Economic Research and Perspectives

Economic Research and Perspectives

The Outlook on Budget Deficits, Debt Securities, and Financial Sustainability of the Government in Iran's Economy: A Macroeconometric Approach

Document Type : مقالات علمی پژوهشی

Authors
Alireza Saedi Sarkhanlou 1
Hassan Dargahi 2
1 Department of Economics Shahid Beheshti University
2 Associate Professor of Economics, Faculty of Economics and Political Sciences, Shahid Beheshti University
10.48311/ecor.2025.116650.82876
Abstract
Abstract
The aim of this article is to examine the outlook for budget deficits and government debt in the Iranian economy within the framework of various scenarios, and to analyze the application of fiscal rules in financial sustainability.
For this purpose, a medium-scale macro-econometric model was estimated by autoregressive distributed lags approach and simulated to analyze the interaction between government debt and the macroeconomy. The results of the baseline scenario over a five-year horizon indicated that with an average economic growth of 2.5%, the debt-to-GDP ratio would reach 58%. Even assuming inflation is controlled, due to the increase in real interest rates, the debt situation worsens. If the government wants to contain the debt-to-GDP ratio at 50 percent., it will need to raise the tax-to-GDP ratio to 11% by 2027, which will be accompanied by an economic recession. If the government borrows up to 40% of the budget deficit from the development fund, although economic growth increases, the debt ratio rises to 64%. Therefore, it is recommended that a fiscal rule for stabilizing G/GDP be implemented to manage the budget deficit and government debt, while simultaneously defining a stabilization fund within the framework of the National Development Fund. The results of the research model indicate that in this case, alongside improving the economic growth rate, the debt ratio would also decline to an acceptable range.
Thus, stabilizing government expenditure relative to GDP, gradually increasing taxes, and controlling inflation while establishing a stabilization fund with a balance proportional to oil revenue trends can place the government debt ratio in a managed state
Purpose/Aims:
This article aims to evaluate the outlook of Iran’s budget deficit and public debt sustainability under multiple policy scenarios. The authors seek to determine how different fiscal and monetary policies particularly the introduction of fiscal rules and the creation of a stabilization fund can influence the government’s debt dynamics and long-term financial stability. In essence, the research investigates the two-way interaction between public debt and macroeconomic indicators in Iran, emphasizing how fiscal behavior affects inflation, growth, and real interest rate.
Given the current budget deficit and the growing reliance on debt financing through Islamic securities (sukuk), the study tries to address a key policy question: Under what fiscal and macroeconomic conditions can Iran maintain debt sustainability without jeopardizing economic growth or stability? The authors’ contribution is novel in that they employ a comprehensive macroeconometric model to simulate the future trajectory of Iran’s debt-to-GDP ratio, considering the interlinkages between fiscal variables, monetary conditions, and oil revenue fluctuations.
Methodology & Framework:
The research adopts a medium-scale macroeconometric model using the Autoregressive Distributed Lag (ARDL) approach. This model captures the dynamic feedback among the government’s fiscal position, macroeconomic aggregates, and the financial sector. It integrates relationships across key components such as real GDP, inflation, real interest rate, public and private investment, consumption, and external trade. The model distinguishes between five scenarios to analyze the sensitivity of debt sustainability to different strategies:
1-Baseline Scenario: Continuation of current conditions with moderate recovery in oil exports.
2-Contractionary Monetary Policy: Reducing money supply through tighter monetary control.
3- Fiscal Policy: Via increasing tax revenues to stabilize the debt-to-GDP ratio around 50%.
4- Financing up to 40% of the deficit through borrowing from the National Development Fund (NDF).
5- Establishing an expenditure rule to stabilize government spending as a share of GDP while creating a stabilization buffer under the NDF framework.
The framework links government debt accumulation to growth, inflation, interest rates, and real exchange rate movements. The model also allows for endogenous responses of monetary aggregates (money supply, credit, and interest rates) to fiscal imbalances. Validation tests confirm the model’s structural stability and its ability to replicate historical behavior of key variables.
