The Job of Iran's Central Bank Governor Just Got Harder

Last Friday, Iran’s Supreme Leader, Ali Khamenei, declared that negotiations with the United States were “not smart, wise, or honourable.” Addressing an audience of Iranian military brass, Khamenei did not explicitly rule out negotiations. But his tone made it clear that Iran was not about to begin talks with the Americans, despite American President Donald Trump stating just two days earlier that he wishes to start working on a nuclear deal with Iran “immediately.”

As is the case in sanctioned economies, when hopes deflate, prices inflate. Within the few days following Khamenei’s speech, the dollar appreciated nearly 7 percent against the Iranian rial, pushing the free-market exchange rate towards the threshold of 1 million rials to the dollar.

The free market accounts for a very small proportion of Iran’s multi-faceted foreign exchange market, generally reflecting the prices available to individuals purchasing physical bills at exchange bureaus. The free market dollar is the dollar that ordinary Iranians use to protect their savings in the face of chronic inflation (dollars stuffed under the mattress, so to speak) or to take their wealth abroad (dollars hidden in a briefcase, so to speak). These limited uses explain why the price of the free market dollar is such an important signal in the Iranian economy: it is the country’s highest-frequency measure of economic sentiments.

In this respect, Khamenei’s speech appears to have gifted Trump the first victory of his renewed “maximum pressure” policy. Despite Trump indicating he was “unhappy” to sign the presidential memo which directed his cabinet to increase pressure on Iran—and despite the limited scope and impact of his only enforcement action so far, the designation of three oil tankers—the rial plummeted against the dollar. Sometimes maximum pressure is self-inflicted. 

Now that Iranian leaders appear to have rejected the opportunity to negotiate with Trump, at least for now, the question becomes whether maximum pressure policies will begin to have more than psychological impacts for Iran’s economy.

This question can be answered by monitoring the indicator that really matters for Iran’s economy— the commercial foreign exchange rate. Until recently, this was called the NIMA rate. The NIMA foreign exchange market was a centralized electronic system established by the Central Bank of Iran in 2018 to streamline the purchase and sale of foreign exchange among Iranian companies. The commercial exchange rate has been notably stable in recent weeks, showing little movement after Trump signed his presidential memo or after Khamenei declared that negotiating with the United States is “not smart.” This is not because Iran’s central bankers have managed to inure the commercial exchange rate to psychological impacts—it is because the impact was preempted in December.

The NIMA rate began to slide in the days after Trump’s election victory on November 4, 2024. This may indicate that, like in the free market, Trump’s victory spurred more demand for hard currency. Iranian companies, anticipating the return of maximum pressure, may have sought to import more goods and build-up inventories in order to mitigate future disruptions in their supply chains. Though, it is also possible that the election outcome led to a change in foreign exchange supply. For example, financial institutions facilitating Iran’s access to hard currency may have grown wary of future sanctions enforcement and could have begun to throttle payments flowing from customers to Iranian exporters. Whatever the reason, the commercial exchange rate was rising at a steady clip.

By mid-December, as rolling blackouts began to hit Tehran, the Central Bank made a dramatic move to devalue the rial. Between December 12 and December 16, the dollar price rose nearly 10 percent—the sharpest such increase since the NIMA rate was established. On December 14, the Central Bank issued an announcement about the new price-level and a plan to restructure the centralized foreign exchange market under the Iran Currency and Gold Exchange Center. Central bank governor Mohammad Reza Farzin, like his predecessors, has instituted new rules and names for Iran’s multi-level foreign exchange market; the aim is for these largely superficial changes to help the central bank manage the largely intractable structural imbalances of the foreign exchange market.

The central bank aims to encourage Iran’s major exporters, such as firms exporting petrochemical products and steel, to sell their foreign exchange earnings through the new Iranian Commercial Foreign Exchange Market. From the outset, Iran’s major exporters have been reluctant to supply the central bank’s foreign exchange market, despite regulations mandating them to repatriate foreign exchange earnings. Managers at these firms who had the political weight to ignore regulations have known that, in an environment where the rial was expected to continually weaken, holding onto dollars was a smart bet.

By allowing a sudden devaluation of the rial in December, the central bank made a major concession to the major exporters. The move may help the bank keep the foreign exchange market supplied with dollars and euros, but it fails to address the fundamental issue which is found on the other side of the ledger—there is no underlying demand for rials given the dim prospects for the Iranian economy.

It is yet to be determined what “maximum pressure” will mean during the second Trump term. Unlike in the first term, there is no Mike Pompeo and Brian Hook to lead the pressure campaign. Plus, little had to be done to restore maximum pressure, as the new presidential memo set out, given that the Biden administration had never rolled back the sanctions imposed during Trump’s first term.

Still, if Trump decides he has been jilted by the Iranians, he could take a more forceful approach to maximum pressure. Any such shift in rhetoric will no doubt push the free-market exchange rate to new highs. The real indicator of whether maximum pressure is hitting Iran’s economy will be the movement of the commercial foreign exchange rate. If the free market rate reflects the mood of Iran’s economy, the commercial rate measures its pulse.

Photo: IRNA

Is Iran's 'Bread' Subsidy Reform a Half-Baked Idea?

A new round of protests has begun in Iran. People are taking to the streets following a controversial subsidy cut perceived as an increase in the price of bread. These protests were inevitable in a country in which there are so many economic and political grievances and in which civil society and labour groups, demoralised about their ability to influence policymaking through the ballot box, have turned to mobilisations to get their voices heard and their anger registered.

The policy that has triggered the protests has been widely reported as a cut to a “bread subsidy” that has suddenly increased the cost of bread and cereal-based products. This is inaccurate. The subsidy that has been eliminated was an exchange rate subsidy. The government had been providing Iranian importers allocations of hard currency below market prices. This policy indirectly subsidised the purchase of wheat and a few other foodstuffs by the importers. It did not directly subsidise the purchase of bread by ordinary people.

Importers could apply for foreign exchange allocations from the Central Bank of Iran to import wheat. In theory, this would allow them to bring wheat to the Iranian market at a lower price. But in practice, the subsidy had long ago stopped working. Several distortionary effects of the policy were likely generating inflationary pressure across the economy.

First, the exchange rate subsidy was poorly targeted. To put it simply, the Iranian government was intervening to make foreign money cheaper, not bread prices themselves. The subsidy was therefore ill-suited to stabilise prices when Iran’s import needs rose, a periodic occurrence when the domestic harvest falls short of targets. It was also unable to counteract the effects of global increases in the price of wheat. Breads and cereals prices have risen steadily in Iran for years, quadrupling since 2018. 

Second, providing foreign exchange at a subsidised rate was exacerbating Iran’s fiscal deficit. Financing this deficit is a major driver of inflation in Iran. The official subsidised exchange rate diverged from the exchange rate on which Iran’s government budget is balanced in 2015. Since then, the spread between the two rates has increased dramatically. The subsidised exchange rate has been fixed at IRR 42,000 since 2019. The exchange rate in the Iranian government budget for the year beginning March 2022 is IRR 230,000. As this spread widened, the Central Bank of Iran faced increasing difficulty in meeting demand among importers for subsidised foreign exchange, creating a foreign exchange liquidity crunch that made it harder to stabilise Iran’s currency outright. In recent years, the Iranian government was spending around $12 billion in hard currency on a subsidised basis.

Third, this additional exchange rate volatility has increased the pass-through effects related to Iran’s dependence on imports more broadly. The Central Bank of Iran has had partial success in stabilising the exchange rate by introducing a centralised foreign exchange market for importers and exporters called NIMA. But Iran’s economic policymakers were tying their own hands in the stabilisation of this exchange rate, which is far more critical for Iran’s economic performance, by diverting precious foreign exchange resources towards essential goods importers. When it comes to inflation generally, the government ought to focus on intermediate goods on which “made in Iran” products depend. The exchange rate subsidy for essential goods was making it harder to stabilise the exchange rate for all other goods.

Fourth, the exchange rate subsidy was always subject to abuse. Particularly in the early years, importers were known to seek and receive allocations of subsidised foreign exchange and either pocket those allocations or turn around and sell on the hard currency to other firms at the market rate. This kind of profiteering was difficult to police. As more scrutiny came upon the allocations, importers with political connections were most likely to continue receiving allocations from the Central Bank of Iran, making enforcement politically fraught.

The evidence that the exchange rate subsidy had failed can be seen in consumer price index data. Bread and cereals inflation has outpaced general inflation since last summer. This is a likely reflection that, in practice, a diminishing volume of wheat imports were being conducted using the subsidised exchange rate—the reform was already being priced-in by the newly elected Raisi government. The sudden price increases were are seeing now are more likely the result of price gouging. Firms across the food supply chain are using the policy reform as an opportunity to raise prices, knowing the blame will be cast on the government.

Whether or not the reform is half-baked, the idea has been cooking in the oven for a long time. The subsidy cut was years in the making and the preferential exchange rate was nearly nixed in 2019, as the Iranian economy underwent a painful adjustment following the reimposition of U.S. secondary sanctions. At the time, the Iran Chamber of Commerce, the voice of the country’s private sector, issued a strong statement calling for the elimination of the subsidy. But the reform was eventually shelved—the Rouhani administration had been cowered by the 2017 and 2018 economic protests, which were instrumentalised by their political rivals.  

In the end, the Central Bank of Iran took a different tack. They kept the exchange rate in place but began to eliminate the range of imports eligible for the rate. Initially, importers could apply for subsidised foreign exchange allocations for the purchase of 25 essential goods and commodities. As of September 2021, that list was cut down to just seven goods—wheat, corn, barley, oilseeds, edible oil, soybeans and certain medical goods.

These were preparatory steps for the elimination of the subsidy. In practice, many Iranian grain importers had stopped using the subsidised exchange rate, both in anticipation of its elimination and because it was impractical. One of the fundamental problems facing Iran’s food supply chain is that even when Iranian importers can identify buyers and arrange logistics—difficult things to do when under sanctions—the payments that need to be made for those purchases are often delayed. Importers that were applying to the Central Bank of Iran for allocations of subsidised foreign exchange might wait weeks before the money hit their accounts. Cargo ships would sit idle off Iran’s shores, unable to deliver the grain until the seller received their funds. These delays added costs. The Iranian importers were on the hook for huge fees as the ships they chartered remained out of service. Importers that opted to use the NIMA rate have been able to make payments to their suppliers more quickly and reliably. This is because there is far more liquidity in the NIMA market, in which foreign exchange is supplied by Iranian exporters who are repatriating their export revenues as required by law.

Overall, there is a sound economic argument for eliminating the subsidised exchange rate. But that does not mean that there will not be pain for ordinary people in the short term and the protests are motivated in part by an expectation of further pain. The abject failure to communicate a plan around the subsidy reform will lead to its own distortionary effects, including predatory pricing. Failing to communicate directly and clearly with the Iranian public about this major reform is its own kind of contempt, even if the reform itself is not contemptuous.

 In that vein, the elimination of the subsidised exchange rate has been criticised as “neoliberal” and in many respects, it is. As part of the continuity in economic policy, the Raisi administration appears to be continuing the Rouhani administration’s commitment to austerity, seeking relief from inflation through fiscal tightening. The national protests in 2017 and 2018 were triggered by the same anxieties around the government’s perceived failure to protect economic welfare within the Islamic Republic’s social contract.

But on the other hand, this is not a simple economic reform. Iranian officials have likened it to “economic surgery” necessary to repair an economy weakened by sanctions. The reform also does not preclude other redistributive policies. The subsidised exchange rate was a poorly designed and inefficient policy that did more for a small number of elites than it did for Iran’s poor.

The Raisi administration has promised to soften the blow of the reform by providing targeted cash transfers (for two months) to the most vulnerable in Iranian society. Electronic coupons are also being provided. Iran has a good track record with cash transfers, which do something the exchange rate subsidy did not. Such transfers directly boost the consumption of ordinary people in the face of rising prices. If the government can use the fiscal savings from the elimination of an inefficient and poorly targeted policy to shore the economic welfare of Iran’s poor more directly, while also addressing long-running distortions in the foreign exchange markets, this reform may succeed yet. But if the government fails to communicate clearly about its implementation of the reform, the Iranian public will continue to only see failure.

Photo: IRNA

Iran, Russia, and the Limits of Financial War

In response to Vladimir Putin’s increasingly brutal invasion of Ukraine, the West has declared a financial war on Russia. The US Department of Treasury unveiled new sanctions on the Russian financial sector late last week, measures that “target nearly 80 percent of all banking assets” in the country. Forthcoming sanctions on the Central Bank of Russia (CBR), announced by the European Union jointly with the United States, United Kingdom, and Canada, will effectively freeze Russia’s gross international reserves. Further measures targeting Russia’s energy sector will make the Western sanctions programme among the most expansive ever devised, and certainly the most significant to target such a large economy. There has been impressive coordination between US and European authorities in designing and implementing these sanctions, which have been justified by Putin’s provocations. In their rapid imposition and their broad scope, these sanctions are clearly intended to have significant deleterious effects on the Russian economy. The strategy has shifted from deterrence to attrition and from targeted measures to full financial war.  

The only other comparable financial war waged by the United States and Europe has targeted Iran. The Iran sanctions were applied more gradually than those being applied to Russia today. But in 2012, Iran’s central bank assets and energy exports were targeted in move that will be the model for the sanctions on CBR and Russia’s energy industry. These sanctions were initially multilateral in nature, with UN, US, and EU measures imposed in tandem. The multilateral sanctions were in place until 2016, when the implementation of the Joint Comprehensive Plan of Action (JCPOA) saw the lifting of most UN and EU sanctions as well as US secondary sanctions. Iran benefited from sanctions relief for just two years, enough time for a return to economic growth, but not enough time for a remediation of the harm that sanctions had caused most Iranian households. In 2018, President Trump withdrew from the JCPOA and reimposed US secondary sanctions on Iran, once again thrusting Iran into an economic crisis, later compounded by the COVID-19 pandemic.

Broadly speaking, the financial war on Iran has been in effect for a decade. The damage incurred by the Iranian economy has been extensive. Currency volatility and high inflation have sapped Iranian purchasing power, pushing millions of Iranians below the poverty line. Chronic weaknesses of the Iranian economy, such as high unemployment and systemic corruption have been exacerbated. Still, despite the many hardships, the Iranian economy did not collapse. Rather, the economy stagnated, growing an average of just 0.37 percent between 2012 and 2020. When excluding 2016 and 2017—the two years of sanctions relief under the JCPOA—the average falls to -1.96 percent. A decade of stagnation and the diminishing welfare of ordinary Iranians combined to create new political pressures on the Iranian government. Labour mobilisations have become commonplace and there have been multiple waves of nationwide protests focused on economic grievances. These protests have been violently suppressed by authorities. Even so, the Iranian government is today pursuing sanctions relief—in the context of renewed negotiations over the JCPOA—not because of fears an impending economic collapse, but because of a view that economic resilience allows Iran to engage in negotiations from a position of relative strength, seeking the conditions for a return to growth.

