Iran is Losing Sight of its 'Developmental Vision'

This article was originally published by the Atlantic Council.

On December 11, Iran’s information minister announced via social media that he had a “surprise” to reveal. Mohammad-Javad Azari Jahromi, the Islamic Republic’s youngest-ever cabinet minister, had been the subject of intense criticism from the Iranian public following a week-long internet blackout. Authorities had taken the unprecedented step to cut internet access in response to the nationwide protests that erupted on November 15 following a subsidy reform that doubled fuel prices. Angered by the crackdown, many Iranians “surprised” Jahromi by blocking him on Twitter. 

Undeterred, Jahromi made his grand reveal on December 12: a slickly produced video that showed Iran’s postal service delivering a package to the information ministry by drone. While such drones may be helpful for rural communities and disaster response, Iranians were understandably bewildered by the PR stunt. 

Jahromi’s postal drone offers a metaphor for perhaps the central political challenge facing the Islamic Republic. In the wake of a brutal response to protests that has left over 300 dead, commentators have pointed to a crisisof legitimacy now facing Iran’s leaders and their ideological tenets. But in reality, it is the compounding failure of technocrats like Jahromi to manage a decade of economic volatility that best explains Iran’s new political turmoil. 

As a recent study of the fuel protests shows, “economic grievances were likelier to inspire protest in areas where frustration with the whole system was endemic… Economic hardship turned frustrations with the system into assertive protest activities.” The protests appear to have comprised largely of individuals newly confronting economic hardship, which suggests the emergence of a precariat class in Iran. Just last year, 1.6 million Iranians fell into poverty due to high inflation. The study details how the counties in Iran which saw protests were often those more dependent on state support, meaning that the withdrawal of that support—such as the reduction of the fuel subsidy—was felt most acutely. As the study observes, “the Islamic Republic, through its long-term developmental and welfare programs, has empowered a citizenry that now resists neoliberal policies, such as cuts to energy subsidies.” 

These long-term developmental and welfare programs are the underappreciated pillars of the Islamic Republic. As sociologist Kevan Harris has described, state-society relations in Iran have been shaped by a “developmental vision” established when the young Islamic Republic began to emerge from the brutal Iran-Iraq War. As revolutionary fervor and wartime zeal ebbed, a core group of technocrats, many of whom had served in the Shah’s civil service and who had been educated abroad, began to set the country’s development agenda. After a few years of structural readjustment, the country’s economy started to grow, and the technocrats became firmly ensconced in the powerstructures of the Islamic Republic. 

Iran’s GDP per capita peaked in 2012, buoyed by record-high oil prices. But the same year, the international community imposed strict sanctions on Iran over its nuclear program, triggering a 7.4 percent contraction and ending 23 years of consecutive increases in GDP per capita, which had risen from just over $2,200 in 1989 to just under $8,000 by 2012. The developmental vision of the Islamic Republic had significantly improved the welfare of the average Iranian. For millions of Iranian households, development meant the arrival of electricity, gas, refrigeration, personal mobility—and in the last decade, access to the internet. But success in economic development is inherently relative. Iran fared much better than Iraq in the two decades following their eight-year war. Iraq’s GDP per capita had been higher than Iran’s in 1989, at $3,800, but rose to just $6,800 by 2012, having lagged behind Iran even before the 2003 US invasion. In the same period, however, Poland, which emerged from its stagnation behind the Iron Curtain in 1989, saw its GDP per capita rise from just below $1,800 to $13,000, becoming a widely touted example of successful development. 

That Iran finds itself between Iraq and Poland on the measure of GDP per capita speaks to the predicament facing the country’s technocrats. The political establishment in Iran is, in some respects, the victim of its success. Economic development became, even in an ostensibly “revolutionary” state, the foremost expectation of governance among the Iranian people. The Islamic Republic has only recently ceased delivering consistent distributive economic growth, leaving chronic and underlying issues of inflation, unemployment, and corruption unassuaged by economic expansion. Sanctions—which have deprived the country of investment, stifled trade, and weakened the currency—have contributed to nearly a decade of stagnation. 

In a prescient 2011 study on the impact of economic crises on Iran’s youth, economist Djavad Salehi-Esfahani concludes with a question. He wonders how a lack of economic opportunity “shapes the attitudes of Iran’s youth about the country’s future and their ability to lead and build the nation.” Are Iranian youth “slowly losing not only their skills but also their hope and optimism?” 

