Iran Trade Mechanism INSTEX is Shutting Down

At the end of January, the board of the Instrument in Support of Trade Exchanges (INSTEX) took the decision to liquidate the company. Established in January 2019 by the United Kingdom, France, and Germany, INSTEX’s shareholders later came to include the governments of Belgium, Denmark, the Netherlands, Finland, Spain, Sweden, and Norway.

The state-owned company had a unique mission. It was created in response to the Trump administration’s withdrawal from the Iran nuclear deal in May 2018. European officials understood that the reimposition of US sanctions would impede European trade with Iran. The nuclear deal was a straightforward bargain. Iran had agreed to limits on its civilian nuclear programme in exchange for the economic benefits of sanctions relief. If European firms were unwilling or unable to trade with Iran, that basic quid-pro-quo would be undermined. For this reason, supporting trade with Iran was seen as a national security priority.

In August 2018, EU high representative Federica Mogherini and foreign ministers Jean-Yves Le Drian of France, Heiko Maas of Germany, and Jeremy Hunt of the United Kingdom, issued a joint statement in which they committed to preserve “effective financial channels with Iran, and the continuation of Iran’s export of oil and gas” in the face of the returning US sanctions. They pointed to a “European initiative to establish a special purpose vehicle” that would “enable continued sanctions lifting to reach Iran and allow for European exporters and importers to pursue legitimate trade.”

In November 2018, when the basic parameters of a special purpose vehicle were still being formulated by European officials, I co-authored the first public white paper explaining why establishing such a company made sense. Conversations with European and Iranian bankers and executives had made clear to me that trade intermediation methods were being widely used to get around the lack of adequate financial channels between Europe and Iran. If these methods could be packaged as a service by an entity backed by European governments, it would reassure European companies about remaining engaged in the Iranian market, while also reducing costs.

A few months later, INSTEX was founded. In the beginning, the company was run by the Iran desks at the EU and E3 foreign ministries. The officials tasked with working on INSTEX, who were often very junior, quickly realised they had little knowledge of the mechanics of EU-Iran trade. When they sought to enlist help from colleagues at finance ministries and central banks, they frequently met resistance. Many European technocrats were reluctant to support a project which had the overt aim of blunting US sanctions power, even at a time when figures such as French finance minister Bruno Le Maire and Dutch prime minister Mark Rutte were making bold statements about the need for European economic sovereignty. Even INSTEX’s inaugural managing director, Per Fischer, departed given concerns over his association with a company that had been maligned by American officials as a sanctions busting scheme. Then, in May 2019, when the Trump administration cancelled a set of sanctions waivers, European purchases of Iranian oil ended. That left INSTEX as Europe’s only gambit to preserve at least some of the economic benefits of the nuclear deal for Iran. 

Later that year, INSTEX hired its first real team after a new group of European governments joined as shareholders and injected new capital into the company. For a time, things looked more promising. Under the newly appointed president, former German diplomat Michael Bock, a small group of talented individuals worked to define INSTEX’s mission and build a commercial case for the company’s operation. Their efforts led to INSTEX’s first transaction, which was completed in March 2020—the sale of around EUR 500,000 worth of blood treatment medication. The political pressure to provide Iran some gesture of tangible support during the pandemic had also greased the wheels in European governments.

But many considered the INSTEX project doomed even before the first transaction was completed. Certainly, Iranian officials were derisive of the special purpose vehicle. Given that Europe had failed to sustain its imports of Iranian oil and was unable to use INSTEX for that purpose, focusing instead on humanitarian trade, Iranian officials dismissed the effort, even after the feasibility of the special purpose vehicle was proven. That it took more than a year to process the first transaction also meant that the Europeans missed their chance to fill the vacuum caused by the US withdrawal from the nuclear agreement. Without full cooperation from its Iranian counterpart, which was called the Special Trade and Finance Instrument (STFI), INSTEX could not reliably net the monies owed by European importers to Iranian exporters with those owed by Iranian exporters to European importers.

European officials will no doubt blame Iran for the fact that INSTEX failed, and it is true that the Iranian government never fully appreciated the political significance of European states taking concrete steps to counteract even the indirect effects of US sanctions. Of course, the decision to liquidate the company follows a spate of recent actions by the Iranian government—nuclear escalation, the sale of drones to Russia, and the brutal repression of protests—that make the continued operation of INSTEX politically untenable.

But most of the blame for INSTEX’s failure must lie with the Europeans—the company’s demise predates Iran’s recent transgressions. European officials promised a historic project to assert their economic sovereignty, but they never really committed to that undertaking. A mechanism intended to support billions of dollars in bilateral trade was provided paltry investment. European governments never figured out how to give INSTEX access to the euro liquidity needed to account for the fact that Europe runs a major trade surplus with Iran when oil sales are zeroed out. For the Iranians, this alone was the evidence that European leaders saw INSTEX as a political gesture that might placate Tehran, rather than an economic instrument that would bolster Iran’s economy in the face of Trump’s “maximum pressure.” 

Paradoxically, Iran will lose nothing as the liquidators shut down INSTEX, quietly selling the few assets the company had accumulated—laptops, office chairs, and perhaps some nifty pens. It is Europe that is losing out. INSTEX was supposed to be a testbed for new ways of facilitating trade without relying on risk-averse banks to process cross border transactions. Successful innovation in this area would have given a new dimension to European economic diplomacy and helped Europe assert the power of the euro in global trade. 

With the writing on wall, INSTEX’s management made one final attempt to give the company a future. Beginning in 2021, the company pursued a French banking license—a pivot that INSTEX’s board had approved on a provisional basis, but which was halted in early 2022. It is hard to overstate how significant it would have been had INSTEX emerged as a state-owned bank with a specific mandate to process payments on behalf of European companies that wish to work in high-risk jurisdictions, including those under broad US sanctions programme. Such a bank could have become a powerful tool for Europe to assert its economic might in the face of US sanctions. Moreover, it would even have been useful in cases where Europe is applying sanctions, like Russia. After all, a commitment to humanitarianism means that goods such as food and medicine must continue to be bought and sold even when most transactions with a given country are prohibited. INSTEX could have helped make European sanctions powers more targeted and more humane. 

For a company that managed just one transaction, a surprising amount has been written about INSTEX. It has been the subject of news reports, think pieces, and academic articles. Even if many people struggled to understand what the special purpose vehicle aimed to do, its existence was novel and therefore noteworthy. For those insiders directly involved in the company’s saga, and for those of us who have closely followed from the outside, the main takeaway seems to be that there is much yet to be learned about the complex ways in which US sanctions impact European policy towards countries like Iran, through both political and economic vectors. In this respect, INSTEX did achieve something. A group of technocrats in European foreign ministries and finance ministries learned valuable lessons, often reluctantly and with great difficulty, about the limits of Europe’s economic sovereignty. Whether those lessons can be institutionalised remains to be seen. But a fuller post-mortem on INSTEX would no doubt offer important lessons for the future of European economic power in a world dominated by US sanctions. Learning those lessons would be its own special purpose.

Photo: Wikicommons

For Iran, the JCPOA is Worth Restoring, Even if Trump Returns

The Raisi administration appears poised to resume negotiations over the US re-entry into the Joint Comprehensive Plan of Action (JCPOA). But there remain many critics of the JCPOA in Iran who question whether restoring mutual compliance with the nuclear deal makes sense given that a Republican president might once again tear up the agreement in 2025. It is a reasonable fear. Trump has an iron grip on the Republican party and has shown interest in running for president again. Other aspirants to the Oval Office, such as Nikki Haley and Mike Pompeo, are decidedly Trumpian in their views, including towards Iran. Given the JCPOA’s nature as a political agreement, there is no way for Biden to provide a legal guarantee that future administrations will remain in the deal.

But if Iranian leaders are concerned that the “economic war” might resume in 2025, they ought to remember that they are in an economic war right now. What the restoration of the JCPOA represents, therefore, is an opportunity for a ceasefire. The spectre of a Republican president taking office in 2025 reduces the likelihood that this ceasefire will become a durable peace. Still, the possibility of the deal’s future demise does not negate the certain benefits of sanctions relief on offer now. Political leaders and parties frequently pursue policies that might be overturned in the future because they wish to reap the benefits for as long as they can. In rare cases, reputational concerns may dissuade political actors from adopting a policy that is bound to be overturned—such an outcome may be viewed as a failure of implementation, as was the case in the Rouhani administration’s experience with the JCPOA. But this reputational concern is probably less significant for Iran’s new president, Ebrahim Raisi, given the political consolidation and electoral engineering that brought him to office. On the other hand, not pursuing a genuine opportunity to secure sanctions relief will likely deepen social grievances. The Raisi administration has consistently signalled that it will “definitely seek to eliminate and lift the tyrannical sanctions.”

This framing helps us reconsider the primary role of the “objective guarantees” sought by Iran’s negotiators as they prepare for a seventh round of talks over the restoration of the JCPOA. Iran is not seeking guarantees to eliminate the risk that the nuclear deal is undone by a future American president. Rather Iran needs to guarantee that it gets significant benefits from the deal for the remainder of Biden’s term—the period of approximately three years during which mutual compliance would not be in doubt. Should the deal be implemented successfully during this period, Iran will be able to achieve two things.

First, Iran can seek to maximise the economic benefits of sanctions relief, providing Iranian companies and households a much-needed reprieve after a decade of economic stagnation. The period of boosted growth, even if limited to about three years, will provide companies and households a chance to either make long-delayed investments or replenish their savings. In both cases, companies and households will be increasing their resilience in the face of any future economic crisis, including one precipitated by reimposition of sanctions. At the same time, the Iranian government, with the benefit of more fiscal space and renewed access to its ample reserves, can bolster the welfare state and rein in inflation, giving those Iranians hardest hit by the recent years of economic recession a chance to recover.

Second, Iran can use the period of sanctions relief to make its economic system more resilient in the face of future shocks. Trump’s reimposition of secondary sanctions taught Iranian leaders harsh lessons about the impacts of unilateral sanctions on the country’s trade relations and the mechanisms behind those impacts. With these lessons in mind, Iran can work to gird its economy against the exogenous shock of sanctions. Iranian policymakers have been remarkably successful at building a “resistance economy,” relying in large part on the grit of Iranian businesses and households. But when it comes to economic war, rebuilding defences is best done under a ceasefire.  