Unsurprisingly, Iran has become a touchpoint in the discussion around the growing Russia sanctions programme. But the focus has been the Iranian precedent for key moves, such as the removal of Russian banks from the SWIFT messaging network. So far, there has been little consideration of what the outcomes of the financial war on Iran might tell us about the prospects for the financial war on Russia. The cases are not only comparable because of the kinds of sanctions that are being applied, but because the two economies share important similarities. Of course, Russia and Iran are both major energy producers and revenues from oil and gas exports are centrally important for government budgets. But the two countries also boast large manufacturing sectors principally supplying internal markets. Despite general corruption and rentierism, key institutions exhibit technocratic sophistication.

In response to the 2012 and 2018 sanctions shocks, Iran demonstrated that its flawed economy could undergo structural adjustments to sanctions pressure. Such adjustments begin immediately, meaning economies targeted by sanctions can return to fragile growth in as little as a year. In Iran, this capacity for adjustment reflected the bottom-up resilience of households and companies seeking to survive the financial war. The Iranian state lucked out. Officials boasted of their “resistance economy” policies, despite failing to develop a cohesive response to sanctions pressure. Meanwhile, the composition of the Iranian economy meant that sanctions pressure could be absorbed. There is reason to believe that Russia will also absorb such pressure. Across key indicators, Russia appears in a stronger position than Iran was at the outset of its financial war.  

Access to Foreign Exchange

Sanctions targeting a country’s central bank are the most significant measure in any financial war because of the direct impact on the national currency. During the Trump administration’s “maximum pressure” sanctions campaign, Iranian authorities maintained ready access to just 10 percent of the country’s gross international reserves, putting enormous pressure on the Iranian currency and making it very difficult for Iran to manage deficits with key trade partners. In January 2018, a few months before Trump announced his withdrawal from the nuclear deal, the free market dollar exchange rate in Iran was IRR 46,000. Today the exchange rate is IRR 263,000. The dramatic devaluation of the rial is often cited as evidence of the devastating impact of US sanctions. Indeed, devaluation made imported goods, including foodstuffs like wheat, on which Iranian households rely, more expensive. But the Iranian government demonstrated an ability to return order to currency markets, both by finding ways to supply foreign exchange into the market despite sanctions and also through better technical management of the market itself, including through the creation of a parallel market whereby exporters are required to sell foreign exchange earnings to importers. Russia is arguably in a better position than Iran to weather the attack on the value of its currency. It has gone through this storm before—the rouble lost half its value following the imposition of more limited sanctions in 2014, as part of the Western response to the annexation of Crimea. In response to the latest crisis, CBR has already hiked interest rates to 20 percent and imposed a new requirement for companies to repatriate foreign exchange earnings. If we assume that the 10 percent figure represents maximum efficacy for the freezing of central bank reserves, then that would leave CBR with access to approximately $63 billion. However, Russian reserves are equivalent to about 42 percent of GDP. In 2012, Iran’s reserves (then $104 billion) amounted to just 17 percent of GDP. So even if a similarly small percentage of the reserves remain available to CBR following the implementation of the financial sanctions, Russian authorities could fare better than their Iranian counterparts in stabilising the value of the rouble after the latest devaluation shock caused by the financial sanctions.  

Energy Revenues and Fiscal Space

Despite initial attempts to create carve-outs for Russia’s energy exports, motivated by a desire to shield Europe from an economic shock and to leave room for escalation, it now appears likely that Russian energy exports will be targeted by Western sanctions. In the case of Iran, such sanctions provided highly effective in reducing exports of crude oil and mostly effective at reducing exports of petrochemical products. Broadly speaking the purpose of energy sanctions is to induce a fiscal crisis. Even in periods in which Iran was permitted to export limited volumes of crude oil under so-called Significant Reduction Exemption waivers, the revenues from these sales could only be used for humanitarian trade, meaning that the fiscal constraints remained significant. In the lead-up to 2012, oil sales accounted for around 80 percent of Iran’s total exports and around 60 percent of government revenues. Russia has a significantly lower dependence on energy sales, which today account for around 60 percent of exports and around 40 percent of government revenues. Tax administration in Russia is also significantly more developed than in Iran. In 2020, the Russian government collected $387 billion in tax revenue, equivalent to around one-fourth of GDP. By comparison, tax revenue in Iran was just $32 billion in 2012, equivalent to one-twentieth of GDP. Like the Iranian government, the Russian government is not heavily indebted. In 2012, Iran’s government debt was equivalent to 10 percent of GDP. Government debt in Russia was equivalent to 16 percent of GDP in 2021. The Russian government is likely to have more fiscal space than Iran in the aftermath of the sanctions shock given a similar debt level and more robust revenue sources. Notably, Iran did not really use what fiscal space it had as part of its response to sanctions, choosing to run austerity budgets aimed at slowing inflation. Russia could take a different approach, directing state investment to compensate for the lost growth in the energy sector.

Dependence on Manufacturing

Russia is the world’s second largest consumer of natural gas. Iran is the fourth. These high rates of consumption reflect that natural gas is used for heating homes, for power generation, and as feedstock in the manufacturing sector. The energy sector in Russia will contract dramatically just as it has in Iran over the last decade, but it will not collapse in large part because of the important role of the manufacturing sector in the adjustment to sanctions and wider economic resilience. In 2012, Iran’s manufacturing sector accounted for 14.4 percent of GDP. In Russia, based on data for 2020, the manufacturing sector accounted for 13.3 percent of GDP. The sectors are of similar importance to their respective economies. But these statistics also underestimate that importance. The relative size of the manufacturing sector in Russia and Iran fluctuates with the oil price—high prices mean that the oil sector contributes more than usual to GDP. Moreover, in both countries the manufacturing sector is a larger employer than the energy sector, given the relatively limited manpower necessary to operate modern energy infrastructure. Manufacturing is the sector that really matters.

The latest World Bank report on Iran, which details the country’s fragile economic recovery, notes that recent growth has been driven by manufacturing. The report points to two aspects of the adjustment to sanctions: “Less market competition—due to import restrictions on nonessential goods—and the price competitiveness of manufacturing and mining production—following the currency depreciation.” The resilience of Iran’s manufacturing sector under sanctions has been further detailed in a study by Hadi Esfahani, who used firm-level data to show that “manufacturing firms adapted to the sanctions environment, and many resumed growth based on domestic demand and resources.” While the sanctions shock does lead to a contraction in the manufacturing sector, it is declining output, not “exits” that are to blame. In other words, manufacturing firms do not tend to go out of business. In fact, manufacturers who produce goods for export markets, especially regional markets, can grow their profit margins as they earn foreign exchange. This adjustment is easiest for firms engaged in light manufacturing, as demand for consumer goods is relatively inelastic and as production of these goods is less capital intensive, shielding manufacturers from higher producer prices. But to take advantage of these conditions, manufacturing firms must maintain output.

Shifts in Trade Composition

The fundamental challenge for the Iranian manufacturing sector since 2012 has been disruptions in the supply of inputs and high producer prices. In this way, the impact of sanctions on imports of industrial goods may be more consequential for the targeted economy than the impact of sanctions on the sale of energy products. Iranian manufacturing firms remain in business and continue to produce for a large domestic market and newly growing regional demand. But to do so, they needed to maintain imports of industrial equipment. Purchasing managers’ index data for Iran makes clear that the primary constraint on the manufacturing sector’s economic performance under sanctions has been the reduction in raw materials and intermediate goods inventories and the high cost of replenishing those inventories. Historically, intermediate inputs and equipment were sourced from Europe. But beginning in the late 2000s, China became a larger supplier. The financial war on Iran accelerated the shift in the country’s trade composition as Chinese suppliers proved more willing to sell to Iran in the face of sanctions. One way to express the relative importance of Chinese and European supply is to look at the ratio of exports from the two suppliers. In 2012, Iran imported 1.2 times more goods from China than it did from the European Union. But machinery imports (HS Chapters 84 and 85) from China and Europe were about equal. By comparison, Russia is significantly more dependent on Europe as its financial war begins. The total value of all imports from the European Union is about twice that from China. The dependence is slightly lower when looking at machinery—the total value of Chinese machinery exports to Russia is 70 percent of European Union exports.

On one hand, this higher dependence may mean that the sanctions shock to the Russian manufacturing sector will be greater than that in Iran. But on the other hand, it demonstrates that Russia has yet to make the “Eastward turn” that many have observed in Iran and other Eurasian economies. To be clear, Chinese firms did not completely ignore Western sanctions on Iran and did engage in de-risking that left Iran behind its regional neighbours with regards to economic ties to China. Bilateral trade has stagnated since 2012 and the inability of Iran to maintain significant oil sales to China for large periods over the last decade also posed financial challenges for maintaining industrial imports. But whereas Iran is one of China’s many economic partners in West Asia, Russia has presented itself as a unique geopolitical partner within a wider Eurasian context. This may make the difference as Russian manufacturers seek alternative suppliers for crucial industrial goods.  

Capital and Its Survival Instincts

If Russia does demonstrate a similar kind of economic resilience to Iran, that does not mean that there will not be economic hardship. In Iran, annual inflation exceeded 30 percent following the 2012 and 2018 sanctions shocks. Skyrocketing prices, especially for food products, pushed many working-class families into poverty. For a once upwardly mobile middle class, the diminished standard of living has been embittering. For most in Iran’s upper class, sanctions have been a nuisance. For some among the wealthy, they have been a boon.  

One unique feature of the Russia sanctions programme is the focus on oligarchs and the perverse influence that individuals with extreme wealth have on the country’s politics, particularly in their perceived fealty to Putin. Western officials are directly targeting these oligarchs, both by targeting their personal assets and through measures targeted at the conglomerates they own. The Moscow Exchange suspended trading last week after a massive sell-off saw the main index fall 50 percent. European and American regulators are promising to review the lax rules that have allowed Russian oligarchs to purchase extensive real estate in Western cities. In both capital markets and real estate, the wealth of Russia’s ruling classes has been augmented by the commingling of domestic and foreign investor capital. As foreign investors retreat from Russia, and as high-net worth Russians are blocked from foreign real estate markets, oligarchs will take a hit. But capital has its own survival instincts.

Russia’s capital markets are far more developed than those of Iran. Unlike the Moscow Exchange, the Tehran Stock Exchange has never hosted significant foreign investment. Still, capital markets did play a role in Iran’s sanctions response in a way that diminished the political, if not absolute economic, impact of sanctions. In 2019, deep into Trump’s restarted financial war on Iran, the Tehran Stock Exchange was the world’s best performing equity market, with market value doubling in dollar terms. There were three reasons for this remarkable performance. First, many listed companies, particularly manufacturing firms, were posting strong financial results after adjusting to the new sanctions reality. Second, high inflation left Iranians scrambling to invest in a safe asset while sanctions made capital flight difficult and costly. For middle class families, the safe havens were hard currency or gold. For upper class families they were domestic real estate or stocks. Third, as wealthy Iranians increased their exposure to capital markets, a policy shift took place. Suddenly, developing the capital markets became a priority for the government and for the nascent financial services industry, particularly with the aim of increasing the number of retail investors. More money poured into the market, even from middle class households, driving prices higher. The returns outpaced inflation, drawing in more investment, and giving rise to what many considered to be a dangerous bubble. But in the meantime, a new feature of Iranian political economy emerged. The newfound importance of the country’s capital markets, an outcome of the financial war, was exemplified in the decision of the government to liberalise a “justice shares” programme that had granted shares in state-owned enterprises listed on the stock exchange to disadvantaged families. Overnight, Iran had 50 million new retail investors with an interest in the political and economy stability that favours stock price appreciation.

By comparison, Russia has around 13 million retail investors. There is significant potential for domestic wealth to pour into the stock exchange, whether spurred by the inflationary environment or encouraged as a matter of new government policy. The implication is that capital markets are useful tools for preserving capital—the desperation of middle and working classes in Russia may help shore the wealth of oligarchs, already in stocks and real estate. Many of the enterprises that oligarchs control may successfully adjust to the new reality and remain profitable. A new class of “light” oligarchs may emerge as certain light manufacturing enterprises benefit from reduced competition and better export prospects. The financial war could also provide a pretext for state capture, with private capital facilitating rentierism, corruption, or smuggling deemed expedient in the face of sanctions.

Take all of this together and it becomes clear that the most problematic aspects of Russian political economy—the obscene concentration of wealth among a politically-connected ruling class—will remain unchanged in the financial war. Meanwhile, the immiseration of the middle and working classes will further disempower civil society, creating a dynamic where dangerous protests are the only means through which to air grievances and in which deprivation focuses those protests on wages and bread. As Bourse & Bazaar Foundation board member Djavad Salehi-Isfahani has shown, just as poverty has increased since sanctions were imposed on Iran, so too has inequality risen. The rich are not getting poorer, but the poor certainly are.

Confounding Aspects

Iran’s economic resilience in the face of sanctions owes little to the state and a lot to its people, who have simply tried to prevent their own financial ruin. Economies are made up of individuals—some wealthy, most poor—who marshal the resources they have. How those resources are distributed determines the effects of sanctions on the wider economy. When comparing the fundamentals of the Russian and Iranian economies—the depth of the comparison here is limited by my lack of detailed knowledge about the Russian economy—it seems reasonable to assume that Russia will endure its financial war. The composition of its industry, the size of its domestic and regional markets, and the resources available to the state are all comparable to what Iran had at its disposal in 2012 on the eve of the financial war that has now lasted a decade. Given the fundamental comparability of the Russian and Iranian economies, it stands to reason that the Russian structural adjustment to the newly imposed sanctions may not even require astute political leadership. This may be a good thing. The Iranian leadership was more inclined to pursue diplomacy when it believed that it had achieved a stalemate in the economic war.

As Nicholas Mulder has observed, “Perhaps the most confounding aspect of sanctions is that regardless of technical sophistication, their outcome is never a matter of economic factors alone.” Western governments will no doubt be able to cause massive damage to the Russian economy, but the individuals who comprise that economy will attempt to adjust. The Russian public, like the Iranian public, is at best ambivalent about the policies of their leaders in response to which sanctions have been imposed. In Iran, a decade later, there is a widespread sense that the price endured by ordinary people is no longer proportional to the wrongs committed by their government. If the sanctions persist in the aftermath of a cessation of the conflict in Ukraine—which is likely—a similar reality may come to pass for the Russia. In this context, the resilience of ordinary people in the face of financial war will not be an act of political resistance, but of basic survival. They will toil for low wages in factories and fields, struggling to put food on the table and at times they will protest, facing down the violence of the state. Meanwhile, the economy will stagnate. So too will a dismal political reality.

Photo: Getty Images

Tracing the Duality of Iran’s New Central Banker

The appointment of Ali Salehabadi as Iran’s new central bank governor reflects the generational shift underway in Iranian policymaking—he was born just one year before the revolution that led to the establishment of the Islamic Republic. But beyond tapping youth, Iranian president Ebrahim Raisi, has also, at least on paper, appointed an individual with technocratic credentials and managerial experience. Since 2014, Salehabadi has served as the CEO of the Export Development Bank of Iran (EBDI). From 2006 to 2014, he led the Securities and Exchange Organisation, Iran’s capital markets regulator. In that role Salehabadi was largely successful in driving the development of the Tehran Stock Exchange, despite then-President Mahmoud Ahmedinejad’s skepticism of capital markets development.

