exported from the oil port of Bandar Mahshahr which is able to load tankers up to 50,000 d.w.t.

358. In 1972, Consortium trading companies exported 200 million tons (4 million b/d)..of crude oil and 15 million tons (300,000 b/d) of refined products. NIOC takes crude oil needed to meet internal consumption and a stated quantity for export:in the form of crude oil or products. The stated quantity is set forth contractually by year in the agreement. The balance is available for export by Consortium trading companies. In mid-1973 NIOC announced a forecast of crude oil production and disposal from the Consortium area as follows:

Table 23: CRUDE OIL OUTPUT AND DISPOSAL ('000 b/d)

Internal Export by Sale to Total Consumption NIOC Consortium Production

1973 284 200 4,833 5,317 1974 304 300 5,074 5,678 1975 352 450 5,515 6,317 1976 388 600 5,959 6,947 1977 428 750 6,422 7,600

Source: NIOC. - 121 -

This forecast assumes that Iran will produce 42.5 billion barrels of oil from the former Agreement area during the 20 year period. Production would rise to a maximum of 7.6 million b/d by 1977 and be maintained at this level until 1984, after which it could decline rapidly to 1.5 million b/d, almost all of which would be used for internal consumption. Exports by the consortium, likewise, will increase from aestimated 5.0 million b/d in 1974 to 6.4 million b/d in 1977. Thereafter, consortium exports will decline gradually as domestic consumption and exports by NIOC increase. 1/

359. In addition to oil which NIOC lifts for the domestic market from the Naft-i-Shah field and the Consortium area fields, NIOC has exported crude oil from its joint venture output mainly to refineries in India and South Africa in which it has equity participation and some 20 million tons during 1968-1972 from the Consortium area under a supplemental agreement of 1966, for delivery to Romania and Yugoslavia as part of Iran's barter-trade agreements. In 1972 NIOC's exports amounted to 230,000 b/d. Under the new Con- sortium agreement of March 1973 NIOC acquired entitlement to a stated quantity of crude oil for export. It successfully sold the stated quantity of 200,000 b/d for the first period, March 21-December 31, 1973 to Japanese and US oil importers at market prices equivalent to posted prices minus 12 cents per barrel and to eastern European countries under barter deals which have now been renegotiated essentially on to a cash basis. NIOC is selling its entitlement for 1974 and thereafter on a yearly basis only, until it completes projects for processing crude oil through joint refining ventures.

360. Export sales of Iranian oil are made on the one hand by NIOC itself and on the other by NIOC's foreign partners in the Consortium and joint venture arrangements who dispose of their entitlement to affiliates and third parties abroad as they choose. Iran's priorities for NIOC's export sales are in the following order: (i) it will process crude oil within Iran and hence maximize value added there, (ii) it will then seek new joint refining ventures abroad, and (iii) it will sell the balance to unaffiliated foreign buyers. To that end NIOC is seeking partners who are willing to build export refineries in Iran including provision of finance for construction and guarantee of product exports. It is also seeking partners willing to sell to NIOC a 50 percent equity participation in existing refining and marketing facilities abroad, for which NIOC would pay out of subsequent profits from such facilities.

361. NIOC is negotiating 50:50 joint ventures separately with Japanese, US, and German interests for the construction of export refineries in Iran, each of about 500,000 b/d capacity. Such refineries would be as big as the largest now existing worldwide and would reverse the trend since World War II of refining crude oil in consuming countries. The projects envisage the

1/ These forecasts, however, are based on present proven reserves. In practice, production and exports may not decline in this fashion in view of likely additions to reserves from exploration and secondary recovery measures. - 122 - use of large multi-product tankers, 80/100,000 d.w.t. or larger, to offset the freight disadvantage to Europe and Japan vis-a-vis very large crude carriers. The present proposal to reopen and subsequently expand the Suez Canal would presumably favor the Iranian refining projects.