It is true that the uncertainty over the long-term future of the JCPOA may diminish the economic benefits in the short-term. As Darya Dolzikova wrote in an analysis for the Bourse & Bazaar Foundation published in January, “the possibility of another snapback of US nuclear-related and secondary sanctions on Iran under a future change of administration in Washington will also discourage businesses investment.” But Dolzikova’s analysis also made clear that this is a problem that can be addressed as part of the deal’s implementation. Iran has cited the “verification” of sanctions relief as a key demand for this reason. While there may be a smaller pool of companies willing to do business with Iran, a greater proportion of those companies that are interested in conducting trade or making investments should be able to see their projects through. For Iran, successful sanctions relief does not mean that one hundred oil companies or one hundred automakers flock to the Iranian market, but rather that the likes of Total and Shell and Peugeot and Volkswagen, thwarted in their previous attempts to invest in Iran, are able to get to the stage of ribbon cutting this time around.  

Despite these challenges, the economic benefits of sanctions relief are not in doubt. As Bijan Khajepour has projected, by the Iranian calendar year ending in March 2025, Iran’s economy would be 13.5 percent larger if sanctions were lifted than if they remained in place. It is difficult to project exactly what sanctions relief will entail for the Iranian economy—but the outcome will certainly be an improvement over the economic malaise of the status quo. American negotiators should make clear to their Iranian counterparts that they wish to help deliver these economic dividends. In doing so, they would be building a kind of “sanctions relief wall” that can help protect the nuclear deal from any economic war waged by a future Republican administration.

Finally, we should be careful about overstating the probability that the JCPOA will be torn-up in just a few years. There is no guarantee that Trump nor another Republican will win. Even if they did, there is no certainty that they will focus their political energies on undermining the nuclear deal. By 2025, the political context could be dramatically different. Given the current trajectory of regional diplomacy, it is possible that US partners in the Middle East will lobby against an unwarranted US withdrawal from the JCPOA, which would again destabilise the region, threatening the achievements of the regional diplomacy underway today, however meagre those achievements might be. Looking at the trajectory of American politics, it is very possible that Democratic and Republican hawks will be laser-focused on China in the next few years, with Iran ceasing to be the lightning rod it was in the final years of the Obama administration. Plus, if the regional dynamics continue to improve and attentions turns towards China, it is reasonable to expect that fewer think tanks and lobbying shops in Washington will be agitating against the deal.

In deciding to let the US back into the deal and restore mutual compliance with the JCPOA, Iranian policymakers are weighing the certainty of a meaningful economic reprieve against the prospect that the reprieve will be cut short. Trump’s return in 2025 is a possibility that Iran must face. Lifting the “tyrannical” sanctions is an opportunity to prepare.

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

Survey Shows Iranian Pessimism on Economy, Pride in Healthcare Response

Recent Western reporting and analyses of Iran depict dire circumstances and make natural assumptions about how the population must be reacting to an economy battered by sanctions from the United States and ravaged by the COVID-19 pandemic. A public opinion survey conducted in September and early October by the University of Maryland’s Center on International and Security Studies and IranPoll provides data to compare with these assumptions. The telephone survey included a national probability sample of 1,004 respondents. Some results are surprising, and some are remarkably similar to public attitudes about the pandemic in the United States and European countries.

The survey finds that Iran’s public is more pessimistic about the economy than they were earlier in the Trump administration’s maximum pressure campaign. But domestic mismanagement and rising inflation appear to be bigger factors in this shift than the sanctions per se. Those most directly affected by COVID-19 are more negative about the economy. Yet, the Iranian public is generally satisfied by the government’s response to the pandemic and support public health efforts, even when they make a bad economic situation worse. 

Reactions to the Economy

Those Iranians who believe the economy is very bad and getting worse are more numerous now than at any time since CISSM first asked these questions in 2015. When asked to rate Iran’s economic situation, 74 percent called it either somewhat bad (22 percent) or very bad (now a 53 percent majority). Throughout 2018 and into fall 2019, those seeing the economy as “very bad” fluctuated between 40 and 45 percent. The October 2020 level of those saying “very bad” is a marked increase—13 points higher than a year ago. When asked about the direction of economic conditions, 72 percent said they were getting worse—18 points higher than a year ago (October 2019). Only 22 percent said they were getting better.

Optimism about Iran’s economic future has declined unevenly over time. The last time our polls recorded a plurality thinking the economy was getting better was in May 2015, shortly before the nuclear deal was signed. When JCPOA conditions for suspension of nuclear-related sanctions were met in January 2016 but the economy did not show tangible gains, pessimism began to gain ground. Its previous peak was in April 2018, shortly before the Trump administration fulfilled its threat to withdraw from the JCPOA if Iran did not make more concessions. As the Trump progressively ratcheted up its maximum pressure campaign by reimposing sanctions the Obama administration had lifted and adding new sanctions on Iran, the public remained generally pessimistic. Yet, the percentage holding that view declined ten points from April 2018 to October 2019 as the negative effects of new sanctions had less impact on everyday life than anticipated, unemployment decreased, and currency devaluation slowed. 

Respondents with higher nominal monthly incomes were progressively more likely to see Iran’s economy as very bad and getting worse. For example, of those in the highest income bracket (average household monthly income over 6 million tomans), 64 percent said the economy was “very bad” and 88 percent said it was “getting worse.” In the lowest income bracket (under 1 million tomans), a lesser 52 percent said the economy was currently “very bad” and 60 percent thought it was getting worse.

This suggests that the recent jump in economic pessimism is related to Iran’s steep currency de-valuation. Average consumer prices have increased by 30 percent this year, which is high – but lower than 41 percent last year. Higher-income Iranians have experience even steeper inflation, because the currency has depreciated sharply despite government efforts to stabilize it in mid-2019. The open exchange rate went from 11,369 tomans to one U.S. dollar in October 2019 to 29,740 tomans to one dollar in October 2020--a 162 percent increase.

We periodically ask Iranians what has the greatest negative impact on their economy: foreign sanctions and pressures, or domestic economic mismanagement and corruption. Given the emphasis placed by Western media and policy experts on “crippling economic sanctions,” it would be natural to expect that a majority of Iranians see this factor as paramount, but that has never been true in CISSM surveys.

In our most recent survey, 57 percent saw domestic issues as the bigger factor, while 36 percent blamed sanctions more. Before the Trump administration withdrew from the JCPOA, a slightly higher 63 percent called domestic mismanagement the more important issue. If the renewed US sanctions have affected general public attitudes at all, they have caused more Iranians to blame foreign pressures rather than their own government. Iranians with higher monthly incomes, however, are progressively more likely to attribute bad economic conditions to domestic mismanagement, with 75 percent of those at the top holding this view. 

Reactions to the Pandemic

Iran’s weak economy and the ravages of COVID-19 are mutually reinforcing. When Iranians think about how their society should respond to the pandemic, large but not overwhelming majorities endorse strong measures, while a significant minority disagrees—a pattern similar to that found in Western countries. This is striking given the severity Iranians clearly see in the country’s economic situation. A clear majority of 58 percent thought the government should close restaurants and “workplaces where people work in close proximity” to prevent the virus’ spread--“even if this would damage Iran’s economy.” Twenty-nine percent disagreed, saying “it is more important for the government to encourage economic activities, even if this would lead to more people getting sick.” 

Experience of the virus in one’s own circle is a majority phenomenon in Iran. Fifty-nine percent knew someone who has gotten sick “among…family, friends, and acquaintances,” while 41 percent did not. Over a third (37 percent) report personally knowing someone who has died from the disease. The virus’ economic impact has also been harsh, with one in five (19 percent) Iranians reporting that someone had lost a job in their own household. Iranians who know somebody who has died from the virus or who have suffered a pandemic-related job loss are about ten points more likely to say that economic conditions are very bad than those who have not had these experiences.

For comparison with the United States, Kaiser Family Foundation found in September that a lesser 24 percent of Americans knew someone who has lost their life to COVID-19. On the pandemic’s job costs, Kaiser asked a broader question in the United States—whether someone in one’s household had “lost a job, [has] been placed on furlough, or had…income or hours reduced because of the coronavirus outbreak.” In October, 45 percent of Americans said yes. It appears that in the early fall, somewhat more Americans had been affected by job loss, while somewhat fewer had lost somebody they knew to COVID-19 than was the case in Iran. 

Despite the strain that the coronavirus has placed on Iran’s public health care system, we did not find widespread dissatisfaction. Asked to “rate the performance of the public healthcare system in Iran,” a strikingly high 85 percent called it “very good” (38 percent) or “somewhat good” (47 percent), with only 15 percent calling it somewhat poor (9 percent) or very poor (6 percent). Rural respondents viewed the system especially warmly, with 45 percent calling it “very good” (urban respondents, 35 percent). This may reflect past investments Iran has made in building out basic healthcare in more isolated areas.

Although Iran has been hard-hit compared to other countries in the region, most Iranians seem relatively satisfied with their government’s performance. We asked respondents to think of “other countries that are similar to Iran” and then ponder whether Iran’s response has been more effective, less effective, or about the same. Given this subjective yardstick, only 25 percent thought Iran had been less effective. Thirty percent thought it had been about the same, and 40 percent thought Iran had been more effective than other similar countries. The more dissatisfied quarter of respondents tended to be more urban, and more pessimistic about the economy than the average Iranian.

These numbers suggest that Iranians are less pleased with their government’s handling of the pandemic that citizens of some advanced countries are, but more positive than people in the United States and the United Kingdom. The Pew Summer 2020 Global Attitudes Survey asked respondents in 14 advanced countries whether their country had done a good job or a bad job with COVID-19. Top scores went to Denmark (95 percent) and Australia (94 percent), and Sweden (71 percent) was comparable to Iran, while the U.S. (47 percent) and U.K. (46 percent) had the lowest satisfaction levels.