Salehabadi holds a PhD in Financial Management from the University of Tehran. He is a faculty member at Imam Sadeq University, where he completed his master’s degree. His affiliation with Imam Sadeq University, which is shared by economy minister Ehsan Khandoozi and social welfare minister Hojjatollah Abdolmaleki, firmly places Salehabadi in the network of “revolutionary experts” from which Raisi has drawn his cabinet members focused on economic policy.

Perhaps even more so than Khandoozi or Abdolmaleki, Salehabadi’s education and subsequent experience have given him a grounding in both conservative political thought and liberal economic planning. As journalist Fatemeh Bahadori observed in a profile of Salehabadi published last year, “in his books and articles, you can see the combination of these two [educations].” It is this duality that has enabled Salehabadi to hold senior positions in state entities during both the Ahmadinejad and Rouhani administrations. Now, as Raisi pursues syncretic policymaking by his revolutionary experts, Salehabadi finds himself in the most important role in Iranian economic policy.

The Central Bank of Iran (CBI) is on the frontlines of the “economic war” that Iran currently faces. U.S. sanctions policy has directly targeted the operations of Iran’s central bank through designations and measures intended to interfere with the bank’s routine operations, especially the management of the country’s foreign exchange reserves. Salehabadi replaces Abdolnasser Hemmati, who oversaw the response in Iranian monetary policy to the reimposition of sanctions following his appointment in July 2018, just a few months after the Trump administration’s decision to withdraw from the Joint Comprehensive Plan of Action and to reimpose secondary sanctions on Iran.  

Hemmati, who left the central bank during his ill-fated run for the presidency earlier this summer, was largely successful in steering the bank through the sanctions-induced crisis. He implemented a centralised foreign exchange market that streamlined the repatriation and sale of currency by Iranian exporters for the benefit of Iranian importers. He also embarked on economic diplomacy, engaging officials in China, Iraq, and South Korea to pursue greater access to the foreign exchange reserves frozen as part of the Trump administration’s maximum pressure sanctions.

These efforts helped defend the value of Iran’s currency, and by extension alleviated inflationary pressures, at least for a time. Salehabadi will need to continue using the playbook set out by Hemmati—there are few better options. In the current environment, in which the Biden administration has maintained maximum pressure sanctions, Iran’s central bank lacks the policy space to fully shape Iran’s macroeconomic conditions. Exogenous forces, particularly the impact of sanctions on the country’s balance of payments, will determine Iran’s economic prospects—the central bank’s role is to mitigate the damage caused. 

Salehabadi appears to understand the mitigation strategies that are necessary. While leading EBDI, he had a hand in the Rouhani administration’s efforts to shore the economy, particularly as the Trump administration’s sanctions hit oil exports and access to foreign exchange reserves. Today, Iran retains ready access to just 10 percent of its foreign exchange.

Salehabadi has highlighted the role of non-oil exports in providing Iran resilience in the face of sanctions. In an October 2019 statement reflecting on Iran’s first year weathering Trump’s maximum pressure sanctions, Salehabadi highlighted the role that non-oil exports played in supporting the country’s economy. “Simultaneously with the intensification of sanctions and the reduction of oil revenues, there was a belief that non-oil exports could meet the country's foreign exchange needs, and fortunately this has been largely achieved through the repatriation of foreign exchange,” he noted. EBDI was also one of the banks through which money from the National Development Fund of Iran, the country’s sovereign wealth fund, was lent to Iranian exporters in order to support private companies during the economic downturn. As part of this strategy, Salehabadi helped facilitate increased lending to “knowledge-based” exporters, as part of the Rouhani administration’s wider strategy to achieve greater economic resilience through diversification.  

Raisi made big economic promises during his presidential campaign and also vowed to fulfil these promises within a “resistance economy” model, which is largely focused on boosting domestic production. But production can only rise in step with demand, and at a time of diminished domestic consumption, increased exports remain the best option for Iran’s economy to return to sustained economic growth. As such, truly restoring policy space for the central bank will require the lifting of sanctions.

Here, Salehabadi has experience that could help Iranian negotiators address the thorny problems surrounding the implementation of sanctions relief, especially the restoration of correspondent banking with a wider range of trade partners. While European export credit agencies favoured cooperation with private sector Iranian banks, Salehabadi was nonetheless involved in negotiations around increased bilateral banking ties during his time at EBDI. Despite initial enthusiasm, European export credit agencies ultimately failed to extend financing for trade with Iran due to the reluctance of European banks to process the related payments—a failure that cannot be repeated if sanctions relief commitments made under a restored nuclear deal are to be successfully met.

Of course, the policy space afforded to CBI is also a function of the bank’s independence. Hemmati was an adept political operator and mostly succeeded in insulating CBI from the political attacks that dogged the Rouhani administration in its second term. This independence also improved the perception of bank among Iran’s business community. Hemmati made clear that financial corruption was a systemic problem in Iran and implemented policies to reduce opportunities for corruption. During his bid for the presidency, Hemmati claimed to have “dried the roots of corruption” while at the bank. While that claim is probably an overstatement, Hemmati himself was never implicated in a corruption scandal.

It remains to be seen whether Salehabadi, who is both young and drawn from conservative networks, will be able to assert his own independence and that of the bank. But what is clear is that a great deal is riding on his tenure. In a sense, Salehabadi’s success in steering Iran’s economy back to sustained growth would legitimate “revolutionary expertise” as the new dualism in Iranian economic policymaking.

Photo: IRNA

Did Presidential Hopeful Hemmati Successfully Defend Iran's Currency?

Iran’s economic stagnation and widening inequality are top concerns for Iranian voters ahead of the presidential election on Friday. It is therefore no surprise that during three televised debates, candidates ganged up on Abdolnasser Hemmati, until recently Iran’s central bank governor. Frontrunner and head of the judiciary Ebrahim Raisi railed against Hemmati, promising voters that he would reduce the impact of exchange rates on prices, succeeding where Hemmati failed. Former IRGC officer Mohsen Rezaei claimed that Iran’s currency had lost so much value under Hemmati’s watch “the train of the revolution has turned into a scooter.”

It is true that Iran’s currency suffered a steep devaluation while Hemmati was central bank governor, but the attacks from the likes of Raisi and Rezaei are spurred not by the failure, but rather the demonstrable success of Hemmati’s management of Iran’s economic crisis. At least in the narrow area of currency policy, Hemmati made considerable progress in returning stability to foreign exchange markets at each point of crisis, meanwhile reducing the ability for special interests to profit from Iran’s system of multiple exchange rates.    

When Hemmati was appointed governor of the Central Bank of Iran in July 2018, Iran’s currency had already begun to lose value. Beginning in April 2018, Iran’s currency markets responded to the news that the Trump administration was to reimpose secondary sanctions on the country. The accelerating currency crisis would be the first test of a platform the Central Bank of Iran had introduced earlier that year—a new Integrated Foreign Currency Trading System, known by its Persian acronym “NIMA.”  

NIMA is part of Iran’s Comprehensive Trade Platform (NTSW), a set of registries and systems that enable companies to receive licenses to conduct certain kinds of trade and to purchase and sell foreign exchange as part of that trade. NIMA is paired with another platform called “SANA,” the Persian acronym for Foreign Currency Control System. The main difference between these two platforms is that NIMA is for international transactions with importers and exporters, while SANA is for transactions of foreign currency within the country, for instance between exchange bureaus. 

Using NIMA companies no longer needed to seek allocations of foreign exchange from the Central Bank of Iran or commercial banks, a system that disadvantaged companies with less established banking relationships and less political clout. All importers and exporters are required to use NIMA.  

The implementation of NIMA was slow and Hemmati, coming into office at a moment of crisis, struggled to get companies to use the new platform. By September 2018, the price of the dollar had reached a historic high of IRR 170,000 as supply-side pressure grew in advance of the full reimposition of secondary sanctions in November 2018. Imported intermediate and finished goods grew more expensive as suppliers dropped out of the market. At the same time, the Iranian financial system faced reduced liquidity in key currencies such as the Euro. As foreign exchange revenues declined, the central bank was unable to tap into foreign reserves. The Trump administration moved aggressively to freeze these reserves, even for use in humanitarian trade, leading just 10 percent of Iran’s overall reserves freely accessible by the end of 2019. To address these pressures, Hemmati sought to ensure that Iranian companies earning foreign currency made that currency available for sale through NIMA.

As per the guidelines issued by the central bank in November 2018, all exporters have a “foreign currency repatriation obligation.” According to these regulations, companies earning more than EUR 10 million a year in export revenue are obligated to repatriate 90 percent of those earnings through NIMA.

At first, adherence to the guidelines was disappointing. Hemmati publicly criticised large exporters, particularly petrochemical companies, that were failing to repatriate revenues. These companies were delaying in order to profit in rial terms as the currency continued its slide. In February 2019, CBI made a further announcement and instituted an incentive package, in which the exporters were categorised based on their performance in complying with the rules set in the market. Exporters with higher compliance—those who repatriated funds most reliably—would benefit from lower obligations for supply of foreign currency in NIMA.  

Over time, the public pressure and improved incentives led to greater uptake of the NIMA system. The electronic platform significantly increased transparency in Iran’s foreign exchange market. The earnings of exporters are linked to their export licenses, exchange bureaus bought foreign currency according to offers in which the currency, exchange rate, total value, and origin of funds are all known. Importers register their offers to buy foreign currency from exchange bureaus. Each transaction is duly recorded in NIMA.

Hemmati claimed moderate success by March 2019, noting that $19 billion of export revenue had been repatriated via the NIMA system. This was still just a fraction of Iran’s overall export revenue. But the impact of the foreign exchange market was noticeable. When combined with the economy’s structural adjustments to the reimposition of sanctions, the currency policy instituted by Hemmati saw the value of the currency remain below the September 2018 peak for the duration of the next year. A steady decline in the price of the dollar began in May 2019, at which point the price reached IRR 160,000 following the Trump administration’s revocation of waivers permitting Iran to export limited volumes of oil. By the end of 2019 the dollar price was around IRR 130,000.

In the first quarter of 2020, Iran’s economy faced a new shock—the pandemic. The impact of the pandemic was in many respects similar to the impact of sanctions—supply chain disruptions made imported goods more expensive. But at the same time, Iran’s non-oil exports fell due to the impact of lockdowns on production, logistical constraints, and reduced demand, particularly in regional markets. Iran was facing an acute balance of payments crisis. The value of the rial began to slide in earnest around February 2020, when the pandemic hit Iran. The value of the dollar peaked in October 2020 at IRR 330,000, an increase that had contributed to high rates of inflation. The situation may have been worse had NIMA not been in place. During the Iranian calendar year ending March 2021, Iranian exporters repatriated 72 percent of their foreign exchange earnings, around $52 billion.

After the dollar hit its peak price in October 2020, the rial recovered value quickly because of two factors. Iran’s economic recovery was picking-up steam. Greater oil exports to China and greater regional demand for non-oil goods had buoyed export revenue. Iran’s economic was actually returning to growth. Meanwhile, in Washington, the re-election prospects for Donald Trump were fading, and the notion that Iran could once again benefit from sanctions relief reduced demand for foreign currency, especially among ordinary Iranians who frequent exchange bureaus and purchase dollars and euros as a hedge against inflation.

Iran’s currency has been remarkably stable since October and in another indication of the success of the NIMA platform, the spread between the free market rate and the NIMA rate has been reduced significantly. Combined with a reduction in the number of goods eligible for the subsidised exchange rate of IRR 42,000, this has resulted in a de facto unification of Iran’s three-tiered exchange rate system. Given that one of the largest sources of corruption in the country has been the arbitrage between these rates, including situations in which companies would receive fraudulent allocations of foreign currency at the subsidised rate only to turn around and sell that currency at the free market rate, Hemmati’s interventions can be said to have had a significant impact on corruption—a point he alluded to during the debates.  

To understand Hemmati’s impact, it is perhaps best to compare the case of Iran with that of Turkey or Lebanon, two countries where the devaluation of national currencies is continuing unabated, precisely because leaders at the central bank lack the means or the might to arrest the decline. Hemmati saw that the train of the revolution was at risk of careening into the abyss and at least he sought to keep it on track. His opponents may not prove so adept.

Photo: IRNA

What's the Deal with Iran's Foreign Exchange Reserves?

Editors note: The IMF has now updated the footnote referenced in this piece to reflect their estimate of Iran’s gross international reserves in 2020, which stood at $115.4 billion.

When it comes to Iran, even economic data can cause controversy. The International Monetary Fund’s latest regional report for the Middle East and Central Asia places Iran’s gross international reserves at $4 billion in 2020, a tiny fraction of the $122.5 billion of reserves Iran held in 2018, and down further from the estimate of $8.8 billion published in October of last year.

For some, the IMF data was evidence of Iran’s stunning economic decline, achieved through “maximum pressure” sanctions. Former Wall Street Journal reporter Jay Solomon tweeted a screenshot of a table from the IMF report, stating that “accessible foreign exchange reserves plunged to $4 billion in 2020 from $123 billion in 2018.” Former Secretary of State Mike Pompeo, a key architect of the Trump administration’s maximum pressure policy, responded to Solomon’s tweet, boasting that “over 96% of Iran’s foreign exchange reserves have been wiped out.”  

Radio Farda ran a story claiming that Iran’s gross international reserves had collapsed to $40 billion, a figure they reached by concluding that the $4 billion of accessible reserves reflects 10 percent of Iran’s total reserves. Faced with these dire estimates, Iran’s central bank governor Abdolnasser Hemmati responded on Instagram, criticising the IMF and stating that they had used incorrect data in their report.  

The controversy stems from a misunderstanding of the assumptions made by the IMF in estimating Iran’s gross international reserves. A footnote in the statistical appendix of the latest Regional Economic Outlook report explains that the gross international reserves data for Iran “has been amended to reflect the amount of external assets that is readily available and controlled by the monetary authorities after the re-introduction of financial sanctions.”  

Since the Trump administration reimposed sanctions on Iran’s financial system in 2018, Iranian authorities have been unable to use most of their foreign assets, a situation exemplified by the current dispute over $7 billion of frozen assets held in banks in South Korea. For this reason, IMF economists estimate that only “only 10 percent of the previously reported gross international reserves are readily available for [balance of payments] purposes from 2019.” This estimate is likely derived from statements made by Trump administration Iran envoy Brian Hook in December 2019. Hook claimed that Iran retained access to just 10 percent of its $100 billion of reserves due to sanctions—Pompeo probably had this soundbite in mind when he tweeted that the $4 billion estimate meant that 96 percent of Iran’s reserves had been “wiped out.”

Given that Iran’s financial assets are a target of US sanctions, Iranian authorities do not publish their own figures on gross international reserves, although they do publish information on quarterly data on changes to reserves and a more general figure for “foreign assets.” That leaves the IMF little option but to run with the 10 percent figure to estimate what proportion of Iran’s reserves are readily accessible. Another assumption made by the IMF is that any balance of payments deficit Iran runs will need to be financed exclusively from that smaller pool of accessible reserves—this is indicated in the footnote, but it could have been made clearer.  