362. Iran and West Germany have reached agreement in principle on a joint venture to build and operate a refinery and petrochemical complex on the coast at Bushehr. The German partners are expected to consist in the oil group of Vega, Gelsenberg, Wesseling and German subsidiaries of Shell and BP, and in the chemical group to include Bayer. Negotiations are continuing between Iran and seven Japanese firms for a $1 billion petrochemical project. And NIOC has signed a memorandum of understanding with a group of five US firms to form a 50:50 joint venture named Iran-America Refining and Marketing Com- pany; subject to the results of a feasibility study, the project would go on stream in 1977. If all three projects come to fruition, they would take 1.5 million b/d from NIOC's 1980 estimated availability of 2.0 million b/d crude oil for export. Advantages to Iran include value added in refining, creation of employment, and securing of markets in consuming countries. Advantages to foreign partners include long-term access to oil supplies, and availability of refining sites which are becoming harder to find in consuming countries, particularly with rising concern for the environment.

363. Apart from the interest which NIOC has in two overseas refineries, other joint refining ventures under discussion are for partial acquisition of Ashland Oil's refinery in New York State and the construction and operation of refineries tied to Iranian oil supplies, one in the Philippines, one in Greece and one in Belgium.

364. With the rising concern of oil-importing countries to have access to and be able to pay for long-term secure sources of oil supplies, some in- dustrially advanced countries have recently been entering into bilateral arrangements. In February 1974, France and Iran concluded a 10-year indusLrial cooperation agreement worth initially $3 billion and ultimately perhaps $5 billion. It is reported to help finance French crude oil imports from Iran at present levels. France will supply a substantial part of Iran's nuclear power program, including up to five nuclear power stations with a total capacity of 5,000 mw worth $1.2 billion. It will participate in building a proposed natural gas pipeline from Iran to Europe and - if additional Iranian gas is available - will also build a gas liquefaction plant in Iran worth about $1 billion; additional cooperation in building tankers to carry Iranian petrochemical products and LNG is envisaged. The joint Franco-Iranian Commission will discuss requests by French oil companies for access to new areas in Iran and examine the possibility of joint ventures in third countries. Negotiations will continue on the proposal for a joint venture between CDF-Chemie of France and the National Petrochemical Company (NPC) of Iran to build a $500 million petrochemical complex producing caustic soda, vinyl chloride, polyethylene, styrene and polystyrene. The French partner will guarantee marketing part or all of the output. The agreement covers cooperation in a wide range of industrial projects, including construction of a 250,000 ton per annum special steel plant by Creusot-Loire and an electrical equipment plant by CGE of France. A housing program and joint agricultural project are also under consideration. - 123 -

365. Britain and Iran have concluded an oil-for-goods agreement under which Britain will receive 5 million tons of crude oil in 1974 in exchange for goods worth L 110 million. The grades of crude oil will be Iranian Light and Heavy and will be bought directly by the UK Government which will pay a commission to BP acting as agent for shipping, refining and marketing. The price is understood to be that currently being provided by the Consortium, or somewhat over $7.00 per barrel. British firms are to supply Iran with goods in short supply in world markets: polyethyhele, PVC, plasticizers and textile fibers (ICI); steel (British Steel Corporation); newsprint (Bowater); tripolyphosphate and plasticizers (Albright and Wilson); and other goods (Courtaulds).

366. West Germany and Iran have been discussing a 25 year trilateral deal for supply of Iranian natural gas to the Soviet Union in exchange for Russian gas deliveries to Western Europe of about 12-13 billion cubic meters annually (115-125 million cfd), of which West Germany would take about 10 billion cubic meters. In addition a 500,000 b/d export refinery in Iran may be built by the West German firm Thyssen Stahlunion; four German oil companies would be involved including subsidiaries of Shell and BP; and Iran is reported to be negotiating for part of the output to be processed domestically in an ancillary German-financed petrochemical complex.

IV. INTERNATIONAL OIL PRICES

367. From the late 1950's to mid-1970, market prices of international oil outside the United States had declined steadily from the peak reached during the first closing of the Suez Canal in 1957. Reasons were as follows: (a) some new investors in Venezuela and North African oil production sought a rapid payback on investments in new concessions, (b) US overseas producers could import only a limited share of their production into the United States because of import restrictions and had to seek new markets, (c) proven recoverable reserves of crude oil were growing faster than world consumption, (d) some oil-producing countries prevailed on companies to increase oil output from their countries to the detriment of others, and (e) the increasing size of tankers lowered freight rates and extended international competition over a wider area. Efforts to establish an OPEC quota system of production program mining were unsuccessful. From 1960, Middle East oil exporting countries resisted any decrease in posted prices, which are the base for calculating royalties and taxes, but, as a result, crude oil sales were made at increasing discounts off posted price. For example, Iranian Light crude oil was sold at about $1.30-1.40 per barrel in early 1970, an average discount of about 25 percent off the posted price.