We asked about personal compliance with COVID-19 guidelines and about closing schools during the pandemic. The responses were similar to attitudes in the United States. A clear majority of Iranians supports public health measures, but this is not unanimous. Thus, 91 percent said they “wear a mask over [their] mouth and nose” when going out in public, but only 57 percent said they “always” do so. When a vaccine “becomes available in Iran and is approved by Iran’s Ministry of Health,” only 10 percent said they would not take it; however, less than two thirds (62 percent) said they would definitely get themselves vaccinated. Nearly two-thirds (67 percent) said schools should remain closed while 27 percent responded that they should be open for in-person classes.

In conclusion, Iran’s public has a consensus that the country’s economic situation is worse than any time since at least 2015. But they do not see the United States as the primary cause of the country’s troubles. Iranians also seem quite aware that Iran is not the only country in crisis now. Their attitudes toward the pandemic are not different in kind from those found in richer countries, and they are generally proud of their public health service’s response. 

Photo: IRNA

The Optimistic Case for Biden and Iran

“It’s over.”

So reads the November 8 headline of Hamshahri, one of the leading newspapers in Iran. The past four years have been brutal for ordinary Iranians. The Trump administration waged an economic war on Iran that exacerbated the political and social tensions endemic to the country. Iranians are hoping that the election of Joe Biden and Kamala Harris will enable a return to the optimism they experienced in the short period between the implementation of the Joint Comprehensive Plan of Action (JCPOA) in January 2016 and the dismaying election of Donald Trump in November of the same year.

In a CNN op-ed published in September, Biden made clear his intention to “rejoin the [JPCOA] as a starting point for follow-on negotiations” so long as “Iran returns to strict compliance with the nuclear deal.” Here, Biden is accepting the basic premise of “compliance-for-compliance.” In response to Trump’s withdrawal from the nuclear deal, Iran has reduced its own commitments to the deal, particularly by increasing its levels of uranium enrichment beyond what is permitted by the JCPOA. These moves, which have dismayed the remaining parties to the agreement—France, Germany, the United Kingdom, Russia, and China—are nonetheless perceived as tactical and reversible. The administration of Iranian president Hassan Rouhani remains committed to the JCPOA and appears ready to welcome the U.S. back into the deal so long as the U.S. policymakers accept “to be held responsible for damages” caused to “the people of Iran” as a result of Trump’s withdrawal, while also providing “guarantees” that such an event would not be repeated. Notably, Iranian foreign minister Javad Zarif has described the stance of the Biden administration as “promising.”  

Despite these encouraging statements by both the Biden camp and officials in the Rouhani administration, there is a remarkable degree of pessimism surrounding the prospect of a U.S. reentry to the JCPOA. These assessments highlight pressure, particularly from U.S. allies in the Middle East, to build on the nuclear deal and achieve diplomatic breakthroughs on issues such as regional security and Iran’s missile program. They also point to the ascendency of Iran’s hardliners, a loose coalition of politicians who savaged Rouhani and his moderate bloc as the nuclear deal faltered. The vocal anti-Americanism of these conservative politicians and their labeling of figures such as Rouhani and Zarif as either naïve or knowing traitors, has furnished dire predictions for the future of U.S.-Iran diplomacy under the hardline president expected to prevail in Iran’s elections next year. 

In a recent piece, Ariane Tabatabai and Henry Rome seek to account for the likely victory of a hardliner president, arguing that “the United States shouldn’t rush to secure a deal in the hopes of shaping Iran’s domestic politics, or for fear that the window of opportunity will close.” They observe astutely that “the new administration shouldn’t assume that without Rouhani, diplomacy wouldn’t stand a chance.” Tabatabai and Rome explain that the next Iranian president “will almost certainly be more conservative,” but note that the decision to engage in diplomacy with the United States will not be the prerogative of this hardline figure. Rather, such decisions require “buy-in from the whole system.” So long as Iran’s national security interests would be advanced by negotiations, it is reasonable to expect a receptiveness to talks, even with the U.S.

According to Tabatabai and Rome, it follows that the new Iranian administration will “have no choice but to negotiate” with the U.S. principally because of the country’s weak economic position. But this assessment likely underestimates the ability of the Iranian economy to limp along under sanctions pressure—even for four or more years. Before the COVID-19 pandemic hit the country, the Iranian economy was already returning to growth despite two years under Trump’s maximum pressure sanctions. High inflation has emerged as the single most significant challenge facing Iranian policymakers, but as the case of Venezuela shows, even the most extreme circumstances of hyperinflation can prove insufficient to coerce policymakers to the negotiating table.

Trump’s national security advisor, Robert O’Brien, recently conceded that the administration was seeing diminishing returns from economic coercion, having imposed “so many sanctions” that there was little pressure to add. This view reflects the assessments of the U.S. intelligence community, which is developing a more sophisticated understanding of the Iranian economy and its adaptability to sanctions pressure. The takeaway is that Trump’s sanctions offer Biden no real leverage on Iran and that it will not be possible to coerce Rouhani nor his successor into talks.

Despite this, Tabatabai and Rome are still correct to claim that Biden will have a shot at diplomacy—a very good one at that. To understand why, it is important to look beyond Trump’s withdrawal from the nuclear deal as the critical political act of the last three years. Far more significant is the fact that Iran remains in the agreement. Sure, Iran has reduced its compliance with key aspects of the deal. But the extraordinary political price paid by the Rouhani administration, spurred by a creditable commitment to diplomacy for its own sake and also by the strategic considerations of the wider Iranian “system,” suggests that understanding the logic of Iran’s persistence with the deal is the key to understanding the prospects for U.S.-Iran talks.  

Back in 2018, on the eve of John Bolton’s appointment to lead the National Security Council, it appeared that the writing was on the wall for the Iran deal. As I wrote at the time, “by any conventional assessment, then, the Iran deal is dead.” Implementation of the deal was already faltering, and Bolton was hellbent on killing the agreement outright. But I foresaw a different outcome, arguing that “the Iran deal cannot be killed” because of a set of “several undeniable truths about Iran and its place in the world.” My argument focused on three structural factors that underpin Iran’s diplomatic engagement: the geopolitical influence of Iran, the demographic and economic drivers of the Iranian policy of engagement, and the fact that the United States has limited leverage because there is no credible or affordable military threat behind diminishing sanctions pressure.  

Each of these structural factors is even more pronounced today. The Islamic Republic is less isolated diplomatically than ever before because it opted to remain in the JCPOA following the U.S. withdrawal. In the face of reduced oil revenues, the Iranian economy is more dependent on economic diversification, including in its trade partnerships. The combination of sanctions overuse and the American public’s calls for a pullback from the Middle East will leave Biden with less scope to coerce or threaten Iran.  

The notion that Iran’s commitment to engagement (and the nuclear deal) is structural was underscored in a November 3 speech by Iran’s Supreme Leader, Ali Khamenei. Addressing the possible impact of U.S. elections on U.S.-Iran relations, Khamenei stated, “We follow a sensible, calculated policy which cannot be affected by changes of personnel.” Many took the statement to be Khamenei’s way of pouring cold water on the prospect of a Biden victory revitalizing the JCPOA. But again, in the Iranian assessment, the deal is not yet dead. The calculated policy to which Khamenei is referring is the policy of keeping the nuclear deal alive in accordance with Iran’s strategic interests.

This structural commitment means that the Biden administration does not need to rush to make a deal with Iran—the window of opportunity will not close when Iran elects a new president next summer. However, that does not mean Biden will not need to make some early gestures to signal the depth of his own commitment to diplomacy. In an excellent report envisioning a roadmap for the Biden administration’s reengagement of Iran, Ilan Goldenberg, Elisa Catalano Ewers, and Kaleigh Thomas, point to the importance of an early “de-escalation” phase, stating that the Biden administration “should start with immediate, modest unilateral confidence-building measures” in order to achieve both compliance-for-compliance on the nuclear file and “calm-for-calm” when it comes to regional tensions.

As Edoardo Saravalle has convincingly argued, the Biden administration can use executive orders to implement its sanctions relief commitments under a compliance-for-compliance framework in under sixty days. These moves can be made tangible by coordinating moves with European allies and international bodies to deliver tangible economic benefits to Iran. For example, this coordination can ensure that sanctions relief enables the unfreezing of foreign exchange reserves and the provision of Iran’s requested COVID-19 relief loan by the International Monetary Fund—moves that would ease inflation, delivering appreciable economic relief for ordinary Iranians. Should the Biden administration choose incentivization over coercion and thereby prove itself a credible counterparty for follow-on negotiations by the time of the Iranian election in the early summer of 2021, it is more than likely that any Iranian president elected—even a so-called hardliner—will take up the mantle of new talks.

The fierce opposition of hardliners to the nuclear deal was far more about the stakes of domestic politics than the terms of the deal itself. Even before talks had concluded, hardline politicians were gripped by anxiety that the successful implementation of the nuclear deal would grant Rouhani, a savvy political operator, a diplomatic and economic triumph that would consolidate the dominance of reformist politics in Iran for a generation. The opposition to the nuclear deal, which extended to efforts to undermine the deal itself, was intended to take Rouhani from the heights of popularity—he won two stunning mandates in high-turnout elections—to the depths of disgrace. The hardliners succeeded in this cynical mission and Rouhani was battered. But tellingly, the nuclear deal, as a product of Iran’s largely apolitical strategic decision-making, has survived.

A hardline president in Iran can be confident of his ability to run the country for an initial four-year term without needing a détente with Biden. The economy will limp along, regional tensions will remain high, and domestic unrest will simmer. But the presidential administration will be able to coordinate with state organs to keep Iran resilient to external and internal pressure—even as the Iranian people continue to suffer from the country’s stagnation.

But what president would choose to preside over a constant slow-moving crisis, particularly one that was not of his own making? For hardliners, 2021 represents an extraordinary political opportunity. For the first time since 1989, Iran and the United States will have first-term presidents at the same time. Meanwhile, Iran’s conservative politicians are increasingly concerned about the political legacy and legitimacy of the Islamic Revolution as it enters its fifth decade. Negotiations with the Biden administration offer Iran’s next president, and his political backers, the opportunity to give to the Iranian people that long-awaited gift—a robust, transformational deal with the world powers, chief among them the United States.   