While Jahromi was busy toying with postal drones, a new budget was being prepared for the forthcoming Iranian year (March 2020). As analyst Henry Rome explains in his study of the new budget, the Iranian government will seek to mitigate the harms of high inflation, which the IMF projects at around 30 percent next year, by instituting new cash transfers and increasing the wages of public sector employees. Overall, the new budget represents an 8 percent increase in spending in rial terms. But with the contribution of oil revenues down from 29 percent in last year’s budget to a likely-too-optimistic 9 percent, the government will be seeking to increase tax revenue in to fulfill its fiscal burdens, ostensibly increasing the importance of functional state-society relations. 

Iran’s technocrats will continue to seek policy solutions to address widespread economic frustrations and alleviate poverty. But as Salehi-Isfahani observes in his study from eight years ago, there is only so much that the technocratic solutions can achieve. In the face of myriad economic pressures, including “maximum pressure” sanctions, Iran’s resilience is a remarkable achievement, but it is nonetheless approaching a kind of political limit. Referring to the government’s response to the economic malaise of the Mahmoud Ahmadinejad years, Salehi-Isfahani notes, “there are new policy initiatives ranging from the reform of the nation’s decades-old subsidies, to amending the family laws, to reviving population growth, not to mention the nuclear standoff with the West, but none that help salvage Iran’s demographic gift.” That an article written years ago describes the current dilemmas so accurately speaks to Iran’s stagnation. 

In the aftermath of the protests, Iran’s political elites have begun to realize the stakes. In a speech one week after the fuel protests, Mohsen Rezaei, the hardline secretary of the country’s influential Expediency Council, acknowledged that Iran was failing to deliver economic development. Pointing to the importance of economic development in state-society relations, Rezaei stated, “Since the beginning of the revolution until today each government of the Iranian people has tried to make an impact on the economy, and particularly in the last two decades the focus various stakeholders has been the economy, but we have yet to find a pathway that gives us optimism for the future.” While the Islamic Republic had proven able to “address the issue of elections, defense, security, and freedom,” it had failed to reach the optimal model for “economic development and economic justice.”

Today, an Iranian precariat class is seeking economic justice. Iranian economic planners and policymakers, like their fellow technocrats around the world, are struggling to find the pathway to continued growth in the face of factional infighting and foreign interference. Signing-off in his announcement of the postal drone, Jahromi declared, “We must make Iran the best and most advanced country in the world!” 

If only it were so easy. 

Photo: IRNA

Europe Can Use Local Currency Bonds to Sustain Economic Ties with Iran

For over a year, European governments have been struggling to determine how they can create a financing facility for projects in Iran. Access to external finance was a major expectation of the sanctions relief promised in return for Iran’s implementation of the JCPOA nuclear deal. With the full return of US sanctions just weeks away, the prospect that Europe will be able to contribute to Iranian economic development through project finance is growing slim.

The European Investment Bank has rejected calls to invest in Iran citing its reliance on global institutional investors, many of them American, to raise capital. A mooted European Monetary Fund, which would source its investment capital from European central banks, is still just a policy idea. Member-state financing vehicles, such as Italy’s Invitalia and France’s Bpifrance have proven unable to engage Iran, despite encouragement from government leaders.

But what if it is a mistake to focus on “external” finance? What if rather than try to source capital from outside of Iran to finance projects within the country, Europe sought to make use of the wealth already within Iran?

One underreported effect of Iran’s currency crisis has been the rapid expansion of liquidity in the market. Iranians are scrambling to convert their devaluing rials into safe-haven assets such as dollar and euro banknotes, gold, property, and even cars. But this scramble, which has seen Iranians draw down their vulnerable rial savings, has led to a rapid expansion in liquidity, which is itself creating inflationary pressure. The Central Bank of Iran is even considering raising interest rates in an effort to reabsorb some of over USD 350 billion floating around the economy.  

Perhaps surprisingly, as the currency crisis has unfolded, the Tehran Stock Exchange has hit historic highs. Iranians investors—particularly those whose wealth exceeds that which can be reasonably protected through the purchase of property and gold coins—are increasingly seeing securities and other forms of equity investment as a way to hedge against devaluation. The only problem is that this kind of reinvigorated investment is unlikely to help Iran avoid a recession, particularly in the non-oil sector. Investments on the Tehran Stock Exchange does not lead to the efficient and smart fixed capital formation the country needs to achieve real growth.

The demonstrable hunger for investment opportunities resulting from inflation fears and rising liquidity presents a valuable opportunity. In other emerging markets, such investor demand has been successfully use to source the capital necessary for impactful development projects. The best example can be seen in the financing methods of the European Bank for Reconstruction and Development.