Working backwards, the $4 billion figure reflects 10 percent of 2019 total reserves minus Iran’s balance of payments deficit in 2020, which can be estimated from the difference between the 2019 and 2020 estimates for accessible reserves—$8.4 billion. Given the decline in accessible reserves it attributable to the balance of payments deficit, there has been no dramatic fall in Iran’s gross international reserves, which are estimated at $123.8 billion for 2019 and down by $8.4 billion to $115.4 billion for 2020. The relative stability of such reserves is corroborated by data from the Central Bank of Iran on changes to international reserves, which decreased by an average of just $1.15 billion per year between March 2017 and March 2020. Logically, if Iran is unable to access or spend the money, there is no real way for its reserves to be “wiped out.”

Iran’s dwindling accessible reserves pose a major challenge for authorities—$4 billion is equivalent to just under three weeks of Iran’s annual import total. Iranian officials will hope that the resumption of trade post-pandemic and the resurgence of Iranian oil sales will ease the country’s balance of payments crisis. Indeed, the IMF sees accessible reserves rising to $12.2 billion this year, suggesting a balance of payments surplus of $8.2 billion. Importantly, this projection does not take into account sanctions relief Iran may receive as part of ongoing negotiations with the United States.

For now, what a closer inspection of the data makes clear is that those who claimed that Iran’s foreign exchange reserves have collapsed are wrong—total reserves today are higher than in 2019, when Hook was boasting about the success of maximum pressure. Iran remains a wealthy country, albeit without the means to use much of its wealth.

Photo: Getty Images

U.S.-Iran Talks Will Falter Unless Abdolnaser Hemmati Is at the Table

By Esfandyar Batmanghelidj and Saheb Sadeghi

The United States and Iran may soon be sitting at the negotiating table once again. In just the last week, the Biden administration has offered to restart negotiations, and Iran has struck a deal with the International Atomic Energy Agency to slow moves to limit inspections of its nuclear program. A window of opportunity has emerged for the two sides to talk, likely in a format facilitated by the European Union. If and when the United States and Iran sit across from one another again, there is a key figure who ought to be present—Abdolnaser Hemmati, the governor of Iran’s central bank.

In many respects, Iran’s central bank was the primary target of former U.S. President Donald Trump’s economic war on Iran. Much of the economic hardship that Iran has experienced due to the reimposition of secondary sanctions can be attributed to the Trump administration’s success in limiting the central bank’s access to its foreign exchange reserves.

According to the International Monetary Fund (IMF), Iran retains access to just $8.8 billion of readily available foreign currency, roughly one-tenth of its total reserves. Without access to its reserves held in countries like Iraq, South Korea, Japan, and Germany, the central bank has struggled to forestall the weakening of Iran’s currency, which is today worth less than one-fifth of its value prior to Trump’s withdrawal from the nuclear deal, formally known as the Joint Comprehensive Plan of Action (JCPOA). This deep depreciation made imported goods more expensive, contributing to annual inflation rates of nearly 50 percent.

Hemmati, a veteran banker, was appointed as central bank governor in July 2018, parachuting in just a few months before secondary sanctions were fully reimposed on Iran. He has performed remarkably well in difficult circumstances. Iran’s currency was regaining value for most of 2019, a trend disrupted by the COVID-19 crisis, which hit the country’s economy hard, throwing trade into disarray.

Since reaching a historic low in October 2020 of just over 320,000 rials to the dollar on the free market, the currency has since stabilized at around 250,000 rials to the dollar—with this stability helping to undergird Iran’s slow economic recovery. Along the way, Hemmati has proved an adept communicator, using his Instagram account, the central bank’s website, and even select interviews with international media to outline his priorities and reassure the Iranian public about the bank’s capacity to defend the rial from hyperinflation.

Iran has not faced a full-blown economic meltdown, despite the best efforts of the Trump administration. But the country finds itself in a painful period of economic stagnation, and sanctions relief will be needed should any government wish to deliver on promises of prosperity. However, Trump sought to make sanctions relief more difficult.

In September 2019, the Trump administration designated Iran’s central bank under a terrorism authority, a move that jeopardized long-standing exemptions permitting the bank to play a crucial role in facilitating the purchase of humanitarian goods such as food and medicine.

In February 2020, the U.S. Treasury Department issued a new general license to allay those concerns. But more troubling was the intention behind the terrorism designation, which was applied to Iran’s central bank for the express purpose of making it harder for a potential Democratic administration to lift sanctions on the bank in the future.

The Biden administration will likely need to remove this designation to bring the bank back to its original status under the JCPOA—but removing a designation ostensibly tied to Iran’s purported support for terrorism may prove politically tricky as part of U.S. reentry into an agreement focused exclusively on the country’s nuclear program.

Lifting sanctions was difficult even before the Trump administration’s cynical moves. Iran’s experience of sanctions relief following the implementation of the JCPOA was disappointing. International banks remained hesitant to process Iran-related transactions, citing unclear guidance on how to conduct business in a compliant manner and the risks of punitive fines if the remaining sanctions were inadvertently violated.

This limited the rebound in trade and, particularly, investment in Iran. While there had been some technical exchanges on banking during the JCPOA negotiations, including working-level exchanges with Iran’s central bank, these were largely focused on the unfreezing of Iran’s assets—the challenges Tehran faced in mundane banking blindsided the JCPOA parties.

In March 2016, then-Treasury Secretary Jacob Lew noted that the “experience with Iran demonstrates how difficult [sanctions lifting] can be.” Despite what Lew referred to as “widespread global outreach” by officials at the U.S. Treasury and State departments, the banking challenges persisted and continued to stymie trade and investment until Trump’s eventual withdrawal from the nuclear deal.

In an interview last July, Valiollah Seif, who was central bank governor at the time of the JCPOA negotiations, suggested that Iran had not had the right experts in the room. “The JCPOA could solve the problem related to oil sales at that time, but it could not solve our banking problems. … Our economic and banking expert team was weak in the JCPOA talks,” he said.

Understandably, Iranian leaders are keen to get sanctions relief right this time around. In a recent speech, Iran’s supreme leader, Ayatollah Ali Khamenei, insisted that any sanctions relief offered by the United States must take place “in practice” and not just “on paper.” Moreover, the efficacy of that sanctions relief will need to be “verified.”

What’s clear is that as new negotiations approach, the JCPOA parties cannot rely on diplomats to untangle the complex knots that have constricted Iran’s banking ties for so long. To ensure sanctions relief succeeds, Hemmati ought to be in the room as part of a high-level technical dialogue, which could eventually include top officials such as U.S. Treasury Secretary Janet Yellen and French Finance Minister Bruno Le Maire.

There are a few reasons why a dialogue on sanctions relief, which would be similar in structure to the pre-JCPOA exchanges on nuclear issues between then-U.S. Energy Secretary Ernest Moniz and Ali Akbar Salehi, the head of Iran’s atomic energy agency, ought to center on Hemmati.

First, Hemmati has emerged as a key figure of Iran’s economic diplomacy. In the last two years, he has made trips to Iraq, Oman, South Korea, and China in order to ensure Iran retained functional financial channels with key trade partners while the Trump administration sought to put pressure on the governments of these countries. His participation in the new talks would be a natural extension of this global outreach, and most of the sanctions relief benefits promised by the United States will need to be delivered via third countries. Hemmati is the only stakeholder to have full technical knowledge of the challenges U.S. sanctions have posed in economic relations with key trade partners.

Second, Hemmati’s stewardship will be critical for the implementation of both early and late-stage sanctions relief measures. Whether it is the easing of access to foreign reserves or the granting of Iran’s COVID-19 IMF loan—both under consideration as early economic gestures by the Biden administration—or the consideration of new economic incentives such as reauthorization of the “dollar U-turn,” an exemption revoked in 2008 that allowed U.S. banks to process Iran-related transactions in cases where a payment is being made between two non-Iranian foreign banks, effective implementation depends on Iran’s central bank.

Importantly, the international community will also expect Iran to continue to reform its banking sector in line with international standards. On this point, Hemmati has been a key champion, stating recently that if the JCPOA were revived, Iran would need to complete adoption of the action plan set forth by the Financial Action Task Force, a standards-setting body, in order to see the benefits of sanctions relief in the banking sector.

Finally, Hemmati would bring some technocratic continuity to the economic implementation of a restored JCPOA. There is considerable concern that the possible arrival of a new Iranian president in August could leave any diplomatic agreement vulnerable to changing politics in Tehran.

While it may be possible for some of Iran’s top diplomats to remain in their posts in a new administration, it is Hemmati, whose term ends in 2023, who is best positioned to offer institutional continuity on implementation issues. He has proved to be an adept political operator. By insisting on the central bank’s technocratic independence, he has largely avoided the attacks regularly made against members of the Rouhani government.

He also maintains a good relationship with Khamenei and has been able to turn to the supreme leader to insulate the bank’s policies from political attacks. It is often argued that restoring the JCPOA would help boost the fortunes of Iran’s political moderates, but it is equally important for U.S. President Joe Biden to strengthen the hand of Iran’s technocrats who work on policies, not politics.

The Biden administration’s early appointments made clear that when it comes to Iran, personnel is policy. The same holds true in Tehran. If the right people are not in the room during upcoming negotiations, not only will the agreed policies be deficient, but so too will implementation falter. The United States, the other permanent members of the U.N. Security Council, and Germany need to provide Iran a pathway to the normalization of its banking ties—to do so, it would make sense to engage Iran’s top banker.

Esfandyar Batmanghelidj is the founder of the Bourse & Bazaar Foundation.

Saheb Sadeghi is a columnist and foreign-policy analyst on Iran and the Middle East.

Photo: IRNA

US Weighing Sanctions to Cripple Iran Humanitarian Trade

The Trump administration is reportedly considering a new set of sanctions designations targeting 14 Iranian banks that are not currently subject to secondary sanctions. The new designations would be made under authorities associated with “terrorism, ballistic-missile development and human-rights abuses.” The targeting of these banks would cripple Iran’s already degraded channels for the importation of humanitarian goods—including food and medicine—at a time when the country is battling the COVID-19 pandemic.

This new proposal, spearheaded by the Foundation for Defense of Democracies, long-time opponents of the 2015 nuclear deal, would be the latest and most extreme in a series of sanctions moves intended to deliberately undermined long-standing protections for humanitarian trade. Proponents of the proposal believe that it will be “possible to mitigate the humanitarian costs, chiefly through so-called comfort letters from the Treasury Department.”

However, considering the precedent set by the Trump administration, there is no reason to believe that the humanitarian costs can be mitigated. In 2019, Iran imported over $1 billion of pharmaceutical products and over $3.5 billion in cereals. This trade is so sizable that no degree of licensing or special accommodations by the Treasury Department, nor any recourse to the still non-functional Swiss Humanitarian Trade Arrangement, will suffice to ensure that ordinary Iranians are not unduly impacted by the consequences of the move. In short, the Treasury Department lacks the means to designate these banks while ensuring that Iran’s imports of food and medicine remain routine and reliable.

The designation would have three distinct consequences:

1.     Iran’s rial would lose value.

The designation would serve as a supply-side and demand-side shock for Iran’s foreign exchange markets. On the supply-side, the closure of the few remaining correspondent banking channels between Iran and the global financial system would make it near-impossible for Iranian exporters to repatriate foreign exchange revenue. This makes it significantly more expensive for Iranian importers to purchase foreign exchange through the centralized NIMA exchange.

On the demand-side, ordinary Iranians will respond to the new uncertainty by seeking to convert more of their savings into foreign currency, pushing up the free market exchange rate, beyond its recent historic highs. The net effect will be that all Iranian imports become more expensive in the short-term, exacerbating the already significant inflationary pressures that have seen year-on-year inflation rise as high as 50 percent in recent months. Because Iran imports significant volumes of food and medicine products, these humanitarian goods will likewise become more expensive for Iranian households. 

2.     There would be a liquidity crisis around Iran’s humanitarian trade. 

While foreign currency within Iran would become more expensive, the foreign currency held by Iranian these banks and their Iranian clients in accounts outside of Iran will be frozen . Since the Trump administration hit Iran’s central bank with a new designation in September 2019, it has become increasingly difficult for the Central Bank of Iran to freely use its funds for the purposes of facilitating humanitarian trade as long allowed under US sanctions exemptions. In July of this year, Reuters reported on how these challenges were having a direct impact on Iran’s ability to make payments for purchases of food commodities such as grain and soybeans.

In the face of these challenges, Iranian pharmaceutical and food importers have increasingly used funds held by private sector banks and companies outside of Iran as means to make payments for goods. These funds are often held at accounts belonging to Iranian banks at foreign financial institutions in countries such as Turkey, South Korea, and China. If these Iranian banks are designated in a manner that eliminates the clear exemptions for the use of Iranian-origin funds for humanitarian trade, foreign financial institutions will be obligated to freeze the accounts of Iranian banks and their clients.

Such a situation, which is functionally the same as the situation facing funds belonging to Iran’s central bank, would contribute to a sudden liquidity crisis. Even if European and Asian companies remain willing to sell humanitarian goods to Iran, and even if the Treasury Department issues new licenses and comfort letters to try and reassure companies about the permissibility of these sales, Iranian importers will struggle to source the foreign currency needed to pay for these goods. This will likely contribute to significantly more delays in the importation of food and medicine which could lead to issues of scarcity and affordability.

Because of the restrictions imposed by sanctions on Iran’s banking sector, the financial transactions that enabled these imports are facilitated through an increasingly complex and fragile set of banking channels. Iranian importers and their suppliers are required to have multiple channels, knowing that new sanctions designations or financial circumstances could render any channel non-viable overnight. This byzantine system is the direct opposite of the simple, reliable banking channels countries need to ensure the availability of food and medicine. Targeting these key Iranian banks with new sanction will smash the remaining few reliable channels. 

3.     Many global pharmaceutical and food companies would quit the Iranian market.

Among the banks that may be targeted are those Iranian institutions that have gone to the greatest lengths to adopt anti-money laundering and counter terrorist financing policies, including those policies recommended by the Financial Action Task Force. While such policies have been only partially implemented across the wider Iranian financial system, these banks have instituted policies that exceed regulatory requirements in Iran in order to effectively serve Iranian importers and the multinational pharmaceutical and food commodities companies that supply them. These banks take an active role in helping these companies meet the stringent due diligence requirements necessary to successfully process Iran-related payments at banks in Europe and Asia. The impact of such a designation on these banks would be grave.

We know this because of the experience of Parsian Bank, a similar private sector financial institution which became subject to a terrorism-related designation in October 2018. As reported by the Washington Post, the designation of Parsian Bank left many multinational companies, including German drugs giant Bayer, scrambling to transfer their accounts to new Iranian banks in order to maintain their sales to Iran. But should the Trump administration move to designate all the remaining banks, there will be no alternatives available.

This will be a significant blow to the operations of many multinational companies which still maintain a local presence in Iran—companies overwhelmingly involved in the importation and production of food and medicine. Given these new operational restrictions, it is likely that many of the European and Asian companies still selling into Iran will either temporarily or permanently cease operations. As an employee at Bayer Iran commented to the Washington Post on the impact of sanctions on foreign pharmaceutical companies in Iran, “Many companies have started limiting their activities and laying off employees.”