The impact of Biden’s election on U.S.-Iran relations has been the subject of strategizing for months. Today, what was once a hypothetical has become a reality. The impetus for U.S.-Iran talks arises from both an emergent political opportunity and the unchanged structural factors that push both sides towards engagement. The mechanics and sequencing of an American reentry into the JCPOA remain to be determined, but it will not be harder than when the deal was originally struck, when taboos needed to be broken in Tehran and Washington alike. Much has been learned over the last four years about what it takes to implement an “Iran Deal” successfully. We ought to be optimistic about comes next.

It’s a beginning.

Photo: Wikicommons

What You Should Know About Iran's Weakening Currency

The Iranian rial has hit a historic low against the dollar, adding to the perception that the country is in the throes of a deepening economic crisis. But the figures that are most concerning for Iranian economic policymakers (there are many) are rarely the most dramatic or those that make the headlines. The rollercoaster ride that has taken the rial to a historic low of IRR 215,000 to the dollar does not tell us as much about the health of the Iranian economy as is widely assumed.

Reporting on Iran’s currency focuses on the azad or free market rate, which is the price of purchasing a single, physical dollar bill at an exchange bureau in Tehran. The buying and selling of eskenas, or hard currency, represents a small proportion of the overall foreign exchange market in Iran, likely accounting for less than 20 percent of all foreign exchange transactions. 

There is also a fixed subsidized rate of IRR 42,000 for each dollar. This rate is made available to importers of critical goods such as food and pharmaceutical products, but the Iranian government has been seeking to shrink the number of goods eligible to be imported at this rate.

The most important rate, which is rarely cited in reporting on Iran’s currency woes, is the rate available in the NIMA exchange, 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 NIMA rate has hit just over IRR 168,000 in the past week, also a historic low.

The NIMA rate has also risen in recent months, reflecting the reported shortages of foreign exchange available in the market due to trade disruptions brought-on by COVID-19 as well as the underlying difficulties facing Iranian banks, and particularly the Central Bank of Iran, in accessing foreign exchange held in accounts at foreign financial institutions.

After approaching convergence in the summer of 2019, the spread between the free market and NIMA rates has widened considerably, meaning that the devaluation of the rial in the free market is not the best indicator of the strength of the rial, nor an accurate reflection of concerns around inflation.

Since the NIMA exchange began operating in earnest in the last quarter of 2019, inflation, as measured by the consumer price index, has tracked most closely the NIMA rate and not the free market rate. This is to be expected. The NIMA rate reflects the price at which most foreign currency is bought and sold in Iran and crucially it reflects the price at which Iranian companies purchase foreign exchange in order to pay for imported goods.

On one hand, the devaluation of the rial over the last decade has benefited Iranian exporters, making their goods more attractive to foreign buyers. The more liberal approach to foreign exchange policy has helped Iran grow its non-oil exports—a lifeline for the economy as oil exports are constrained by sanctions.

But on the other hand, the more liberal approach to the exchange rate has had an impact on the price of imported goods, whether those are finished goods or raw materials and parts used in the manufacturing of finished goods in Iran. This relationship is most clear when comparing the changes in the NIMA rate with the price index for consumer durables, a category of goods more likely to have imported parts content. When the NIMA rate increases, so does the price of durable goods, contributing to the total cost of the consumer basket.

Often, reports about the plunging value of the rial suggest that the appreciation of the dollar in the free market reflects the erosion of Iranian purchasing power. But the relationship between the rial’s free market rate and inflation is limited. Unlike in other economies that have experienced currency crises, such as Lebanon, Iran’s economy is not dollarized. When ordinary Iranians exchange rials for physical dollars, they are acquiring an asset that they will most likely exchange back into rials at some future point, preserving the value of their savings in the process. Iranians purchase dollars for the same reason they purchase gold, real estate, and even used cars—they are seeking a hedge against inflation. Hard currency dollar appreciation does not depress the value of the rial as a medium of exchange.   

However, the free market rate could be a signal for price makers about expectations of future inflation, and therefore may influence producers and retailers to increase prices. Moreover, the free market rate may also have an impact on the price of real estate, which is also used as a hedge against inflation. In both instances, the devaluation of the rial in the free market could contribute to higher prices for Iranian households.

But when considering that the free market represents a small proportion of the overall foreign exchange market in Iran, fluctuations in the free market rate are perhaps best understood as a response to inflation, among other economic indicators. In fact, at a time when the central bank is pumping historic amounts of liquidity into the Iranian economy, the conversion of rials into dollars may actually serve to absorb some liquidity. 

This is perhaps the other parallel that can be drawn between the purchase of dollars and assets such as stocks and gold—the currency free market has some of the hallmarks of a bubble, particularly as the spread with the rates available on the NIMA exchange widen. The devaluation of the rial that can be observed in the NIMA exchange, which is equivalent to the rial losing about a third of its value since Iran reported its first two cases of COVID-19 in February, lags behind the devaluation in the free market exchanges, which has seen the rial lose half of its value in the same period.

Given the media attention both inside and outside of Iran to the rial’s free market fluctuations, it is perhaps no surprise that psychological factors may be responsible for the recent devaluation episode. Given that the NIMA rate is a better indicator of the vulnerability of the Iranian economy to inflation, both when considering how much foreign exchange is available in the market, but also when considering changes in the money supply in Iran, it is notable that the free market rate has deteriorated more sharply.

This divergence, which the central bank had worked hard to limit, is beneficial to a wide range of actors within Iran’s financial system, including those engaged in corruption. The arbitrage between the two rates incentivizes commercial enterprises that earn foreign exchange revenue to circumvent the NIMA system. The panic buying of dollars by working class Iranians benefits wealthy Iranians who are more likely to maintain a large portion of their savings in hard currency, or who can bring hard currency back to the country from abroad. Ironically, in the short term, the devaluation of the rial has probably created more wealth than it has destroyed 

Nonetheless, Iranians should be worried about inflation. The COVID-19 crisis has widened Iran’s fiscal deficit and also given rise to balance of payments challenges. There is growing concern that inflation will rise in the coming months as the central bank prints money.

Iran’s central bank governor, Abdolnasser Hemmati, has sought to calm nerves by arguing that increased liquidity is a “structural phenomenon” in the Iranian economy. His statements have yet to reduce demand for dollars, which has risen in anticipation of increased inflation. Nonetheless, the increased demand does not itself mean that Iran is presently experiencing or is set to experience the scenarios of “hyperinflation” that have been long predicted. Rather, those purchasing dollars in the free market are betting that the policymakers will fail to keep inflation under control as it edges towards 30 percent.

Photo: IRNA

Why Hassan Rouhani Ended Iran’s Lockdown

By Saheb Sadeghi

As businesses resume their activities in Iran at the behest of President Hassan Rouhani, many experts have criticized the government’s decision and warned of a second wave of the coronavirus outbreak. Some even have accused Rouhani of favoring the economy over the health of the people.

According to the latest official figures, there are more than 95,000 confirmed coronavirus cases in Iran, and the death toll has exceeded 6,000.

On April 22, Rouhani described the reopening of businesses as “a necessity for the country.”

To understand the reasons behind Rouhani’s risky and possibly dangerous decision, one needs to look back at the Iranian economy’s condition before the coronavirus outbreak. Iran’s economic growth rate was negative 7 percent. Stagflation had put the economy into a serious crisis.

After the United States’ 2018 withdrawal from the nuclear deal and reimposition of sanctions, Iran’s foreign trade and oil exports declined dramatically—and political tensions with Gulf neighbors spiked as the United States deepened the crisis.

In the meantime, the International Monetary Fund had predicted that Iran’s economy would shrink 9.5 percent last year, and according to the Central Bank of Iran, the annual inflation rate reached 41 percent, the highest level in 25 years. The number of unemployed people had already reached about 3 million before the coronavirus crisis, and some estimates would suggest the number to be even higher.

Then came the coronavirus outbreak. After the government’s decision to shut down businesses, at least half of Iran’s economy, which is dominated by service sector jobs, was seriously affected. The living conditions and welfare of an estimated 7.3 million people became precarious as millions lost their jobs and others had their wages or hours cut.

The shutdown came at a time when many businesses were expecting almost 50 percent of their annual income during the last two months of the Iranian year before Nowruz, the Persian New Year, at the end of March.

Every year during the last Iranian month of Esfand (beginning in February and ending in March) and before the New Year people usually do most of their shopping. Esfand is followed by the first month of the year, Farvardin (March 20-April 19), which is generally a month of holidays and tourism. During Farvardin, many businesses—including restaurants, travel agencies, and hotels—tend to witness a boom, but this year their revenues reportedly fell by more than 90 percent.

Estimates suggest that Iran’s GDP has now decreased by about 15 percent as a result of the disruption to businesses, and that the economy will shrink further compared to last year. Businesses have reduced their activities as well as their workforce, and statistics show that about 36,000 people are applying for unemployment insurance each day.

Although the increase in the unemployment rolls caused by coronavirus outbreak has not been officially announced yet, some estimates indicate that 1 million Iranians have lost their jobs during the crisis, while other figures put the number at 2 million.

Under such circumstances, government support could have eased the pain, but extending a safety net was not an option in Iran. While income support measures were introduced all over the world to deal with the economic consequences of the coronavirus outbreak, Rouhani’s government could not afford to assist affected businesses due to a lack of financial resources, largely because U.S. sanctions have denied Iran access to its assets and money held in foreign banks.

The financial assistance amount that Rouhani has so far promised to support affected businesses is 100 trillion tomans ($6.25 billion), most of which is supposed to be paid to businesses in the form of loans. (One toman is equivalent to ten rials. Although the rial is the official currency, Iranians use the toman in everyday life.)

These loans have a three-year repayment term with a 12 percent interest rate. In the event of a second coronavirus outbreak and a bad economic situation, the government will give these loans to businesses; in normal times, bank loans would come with a higher 20 percent interest rate.