368. In mid-1970, the buyer's market came to an end, with increases in both posted and market prices. From that time to early 1971, the closing of the Trans-Arabian Pipeline and the production cut in Libya both made for a sharp increase in the demand for shipping to bring Middle Eastern oil to Europe via the Cape of Good Hope and drove up freight rates worldwide. Euro- pean oil stocks were low. Meanwhile oil demand was growing at a faster rate - 124 - than had been expected. Under a series of agreements from 1971 to 1973 1/ OPEC countries were able to negotiate new posted prices, tax rates, government participation in concessions, and adjustments for currency realignments and inflation. Posted prices of Iranian crude oil were increased in February and June 1971 by a combined 27 percent; in January 1972 by another 8.49 percent reflecting the Smithsonian currency agreement; and in January 1973 by a further 4.5 percent. With the dollar devaluation of February 1973, crude oil posted prices rose in April 1973 by 6.4 percent and in June 1973 by a further 5.1 percent. The posted price for Iranian Light crude stood at $2.995 per barrel on October 1, 1973. Discounts off posted prices remained at roughly 25 percent until mid-1972; thereafter they diminished to roughly 10 percent of posted prices by September 1973 and in a few sales at that time were said not to have been granted at all.

369. On October 16, 1973, the first of two unprecedentedly large increases in posted prices took place in the Middle East with far-reaching repercussions for international oil prices, energy costs, economic growth and the balance of payments. It signified the effective end of the Tehran Agreement which had provided for the contractual escalation of posted prices from February 15, 1971 to December 31, 1975. The increase followed the breakdown in early October of negotiations between the six Gulf member states of OPEC and the oil companies on increasing the general level of posted prices and the inflation provision in the Tehran Agreement. The six Gulf states thereupon determined that the f.o.b. market price of oil (Arabian Light), which had risen from about $1.30 per barrel in early 1970 in steps to rougly $2.70- 3.10 in mid01973, would become $3.65 effective October 16. The posted price was set at 40 percent over the market price; the new level of posted prices thus was about 70 percent higher than on October 1, 1973.

370. Market and posted prices of other Middle Eastern crude oils were aligned with Arabian Light, taking into account product yield, location of loading port, and sulphur content. Posted prices of Iranian Light and Heavy were set at $5.341 and $4.991 per barrel respectively on October 16. A premium for low sulphur content was introduced into the posted price of Iranian Light at 25 cents from October 16 and into that of Iranian Heavy at 10 cents from November 27, 1973. NIOC set the f.o.b. market prices in Japanese sales of its entitlement of these crude oils from the Consortium area at $3.70 and $3.62 per barrel respectively for October 16-31, 1973 but raised them to $3.85 and $3.66 during November 1973; these prices were reported to include about 5 cents for low sulphur merit. Government unit revenue (royalty and taxation) from Iranian Light crude, which had risen from about 90 cents per barrel in 1970 to about $1.75 by October 1, 1973, rose to about $3.18 on October 16, 1973.

371. The six Gulf member states of OPEC announced their intention to change market prices - over which posted prices were to maintain a 40 percent premium - whenever "market conditions" were to alter. Government oil

1/ Tehran and parallel agreements in 1971, Geneva in 1972, amendments to the Geneva agreements in June 1973, and participation agreements in 1973. - 125 - companies proved able to market their equity share of oil production at prices higher in direct sales to third parties than the general "market" price; these prices were typically set by Gulf States at 93 percent of posted price, i.e. at about $4.76 per barrel for Arabian Light (93 percent of the October 16 posting). In the dislocated market conditions of December 1973 NIOC successfully auctioned substantial quantities (470,000 b/d) of different grades of crude oil for delivery in January-June 1974 at prices up to more than $17 per barrel; the crude oil represented NIOC's full direct deal entitlement of 300,000 b/d in 1974 from the Consortium area and 170,000 b/d of joint venture crude oil.

