Analysis of Government Debt Sustainability in Iran Over the Past Half-Century

Ghodsi Dehaghi, Ahmad; Zamani, Reza; Ghasemi, Mohammad

doi:10.48311/ecor.2025.27941

Analysis of Government Debt Sustainability in Iran Over the Past Half-Century

Document Type : Original Research

Authors

Ahmad Ghodsi Dehaghi ¹

Reza Zamani ²

Mohammad Ghasemi ²

¹ Ph.D. Student, Department of Economic Planning and Development, Allameh Tabataba’i University, Tehran, Iran

² Assistant Professor, Department of Economic Planning and Development, Allameh Tabataba’i University, Tehran, Iran

10.48311/ecor.2025.27941

Abstract

Abstract
The primary objective of this study is to examine the sustainability of government debt in Iran over the past half-century. Debt sustainability is assessed using the fiscal reaction function approach, employing the vector autoregression (VAR) method for the period 1974-2023. Additionally, a government budget deficit index is defined and calculated, and government debt is estimated using a new method for the period 1974-2014. The findings indicate that a positive shock to government debt initially increases the budget deficit. However, over time, the rate of increase in the deficit declines, and in the long run, the deficit decreases. In other words, the government responds to rising debt by reducing the budget deficit, implying that government debt in Iran is sustainable in the long-term horizon. Furthermore, the study finds that an increase in government debt does not affect the output gap, suggesting that expansionary fiscal policies through debt accumulation have not contributed to long-term economic growth in Iran.
Aim and Introduction:
The primary objective of this study is to examine the sustainability of government debt in Iran over the past half-century. Government debt sustainability is a key topic in macroeconomics and public finance, focusing on a government’s ability to manage and repay its debt in the long run without experiencing a financial crisis. This issue has gained increasing importance, particularly following global and regional financial crises in recent decades.
In this research, government debt sustainability is analyzed using data from the past fifty years. The time series of government debt (1974-2014) is estimated while considering that a portion of the budget deficit has been financed through the banking system. By employing different definitions of the budget deficit, the time series of the Iranian government’s budget deficit (or surplus) is calculated and utilized. Specifically, the budget deficit is defined as the portion of government budget resources financed through debt issuance (borrowing).
Methodology
This study analyzes the sustainability of government debt using the fiscal reaction function approach. According to this approach, government debt is considered sustainable if the government responds to an increase in the debt-to-GDP ratio by raising the budget surplus-to-GDP ratio (or reducing the budget deficit-to-GDP ratio).
To assess debt sustainability, three key variables are incorporated into the model: the government debt-to-GDP ratio, the budget surplus-to-GDP ratio, and the output gap. Given the time-series nature of the data, the model is estimated using the VAR method. Moreover, since the total government debt for a given year is determined in the following year and the annual budget is approved in the preceding year, two lags are included in the estimation process.
Results and Discussion
After estimating the model using the VAR method, impulse response functions (IRFs) were derived to analyze how each of the three variables—government budget surplus, government debt-to-GDP ratio, and output gap—responds to shocks in these variables.
The results indicate that following a one-standard-deviation positive shock to the government debt-to-GDP ratio, the budget deficit initially increases but gradually declines in the medium term, eventually converging to a balanced budget in the long run. This finding suggests that, over the 50-year period examined, government debt in Iran has remained sustainable.
Moreover, the output gap appears to be neutral in response to positive shocks in government debt and budget surplus, implying that changes in government debt or budget surplus have neither stimulated economic growth nor induced recessions in Iran over the past half-century. This result aligns with the classical economic perspective that long-term economic growth is driven by productivity improvements rather than expansionary fiscal policies such as increased budget deficits or government debt accumulation.
Additionally, a positive shock to the output gap initially leads to an increase in the government budget surplus, followed by a slight decline that eventually dissipates over time. This response can be explained by the rise in government revenues— particularly from taxes and oil exports—during economic booms in Iran. Furthermore, a positive output gap shock leads to a reduction in government debt in the first two years, followed by a slight increase, and eventually has a neutral effect on the debt-to-GDP ratio.
Conclusion
This study employed the fiscal reaction function approach to analyze the sustainability of government debt in Iran. The calculations indicate that the highest debt-to-GDP ratio occurred during the Iran–Iraq War, reaching 114% in 1988. Moreover, this ratio exceeded 50% only during the 1979-1992 period and has not returned to such levels since.
To calculate the government budget deficit, revenues from the privatization of state-owned enterprises and withdrawals from the Currency Reserve Fund were subtracted from the operating and capital balance deficit (or added to the surplus). The results show that during most years of the 2000s, when oil revenues surged, the government recorded a budget surplus. In contrast, in the remaining years of the past half-century, the government faced a budget deficit.
The IRF analysis reveals that although a positive shock to the government debt-to-GDP ratio initially increases the budget deficit ratio in the short run, this effect gradually diminishes, and in the long run, the budget deficit ratio declines as the debt-to-GDP ratio rises. This finding supports the conclusion that government debt in Iran has remained sustainable over the past 50 years. Additionally, the results indicate that an increase in the output gap leads to a reduction in the budget deficit, which is consistent with expectations, as economic booms generate higher tax and oil revenues.
Furthermore, the findings demonstrate that an increase in the budget deficit-to-GDP or debt-to-GDP ratio has a neutral effect on the output gap, implying that expansionary fiscal policies—through higher deficits or government borrowing—have not contributed to long-term economic growth in Iran.

Keywords

Government Debt Sustainability Government Debt

Budget Deficit

Output Gap

Vector Autoregression (VAR)

Subjects

Public Economics

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