According to the Iranian economist Mohammad Hashem Botshekan, this economic package was more like a monetary policy than an economic stimulus; if the government were seriously considering an economic survival package, it would need to give interest-free loans to businesses, and it would provide free economic assistance to the people. Furthermore, the amount spent by the government compared to the volume of Iran’s GDP was insignificant.

After all, the U.S. government’s package accounts for approximately 10 percent of the country’s total GDP, the German and Japanese support packages are equivalent to about 20 percent of their GDPs, while the economic packages of some Persian Gulf countries accounts for about 30 percent of their GDPs. But the offered economic survival package from the Iranian government only equates to 2 percent of the country’s GDP.

Rouhani’s government also announced that it would give a 1 million-toman loan (about $62) to low-income families—an interest-free loan that would be repaid in 24 monthly installments, sparking widespread criticisms. This amount is equivalent to half of the minimum monthly salary of a laborer in Iran and would not do much to help people with their economic hardships.

But the Rouhani government’s revenues have shrunk dramatically. Since the coronavirus pandemic began, demand for oil has declined, pushing prices down. Moreover, another source of revenue for the Iranian government—taxes—has been seriously eroded due to the closure of businesses. Indeed, the government has stopped collecting taxes from some businesses that have been financially damaged as a result of the coronavirus pandemic—but it is the government that will decide which businesses receive a three-month deferment of tax payment.

In the end, Rouhani had only two options: Either he could go on with the shutdown of businesses and government bodies until the virus is brought under control and the medical and health system of the country is restored to normal, or, due to the dire economic situation, he could allow the businesses and government offices to resume their activities.

He opted for the latter and reopened the markets and government offices on April 11, a decision that sparked a great deal of criticism from medical experts as well as some high-ranking government officials such as the head of the judiciary, who criticized the government for prioritizing the economy over the health of the people.

Rouhani ordered almost all economic sectors, including financial markets and shopping centers to fully resume their activities. Some high-risk businesses such as sports clubs, big restaurants, and cinemas are not still allowed to reopen. Even now, several weeks after the decision was implemented, Iranian health officials are still declaring their opposition to it.

Since the reopening of businesses and government bodies, social distancing measures in Iran have not been observed; in a matter of few days, people began to act as if the coronavirus crisis was over and life had returned to normal.

Although the pace of coronavirus-related deaths has decreased recently, more than 1,200 new cases and about 100 deaths from the virus are still being reported each day. According to health officials in some cities, such as Tehran, the number of people infected with the coronavirus is increasing. Many doctors and officials in Iran’s health sector are scared, saying that the government’s decision to lift social distancing restrictions may soon lead to a second wave of infections.

Indeed, a resurgence of the pandemic could have a much more devastating impact. The illness and death of tens of thousands of people in a second wave would force businesses to close once again, and the Iranian health care system would come under immense pressure. Under such circumstances, the government would barely be able to keep the economy alive and stable. The government’s revenues would further shrink, and it would probably not be able to support poor and low-income families. In such a situation, millions of people could lose their jobs and a greater economic recession might put Iran’s economy at risk of collapse.

While Rouhani’s move could lead to a new outbreak with all the devastating consequences it brings, his unpopular decision has, for now, saved the economy from further deterioration and possible protests.

Rouhani’s decision was based on the view that Iran has passed through the first major wave of the coronavirus outbreak and that continuing curbs on economic activity are no longer justifiable. According to this view, an ongoing economic lockdown would have dangerous consequences for the country. The unemployment rate would rise sharply, many businesses would go bankrupt, and social unrest could follow.

While Rouhani is well aware that there is a risk of a second wave, the country cannot keep the lockdown in place for another month or two because the government cannot make up for the losses suffered by businesses, as wealthier governments in Europe and North America have done. That is why he is insisting on bringing the economy and society back to normal as soon as possible.

The country has yet to leave behind last November’s public protests against the substantial increase in the prices of gasoline, fear of reemergence of public protests and riots was evident in a letter sent to Rouhani by 50 economists on April 3. They cautioned him that the economic consequences of the coronavirus crisis could lead to unrest in the second half of the Persian Year 1399, which has just begun, and that the next year, 1400, would be a year of crisis.

Saheb Sadeghi is a columnist and foreign-policy analyst on Iran and the Middle East. Follow him at @sahebsadeghi.

Photo: IRNA

Bleak Estimates of Economic Impact Spur Iran to End Virus Lockdown

Following two years of recession triggered by the Trump administration’s “maximum pressure” sanctions campaign, Iran was showing signs of economic recovery in the last quarter of 2019. But when authorities announced the country’s first confirmed deaths from COVID-19 in mid-February, Iran was thrust into a new crisis. According to official statistics, COVID-19 has caused over 5,000 deaths and 83,500 infections to date.

Fears that authorities were slow to contain the crisis have now been replaced by a new concern—like many developing economies, Iran may not be able to afford the protracted lockdown necessary to bring the virus fully under control.

Iran entered a partial lockdown on March 13, one week before the Nowruz holiday. The lockdown measures were further tightened on April 4, just after the holiday period ended. But on Saturday, authorities allowed some businesses to begin reopening, including shops and bazaars. The decision to rollback the containment measures despite the continued risk of infection was informed by a set of reports, which presented dire assessments of the virus’ economic impact.

A 17-page report published earlier this month by the Majlis Research Center, a highly-regarded research organization affiliated with Iran’s parliament, called on the Iranian government to focus on two goals: o provide more support for businesses through tax breaks and delaying debt servicing in order to prevent mass layoffs and to stimulate demand while shielding the most vulnerable in society from the economic blow of the pandemic. In support of containment measures, the report explained that “a maximal reduction in social interactions will be necessary for the coming month” in order to slow the spread of COVID-19. But at the same time it warned of the steep economic costs of any protracted lockdown.

Similarly focused on the impact of the lockdown on Iran’s service sector, an assessment by the Ministry of Welfare, Labor and Social Affairs suggested that lockdown measures put 4 million people at risk of long-term unemployment, a figure that includes 700,000 individuals who are informally employed.

The macroeconomic impact of the slowdown is also captured in new projections from the International Monetary Fund, which has revised its estimate for Iran’s 2020 economic growth from flat growth to a contraction of 6 percent, which would mark three consecutive years of substantial recession.

Iran’s Ministry of Economy released its own report on the eight challenges facing the Iranian economy for in the coming year. Foremost among these challenges is the impact of intensifying U.S. sanctions on Iran’s access to its foreign currency reserves—an challenge made more acute given that Iran’s foreign exchange earnings will be hit by both the historic low oil price and the slowdown in global trade, which will depress Iran’s non-oil exports. The report also noted the impact of the economic crisis on consumption. While consumption in Iran had remained relatively stable in the face of sanctions pressures, the lockdown and reduced purchasing power have reduced demand.

Efforts to provide relief to ordinary Iranians and boost consumption are straining government budgets already unbalanced by the low price of oil. The Rouhani government’s ratified budget for the current fiscal year—ending March 20, 2021—accounted for substantial oil exports and a global oil price of USD 50 per barrel. Although the government budgets are in disarray, the government has moved to introduce a fiscal stimulus to soften the economic blow of the lockdown.

The Rouhani administration has introduced a cash stimulus package that will provide between IRR 2 million to IRR 6 million in supplementary transfers (equivalent to USD 12 to USD 36 at the free market rate) to households already receiving welfare support. This “coronavirus transfer” will be paid for an initial period of four months. In addition, the government will make available a one-time no-interest loan of IRR 10 million (equivalent to USD 62) to the 24 million households which currently receive welfare transfers.

But the stimulus measures have been criticized as insufficient given the extent of the economic crisis and the hardship facing millions of Iranians. Acknowledging the shortcomings of the stimulus plan, central bank governor Abdolnasser Hemmati expressed regret, saying that if it were not for U.S. sanctions the government would have greater resources to support the public.  

As is tradition, Iran’s Supreme Leader, Ali Khamenei, have a televised address on March 20 outlining his policy goals for the coming year. For this year, Khamenei has called for a “leap in production.” But as the government struggles to manage tradeoffs between public health crisis and economic welfare, the country’s policymakers are set to make a leap into the unknown.

Photo: IRNA

Iran's Urgent IMF Loan Request Challenges Trump Policy

This article was originally published by Responsible Statecraft.

For the first time in 60 years, Iran has requested a loan from the International Monetary Fund (IMF), seeking emergency financing to support its efforts to combat COVID-19. On March 4, the IMF announced that it would make available up to $50 billion in financial assistance through its Rapid Financing Instrument (RFI), a facility targeting “low-income and emerging markets.”

Iran’s request for financial assistance reflects the acute challenges the country faces in its efforts to control the country’s COVID-19 outbreak—over 14,000 Iranians have been infected according to official statistics. The government has mobilized extensive resources to try to respond to the public health crisis, but the Iranian economy is being pushed to a breaking point. Iran is seeking $5 billion in emergency assistance from the IMF, funding that could dramatically improve the prognosis not only for the Iranian economy, but also the health and wellbeing of the Iranian public.

As medical professor Abbas Kebriaeezadeh and recently explained, Iran is struggling to replenish inventories of medicine and medical equipment both because of supply chain disruptions related to border closures and other related restrictions as well as underlying weakness in Iran’s access to the international financial system that make payments cumbersome to complete. Short term aid from the World Health Organization and European governments, as well as countries such as China, Japan, and Qatar, has helped Iran meet immediate needs for supplies. But as the outbreak continues, and as other countries begin to confront their own public health crises, Iran will need to rely on commercial sources of medicine and medical equipment.

However, even if Iran is able to find suppliers that are able to speedily and reliably dispatch these much-needed goods, the country would still face a balance of payments problem—precisely the problem that the IMF’s RFI facility is supposed to solve. Trade data for February, before the outbreak arrived in Iran, point to significant vulnerability as Iran’s non-oil trade deficit reached $1.68 billion on the back of $4.33 billion in imports and just $2.65 billion in exports.

Since the Trump administration eliminated waivers permitting the purchase of Iranian oil in May 2018, Iran has struggled to earn the dollars and euros that are needed to keep its economy supplied with advanced goods. Consequently, over the 18 months, Iran has seen inflation reach as high as 40 percent, straining the finances of ordinary households and pushing as many as 1.6 million Iranians below the poverty line.