372. This led to the second of the two rounds of large price increases. On December 23, 1973, the six Gulf member states of OPEC announced new prices for three months from January 1, 1974, subsequently extended for another two periods each of three months to September 30, 1974. The posted price for Arabian Light, chosen as the market crude oil, was raised to $11.65 per barrel. This new posted price resulted from the decision to set government unit revenues from royalties and taxation on this crude oil at $7.00 per barrel, compared to about $3.05 from October 16 to December 31, 1973. 1/ The formula relating market price to posted price was dropped. Posted prices of Iranian Light and Heavy crude oils were set at $11.87 and $11.63 per barrel respectively.

373. During the first half of 1974 the market price level for Middle Eastern crude has remained somewhat unsettled, though supply conditions have normalized now that the Arab embargoes and production restrictions have for the most part been lifted. Price levels obtained by Government-owned oil companies in sales to third parties have therefore declined to below or at most a little above posted prices.

Participation Arrangements

374. The invoice prices of international oil companies to affiliates and third parties have generally been provisional, reflecting the companies' un- certainties about their costs per barrel of crude oil during 1974 arrangements. Effective January 1973 Saudi Arabia, Abu Dhabi and Qatar acquired an initial 25 percent participation in concessions and could opt to increase it in yearly steps to 51 percent by 1982; they were to pay compensation to the foreign partners on the assessed "updated book value" of their share of the net fixed assets. The foreign partners thus have had available to them 75 percent of total production as equity crude oil at tax-paid cost, i.e. production cost, taxation and royalties. They also buy back most of the government's 25 percent share of output which they market on behalf of governments while the latter build up their own outlets. From the viewpoint of the foreign partners, the purchase of government crude oil at approximately market price, which had

I/ At the Ouito ny'EC meeting in June -1974 t-er nl.so increased the royalty rate (except Saudi Arabia) from 12.5 percent to 14.5 nercent of nnaed price, thereby increasing unit revenues by about another 11 cents per barrel. - 126 - been available to them at tax-paid cost prior to the participation supple- ments, is an additional cost which they pass on to customers. From the governments' viewpoint, the sale of such crude oil to foreign partners - as also to third parties - yields an additional financial benefit equal to the margin between market price and tax-paid cost.

375. In early 1973 the effect of the participation arrangements on government revenue and market price was relatively small: initially about 7 cents net per barrel after taking account of compensation payments. In the fall of 1973, buy-back prices rose substantially and government financial benefit from participation rose to about 40 cents per barrel. The current renegotiations of participation arrangements now seems likely to provide to governments the equivalent of at least 60 percent equity participation from January 1974; financial benefits would depend on the amount and price of buy-back crude oil and might range from $0.90 to $2.25 per barrel.

376. Prices at which Arab government oil companies have been selling crude oil so far this year both to third parties and foreign partners to participation deals are now believed likely to be settling close to $10.84 per barrel for Arabian Light ($11.04 for Iranian Light), i.e. 93 percent of posted price. Of every 100 barrels produced, 25 had been available to government oil companies since January 1973, of which 5 were sold to third parties and 20 to foreign partners. Under revised arrangements recently ratified by Qatar and Kuwait, 60 barrels are now available to the government oil company retroactive to January 1, 1974; it seems that 24 barrels may be available to third parties and 36 to foreign partners. Assuming the arrangements for Iran are revised to give similar financial effect, the government would obtain a 'participation' benefit of $2.21 per barrel.

F.O.B. Market Price of Iranian Crude

377. F.o.b. export prices of Iranian Light crude oil, estimated to average $8.75, are likely to remain (in constant dollars) at this level in 1975. Table 24 shows a medium price projection which assumes no change in real terms by 1980. With the expected continuation of high rates of inflation in international trade the f.o.b. export price of Iranian Light is projected by 1980 (in 1980 dollars) at a range of $11.70-16.65 per barrel. - 127 -

Table 24: PROJECTED F.O.B. MARKET PRICES OF IRANIAN LIGHT CRUDE /1

Participation Royalty & Benefit Taxation Equivalent Market Price Date Low Medium High Low Medium High Low Medium High (US$ per barrel)

1974 7.20 7.20 7.20 1.10 1.10 1.10 8.75 8.75 8.75 1975 7.65 7.90 8.20 1.30 1.35 1.40 9.40 9.75 10.10 1976 7.95 8.50 9.05 1.35 1.45 1.55 9.80 10.50 11.20 1977 8.30 9.15 10.00 1.40 1.55 1.70 10.25 11.25 12.35 1978 8.70 9.80 11.05 1.50 1.65 1.90 10.70 12.10 13.65 1979 9.10 10.55 12.20 1.55 1.80 2.10 11.20 13.00 15.05 1980 9.50 11.35 13.50 1.60 1.95 2.30 11.70 14.00 16.65

/1 These are the latest price forecasts of Iranian crude oil and slightly differ from those used in the projections of macro variables reported in Volume I. The standard assumption used in the report implies a market price of US$8.73 per barrel in 1974 gradually rising to US$13.87 in 1980.