Findings & Discussion:
The baseline simulation projects that if current fiscal and monetary trends persist, Iran’s debt-to-GDP ratio will rise from about 42 in 2022 to nearly 58% by 2027, surpassing the 50% ceiling envisioned in the Seventh Development Plan. Despite modest economic growth averaging 2.5% annually, persistent budget deficits (averaging around 8% of GDP) and inflation (above 30%) will lead to fiscal vulnerabilities. The findings reveal that oil continues to play a dominant role in budget stability, with roughly 70% of oil income being absorbed into government revenue.
In the second scenario, applying a contradictory monetary policy lowers the inflation by roughly 4% points. However, the rising real interest rate worsens debt dynamics and dampens investment and output growth. As a result, the debt ratio increases further (reaching above 70% of GDP by 2027) illustrating a policy trade-off between inflation control and debt sustainability.
Under the third scenario, the implementation of a tax-increase successfully limits the debt-to-GDP ratio to around 50%, but at the cost of economic slowdown. To achieve this stabilization, the tax-to-GDP ratio must increase to 11% by 2027, consistent with Article 47 of the Seventh Development Plan. Yet, without other necessary improvements, this approach risks intensifying the recessionary effects of fiscal tightening.
The fourth scenario, involving borrowing from the National Development Fund, offers short-term relief for government financing and temporarily boosts growth. However, it increases the overall debt burden risk, as such loans must be repaid in foreign currency with interest of at least 10%. By 2027, the debt ratio could rise to 64% of GDP, while debt-servicing costs absorb nearly a quarter of oil export revenue. The analysis warns that reliance on NDF borrowing may undermine both fiscal transparency and exchange rate stability, particularly if oil prices decline.
In contrast, the fifth scenario, which combines a fiscal expenditure rule with the establishment of a budget stabilization fund, yields the most balanced outcome. By capping government expenditure at about 22% of GDP and saving a small portion (around USD 1 billion annually) of oil revenues during the first half of the projection period, the government can create a financial buffer to smooth spending in later years. The results indicate that this policy improves economic growth by up to 1% point relative to the baseline while lowering the debt ratio to a sustainable level by 2027. Inflation also moderates slightly.
Overall, the model demonstrates the critical role of coordinated fiscal-monetary management. Isolated actions—such as tightening money supply or raising taxes either deepen recession or accelerate debt accumulation. Sustainable fiscal adjustment, therefore, requires a hybrid approach combining expenditure discipline, tax base expansion, and countercyclical stabilization fund.
Conclusion & Implications
The study concludes that Iran’s fiscal sustainability is at risk if current policies persist. Under baseline conditions, public debt will exceed the manageable threshold within five years, driven by chronic budget deficits and high interest costs on government securities. Sole reliance on debt issuance to cover deficits will raise borrowing costs, and crowd out private investment.
While contractionary monetary policy can temporarily control inflation, it paradoxically aggravates the debt ratio by increasing real interest payments. Similarly, an aggressive tax strategy may stabilize debt but risks weakening growth. Borrowing from the NDF increases fiscal exposure to exchange rate fluctuations.
The authors therefore advocate for a comprehensive fiscal reform anchored in rules-based governance. A fiscal expenditure rule limiting government spending relative to GDP, implemented alongside a stabilization fund under the NDF, can smooth revenue volatility, mitigate debt accumulation, and support macroeconomic stability. This combination ensures that during periods of high oil revenue, part of the surplus is saved, while in downturns, withdrawals can finance essential spending without new borrowing.
Ultimately, the research underscores that fiscal sustainability in Iran depends not merely on debt containment but on structural reform including expenditure efficiency, diversification of revenue sources, and credible commitment to macroeconomic stability.
Keywords
Budget Deficit
Debt.Sustainability Analysis
Fiscal Rules
Government.Debt National.Development Fund
Subjects
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