Iran’s economy will be hit hard by the various efforts to contain the country’s COVID-19 outbreak. Of particular concern for Iranian economists, among them Masoud Nili, a long-time advisor to the Rouhani administration, is how the skyrocketing cost of healthcare will force the central bank to pump liquidity into the economy, causing a situation Nili calls “inflationary coronavirus.” A shortage of foreign currency will make inflation worse, as the rial continues to lose value relative to other currencies. A loan from the IMF would help Iran’s central banks keep importers of foreign medicine and medical goods supplied with foreign currency, thereby easing inflationary pressures.

Importantly, Iran would not necessarily receive the IMF loan in Iran. More practically, the funds would be deposited into dollar and euro-denominated accounts controlled by the Central Bank of Iran, but maintained in Europe. So few Iranian banks maintain correspondent accounts in Europe that bringing the IMF assistance back to Iran, only to allocate it to commercial banks to be transferred on behalf of clients to suppliers in Europe, would add significant time and expense to the urgent transactions. Depositing the funds in Europe would also eliminate the risk of their misuse—financial regulators will be able to track Iran’s use of the loan within the European financial system. The loan isn’t being paid in cash, after all.

Moreover, given that the funds would likely remain in Europe, the U.S. Treasury Department could insist on oversight of the IMF loan, including the review of due diligence documentation that would be required in each instance where funds originating from the IMF are being paid into the account of a European pharmaceutical or medical equipment supplier—the suppliers have a clear interest in ensuring their sale of goods is fully compliant with U.S. secondary sanctions.

This type of oversight would not be dissimilar to the compliance framework behind the Swiss Humanitarian Trade Arrangement (SHTA), a payments channel created after the Swiss government sought clearer authorizations from the Trump administration to maintain the sale of medicine and medical equipment to Iran by Swiss firms, which include some of the world’s largest suppliers of these goods.

In light of the balance of payments problem and more fundamental issues in cross-border payments, 11 European governments have backed a trade mechanism called INSTEX. But this mechanism was created after requests made to the Trump administration for clarifications around humanitarian trade with Iran were rebuffed. Given the significant role played by the United States in the IMF, the Trump administration would need to effectively approve any financial assistance given to Iran by the IMF—the political and legal issues around an IMF loan to Iran therefore have more in common with the Swiss arrangement.

In this way, by calling upon the IMF to provide it access to a facility that the fund has offered to all similar countries confronting COVID-19, Iran is effectively asking the fund’s leadership to seek such an approval from the Trump administration in order to open the kind of financial channel that Iran’s central bank has found increasingly difficult to maintain. In the two years since the Trump administration launch its “maximum pressure” sanctions campaign, Iran has struggled to freely access the ample foreign currency reserves—valued at around $70 billion—that it maintains in accounts around the world. This is in large part due to the hesitance of central banks, including European central banks, the Bank of Japan, and the Reserve Bank of India, to invite scrutiny from U.S. sanctions enforcement authorities and possibly compromise their ties with the U.S. financial system. If, because of these longstanding impediments, the IMF fails to provide Iran financial assistance that it makes available to countries in similar situations, the fund’s reputation will take a hit, as the fact of effective American control over its operations is laid bare.

It is unlikely that Iran will receive an IMF loan, but interestingly the official request comes just days after the Treasury Department clarified authorizations that permit financial dealings with the Central Bank of Iran in order to facilitate humanitarian trade — further evidence that administration officials do not see systemic issues related to terrorist financing or money laundering stemming from Iran’s humanitarian trade. The latest clarifications became necessary after an unprecedented move to sanction Iran’s central bank under new authorities in September had been widely perceived to eliminate the longstanding humanitarian exemption.

Clearly, there is a discussion-taking place within the Trump administration about the acceptable level of isolation for Iran’s central bank, especially if that isolation harms the Iranian people. While Iran is unable to directly engage with the Trump administration over these issues given the lack of diplomatic ties and ongoing political tensions, the outreach to the IMF can be seen as an effort to help shape the internal debate over these policies at the State Department and Treasury Department. Iran’s request is legitimate, its economic needs are acute, and the stakes could not be higher. Iran should get this loan.

Photo: IRNA

Iranian Businesses Take Stock After Soleimani Assassination

Iran’s business community is taking stock after the assassination of Major General Qassem Soleimani while the possibility of a direct conflict with the United States threatens serious consequences for an already beleaguered Iranian economy.

The economic impact of Soleimani’s death was first felt in currency markets on Saturday, the first day of the working week in Iran. The dollar was priced at about IRR 133,500 before currency markets opened, but jumped to IRR 137,500 by Saturday’s close. On Sunday, the dollar appreciated further against the real to close at IRR 139,500, marking a 4.5 percent drop in value over the two days. The Iranian rial has stabilized over the last year after losing more than 60 percent of its value in 2018.

Similar volatility was could be seen in Iran’s main stock market, which had made significant gains over the last year. TEDPIX, the main index of the Tehran Stock Exchange (TSE), closed at 367,334.20 on Saturday, down by 4.6 percent. It dropped another 1.4 percent by Sunday’s close to reach 362,259.30.

Both the currency market and stock market saw further losses on Monday, the final day of a three-day period of mourning. Millions of Iranians have taken to the streets of Iran’s major cities to participate in funeral processions.

Supreme Leader Ali Khamenei has vowed to exact “severe revenge” for Soleimani’s death. Secretary of the powerful Supreme National Security Council Ali Shamkhani said Sunday that Iran’s “response to this crime will certainly be military, but won’t be limited to military efforts.”

Trump has doubled down on the assassination, using Twitter to threaten the destruction of 52 targets in Iran, including sites important to the “Iranian culture.” Perhaps indicating his knowledge of the target list, Senator Lindsey Graham suggested the president should target Iran’s oil refineries in further airstrikes.

The economic ramifications of a direct conflict with the United States would be serious. But even absent war, the heightened tensions and greater uncertainty will have an impact on the business environment in Iran.

“We are now in a state of limbo where it is unclear what will happen next,” said market analyst Hamid Babalhavaeji.

Babalhavaeji told Bourse & Bazaar he is indeed worried about a potential armed conflict, but also pointed out that Iran’s economy is already in a state of economic war, gripped by high uncertainty and confined to short-term strategies.

Iran’s economy has struggled in the face of a volatile currency and high inflation since the US unilaterally withdrew from the JCPOA nuclear deal and reimposed secondary sanctions last year.

As to whether foreign companies currently working with Iran will be discouraged continuing their dealings as tensions rise, Babalhavaeji believes only a direct conflict touching Iranian soil would have a meaningful negative impact.

In his view, the economy’s key vulnerability is disruptions to the flow of trade through Iran’s southern ports in the Persian Gulf. “But for now, the main issue continues to be sanctions and challenges in transfer of money,” he said.

Iran’s difficulties in international banking have been compounded by its slow progress in implementing an action plan set forth by the Financial Action Task Force (FATF).

In October, the intergovernmental global standard-setting body for anti-money laundering and combating terrorist financing body renewed the suspension of active countermeasures against Iran, but placed a fast-approaching deadline for further progress on legislative reforms.

“If before February 2020, Iran does not enact the Palermo and Terrorist Financing Conventions in line with the FATF Standards, then the FATF will fully lift the suspension of counter-measures and call on its members and urge all jurisdictions to apply effective counter-measures,” the organization declared.

In the weeks prior to the Soleimani assassination, there appeared to be progress in getting the two outstanding bills passed. The Expediency Council, a body that arbitrates disputes between Iran’s parliament and the Guardian Council, had blocked implementation of the bills, arguing that they threatened national security.

But aggressive lobbying by the Rouhani administration and stakeholders in the business community had sought to explain the risks of not passing the required legislation by the mid-February deadline. Pedram Soltani, vice chairman of the Iran Chamber of Commerce, Industries, Mines and Agriculture, had revealed that the governor of the Central Bank of Russia had informed the governor of Iran’s central bank, Abdolnasser Hemmati, that Russian banks would be unable to work with Iranian banks should Iran fail to implement the FATF reforms.

The assassination of Soleimani and Iran’s unfolding national security crisis, will likely halt efforts to enact the Palermo and Terrorist Financing Conventions. Iranian business leaders hope that FATF member states recognize the impossibility of passing such sensitive reforms in the wake of the unprecedented American airstrike, granting more time for reform.

Ali Khosroshahi, an executive vice president at Sepehr Investment Bank, thinks the repercussions of Soleimani’s assassination should be viewed in the context of Iran’s existing economic isolation, which has left companies battling significant financial constraints.

“We are already in war conditions from an economic standpoint. This event has only made things more difficult and increased tensions alongside a whole set of other conditions,” he said.

Khosroshahi  expects that if a major political breakthrough—which he considers unlikely—does not materialize, Iran’s economy will continue to experience high inflation at least until the end of the next calendar year in early 2021.

Speaking on background given the sensitive nature of the topic, a board member of a large Iranian manufacturing firm said that his company has yet to do formal contingency planning around further escalation, but that so far there “hasn’t been any noticeable effect on business as the events have yet to affect material or financing flows.”

The board member suggested that while “what happened wasn’t expected by anyone” the risk of conflict was already “accounted for” in Iranian markets. In his view, it’s global investors that have yet to properly “educate themselves about the growing risks” as Trump grows more erratic.    

As financial economist Peter Dragicevich told Bloomberg, “Everyone got comfortable in that fact that the truce in the trade war had come through and the outlook for 2020 looked a little bit better and then we had another geopolitical reminder come through.”

The US-Iran tensions are “going to be a big driver of markets in the short term,” he added.

Photo: IRNA

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

Iran’s Economic Resiliency Makes Talks More Likely

The International Monetary Fund has revised downward its projections for Iran’s economy this year, predicting a 9.5% contraction, as against its previous projection of a 6% shrinkage. It will be the economy’s worst performance since 1984, when Iran was mired in a war with Iraq.

At first glance, this seems to support the Trump administration’s claims that its “maximum pressure” sanctions campaign is bringing the Iranian economy to the brink of collapse. But this view is challenged by the IMF’s projection that the decline will halt in 2020, when Iran’s economy will rebound to zero growth—despite the sanctions.