Source: IBRD estimates.

378. At these price levels imported oil would no longer be the low cost source of energy relative to alternative sources which it had been through the 1960's and there exists now a strong incentive to conduct research for the development of domestic energy sources in the oil-consuming countries. Some sources can be brought in with existing proven technology, while others may require further development of technology. Thus a major shift could take place in the pattern of energy sources. However, the amount of capital expenditure needed is huge, and for some energy sources the problems of finding acceptable sites, disposing of waste, and operating reliably and safely are large. It is impossible to be precise on the timing of such a shift or on the effect on internationally traded oil, but on present evidence the con- sequences are unlikely to be significantly felt before the mid-1980's.

V. NATURAL GAS

379. At the beginning of 1974 proven reserves of natural gas in Iran were estimated at roughly 270 trillion cubic feet. This is equivalent to roughly 45 billion barrels of oil, nearly as much as proven oil reserves. Potential reserves of gas and oil are much higher. With 10 percent of the world's total gas reserves, Iran stands third in the world following the United States and the Soviet Union. - 128 -

380. The first major steps to exploit these resources were taken in 1966 when Iran signed the Economic Cooperation Agreement with the Soviet Union and undertook to supply up to 1 billion cfd of natural gas in return for construction of the Esfahan steel mill, the Arak machine tool and heavy engineering plant, and the supply of defense equipment. The National Iran Gas Company (NIGC) was thereupon formed with responsibility for domestic and export gas activities. In order to bring gas from the Agha Jari and Marum oilfields in the South to the Soviet Union and the domestic market, the Iranian Gas Trunk- line (IGAT) was commissioned in October 1970. The system receives gas from the Bid Boland treatment plant near Agha Jari and delivers it via the 1,120 km. main pipeline to the Soviet border at Astara, and via spur lines to Shiraz, Isfahan, Kashan, Qom, Tehran and Qazvin basically for industrial usage. Increasing domestic use of natural gas is planned in substitution for middle distillates. Four new pumping stations are being built along the IGAT line to help it reach ultimate capacity of 1.6 million cfd. Sup- plies will be augmented by a new feeder line to be built from the Ahwaz oilfield to Bid Boland.

381. Independently from the IGAT line, Shiraz also receives gas from the Gach Saran oilfield, and Ahwaz from the surrounding oilfields. NIGC is also developing two large gas fields near Sarakhs close to the Iran and Russian border, about 120 km northeast of Mashhad. Reserves there are estimated at about 425 billion cubic feet. It has completed a 122 km gas line from Khangiran to Mashad where a gas processing refinery is under construction. Deliveries of gas are expected to start shortly.

382. Iran has exported gas to the Soviet Union via the IGAT line at a price reported to be $6.60 per thousand cubic meters in the original agreement, or 18.7 cents per mcf. Reflecting the growing value of natural gas, the price was renegotiated effective January 1973 at a level reported to be 25 cents per mcf.

383. In October 1973 Iran and the Soviet Union agreed in principle on a deal whereby Iran would deliver natural gas to the Soviet Union and the latter will deliver an equivalent volume of Soviet gas, on behalf of Iran, to West Germany at the Czechoslovak-West German border; the Soviet Union would be compensated by the equivalent of a transit fee payable in gas or hard currency. Under this project a new 1,100 km gas pipeline would be built from the southern Iranian oil and gas fields to Astara on the Soviet border, parallel to the existing IGAT line, and with a similar capacity of about 1.6 billion c.f.d. The capital cost is estimated at over $1 billion and would be financed by Iran.