Consequences for the US

What is striking about the proposed sanctions is the lack of any clear policy rationale for their imposition. The targeting of these banks in no way advances the Trump administration’s stated aims to curtail Iran’s “malign behaviors.” These banks are not significant vectors for money laundering and terrorist financing nor are they substantively linked to the Iranian government nor entities such as the Islamic Revolutionary Guard Corps. These banks have not been designated so far under the proposed authorities precisely because they are unlike most other Iranian banks. It is these distinct governance and operational characteristics that have enabled several of these banks to play a crucial role in humanitarian trade. As such, there is no national security justification for the designations—the only clear impact will be the further immiseration of ordinary Iranians as the supply of food and medicine becomes increasingly erratic.

Those who support targeting these banks have spoken openly about their intention to make future diplomacy with Iran more difficult in the event that Joe Biden wins the election in the next few weeks. This admission itself exposes the cynical thinking behind the proposal. But more consequentially for those individuals who have spent more than a decade developing US sanctions powers, the application of sanctions in the manner being proposed will no doubt damage the credibility of US sanctions as a tool of foreign policy.

Following significant concerns raised by governments, international organizations, and activists about the ability of sanctioned countries to respond to the COVID-19 pandemic, the Treasury Department issued a new fact sheet in April to clarify the exemptions and general licenses that govern humanitarian trade. At the time, OFAC director Andrea Gakci reaffirmed her office’s commitment to protecting “humanitarian relief efforts related to the COVID-19 crisis.”

The factsheet touted the launch of the Swiss Humanitarian Trade Arrangement (SHTA) as a model financial channel that would enable food and medicine to flow to Iran. SHTA has processed just one transaction during the COVID-19 crisis in Iran. One of the principle challenges facing SHTA and similar financial channels being considered is the failure of the Treasury Department to clearly permit the Central Bank of Iran, to access the foreign exchange reserves necessary to make payments through the channel. Such impediments will only get worse if Iran’s private sector banks are made subject to a similar designation as the central bank.

“Maximum pressure” sanctions are increasingly seen by US allies, and not least the Iranian public, as so poorly targeted as to intentionally harm the health and wellbeing of ordinary Iranians. Any move to designate the remaining Iranian banks at the heart of the country’s humanitarian trade would not only confirm this view of US sanctions policy, but also serve to directly undermine the commitments made by US officials, including Treasury Secretary Steven Mnuchin, who stated in April that his department was “committed to working with financial institutions and non-profit organizations in their efforts to mitigate risks and allow humanitarian assistance and associated payments to flow to those who need it.” Mnuchin should stand by his word and the US government should stand by its principles—the proposal to designate these banks must be rejected.

Photo: IRNA

Iran Resorts to New Financial Tools to Shore-Up Economy

The COVID-19 crisis has forced Iran’s government to turn to little-used financial tools to help stabilize the economy and address a widening fiscal deficit.

In the arena of monetary policy, the crisis is the first test of the new Open Market Operation (OMO) powers announced by the Central Bank of Iran (CBI) on January 18. To address the fiscal deficit, the Rouhani administration has pushed forward with long-planned privatization plans, conducting an Initial Public Offering (IPO) for SHASTA, the investment arm of the country’s largest social security provider. But the government faces hurdles as it resorts to largely unproven measures.

An underdeveloped interbank lending market will hamper OMOs. The interbank lending market in Iran was first established in June 2008. Despite the fact that the number and volume of transactions has grown substantially in recent years, with over 20,000 transactions registered in the last Iranian calendar year, the market remains hampered by the fact that Iranian banks do not maintain large reserves, meaning there are often too few banks with surplus liquidity in the market. As a result, it will be difficult for OMOs undertaken by CBI to influence the interest rate in the interbank market, limiting the central bank’s capacity to enact monetary policy through the bank-lending channel.

Iran’s interbank lending market also presents instrumental limitations. The most common mechanism by which needy banks secure liquidity is by direct borrowing from surplus banks, or, in times of emergency, turning to CBI as a lender of last resort. These loans are typically made without collateral and sometimes even without a formal contract. But given the prevalence of unsecured loans, there remains the possibility that the borrower might default.

While this possibility is generally understood to be low, it has likely increased given the current economic crisis. Iranian businesses will be seeking cheap financing to help them get through the difficult times. But given that Iranian banks struggle to determine the creditworthiness of their clients, any rapid expansion in lending could lead to greater issues with non-performing loans, particularly among the weaker banks.

The Central Bank of Iran had intended to use OMOs to adjust the inflation rate in accordance with its target for the current financial year, which is set at 20 percent—the annual inflation rate reached 41.2 percent in 2019-20.

On one hand, if the central bank aims to enable the country’s banks to lend to ailing businesses, the shift to the expansionary use of OMOs will be at odds with the inflation goals. On the other hand, now that the government is facing a record fiscal deficit, some Iranian economists are worried that the central bank may be pushed to use OMOs as a tool to generate government revenue, issuing bonds to finance expenditures. At a time when markets need clear leadership from regulators, the central bank’s priorities remain unclear.

While the central bank pursues new tools of monetary policy, the Rouhani administration has sought to tackle a fiscal deficit. The government’s IPO of SHASTA, also known as the Social Security Investment Company, was the largest IPO in Iranian history by market capitalization. The public offering of 10 percent of the company’s shares on April 15 generated USD 437 million in revenue for the government.

The strong performance of the Tehran Stock Exchange over the last year, despite the overall economic malaise, suggests that privatization of state-owned enterprises is a viable means for the government to generate much-needed revenues.

The Rouhani administration has long-pushed privatizations as a means to improve the finances of currently state-owned enterprises, to increase transparency, to improve corporate governance, and to reduce the footprint of the government in Iran’s economy. But any rush to privatize enterprises may lead to the loss of a “golden opportunity” as the government pursues public offerings to compensate for budget deficits without ensuring that the companies and their management become fully accountable to the public markets. 

Iran has been grappling with serious challenges in the areas of ​​fiscal and monetary policy in recent years. The Rouhani administration and the Central Bank of Iran have smartly sought to create new tools and establish new policies in response. But as the economy reels from the impact of COVID-19, these challenges have reached a point of crisis—the new tools may not be enough.

Photo: IRNA

Iran’s Currency Begins to Shrug Off Trump’s ‘Battle Rial’

Over the last 18 months, the Iranian rial has lost nearly 70 percent of its value, hammered by the Trump administration’s decision to reimpose secondary sanctions on Iran in violation of the  Joint Comprehensive Plan of Action (JCPOA).

A darkening economic outlook and rising inflation led Iranians to rush to exchange bureaus in order to purchase dollars, considered a safe-haven asset. Iranian companies struggled, or in some cases refused, to repatriate their foreign currency earnings, constraining supply in the foreign exchange market and leaving the market vulnerable to shocks.

Each time the Trump administration announced a new aspect of its maximum pressure campaign; the value of the rial would fluctuate. When the Trump administration took the dramatic step of targeting the IRGC under a new terrorist designation, the rial lost 4 percent of its value in just a few hours.

But there is a growing sense in Tehran that the currency market may have stabilized. When two oil tankers were attacked in the Sea of Oman on June 13—attacks widely attributed to Iran—the United States vowed a forceful response. But there was surprisingly little movement in the value of the rial.

Two weeks later, when the Islamic Revolutionary Guard Corps (IRGC) shot down a US spy drone near the strategic Strait of Hormuz, ordinary Iranians and currency speculators again braced themselves for a free-fall in the rial’s value. But the foreign exchange market barely moved—even after news broke that the US had been minutes from executing a retaliatory strike. 

That the rial has strengthened about 13 percent since the first week of May, corresponding to a period in which the United States revoked waivers permitting purchases of Iranian oil and in which Iran announced it would begin loosening its compliance with the JCPOA, has led some economic commentators in Iran to conjecture that the Iran’s foreign exchange market has developed an immunity to the escalating political tensions. The rial may be shrugging off the Trump administration’s “maximum pressure” campaign.

One possible explanation for the newfound stability in Iran’s currency markets is that while the Trump administration has nearly maxed-out its own maximum pressure sanctions campaign, the Central Bank of Iran has only recently begun to assert its control over the foreign exchange market. Late last month, Abdolnasser Hemmati, the governor of Iran’s central bank, struck a confident tone in an interview with state broadcaster IRIB, stating, “I promise to strengthen the value of the national currency—the situation is improving, the recovery can be felt.”

To defend the rial, the Central Bank has made several interventions. It has implemented a central marketplace to increase transparency and reduce arbitrage in Iran’s foreign exchange market. The Integrated Foreign Exchange Deals System, known by its Persian acronym, NIMA, has improved the reliability with which Iranian importers in need of foreign exchange can purchase currency, taking advantage of a rate slightly lower than the free market rate. Iranian exporters are required to sell their foreign exchange earnings through the NIMA system, ensuring that vital foreign exchange is not sold to currency speculators on the free market. Additionally, the central bank has for the first time engaged in open market operations, in an attempt to try and slow the inflation that has fed demand for foreign exchange.

While some of the stabilization is likely attributable to these interventions, it is also possible that the rial has stabilized due to the fact that the current exchange rate better reflects the relative purchasing power of the rial and the dollar. The rial had long been kept artificially strong by the Iranian government.

Looking at the demand side, it may be the case that the Iranian public has been inured to the economic uncertainty brought about by the reimposed US sanctions or that there is greater confidence in the management of the foreign exchange market by authorities. In both cases, individuals and companies are less inclined to flock to the dollar as a safe-haven asset, even if Iran’s general economic malaise—marked by high unemployment—persists.

The stability of the currency is all the more remarkable as the Trump administration drives down Iran’s oil exports. The revocation of waivers covering imports of Iranian crude has left China and Syria as Iran’s sole customers. Iran’s oil minister, Bijan Zanganeh, has insisted that Iran has the means to get its oil to global markets, though it is clear that exports have fallen sharply. While the Trump administration has crowed that reduced oil sales deprive Iran of vital foreign currency, it is worth considering that under the waiver system that governed Iran’s oil exports for much of the last decade, Iran had a limited ability to repatriate its foreign currency earnings. In that sense the current circumstances are not new.

There remain measures that the Trump administration can pursue to try and spur a new devaluation episode in Iran. Reports that the White House may finalize the designation of Iran as a “primary money laundering concern,” a move that could cut the country’s few remaining correspondent banking links, reflect one such measure. But for now, as economist Djavad Salehi-Esfahani has recently written, “Fears of ‘Venezuelaization’ of the Iranian economy (collapse) have subsided, allowing the government to revive its long neglected public investment program, which could boost employment and production.” The Iranian public, made weary by a year of economic hardship, will certainly hope that the stabilization of the currency is the first step to a broader recovery.

Photo: IRNA

Iranian Bankers Fear IRGC Terrorism Designation Dooms Vital Financial Reforms

Reform-minded Iranians, especially those inside the ailing banking system, are worried that the US government’s step to designate Iran’s Islamic Revolutionary Guard Corps (IRGC) as a terrorist organization has doomed a years-long effort to get the Islamic Republic off a consequential global blacklist.

The administration of Iranian President Hassan Rouhani has been working hard to meet the requirements of the action plan set by the Financial Action Task Force (FATF), the intergovernmental organization established with the mandate of combatting money laundering and terrorism financing.

The required reforms have caused deep political divisions, with opponents arguing that Iran will be compromising its sovereignty should it appease the FATF, while porposents argue that failing to pass the required legislation will eliminate final links Iran maintains with foreign financial institutions while under US sanctions.

Undaunted even as death threats were made against them, a majority of Iran’s parliament voted to pass all four FATF bills over the course of several months. The supervisory Guardian Council then ratified two of the laws, while two others were considered deficient. The council and parliament have failed to find a consensus on adjustments to these two bills, which pertain to regulations that deter terrorist financing and organized crime. Now the powerful Expediency Council must vote to break the deadlock on ratification.

Meanwhile, the clock is ticking for Iran to show progress on the FATF action plan. At the end of its February plenary sessions, the FATF announced, “If by June 2019, Iran does not enact the remaining legislation in line with FATF Standards, then the FATF will require increased supervisory examination for branches and subsidiaries of financial institutions based in Iran.”

When the Trump administration took the controversial move to designate the IRGC a Foreign Terrorist Organization (FTO), the first time the FTO designation had been applied to a part of a foreign state, the condemnations in Iran came swiftly.

As Rohollah Faghihi reports for Al Monitor, hardliners opposed to engagement with the West pointed to the FTO designation to show the futility of the FATF reforms. The day after the FTO designation was announced, Expediency Council member Gholamreza Mesbahi-Moqadam said the designation has decreased the chances that the FATF bills woild be ratified. “The move has strengthened the council’s [unfavorable] stance about the FATF and the chances of the bills not being approved has increased,” he said. Others have even placed the chances of ratification at zero.

Members of Iranians banking community, who have been advocating for FATF reforms for years as part of a larger drive for modernization of the financial sector, share in this pessimism. A senior Iranian banker speaking to Bourse & Bazaar on condition of anonymity agreed that the FTO designation has harmed the odds of the bill passing, by shifting the environment away from constructive discussion and cooperation towards sloganeering.

“The designation has major political implications, the full scope of which has yet to become clear, but I find it unlikely that the bills will be approved under current circumstances,” the banker said. “Essentially whenever the situation gains an emotional aspect, decisions also become largely emotional.”

Several high-level Iranian officials have also confirmed that the FTO designation will have an impact on the FATF bills. Secretary of the Expediency Council Mohsen Rezaei, who counts himself among those opposed to the bills, has said the FTO designation will be factored in forthcoming decisions based on “national interests.”

Meanwhile, Laya Joneydi, Iran’s Vice President for Legal Affairs, suggested it was a mistake to conflate decision-making about the FATF bills and the FTO designation since the two issues are “fully separable.” She did, however, point out that the designation will prompt the Rouhani government to consider any new “reservations” about the two bills.

A source inside the Central Bank of Iran also confirmed to Bourse & Bazaar on condition of anonymity that the IRGC designation should be expected to have an impact on the FATF bills.

“The central bank has always been in favor of having the bills pass into law, but we have already concluded all expert reviews of the bills and now everything depends on the views of the Expediency Council. At at the moment it seems the number of council members opposed to the bills is higher,” the source said.

Central Bank Governor Abdolnasser Hemmati has on multiple occasions voices his support for enacting the bills into law, saying Iran needs to do more to comply with international financial standards. In his latest remarks in early March, he said safeguarding and strengthening what little international banking ties Iran retains is a “necessity.”

In late February, Rouhani mounted his strongest support yet for the bills, saying “we cannot give the country to 10-20 people and say we follow your decisions”. The president called on the Expediency Council to facilitate passage of the bills lest Iran lose its already tenuous link to the global financial system.

But not everyone inside Iran’s isolated banking system is pessimistic about salvaging the FATF action plan.

“The bills will certainly face delays, but we predict that they will ultimately be signed into law,” a senior member of a banking sector association told Bourse & Bazaar on condition of anonymity.

The official likened the situation surrounding the issue to the Iran nuclear deal, noting that many analysts thought such a multilateral agreement could never be reached given opposition from hardliners.

“I believe some members of the Expediency Council harbor doubts about some of the contents of the FATF bills but are not opposed to them outright. Those doubts will be cleared in time,” the official said.

The question remains whether the FATF will continue to show patience as Iran’s complex domestic politics slow the pace of reform even further.