A closer examination reveals an economic recovery is already underway, as stability returns to consumer prices, manufacturing, trade, and the Iranian currency. Somewhat counterintuitively, this could improve the prospects of talks between Iran and the U.S. A stable economy may reassure the Islamic Republic that it can negotiate from a position of some strength.

The most obvious sign of the recovery is the rebounding rial. Since May, the Iranian currency has appreciated 40% against the dollar. The Central Bank of Iran introduced new technologies to connect exchange bureaus with banks, creating a unified foreign-exchange market that is digitally supervised, making it harder for speculators to abuse the market. The new systems appear to be working—even as geopolitical tensions reached new highs this summer, the currency market remained unfazed.

A stronger rial has helped ease inflation. The consumer price index rose just 6.1% in September—the slowest pace since the reimposition of sanctions 18 months ago. Abdolnasser Hemmati, the central bank governor, is predicting “further easing of inflation in the coming months.”

Stability in the foreign-exchange market has also helped support a recovery in manufacturing. After several months of contraction at the beginning of the year, manufacturing activity gradually expanding, as reflected in the purchasing manager’s index (PMI) complied by the Iran Chamber of Commerce. Iran’s PMI score has exceed 50 in five of the past seven months as firms report improved inventories of intermediate goods.

The rebound in manufacturing has helped the Tehran Stock Exchange acquire the unlikely mantleas the world’s best-performing exchange over the past year. More importantly, the fact that most of Iran’s factories are finding ways to sustain output means they can keep their workers employed and foreign customers supplied.

Iran’s non-oil exports are projected to reach a record level of over $40 billion this year. The result of an effort by the government and private sector to boost regional trade, this may be the first year in Iran’s modern history that non-oil exports will exceed oil exports, which will be constrained to around $10 billion following the Trump administration’s revocation of key sanctions waivers in May.

While the fall in oil exports has certainly constrained Iran’s foreign-currency earnings and government revenues, a structural adjustment towards non-oil exports is taking place. It is often overlooked that the oil industry has rarely accounted for more than 20% of GDP. Iran is not in fact an oil economy.

Ordinary Iranians remain generally gloomy about the economy, but there are signs the mood is shifting. In a recent nationally-respresentative survey 54% of respondents felt the economy was continuing to get worse, compared with 64% in April last year. In the same period, the proportion of respondents who believe the economy is getting better has risen 3.5 points to 30.5%. This may reflect the belief of 63% of respondents that Trump’s sanctions campaign is maxed out.

That a recovery is underway does not diminish the harm has been done by U.S. sanctions. Iranian households are feeling a great deal of pain. As detailed in the IMF report, consumer prices increased 35% over the past year, and unemployment rose from 14.5% to 16.8%. The “maximum pressure” campaign has immiserated millions even as it has failed to collapse the Iranian economy. 

Still, economic resiliency is an enabling factor for diplomacy. Recent Iranian overtures for talks with the U.S. and other world powers may reflect, not a fear of pressure, but a confidence that Tehran can survive it.

It is often assumed Iran was forced into nuclear negotiations in 2013 by the debilitating impact of U.S., United Nations and European Union sanctions. What is missed in this analysis is that although the sanctions resulted in a sharp 7.4% contraction of the Iranian economy 2012, this was followed by an immediate recovery: GDP shrank a mere 0.2% in 2013. Iran agreed to the negotiations precisely because the economy had demonstrated resiliency—the government was confident it would not need to grovel for economic relief. The likelihood of a rebound in 2020 may allow history to repeat itself. 

Photo: IRNA

Iran's Economy is Bruised, But Not Broken

This article was originally published in Lobelog.

Last April, in a column for this blog I predicted that sanctions are very unlikely to force Iran to renegotiate the multilateral nuclear deal known as the Joint Comprehensive Plan of Action (JCPOA). In particular, I argued that the belief held by Iran hawks in Washington foreign policy circles, that economic pressure will eventually force Iran to the negotiating table, exaggerated the importance of oil exports for Iran’s economy.

New data indicate that, while Donald Trump’s policy of “maximum pressure” has reduced Iranian oil exports to near zero and seriously hurt Iran’s economy, it has not caused anything resembling economic collapse. Furthermore, these data suggest that the economy is not in a steep decline, one that would anytime soon force Iran to capitulate.

The national accounts data, published by the Statistical Center of Iran (SCI), indicate that, in the Iranian year 2018/19 (21 March 2018 to 20 March 2019), GDP declined by 4.9 percent, which is far from a collapse of output. Coming after two years of robust growth following the July 2015 nuclear deal, it puts the economy still above its 2015 level.

This decline was, not surprisingly, led by the oil sector, which fell by 14 percent, followed by manufacturing (6.5 percent), which depends on imports of parts, and construction (4.5 percent).  However, non-oil GDP, which measures the level of domestic economic activity, fell by only 2.4 percent. This is because output in services, which accounts for 55 percent of Iran’s non-oil GDP, remained unchanged, and agriculture, accounting for another 10 percent, fell by 1.5 percent.

Iran’s economy has taken a beating, but it is not a disaster, as President Trump likes to describe it. To most Iranians, his remarks last September—which he repeated in June—that Iranians “can’t buy bread,” showed how out of touch he is with the consequences of his own policy.  Travelers to Iran have noticed, as I did this summer, that supermarkets shelves were full (though mostly with home produced goods at high prices), and there were no lines in government distribution centers, which are the hallmark of real disaster economies, like Venezuela.

High prices, triggered by the tripling in the value of the U.S. dollar since early 2018, have taken their toll on household incomes. The most recent SCI survey of income and expenditures shows that in 2018/19 average real incomes per capita fell by 6.7 percent in urban areas and 9.1 percent in rural areas, more than the decline in GDP per capita. These are sharp drops, but obviously not enough to ignite urban protests, as the Trump administration had hoped.

Going forward, the question is whether the Iranian economy is on a steep decline, is stabilizing at a lower level, or is on the road to recovery. This will influence Iran’s willingness, or lack thereof, to negotiate with the U.S., and should matter for Washington as it evaluates its Iran policy in light of its failure so far to yield the desired results. As always, Iran hawks recommend staying the course with “maximum pressure,” believing that Iran will “ultimately do a 180 if they perceive that there’s no way out.”

But what if there is a way out? What if Iran can restructure its economy to become less dependent on imports and truck along with reduced oil exports? Iranian leaders may be pinning their hopes on this scenario and thinking that the worst is over when they flatly reject negotiations.

In this belief they can draw support from the International Monetary Fund (IMF). In its April 2019 World Economic Outlook, the IMF predicted that negative economic growth in Iran will end in 2020 and positive growth of around 1 percent per year will prevail till 2024. Not a rosy scenario by any means, as it implies loss of economic growth and declining per capita incomes for the foreseeable future, but it may be enough to convince Iranian leaders not to capitulate.

IMF forecasts beyond a year do not always materialize, and we do not know their assumptions about when U.S. sanctions will end. But the latest evidence from Iran’s labor force survey suggests that an end to the recession may be in sight. They show that in spring 2019, compared to spring 2018 before sanctions came back in full force, employment increased by 324,000 and the number unemployed fell by 365,000. As a result, the unemployment rate fell to a five-year low of 10.8 percent.

Significantly, half of this increase in employment was in industry, the sector that is most exposed to sanctions because its production depends on imports of intermediate inputs. Nearly half of all Iranian imports are intermediate goods.

Cynics have reason to doubt official Iranian surveys, but the rise in employment reported by the SCI makes good economic sense. For over a year, Iran’s currency has been at a historic low and its labor costs the cheapest in memory (about $5 per day for unskilled labor, half that in China). With rising profitability, it makes perfect sense for businesses to increase hiring to fill in for lost imports.

But the switch to local production faces two obstacles. First, the U.S. sanctions themselves. To sustain the structural adjustment needed to reconfigure industrial production requires access to global markets, which trade sanctions inhibit. Second, it requires a banking system to finance businesses to restructure. Iran’s banking system is too weak to do so at present.

While the prospects of economic recovery remain uncertain, it is safe to reject the assumption that Iran’s economy is on a “death spiral,” to use a favorite phrase of Iran hawks. While economic conditions are desperate for many Iranians in need of jobs and medicine, they are not desperate enough for Iran’s leaders to risk getting into a costly war with their southern neighbors and the U.S. just to end the current stalemate. Iran’s Supreme Leader, Ayatollah Ali Khamenei, who has ruled out negotiations with Trump, is for one interested in finding out if the economy will rise to the challenge of sanctions and thus become the “resistance economy” that he has advocated for years.

Photo: IRNA

Iran’s Supreme Leader Emphasizes Practical—Not Political—Economic Aims

Two weeks ago, during a high-level meeting with the Islamic Republic's political elite, Supreme Leader Ayatollah Ali Khamenei reiterated familiar calls for a “resistance economy,” but also placed new emphasis on the “business environment and increasing the ease of doing business.” While it is not unusual for Khamenei to focus on Iran’s economic challenges in such addresses, the specificity of some of his statements suggests a new appreciation for the importance of practical economic reforms that go beyond political slogans.

Pointing to several chronic “illnesses” of the Iranian economy during the meeting—attended by President Hassan Rouhani, Parliament Speaker Ali Larijani, and Chief Justice Ibrahim Raeisi—Khamenei declared, "If those illnesses are cured under the current sanctions, Iran's economy will experience a leap forward."

Khamenei outlined four main challenges facing the Iranian economy: oil dependence, including the spending of oil revenues on “living expenses” rather than long-term development; unnecessary government interference in the economy, including the failure to fully implement the privatization programs outlined in Article 44 of the constitution; the poor business environment, which is hampered by a cumbersome government bureaucracy; and budgetary reform, which extends to government-led reform of the banking sector.

The supreme leader’s latest speech build on an earlier deadline he set for the Rouhani administration, tasking the government to restructure the its budget and overhaul banking regulations. Khamenei took the opportunity to remind government officials that there remain just "two months left for the task to be accomplished.”