EBRD was established in 1991 to support the liberalization of the Eastern Bloc economies after the fall of the USSR. Just a few years after its launch, EBRD began to tap local investors as a source for its project financing by borrowing and lending in local currencies. EBRD issued its first local currency loan in 1994, denominated in the Hungarian forint. Since then, the bank has issued 722 loans across 26 currencies valued at EUR 12.4 billion.

Local currency financing has been made possible through the issuance of local currency bonds. These bond offerings are issued under local laws and regulations, but are backed by the creditworthiness of ERBD and the steady strength of the Euro. Such “local currency Eurobonds” can be particularly useful to offer domestic investors a hedge against inflation.

In November 2016, EBRD issued a “pioneering” EUR 92 million “inflation-linked Eurobond” in the local currency of Kazakhstan. The bonds have a five-year maturity and “pay a coupon of 3-month Consumer Price Index (CPI) rate plus 10 basis points per annum.” EBRD is also seeking to have the security listed on the Kazakhstan Stock Exchange to make the bond even more accessible to local investors.

When the note was launched, Philip Brown, managing director at Citi Global Markets Limited, which managed the issuance, commented on the “demand for inflation protection from the increasingly sophisticated investor base in Kazakhstan. This trade highlights the useful role the EBRD can play in helping local investors meet their needs and in doing so, develop new markets.” While the likes of Citibank would not be managing such a bond issuance in Iran for obvious reasons, it is easy to see how Iran’s own sophisticated investor class would see a rial Eurobond as an attractive asset to guard against rising inflation.

A local currency bond offering would help Europe and Iran achieve several goals. First, European governments would finally be able to source and deploy the the billions of euros in financing that had been promised to Iran in various credit lines, only to be stymied by the hesitance of European banks to facilitate the underlying transactions in the project finance. Second, it would empower European governments to more directly influence regulatory reform in Iran’s banking and finance sector—a role EBRD has actively and successfully played in the markets in which it has investment since its inception. Third, the new bond would help the Central Bank of Iran reign-in excess liquidity in the market in a manner that is likely to create the greatest long-term value for the economy at large. Fourth, the establishment of a European-Iranian development bank would be a powerful political signal at a time when support for the JCPOA is wavering.

Like European Investment Bank, EBRD is too exposed to the United States in order to pursue projects in Iran itself—the US is a 10 percent shareholder of the bank. In order to pursue local currency financing, European governments would need to establish a new state-owned development bank in order to issue the rial-denominated Eurobonds.

Unlike EBRD and for reasons related to sanctions risks, this should be done through the creation of an Iran-registered financial institution owned by European governments, which would enlist the support of local investment banks and brokerages to bring the bond to market. This European-owned and Iranian-registered development bank would raise capital locally and invest locally, reducing the needs to engage in international transactions that are complicated by the returning sanctions. Conceptually, such an institution would be a kind of inverse of the Hamburg-based EIH Bank, but with a development finance rather than trade finance focus.

The creditworthiness of the new bank would be assured based on a sovereign guarantee for the bank and its liabilities from the European shareholders. The fact that the ownership of the bank will not overlap with its country of operation also limits risk. For similar reasons, no multilateral development bank worldwide has had to resort to its callable capital to date.

The envisaged bank would face several challenges including a lack of robust monetary policy in Iran, a relative lack of transparency within capital markets, and high domestic interest rates which could undercut the attractiveness of the bond offering. It would also need to conduct know-your-customer due diligence above and beyond that conducted by Iran’s own brokerages. But the myriad challenges in Iran are probably no greater than those faced in countries such as Kazakhstan, Georgia, and Ukraine where European financial actors have been able to successfully structure the credit facilities.

Encouragingly, the bond market in Iran has matured considerably over the last few years, and local companies and government agencies have developed capabilities in structuring debt instruments with the help of local investment banks and in compliance with the rules of Islamic finance. In the seven years since Islamic sukuk bonds were first introduced to the market, around USD 4 billion in debt has been issued.

Today, Iran’s leading companies regularly raise financing on the order of USD 100 million through individual bond offerings. A local currency Eurobond, which would be used to finance the transformative projects that had been envisioned for post-sanctions Iran, would easily raise amounts on this order. To bring this idea to fruition, European governments would simply need to combine a proven capacity for financial innovation and the commitments of their central banks, two contributions that cannot be sanctioned by the United States.

Photo Credit: Depositphotos