Photo: IRNA

Confronting Failure, Iran Government Mulls New Currency Policy

Despite mounting evidence that the Iranian government’s policy of allocating subsidized foreign currency for the importation of essential goods has failed, the Rouhani administration has signaled that it plans to maintain the policy for at least another year. But lawmakers and Rouhani’s own cabinet ministers may force the administration to change course.

On March 2, Iran’s parliament approved the allocation of USD 14 billion in oil export revenues for the import of essential goods, including food and medicine, during the upcoming Iranian year (beginning March 20). In doing so, MPs gave the green light for the Rouhani administration to continue to make foreign exchange available to importers of essential goods at the subsidized rate of IRR 42,000 to the dollar.

However, lawmakers also encouraged the government to consider an alternative approach that would require essential goods importers to purchase foreign exchange at the IRR 90,000 rate available on the centralized NIMA marketplace. The government would then redirect the savings from the elimination of the currency subsidy towards programs that directly assist Iranian consumers and manufacturers.

Despite the nudge from parliament to consider a new approach, it appears that the administration is intent on maintaining the subsidy for at least another year. The head of the Management and Planning Organization, Mohammad Baqer Nobakht, confirmed this to be the administration’s position in an interview just prior to the parliamentary vote.

The Rouhani government “unified” the country’s dual foreign exchange rates at IRR 42,000 to the dollar in early April as the rial hit new lows due to political uncertainty surrounding Iran’s nuclear deal and the possible reimposition of sanctions by the United States. The foreign exchange rates diverged again shortly thereafter, but the Rouhani administration has persisted in using the “unified” fixed rate for the importation of essential goods.

Rouhani recently claimed that he personally disagreed with the fixed rate when it was first proposed and only consented to rate unification after dozens of top economists backed the move. His administration has since maintained that the allocation of subsidized foreign exchange continues to be the best policy to stabilize prices of essential goods.

Meanwhile, high levels of inflation have dimmed prospects for Iran’s middle and lower classes. The Iranian public has felt the pressure of price hikes, and essential goods have not been spared, despite Rouhani promising otherwise on national television.

Beyond the lived experience of Iranians, new research has also cast doubt on the effectiveness of subsidization. On February 22, the Parliament Research Center published its findings of the government subsidized currency allocation policy. According to the PRC, the price of essential goods as a category increased by 42 percent during the first three quarters of the current Iranian year that ended on December 21.

By comparison, the price of imported goods not eligible for the subsidized rate increased 73 percent in the same period. However, the consumer price index increased by nearly 40 percent, meaning that the increase in the price of essential goods still outpaced general inflation by a significant margin. The question for policymakers is whether this minimal impact on the price of essential imports is worth the many adverse side effects for the wider economy.

At time when Iran’s foreign exchange revenues are being squeezed by  the Trump administration’s “maximum pressure” policy, the Iranian government cannot afford to misallocate USD 14 billion in oil revenue to a subsidization program that may serve to increase corruption and rent-seeking.

Iran’s central bank governor Abdolnasser Hemmati also admitted as much in a frank statement. “In effect, allocating subsidized currency to essential goods has failed to prevent their price hikes in the medium term due to the nature of market in the economy and the weakness of the distribution and supervision systems,” he wrote in a March 9 Instagram post. “Therefore, in most cases the subsidies have gradually moved away from consumers and benefited importers.” Hemmati signaled that a change in the policy may be in order by stating the government will “make the best decision.”

Economy minister Farhad Dejpasand later echoed Hemmati’s view, stating that “The government is currently studying several policies, and we definitely will adopt an approach to minimize the pressure on the poorest sections of society.

“Based on competitive open market principles, any fixed rates that diverge from the open market rate, such as the subsidized IRR 42,000 dollar exchange rate, are a mistake,” Mohammad Mahidashti, a macroeconomic analyst currently serving as an advisor at Iran’s Ministry of Economic Affairs and Finance told Bourse & Bazaar.

“There is simply no positive aspect in this subsidized currency allocation by the government, perhaps save for giving it a justification and a populist slogan to show that the administration is trying to decrease prices of essential goods,” he said.

Mahidashti believes the way forward is for the government to cut its losses as soon as possible by eliminating the subsidized rate and moving toward true rate unification, which he considers both doable and absolutely necessary.

Indeed, the PRC report also called on the Rouhani administration to either fully eliminate subsidized currency allocation or significantly trim the list of essential goods eligible to receive cheap currency. Even in the event of choosing the second route, the parliamentary think-tank said the subsidized rate must be higher and the IRR 42,000 rate is no longer justifiable.

Iran’s private sector, which has for years called for true rate unification would surely embrace such a move. Shortly after Hemmati’s admission of the failure of the subsidized foreign exchange policy, deputy president of the Iran Chamber of Commerce Pedram Soltani welcomed the announcement as a sign that things may be changing. He tweeted, “Subsidized currency is the source of rent and misuse. Let’s stop the flow!”

Photo Credit: IRNA

Facing a Damaging Ban, Iran’s Crypto Community Seeks Policy Breakthrough

For decades, Iranians have had to contend with almost complete isolation from international payment systems due to US sanctions. The situation has only worsened following President Donald Trump’s decision to withdraw from the Iran nuclear deal and embark on a “maximum pressure” campaign that targets average Iranians.

Given these restrictions on traditional banking, it should come as little surprise that Iran is home to a vibrant and passionate cryptocurrency community. Iranians are increasingly turning to bitcoin and other cryptocurrencies to transact with the outside world. Soheil Nikzad, a board member of the Iran Blockchain Community, recently estimated that USD 10 million worth of bitcoin transactions are conducted in Iran on a daily basis.

The decentralized and anonymous nature of cryptocurrency payments means that the Iranian government has so far proven unable to stop adoption of the new technology. But regulators are trying to exert greater control as made clear when the Central Bank of Iran (CBI) published its draft regulatory framework on cryptocurrencies in late January.

The “version 0.0” framework asserts that “using global cryptocurrencies as methods of payment inside the country is forbidden.” Even though the framework recognizes global cryptocurrencies and allows them to be traded in official exchanges in accordance with the country’s foreign currency rules, the proposed ban on their use for payments has disappointed many in the local “crypto” community.

“I don’t view CBI’s framework as remotely adequate because they’ve forbidden many things and in doing so, they’ve created barriers for people trying to develop valuable projects,” blockchain researcher Hamid Babalhavaeji told Bourse & Bazaar, referring to CBI’s ban on the issuance of rial-backed tokens as an example.

Babalhavaeji’s frustration is shared by many in the community. Twitter feeds and Telegram channels are abuzz with debates and sharp criticism of the CBI framework. But there are nuances at play.

“Within the existing legal frameworks, including sensitive rules concerning foreign currencies and money laundering, it was perhaps the best that could be proposed at the moment,” Babalhavaeji acknowledged.  

In this vein, many in the community believe it would be unproductive to simply dismiss the proposed framework as just another instance of overbearing regulations. The community understands the pressures faced by the government, which is grappling with what senior Iranian officials have referred to as an “economic war” being waged on Iran by the U.S.

Reimposed US sanctions have contributed to the rial losing more than 60 percent of its value in 2018. Naturally, at a time when public trust in the national currency is at a low, CBI wishes to keep a tight leash on the currency markets.

Authorizing several dozen global cryptocurrencies as methods of payment inside the country, some of which are pegged to global currencies, could further weaken the rial, threatening the livelihoods of millions of Iranians as inflation worsens due to currency volatility.

On one hand, businesses would be tempted to establish payment gateways to accept cryptocurrencies pegged to the US dollar or other stable globally currencies. As wealthier Iranians begin to earn and spend cryptocurrencies, those in the working class, still paid in rials, would see their meager wages lose even more purchasing power.

On the other hand, fully eliminating the prospect of using global cryptocurrencies as a local method of payment could hurt Iran in other ways. It would create a stigma around a promising new technology, stalling innovation and deterring would-be enthusiasts from employing cryptocurrencies to meet Iran’s need for robust and legitimate payment solutions.

The central bank has given the community one month to offer feedback and has vowed to review and reevaluate its framework in six-months. The crypto community is hard at work trying to devise practical solutions.

One proposal would see cryptocurrency payments connected to the rial, meaning that certified gateways would accept cryptocurrency payments, but the actual clearance would be made in rials. Another proposal would see the payments cleared using Iran’s forthcoming official rial-backed cryptocurrency. Community members aim to arrive at a consensus soon, which they will present to the central bank.

“At the end of the day, it’s about coming up with creative ideas to make the best out of a restrictive framework. We don’t want to create any potential legal challenges for the central bank,” Babalhavaeji said.

Despite the payments dilemma, some have welcomed CBI’s draft framework as a step forward. The proposed regulations recognize cryptocurrency mining as a legitimate industry, authorize digital wallets and cryptocurrency exchanges, and allow issuance of tokens that are not backed by rials, foreign currencies, or gold and other precious metals. Furthermore, the new framework is slated to replace the blanket ban on cryptocurrencies that was issued in April 2018 in the early days of the currency crisis.

“In 2017 when cryptocurrency prices were soaring and new investors were pouring into markets, strange rumors circulated that purchasing and holding cryptocurrencies is illegal in Iran and at times the central bank would be referenced as the source,” explained Tina Kheiri, a young crypto and blockchain educator with Iran Blockchain Academy.

“At least people active in this field now have the reassurance that their activities don’t violate any laws, and this alone should encourage more newcomers to enter the industry,” she added.

But Kheiri also believes the proposed framework ought to be more flexible. She would like to see more straightforward initial coin offerings (ICOs) for businesses and greater use of cryptocurrencies for routine transactions—such as when selling tickets for her courses.

Kheiri also thinks she might have a solution for the threat posed by cryptocurrencies to Iran’s currency markets. “Boosting the mining industry could encourage major players to invest in Iran due to its cheap electricity, something that could actually attract foreign currencies and increase the value of the rial,” she explained.   

The community is not short of innovative ideas, but it remains to be seen whether it will achieve a policy breakthrough with the central bank.

Photo Credit: Bourse & Bazaar

Bankless Task: Can Europe Stay Connected to Iran?

This article is re-published with permission from the European Council on Foreign Relations. 

As part of the effort to salvage the Iran nuclear deal, European governments have vowed to sustain their economic ties—not least their banking connections—with Iran. From 4 November, American sanctions targeting Iran’s banks will make it extremely difficult for European companies to engage in transactions with firms in the country. Many of the pathways to reducing the secondary impact of US secondary sanctions on the European financial sector present significant technical and political challenges—which stem from the US financial system’s global dominance and the integration of the US and European banking sectors. Moreover, the Iranian financial sector must take several proactive steps to ensure it meets the international compliance standards European banks require.

The Banking Blockage

With the incoming US sanctions, European companies face an even greater struggle to engage in transactions with Iran. For instance, Swedish automaker Volvo is leaving Iran because, as one of its spokesman put it, “with all these sanctions and everything that the United States put [in place] ... the [banking] system doesn’t work in Iran … We can’t get paid.”

This problem has driven most of the multinationals once active in the Iranian market to suspend their operations there, ahead of the new round of US sanctions. There is a widespread expectation that several Iranian private banks and the Central Bank of Iran will be designated entities under the measures.

Some European companies, such as Airbus and Total, require a licence or waiver from the US authorities to continue their operations in Iran, as they work in sectors subject to targeted sanctions. Many areas of Iranian trade, such as that in basic goods, are either unsanctionable or will be exempt from the measures. Yet US sanctions have adversely affected even these areas, as outlined in a recent ruling of the International Court of Justice.

Such restrictions on trade arise from the contamination risk that US secondary sanctions pose to European financial institutions, which generates unique pressure on the Iranian banking sector. This risk combines with Iran’s current shortfalls in meeting its commitments under a Financial Action Task Force (FATF) action plan – although the recent passage of the Combating Financing of Terrorism Bill suggests that Tehran is raising its compliance standards. Until the FATF changes Iran’s designation as a high-risk jurisdiction, global financial institutions will limit their dealings with Iranian banks.

Since President Donald Trump withdrew the US from the Iran nuclear deal in May this year and announced the re-imposition of secondary sanctions on Iran, banks in Europe have come under growing direct and indirect pressure from American regulators. Following the repeal of international sanctions on Iran in 2016, many large European banks began quietly facilitating transactions involving Iran for their largest industrial clients, especially those with long-standing operations in the country. Among these institutions, Danske Bank was the most visibly open to business with Iran, even opening a €500 million line of credit to support Danish firms’ expansion in the country. But as it falls into disrepute over suspected money laundering at its Estonian subsidiary, Danske Bank has opted to cease transactions involving Iran as an immediate show of responsiveness to US regulators. More broadly, banks tend to jettison their business with Iran if regulators exert pressure on them, even in the absence of a direct compliance issue.

Meanwhile, small European banks are coming under pressure from their larger competitors. When these institutions, which have relatively limited exposure to the US financial system, engage in Iran-related transactions, their routine SEPA transfers – payments to other banks within the Single European Payments Area – are often refused outright. This isolates the banks and complicates other aspects of their business. And the refusals extend beyond Europe. Asian banks have shown increasing concern about dealing with small European financial institutions that engage in business with Iran, understanding that they too could fall foul of the US authorities.

Europeans banks have been reluctant to engage with Iran due to fears about the response from their shareholders and creditors. This is most clear in the case of the European Investment Bank (EIB), which has refused to invest in Iran. European governments (which number among the bank’s shareholders) encouraged the EIB to consider lending to Iran, but the bank’s leadership felt that investing in the country would jeopardise its ability to raise capital from American institutional investors in the bond market.

Europe’s Possible Solutions

Despite their efforts to sustain economic channels with Iran, European governments have been unable to ease this pressure on banks. With US sanctions on Iran’s banking sector due to come into effect soon, European countries are now considering measures that would facilitate trade transactions with Iran through a new legal and institutional structure.

On the sidelines of the recent United Nations General Assembly, EU High Representative Federica Mogherini announced that “EU Member States will set up a legal entity to facilitate legitimate financial transactions with Iran and this will allow European companies to continue trade with Iran, in accordance with European Union law, and could be opened to other partners in the world”.

European governments have been reviewing this legal entity, known as a Special Purpose Vehicle (SPV), for months. The timing of this public announcement suggests that they have a degree of confidence that the SPV can become operational, and that Europe can use the model to showcase its ability to deliver on its commitments.

US Secretary of State Mike Pompeo immediately responded that he was “disturbed and indeed deeply disappointed” at the news. US National Security Advisor John Bolton commented: “we will be watching the development of this structure that doesn’t exist yet and has no target date to be created. We do not intend to allow our sanctions to be evaded by Europe or anybody else.”

There remains scant detail on the SPV. In her statement, Mogherini added that more information will become available “as the technical work continues in the coming days”. It may be advisable for European actors involved in the creation of the SPV to keep the details private for now. Operationalising the SPV will require a period of trial and error. Making the details of the project public in its early stages would provide the structure’s opponents with further opportunities to undermine it.

Can the SPV Model Work?

Reportedly, an internal European Commission paper describes the European Union’s efforts to “bundle and reduce cross-border payments to and from Iran”. In this way, the SPV would “avoid or severely restrict the role of commercial banks in the payment system and protect payment transactions with Iran from US sanctions”. European policymakers’ apparent consideration of this approach indicates that they want to avoid placing critical European financial institutions, such as the EIB, in the crosshairs of the Trump administration.

