Sanctions hurting Iran economic activity, says IMF

WASHINGTON (Reuters) - Stepped-up international pressure and sanctions against Iran over its nuclear program are hurting its economy, making trade financing and payments difficult and discouraging foreign investment, according to an IMF report published on Thursday.

The International Monetary Fund said profits of state-owned banks have been hit hard by U.S. and U.N. economic sanctions, forcing the government to recapitalize three banks.

Boosting banks' capital was the right move, the IMF staff report said, but it also said some banks were still undercapitalized as of the end of March.

"Intensified international pressures on Iran have negatively affected economic activity," the report said.

The U.N. Security Council has imposed three rounds of sanctions on Iran for refusing to suspend its nuclear activities, which the West says is a cover for building bombs. Tehran has denied the charge.

The U.S. Treasury has banned dealings with several Iranian banks -- including its largest, Bank Melli -- and that has forced many businesses to steer clear of Iran.

IMF staff met with Iranian Central Bank Governor Tahmasb Mazaheri and senior government officials in May for annual consultations on the economy.

Such visits by IMF staff are conducted in all of the IMF's 185 member countries, many of which agree to publish details of the meetings.

In the discussions, the IMF said Iranian officials had expressed concern over rising inflation and blamed rapid domestic growth for driving up price pressures.

IMF staff said the recent increase in inflation suggested the economy was overheated because of high oil prices. One way to deal with it was to tighten monetary policy, staff said. Still, they said, the central bank's influence over monetary policy had been curtailed through administrative changes last year.

"Looking forward, it is crucial to slow domestic demand growth in order to lower inflation while stepping up structural reforms to increase the economy's growth potential and employment creation," the staff report said.

The report said Iranian officials indicated they try to rein in inflation, currently around 26 percent, by slowing expenditure growth and containing credit expansion by persuading banks to reduce lending to areas that were not a priority.

Mazaheri has pushed to raise rates, but Iranian President Mahmoud Ahmadinejad has made clear he opposed any such move and suggested they be lowered instead.

"There has been no political consensus to implement other (IMF) recommendations such as tightening monetary policy and reducing government interference in resource allocation," the IMF report said.

Overall, IMF staff judged Iran's short-term economic outlook as "good" amid high oil prices that pushed currency reserves to $82 billion at the end of the 2007/08 fiscal year in March, from $61 billion the previous year.

The IMF said the medium-term economic outlook for Iran was very sensitive to the oil price.

According to IMF economic simulations, if Iranian economic policies remained the same and prices for Iranian crude prices decline to $85-$90 a barrel, Iran's growth potential would dwindle, a budget deficit would require central bank financing and the economy's vulnerabilities would increase.

On the other hand, should oil prices for Iranian crude stay above $110 per barrel, Iran would register a significant current account surplus and would accumulate about $190 billion of gross official reserves by end-2013/14, it said.

But if oil prices for Iranian crude fell to $75 per barrel, the country would register current account deficits in the medium term, which would be unsustainable because of Iran's limited access to international financial markets, the IMF added.

(Reporting by Lesley Wroughton. Editing by Gary Hill)