384. Iran is also understood to be considering the construction of a gas pipeline via Turkey to carry Iranian gas directly to Europe. The Italian national oil company ENI and the German firm Ruhrgas are both carrying out feasibility studies. The presently preferred route is believed to be by pipeline to Iskenderun, Turkey for liquefaction and thence by ship to West- ern Europe, though an overland pipeline through Greece and Yugoslavia to northern Italy is a possible alternative. - 129 -

385. In the Consortium Agreement area, natural gas liquid (NGL) is ex- tracted from gas produced in association with oil at the Agha Jari and Marun fields and is delivered to the NGL refinery at Bandar Mahshahr. The-dry gas is delivered to the IGAT pipeline at Bid Boland and to the Abadan refinery which is completely fueled by gas; the refinery itself is one of the main suppliers of liquid petroleum gas (LPG, i.e. propane/butane) to the internal market. The NGL refinery - completed in 1970 and one of the world's largest - can process 48,000 b/d of NGL and make from it 14,000 b/d propane, 15,000 b/d butane and 19,000 b/d natural gasoline. Under the new consortium agreement, NIOC took over management of the NGL refinery and processes the NGL which trading companies have bought from it on financial terms prevailing before the agreement. NIOC and the consortium members can opt to participate in any new NGL projects associated with NIOC's natural gas exports by pipeline.

386. Within the Agreement area NIOC has first right to natural gas for internal consumption in Iran, for use in the Agreement area including secondary recovery, for exports by pipeline, and for certain projects for which the gas is reserved under a "first come, first served" aide-memoire of 1966. The balance if available to NIOC and for sale to consortium members and, if NIOC or consortium members have a project, the other can opt to acquire a 50 percent interest. Several schemes have recently been proposed for the export of Iranian natural gas by tanker, though none have been finalized as yet.

VI. PETROCHEMICALS

387. Iran originally launched into the manufacture of petrochemicals by making use of natural gas as feedstock for fertilizers. The Shiraz Chemical Fertilizer Factory began production in 1963 of fertilizers for the national market; it takes natural gas from the Gach Saran oilfield for fuel and feedstock and makes 135 t.p.d. (tons per day) of ammonia, 195 t.p.d. of urea and 120 t.p.d. of ammonium nitrate. An adjacent plant to make sodium carbonate and bicarbonates (63,000 t.p.a.) was completed in 1972, and work began on mixed fertilizers (50,000 t.p.a.) and sodium tri-poly-phosphate (30,000 t.p.a.) plants.

388. The National Petrochemical Company (NPC) was formed in 1963 as a subsidiary of NIOC to develop industries in which gas would be used as raw material and not just as fuel and took over the Shiraz complex. Following negotiations with several international petrochemical producers, NPC entered into three initial joint ventures with US companies. The first is the Abadan Petrochemical Plant, inaugurated in November 1969 as a joint venture between NPC (74 percent) and B.F. Goodrich (26 percent). It manufactures raw materials for the plastics and detergents industries. The second is the Kharg Chemical Company, formed as a 50:50 joint venture of NPC and American Inter- national Oil Company (AMOCO). The plant was inaugurated in November 1969 and makes about 700 t.p.d. of sulphur and 8,000 t.p.d. of liquified petroleum - 130 - gas (LPG) and heavier hydrocarbons. The third is the Shahpur Chemical Com- pany, originally formed 50:50 with the US firm Allied Chemicals and now understood to be 100 percent owned by NPC. The complex was inaugurated in November 1970 at Bandar Shahpur on the Persian Gulf and produces fertilizers for the domestic and export markets.

389. Another joint venture, Iran Chemical Development Company, was formed in 1973 between NPC and the Japanese firm Mitsui. Two plants are planned for construction at Bandar Shahpur adjacent to the existing plant there. One would make 500,000 tons p.a. of olefins, 450,000 tons p.a. of aromatics, 250,000 tons p.a. of caustic soda, 300,000 tons p.a. of ethylene dichloride, and 150,000 tons p.a. of polyethylene. The second would make 40,000 tons p.a. of dioctyl phthalate, and 20,000 tons p.a. of anhydrous phthalic acid and 2-ethylhexanol. An agreement has also been signed with the US firm Cabot Corporation to build a 15,000 tons p.a. carbon black factory at Ahwaz.

390. These projects form part of NPC's program to make Iran self-sufficient in almost all major petrochemicals and plastic ingredients during 1975- 1980. Negotiations are continuing with CDF-Chemie of France for a $500 million petrochemical complex within the framework of the recent bilateral agreement concluded between France and Iran. The construction of petrochemical complexes are also being negotiated with West Germany and Japan in the context of joint export refinery projects.