To operationalise the SPV, policymakers will need to quickly make progress in several technical areas. Firstly, European governments need to determine how aggressively they will push back against US sanctions; this is a consideration of the first order for the structure and operation of the SPV. Theoretically, the SPV could facilitate payments for what the US authorities consider to be sanctionable activity. Indeed, European officials have openly discussed their intention to use the SPV to support purchases of Iranian oil.

As guidelines from the US Treasury’s Office of Foreign Assets Control make clear, even barter arrangements involving petroleum or petroleum products from Iran are sanctionable – on the basis that they provide “material support” to Iran’s oil industry “regardless of whether a financial institution is involved”. However, because the envisaged SPV would bypass the US financial system and foreign branches of US banks, the American authorities would have no direct jurisdiction over it. Thus, transactions the SPV facilitated would not give rise to the same kind of civil liability that led to hefty fines on Europe’s largest banks in the previous era of sanctions.

The US authorities could, in theory, prevent entities engaged in the SPV from accessing the US market. American officials have stressed that US sanctions will target European central banks and SWIFT – an international payments messaging system headquartered in Belgium – if these institutions facilitate transactions with Iran. Furthermore, this targeting would extend beyond entities engaged in oil purchases, covering all companies that use the SPV to engage in transactions with Iran – even those in sectors that are exempt from sanctions, such food and pharmaceuticals.

European governments working on the SPV will have to find a way to counter such measures. On a technical level, they may be able to use creative structuring solutions. The SPV could be set up primarily as a payment mechanism for only small and medium-sized companies that are content to be excluded from the US market. And the mandate of the SPV could initially facilitate just payments for trade that is exempt from US sanctions.

The SPV is most likely to succeed if takes this approach, starting off small and gradually expanding. The basic structure of the vehicle is replicable. One SPV could focus on sanctionable trade related to support for Iran’s oil, automotive, or aviation sectors. Another could be limited to sanctions-exempt trade in consumer goods, food, and pharmaceuticals – allowing multinationals to use it as a convenient payment channel. With multiple SPVs available, companies could engage with Iranian entities in accordance with their appetite for risk and their business models.

Each SPV could take a different form. It could be a stand-alone, state-owned bank; a conduit for payments that European central banks ultimately facilitate; or simply a clearing house for companies that transfer money to Iran, repatriate funds from the country, or engage in barter trade with it.

The process of establishing the SPV will prove instructive in testing the limits of America’s sanctions power and US willingness to use sanctions as a weapon against its putative allies. Reports indicate that the US Department of the Treasury is already starting to push back against the White House over proposals to sanction European financial institutions, particularly SWIFT, for maintaining ties with Iran.

Of course, creating the SPV will require significant technical work. For its part, Iran will need to demonstrate that its financial system is also continuing to reform in accordance with international standards on money-laundering and terrorism financing. European governments will closely watch the country’s progress in implementing the FATF action plan ahead of an important review on 14-19 October.

From a political perspective, Iran has drawn encouragement from European countries’ sustained and unanimous commitment to the nuclear agreement. Iranian President Hassan Rouhani praised Europe for taking a “big step” to maintain trade. Iran’s foreign minister, Javad Zarif, stated that while implementing the SPV will be difficult, Iran is willing to show “a little bit more patience” with Europe. The SPV is an important immediate contribution to improving conditions for trade between Europe and Iran, but both sides must view it as the start of a road map for long-term economic engagement.

Photo Credit: Depositphoto

Can Iran Weather the Oil-Sanctions Storm?

This article has been republished with permission from the European Council on Foreign Relations. 

In the coming weeks, the US administration will intensify its economic pressure on Iran through sanctions designed to curtail the country’s oil exports. Given that these exports account for a significant percentage of state revenue (despite government efforts at economic diversification), the measures will hit Iran hard. Yet the sanctions will also have an impact on energy markets far beyond Iran, and may lead to a rise in global oil prices. Moreover, they could have a negative effect on global energy security by tapping into most of the spare capacity in the market.

Since President Donald Trump withdrew the United States from the Iran nuclear deal (formally known as the Joint Comprehensive Plan of Action, or JCPOA) in May this year, US officials have stated that they aim to prevent Iran from exporting any oil whatsoever. Although the second phase of the new US sanctions only come into effect on 4 November, Iranian oil production and exports have already started to decline – partly because the US has issued conflicting statements on whether it will provide sanctions waivers to some importers, and partly because the August 2018 round of US sanctions set restrictions on payments, shipping, and insurance.

If the Trump administration truly seeks to ensure that Iran will export no oil, this is a strikingly different approach to that both the Obama administration and the European Union pursued between 2012 and 2015. These earlier measures caused Iran’s oil exports to drop by around 40 percent, to an average of 1.5 million barrels per day (mb/d). In contrast, the new sanctions are likely to reduce Iran’s oil exports to less than 1 mb/d by November. There are several reasons for this difference. One is that the Trump administration has taken a much tougher stance on importers of Iranian oil. Under the Obama administration, the US expected other countries to significantly reduce but not totally end their imports of Iranian oil. Although the Obama administration never stated a clear target for this reduction, it amounted to around 20 percent. Notably, the EU also banned imports of Iranian oil and EU member states halted almost all such imports.

Having borne the brunt of US secondary sanctions in 2012-2015, companies and countries around the world are now well aware of the consequences of non-compliance. They also have a good idea of how accurately the US tracks Iranian exports and how far its surveillance capabilities reach. The Obama administration had to engage in extensive negotiations with importers of Iranian oil to explain the consequences of non-compliance. This time around, the rules of the game are much clearer.

Another factor is that, unlike in 2012, there now is enough oil to make up the shortfall in the market. In recent weeks, traders and importers of Iran’s oil have said they can easily find substitutes for the product. Major oil producers such Saudi Arabia, the United Arab Emirates, and other OPEC members have collectively increased their supply of oil by around 1 mb/d since May, and have signed contracts with importers to provide substitutes for Iran’s oil in the future. However, this substitution of Iranian oil weakens the security of global energy markets: buyers are tapping into most of the world’s spare oil production capacity, heightening the risk of a rise in oil prices.

As oil prices are now much lower than they were between 2012 and 2015, the discount rates at which Iran hopes to export oil provide relatively little incentive for buyers to violate US sanctions. Meanwhile, by restricting financial transactions with Iran and the insurance of Iranian oil, the US sanctions that came in to force in August 2018 have created a tighter regime than that implemented under the Obama administration.

New Obstacles to Iran’s Exports

Ambiguities over how the US will enforce its sanctions make it difficult to estimate the size and duration of the coming decline in Iran’s oil exports. While the US sanctions in place during 2012-2015 accompanied similar EU measures and had a basis in UN sanctions targeting Iran’s nuclear programme, the US is now implementing unilateral sanctions while Russia, China, and Europe continue to support the sanctions relief specified in the JCPOA.

Yet US secondary sanctions have proved to be powerful. There are indications that importers of Iranian oil such as Japan, South Korea, Sri Lanka, and most European countries will no longer buy the product after November. Although China has consistently stated that it will continue to import oil from Iran, it is also attempting to use this position as leverage against President Trump in its ongoing trade war with the US. India, which buys more Iranian oil than any country other than China, significantly reduced its imports of the product in August, but is still negotiating with US administration over sanctions waivers.

Following the introduction of US sanctions on Iran-related financial transactions and oil tanker and cargo insurance, Iran’s crude oil exports dropped from an estimated 2.3 mb/d in July 2018 to less than 2 mb/d the following month. As such, the cause of the decline is not necessarily compliance with the US ban on Iran’s oil imports but rather the new challenges of paying for, and safely transporting, the product. Judging by purchase contracts at the National Iranian Oil Company and other sources, exports of Iranian oil may drop as low as 750,000-850,000 b/d by November.

In August, amid this sharp decline in Iranian oil exports, OPEC increased oil production to 32.89 mb/d, its highest level in ten months. It appears likely that OPEC will further increase production, despite Iran’s efforts to lobby against such a move. Potentially adding to Tehran’s woes, Russia – which is not a member of OPEC – increased its oil output by around 148,000 b/d to 11.215 mb/d in July, coming close to its post-Soviet record high of 11.247 mb/d. 

As no sanctions regime is immune to shifts in the market, time could work against the US policymakers targeting Iran. Along with the increased oil supply from OPEC countries and Russia, other market conditions could have a drastic effect on Iran’s oil exports. The US administration’s ambiguous statements on the scope and duration of its sanctions could lead to non-compliance and even cause the measures to fall apart earlier than planned. For instance, if countries such as India and China continue to import discounted Iranian oil while others stop doing so, the sanctions regime may gradually become ineffective. This is especially so given that, if oil prices rise in line with market expectations, Iran’s discounts on barrels of oil and freight costs will become increasingly appealing.

Nonetheless, the new round of US sanctions will undoubtedly damage Iran’s economy. At a time when it is grappling with several domestic economic challenges, the Iranian government will have to be careful in dealing with further cuts to its revenue. Of course, having survived a series of US and EU oil embargos in the last four decades, Iranian leaders may decide to weather this latest storm through strategic patience and reliance on an “economy of resistance”. Tehran may feel it can manage these sanctions while continuing to comply with the JCPOA, allowing the measures to gradually erode.

China, Russia, and many European countries seemingly aim to support this approach, creating financial incentives that maintain Iranian compliance with the JCPOA (even if most European countries and companies are likely to comply with US sanctions). These incentives will be designed to help Iran’s economy survive the sanctions, partly by mitigating the decline in Iranian oil exports.

It is unclear whether this approach will work. The Iranian economy currently appears vulnerable to the new sanctions: the Central Back of Iran has been forced to devalue the rial much faster in recent months than it did during 2012-2015. The aftershocks of the currency devaluation and rapid inflation may exacerbate the sporadic unrest across the country that began last January – mostly due to Iranians’ economic grievances.

If American sanctions truly block the majority of Iran’s oil exports, the country may opt for an aggressive response. Iranian leaders, including President Hassan Rouhani, have suggested that Iran will disrupt oil shipments from neighbouring countries, targeting the Strait of Hormuz and/or Bab el-Mandeb. Iran could also engage in cyber sabotage or attacks in the Middle East intended to create panic among oil traders, driving up global oil prices. Such operations would create widespread chaos and perhaps lead to the formation a global political and military alliance against Iran.

The prospect of further talks between Tehran and Washington is fading as Iran’s oil production and exports continue their decline. But the ongoing negotiations between Iranian leaders and supporters of the JCPOA may produce a compromise that encourages Iran to wait patiently, in the hope that the course of events will turn in its favor and it will overcome the sanctions.

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Can Europe Defend Itself And Iran From U.S. Sanctions?

This article was originally published in LobeLog. 

In an op-ed published in the German newspaper Handelsblatt, German Foreign Minister Heiko Maas declared that the “the US and Europe have been drifting apart for years.” Nowhere is this clearer than in the disagreement between the United States and Europe over the fate of the Iran nuclear deal. When President Trump withdrew from the Joint Comprehensive Plan of Action (JCPOA) and announced his intention to reimpose secondary sanctions that would impact European businesses, he made clear that he wouldn’t treat Europe in what Maas called a “balanced partnership.” In response, Maas believes that Europe must “bring more weight to bear” in global affairs.

In order to defend the JCPOA and protect European companies active in Iran from U.S. sanctions, Maas outlined three initiatives: “establishing payment channels independent of the US, a European monetary fund, and an independent SWIFT [payments] system.” These initiatives echo ideas expressed by French economy minister Bruno Le Maire in the aftermath of Trump’s withdrawal from the JCPOA. Le Maire has called for European governments to work together to protect Europe’s economic autonomy by creating “independent, sovereign European financial institutions which would allow financing channels between French, Italian, German, Spanish and any other countries on the planet.” Le Maire has declared that “the United States should not be the planet’s economic policeman.”

It will be difficult to realize the political designs of Maas and Le Maire within the economic structures that link Europe and global markets, including Iran. As Maas concedes, “the devil is in thousands of details.” It should be no surprise, therefore, that speaking to President Hassan Rouhani’s cabinet last week, Supreme Leader Ali Khamenei declared that Iran “must not pin hope on the Europeans for issues such as the JCPOA or the economy,” noting that promises must be examined with “skepticism.”

Iran should not take for granted the hopeful vision of more resolute European leadership, especially if that leadership promises to deliver fairer political and economic outcomes for Iran. But in light of the present economic crisis, the Iranian government and Iranian people can no longer afford to take a long-term view when it comes to fundamental questions like access to the international financial system, whether or not that system continues to be dominated by the United States. As such, it is important to try and discern the specific and short-term implications of the new political vision espoused by leaders like Maas and Le Maire.

First, there has been the greatest progress in designing possible payment channels that would help sustain transactions in the face of U.S. secondary sanctions. As an initial step, the central banks of France, Germany, the United Kingdom, Austria, and Sweden have indicated their openness to establishing payment channels with the Central Bank of Iran that would be immune to sanctions since the U.S. government is unlikely to take the extreme step of sanctioning European central banks for transacting with Iranian entities. Importantly, these central banks, which would be facilitating transactions on an ad hocbasis, would not need to rely on payment systems such as SWIFT.

However, the central banks have established a pre-condition: Iran must fully implement the Financial Action Task Force (FATF) action plan. But even if Iran does successful implement the FATF reforms, and even if European central banks fulfill their promise, the creation of limited payment channels does not amount to an independent financial system. In such a scenario, the impact of U.S. sanctions on European and Iranian banks will continue to prevent trade and investment in meaningful volumes.

Second, the creation of an independent payment messaging system is essential to enabling those smaller European banks that lack a “U.S nexus” to transact with Iranian banks, thereby enabling trade and investment at higher volumes. To this end, Maas has called for the creation of “an independent SWIFT [payments] system.” Notably, Maas’ statement makes it clear that European leaders do not expect to successfully defend the independence of SWIFT in its current form. SWIFT, headquartered near Brussels, is a cooperative owned by its member financial institutions, including major American banks such as Citibank and JP Morgan. Even so, SWIFT represents a rare global financial institution in which the United States is not dominant, but dependent. Some analysts, among them former officials from the U.S. Department of Treasury, have observed that it would be harmful to U.S. economic interests to sanction SWIFT. In fact, when SWIFT disconnected Iranian banks from its system in 2012, this was only because the organization voluntarily agreed to do so in accordance with European sanctions policy at the time, not because of the realistic threat that the U.S. would sanction the entity.

It is not entirely clear whether Maas wants Europe to insist on SWIFT’s independence or to devise new messaging systems altogether. A new system would be technically easy to establish but would prove difficult to monitor for possible money laundering or terrorist financing, an important political consideration. Although the former approach would certainly deliver Iran a more immediate solution on banking challenges stemming from U.S. sanctions, given that Iranian banks were reconnected to the SWIFT following implementation of the nuclear deal, Europe will more likely take the latter, more time-intensive approach. German Chancellor Angela Merkel responded to Maas’ op-ed (which she called an “important contribution”) by noting that “on the question of independent payment systems, we have some problems in our dealings with Iran…on the other hand we know that on questions of terrorist financing, for example, SWIFT is very important.” Merkel’s comments suggest that political capital will most likely be spent creating a minimal, ad hoc messaging system in support of transactions with Iran rather than defending the independence of SWIFT in the face of a U.S. sanctions threat.

Finally, if payment channel and payment messaging solutions can be devised, Europe will need to ensure financing flows through these channels to Iran, in order to spur economic growth and support infrastructure and energy projects led by European companies. Here, Maas has pointed to the creation of a European Monetary Fund. Plans for the creation of such a fund have been circulating in European capitals for over a year and are based on upgrading the European Stability Mechanism (ESM), the entity that managed the bailouts of Eurozone states made necessary by the global financial crisis. Currently, ESM borrows on capital markets by issuing bonds. Such a reliance on capital markets has proven the critical barrier to the European Commission’s effort to get the European Investment Bank (EIB), which finances capital projects around the world, to invest in Iran. Like ESM, EIB raises capital by selling bonds, often to American institutional investors. Understandably, the CEO of EIB has publicly rejected calls to invest in Iran, stating that to do so “would risk the business model of the bank.”

The creation of a European Monetary Fund would be supported by financing drawn directly from European central banks and not capital markets, limiting exposure to U.S. investors, and therefore to the risk of U.S. sanctions. Such an institution would also reduce European reliance on the International Monetary Fund and World Bank, which remain politically dominated by the United States. Whereas countries such as Turkey and Egypt have readily used IMF financing to fuel growth and weather economic crisis, longstanding tensions between the United States and the Islamic Republic mean that Iran has been unable to secure IMF loans.

European governments are aware of the need to support Iran’s economic development through capital allocation. The European Commission’s recent move to allocate to Iran 18 million euros of a planned 50 million euros of development aid in order to “widen economic and sectoral relations” demonstrates the desire to fund growth. The European Commission simply lacks the right financial institutions to provide such capital to Iran at a meaningful scale.

Overall, Maas’ message contains real, practical ideas about how to not only sustain trade and investment in Iran in the face of secondary sanctions but also strengthen Europe’s economic sovereignty in lasting ways. However, Iran must recognize that there is no readymade “economic package” that Europe can deliver to save the JCPOA. There is only an “economic process” where improvements in the facilitation of trade and investment will occur over time and in sequence.

In the coming months, it will be feasible to institute a payment channel between central banks. In the coming year, it will be feasible to establish a new payment messaging system. Finally, over the course of several years, Iran could benefit from the creation of a European Monetary Fund, financing from which could truly transform prospects for Iran’s economy. For its part, Iran must remain willing to undertake its own economic process, beginning with critical FATF reforms. In this way, if Europe and Iran each grow stronger, through a renewed insistence on independence and autonomy, the prospects for political and economic cooperation will actually improve. The United States cannot be the fulcrum on which all partnerships must balance.

Photo Credit: German Federal Foreign Office

Iran's Currency Crisis is a Supply-Side Story

On Monday, the Iranian rial sank to a historic low. But those Iranians who scrambled to convert their rials into dollars found it difficult to do so—as they have for months. Since April, reports on the accelerating crisis have consistently noted a lack of hard currency available at Iran’s exchange bureaus.

This important detail of the current crisis has gone largely unexamined in foreign reportage. While the determinants for demand for foreign exchange—widespread anxiety about the state of the economy and the return of sanctions—are well understood, the second determinant of market prices—foreign exchange supply—remains subject to mere passing mention. This is a mistake. Iran’s currency crisis is a supply-side story.

In the absence of data, it is hard to show quantitatively that the currency crisis is primarily a supply-side phenomenon, but there are numerous factors that make this likely. Iran has been prevented from repatriating its foreign exchange reserves held in Europe. Its regional neighbors have vowed to cease using the US dollar to conduct bilateral trade. Illicit networks that have long funneled US currency to the black market have been interrupted. Most tellingly, the Trump administration is being urged by its close advisors to “quickly exacerbate the regime’s currency crisis” by interfering with Iran’s foreign exchange supply.

While the government has no doubt failed to inspire confidence in its economic leadership, contributing to the ouster of both the central bank governor and economy minister, it is unlikely that expectations of rising inflation and economic recession alone would create so dramatic a rush to the safe-haven of the dollar.

In an interview with Euronews, economist Saeed Laylaz, offers more detail on how the historic exchange rate principally reflects a shortage phenomenon. “You might imagine that the dollar price of 12,000 or 13,000 toman accounts for 100 percent of the currency market, when in actuality we have various companies completing imports with a dollar at a price less than 8,000 toman in the secondary market,” Laylaz explains. In his assessment, while the 8,000 toman rate accounts for 80 percent of transactions on the secondary market, “the dollar bill is 12,000 toman.” Greenbacks are physically scarce and this accounts for the historic prices making headlines worldwide. 

For companies with access to dollars at 8,000 toman and especially for those enterprises with access to dollars at the government rate of 4,200 toman, the price of the physical dollar bill offers an immense opportunity for arbitrage. The temptation for companies to divert a portion of their foreign exchange into the most lucrative and speculative parts of the free market has proven hard to ignore. One example can be seen in the petrochemical sector, where major companies, including state-owned enterprises, have been slow to make their foreign exchange available for sale on the secondary market through NIMA, the country’s centralized marketplace, despite instructions from the central bank and oil ministry.

Economist Hossein Raghfar described these companies as “accountable to no one” when it became apparent that they may have sought to sell their currency at the free market rate, rather than at the lower official exchange rate, despite the government instruction. Nonetheless, in the assessment of Masoud Nili, the government's chief economic advisor, this kind of arbitrage activity is a symptom of the rising premium and not its root cause. Nili comes close to acknowledging that the government's focus on profiteering in the early months of the crisis was an attempt to deflect from more consequential interruptions in foreign exchange supply. 

It is likely that the primary cause of the currency crisis is a severe shortage in foreign exchange. This places the Rouhani administration in an especially difficult bind. It might seem straightforward that increasing the foreign exchange supply would help stabilize the rial and prevent the speculation enabled by the extreme scarcity of the dollar and euro. Mohammad Reza Farzanegan looks at some of these issues in his study of illegal trade in Iran from 1970 to 2002. He confirms that easing the ability of actors to “acquire more subsidized exchange” will lead to some part of the currency to be “sold in the black market of foreign exchange.” The actions of the petrochemical companies offer a perfect case study. 

This is especially important at a time when the incentives for illegal import activity are increasing. Farzanegan writes that “whenever state intervention drives a wedge between international and domestic prices… there is an incentive for underground activities.” In subsequent research he has shown convincingly that the “wedge between international and domestic prices” can be applied externally—sanctions spur “underground activities.” In this way, making foreign exchange more readily available may stabilize the exchange rate, but it can serve to accelerate rent-seeking and smuggling, the agents of which have historically used their trading networks to take their profits offshore.

The specter of capital flight looms large over the administration. In a recent address, newly appointed central bank governor Ehsan Hemmati announced that the country would not use oil revenues in order to prop-up the currency. In a likely related move, Iran has decided not to seek to transfer EUR 300 million in cash from its funds in Germany to Iran to increase foreign exchange supply. A report in Shargh, a leading newspaper, suggests that the government had decided not to intervene to support the rial in order to prevent capital flight by allowing the dollar to become a scarce and expensive "luxury item." 

A recent report by Iran’s Parliamentary Research Center estimated that capital flight in the year leading up to March 20 amounted to USD 13 billion dollars. By comparison, during the Ahmadinejad administration, that figure was possibly ten times higher, with reports suggesting that between USD 100-200 billion was taken out of the economy as sanctions tightened. Between 2005-2012 Iran generated USD 639 billion in oil revenues, with falling exports offset to a degree by historic oil prices. Yet Ahmadinejad left office with Iran’s foreign exchange reserves at only around USD 50 billion higher than when he entered.

To prevent capital flight on that order, the Rouhani administration can prioritize rate convergence and stabilization over interventions that would significantly lower the price of the dollar. The Central Bank of Iran has sought to "bridge" the two sides of the market that Laylaz describes, announcing that "authorized exchanges can sell foreign currency bought from exporters and other sources registered through the SANA system, in the form of banknotes in the open market." The banknotes would be purchasable upon request from the central bank. In this way, any increase in the supply of banknotes at the upper end of the market will be associated with reduced supply at the lower end, helping push the rate to convergence, even if the rate remains historically high. A high exchange rate may be a necessary evil in order to protect fragile economic growth.

In a study of the Iran’s economy from 1981-2012, Hoda Zobeiri, Narges Roshan and Milad Shahrazi of the University of Mazandaran identify a strong negative relationship between capital flight and economic growth in Iran. By trapping capital at home, even devaluing rials, the Rouhani administration might hope that wealth is committed domestically towards investments and capital formation that can sustain growth. Some evidence that this may be taking place can be seen in the fact that the Tehran Stock Exchange is on a historic bull run.

Laylaz and others have criticized the administration for “adding fuel to the fire of the market” by failing to curb the demand for foreign currency. But by focusing on demand, critics will miss important supply-side phenomena, such as how the currency shortage may slow the capital flight that has historically preceded the reimposition of sanctions. Whether or not this is an intentional outcome of the Rouhani administration’s policy, that the inability or unwillingness to increase foreign exchange supply may be consistent with attempts to limit illicit trade and capital flight is a surprising outcome and one that deserves to be formalized as part of wider efforts to manage and minimize rent-seeking in Iran.

Photo Credit: Depositphotos

FATF Faces Test of Fairness on Iran at Plenary Meeting

Next week, Iran is facing the end of a four month extension given by the Financial Action Task Force (FATF), a global standard-setting body, for the reform of the country’s AML/CFT regulations. Beginning in June 2016, Iran gave its political commitment to the action plan, accepting technical assistance in order to effectively implement the action plan. This political commitment saw Iran removed from the so called “black list,” the informal name given to the list of Non-Cooperative Countries and Territories (NCCT). The common practice in recent years has been to apply "countermeasures" against non-cooperative countries. With countermeasures suspended, Iran was moved to a list of “high-risk” countries subject to “enhanced due diligence.”

As per the FATF procedure, Iran can only be returned to the countermeasure list if it proves to be non-cooperative. It should be noted that no country has been added to countermeasure list merely because of less-than-perfect compliance; if that was the case, in this world which is full of corruption and terrorism, the list of countries against which countermeasures should apply would be far more extensive. No country has managed to achieve perfect compliance with all forty recommendations that form the basis of FATF’s guidelines.

Iran will be hoping for a further extension of suspension of countermeasures at next week's plenary of the FATF, as it is in the process of amending its national laws. Some FATF members have sought to characterize such extensions as exceptional. However, a quick glance at the list of countries currently in the gray list or those which managed to get delisted, points to the fact that extensions are a common procedure.

Countries such as Iraq, Syria, Vanuatu, and Yemen have remained on the gray list for many years.  Countries such as Bosnia and Herzegovina, Uganda, Afghanistan, and Myanmar were all eventually delisted in recognition of progress in enacting the recommended reforms, but were given between two and six years in order to proceed with their action plans. Iran has been under much more significant pressure, opening FATF to charges of unfair treatment.

For the purposes of a closer comparison, we can look to the case of one country delisted from the so-called gray list in 2017. Based on FATF’s latest evaluation, this country is non-compliant with numerous recommendations outlined in Iran’s action plan. First, the country is non-compliant in terms of “criminalizing terrorist financing.” Second, the country is non-compliant in terms of “Targeted financial sanctions related to terrorism and terrorist financing (identifying and freezing terrorist assets in line with the relevant United Nations Security Council resolutions).” Third, the country is only partially compliant with measures for “customer due diligence.” Fourth, the country is only partially compliant with establishing an effective “Financial Intelligence Unit.” Fifth, the country is non-compliant with wire transfer controls. Finally, the country is only partially compliant with recommendations on criminalizing anti-money laundering.

It is clear that this particular country has deficiencies equal-to or greater-than those of Iran as measured by Iran’s action plan. Yet the country was never included in the FATF blacklist and even managed to be delisted from the gray list as well. This raises the question—is FATF applying double standards against Iran?

FATF emphasizes that it is a technical and not a political body and that all countries are treated equally. Impartiality is important for a global standard-setting body, which seeks to ensure that countries cannot seek to politically undermine one another. 

Iran has attended FATF’s face-to-face meetings and answered extensive questions. Moreover, the FATF recommendations call for the enacting of six laws: criminalizing money laundering (i.e. the AML law), criminalizing financing of terrorism (i.e. the CFT law) and four other laws regarding joining four UN conventions. Of these four laws, two had already been approved by the parliament—Iran has joined the UN Anti-Corruption and Vienna conventions. The remaining laws are being deliberated. These legislative measures are among the most difficult recommendations to enact, as they require the coordination of government agencies, parliamentarians, and other supervisory bodies and therefore it seems that the action plan of Iran has been a difficult one with a rather short deadline provided.

Passing a single law may require 18 months of work, as it needs to be reviewed by the committees of the government and the cabinet, parliamentary commissions and then the parliament itself, and finally the powerful Guardian Council. Iran has achieved a degree of compliance with some aspects of the action plan, a fact acknowledged by FATF itself. Therefore, it would be illogical for the country to be considered non-cooperative.

The authority of FATF derives from the number of countries that have trusted it as a technical body. Therefore, this is not only a sensitive juncture for Iran, but also for the legitimacy of FATF, which must strive to preserve its reputation as an impartial technical body that treats all countries equally.

Photo Credit: FATF Twitter

Governor of Sweden’s Central Bank Visits Iran for Technical Dialogue

The governor of the Riksbank, Sweden’s central bank, will visit Iran on April 5-6 at the invitation of Iran’s central bank governor Valiollah Seif.

Stefan Ingves, the governor of the Riksbank will be leading a day of technical exchanges including a working dinner hosted by Sweden’s ambassador in Tehran, Helena Sångeland. The visit, which comes as political uncertainty around the nuclear deal reaches a fever pitch, underscores the long-standing commercial and economic relationship between Sweden and Iran. In February of 2017, Swedish Prime Minister Stefan Löfven visited Iran with an itinerary that included a visit to the Scania truck factory in Qazvin. 

For the Central Bank of Iran, the visit by one of Europe’s most seasoned central bankers is a valuable opportunity to draw on the Riksbank’s experience in central banking, financial stability, and monetary policy. Ingves has held the position of Riksbank governor since 2006 and navigated the country through the 2009 global financial crisis. He is also the chairman of the Basel Committee on Banking Supervision, which sets global standards for prudential regulation of banks. Iranian banks have been undertaking extensive reforms in order to better conform to so-called “Basel” standards.

A spokesperson for the Riksbank confirmed to Bourse & Bazaar that Ingves will give a presentation entitled “Central Banking and Financial Crisis: Lessons Learned.” The topic is of particular relevance as Iran seeks to manage systemic risk in its banking sector stemming from non-performing loans, a key driver of the 2009 crisis. Sweden was one of the fastest recovering countries in the aftermath of the last major global recession, earning praise as a “rockstar of the recovery” for its combination of intelligent fiscal and monetary measures. 

No doubt, Iran’s central bankers will listen to Ignves’ presentation attentively.

Photo Credit: Riksbank