Over the years Khamenei has given his assent to various economic reforms, including privatization and banking reforms. But he has also extolled the virtues of import substitution and the need for Iranian industries to indigenize new technologies to help reduce the Iran’s vulnerability to sanctions. These aims have given his messaging a predominantly political outlook.

Over the last two decades, the slogans chosen by Khamenei to indicate the focus of economic policy for the Iranian new year—“boosting production,” “supporting domestic commodities,” “economy of resistance and job creation” etc.—have offered a general goal towards which government policies ought to be directed. But there is a new specificity in the supreme leader’s recent statements that suggest a growing awareness—perhaps triggered by the economic protests of early 2018—of how economic circumstances have a direct bearing on the perceived legitimacy of the political establishment.

In his recent comments, Khamenei admitted that Iran’s economic struggles are squeezing the poor and the middle class. But he expressed confidence that the country had not reached a “dead-end in the true sense of the word." While conceding that U.S. sanctions on Iran are “unprecedented,” he insisted that "the Islamic Republic is made up of a strong metal,” and that this strength derives from the Iranian people and their mentality of “resistance.”

The concept of resistance has long been a central motif of Khamenei’s political messaging. In an economic context, the supreme leader uses the word to describe policies that “fortify and lay solid foundations for the economy.” For economic planners and the business community, the concept of the “resistance economy,” has spurred the launch of programs that seek to improve the resilience of the Iranian economy to external shocks, whether fluctuations in the oil price or sanctions.

First Vice President Eshaq Jahangiri leads a recently established department responsible for implementation of such programs. Khamenei even offered a few words of rare praise for steps taken by the Rouhani government within Iran's ambitious self-sufficiency drive, including achievements in wheat production and a recent declaration of gasoline production independence.

Importantly, Khamenei’s latest call to boost industrial production included an acknowledgement that Iran’s industries cannot be fully disconnected from global markets. The supreme leader stated, “At times we may need a certain part or raw material which has to be imported. Financial transactions [for those purchases] are not possible. There are problems. But we need to make a push and produce them indigenously.”

Khamenei also pointed to the phenomenon of Iran’s high interest rates, which are a response in part to chronic high inflation. He relayed an encounter with an industrialist who had told him he “can put his capital in the bank and benefit from the high returns,” but had decided not to do so because “the country needs production.” Khamenei stated that “such people are few” in Iran, and therefore reforms are needed to correct incentives.

Perhaps most remarkably, speaking about the country’s poor business environment, Khamenei stated, “I have heard that in some countries of the world, half the time is needed to launch a new business, but [in Iran] there are many challenges and barriers.” The allusion to “doing business” rankings, which measure the ease of establishing a new business in countries around the world, points to an awareness that successful reform will also require Iran to adopt international best practices, a notion that could have a bearing on the success of key reforms such as those required by the Financial Action Task Force (FATF) action plan.

The new specificity in the supreme leader’s comments on the economy may have spurred Rouhani’s speech last week, in which he insisted that he ought to be granted special powers to enable his government to more effectively respond to the “economic war” waged by the United States. Rouhani’s request, which pointed to the provision of such authorities during Iran’s eight-year war with Iraq, was accompanied by a clarification that opening negotiations with the Trump administration is “absolutely” not his government’s preferred policy at this time. 

Some critics have accused Khamenei of seeking to distance himself from the nuclear deal and the widespread disappointment brought about by the reimposition of sanctions.  The supreme leader advised political leaders not to explain away Iran’s economic woes by blaming sanctions, nor to expect the lifting of sanctions at any point in the near future. In a veiled criticism of the Rouhani administration’s economic policy thus far, Khamenei suggested it was a mistake for the country’s economic plan to depend on sanctions relief, stating "[This has been] one of our problems from the outset… We should not make our economy conditioned on [sanctions relief].”

But Rouhani may sense an opportunity in the supreme leader’s more practical interest in economic issues. Having been significantly weakened by the turmoil surrounding the nuclear deal, the Rouhani administration nonetheless retains well-respected ministers in key posts. Rouhani appears to be making the case that should supreme leader truly wish to see some progress on economic reforms, his cabinet deserves renewed political capital as it enters a final two years in office.

Photo: Khamenei.ir

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

Three Years Later: Europe’s Last Push on the Iran Nuclear Deal

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

The Iran nuclear agreement marked its third anniversary in a gloomy state. Despite repeated attempts to keep him on board, US President Donald Trump withdrew the United States from the deal – signed on 14 July 2015 under the formal title the Joint Comprehensive Plan of Action (JCPOA) – and thereby pulled the rug from under Europe’s feet. European policymakers are now focused on salvaging the agreement. For a growing number of European corporate decision-makers, the deal is already dead. In reality, the JCPOA is on life support and the next few months could open either its next or final chapter. Despite the significant challenges they face, European governments have some limited time to avert the deal’s collapse.

In 2015, global powers unanimously hailed the agreement as a historic achievement that proved the effectiveness of multilateral diplomacy. Indeed, the JCPOA provides unprecedented oversight of Iran’s nuclear programme. Furthermore, the agreement states that parties anticipate it will “positively contribute to regional and international peace and security." Many hoped that the resolution of the nuclear dispute would result in a new understanding between the West and Iran, opening a pathway for detente rather than confrontation. Relations between Europe and Iran have certainly made gains in this direction, but the Trump administration’s maximalist stance on Tehran has created an extremely hazardous environment for all remaining stakeholders in the nuclear deal.

Washington's Pressure Package

Since the formal US exit from the agreement in May this year, the Trump administration has sought to sabotage European efforts to sustain the agreement. This has involved a policy of relentlessly threatening and otherwise pressuring any country or company inclined to maintain economic channels with Iran, by weaponising US secondary sanctions. Reportedly, the US administration recently rejected an appeal by the EU foreign ministers to negotiate broad exemptions to such sanctions for European companies. The US clearly intends to specifically target European trade with Iran – although there remain questions about its ability to do so and the reach of US enforcement.

Together with its allies in the Middle East – particularly Israel, the United Arab Emirates, and Saudi Arabia – the Trump administration is increasing its efforts to squeeze Iran on multiple fronts. As a new report by the European Council on Foreign Relations outlines, this anti-Iran front views the collapse of the JCPOA as the trigger for a wider policy aimed at confronting Iran. The policy seeks to cause a deep economic crisis in the country, creating domestic divisions intended to bring about regime change. As part of this, the Trump administration has signalled its willingness to go further than any previous administration by choking off Iran’s oil exports. 

European Resistance to US Sanctions

European leaders’ have repeatedly stated their commitment to upholding the JCPOA. Policymakers are making genuine efforts to find an economic package that minimises the impact of looming US secondary sanctions to sustain Iranian compliance with the deal. But these efforts have yet to generate an environment in which a reasonable number of European entities can make a firm commercial decision to continue doing business with Iran.

Although the European Union’s leaders remain unified in their support of the JCPOA, divisions are emerging between the 28 member states over how far they are willing to test the limits of US secondary sanctions. Moreover, several proposed ideas for safeguarding European companies against extraterritorial US sanctions would require months or even years to implement, as they require alternative financial mechanisms that are ring-fenced from US exposure. European governments are also falling short in the political momentum needed to salvage the nuclear deal. For instance, Germany and the United Kingdom are now far more preoccupied with challenges at home than they were in 2015, and EU institutions are focused on averting further transatlantic divide on trade and NATO.

Unsurprisingly, many European firms have little confidence that European policymakers will create the conditions necessary to protect them from US secondary sanctions, including by providing alternative mechanisms for doing business with Iran that are compliant with US sanctions. This has resulted in a wave of pre-emptive corporate overcompliance with impending US regulations and a decline in European business with Iran even before sanctions come into force.

Iran's Patience Wearing Thin

This month, the foreign ministers of France, the UK, Germany, Russia, and China (the E3+2) met with Iran to discuss political and economic pathways through which they could safeguard the JCPOA. And Iran’s president, Hassan Rouhani, visited Austria and Switzerland to deliver two overarching messages. The first was that Iran’s patience was wearing thin and its full compliance with the JCPOA was only feasible if it continued to receive tangible benefits from the agreement. The second was that Tehran would abandon the agreement if it became unable to maintain oil exports and, accordingly, its share in global energy markets.

Rouhani’s visit followed a tense OPEC meeting, Trump’s call for Saudi Arabia to increase oil production, and weeks of speculation about the extent to which the US could pressure other countries to halt exports of Iranian oil. In Europe, Rouhani stated: “assuming that Iran could become the only oil producer unable to export its oil is a wrong assumption”. 

The leader of Iran’s Islamic Revolutionary Guard Corps (IRGC) was quick to emphasise that elite forces were prepared to act on Rouhani’s words, noting: “we will make the enemy understand that either everyone can use the Strait of Hormuz or no one”. Iran has issued such warnings in the past, including during the 1980-88 Iran-Iraq war and in 2011 in advance of the EU and US embargo on Iranian oil. Iran may retaliate against any US attempts to curb its oil exports by disrupting regional crude shipments in the strait, through which 35% of all seaborne oil exports pass. Such measures seem unlikely for now – given the risk of military escalation with US and regional naval forces, and of damaging relations with China and Russia, which wish to keep energy markets stable.

Rouhani’s statement suggests that Iran is hardening its position. Qassem Suleimani, commander of the IRGC’s Quds Force, unexpectedly welcomed Rouhani’s threat.

Despite the significant political and economic challenges shaping Iranian domestic politics, the Trump administration’s maximalist posture may inadvertently lead to a consensus between the Rouhani government and the military elite on how to respond to national security threats. This may abruptly or gradually prompt the Iranian political establishment to shift away from diplomacy with Europe and towards confrontation with the US. Calculations on whether the JCPOA can be sustained will heavily influence this decision.

Iran is likely to continue implementing the JCPOA and engaging in diplomacy with Europe for at least a few more months, as it assesses the impact of US sanctions on its economic relations with Europe, China, and India (particularly in relation to oil exports), as well as the likely trajectory of US domestic politics in the aftermath of midterm elections.

Necessary European Action

Unless one side backs down, Tehran and Washington will escalate their dispute in a manner that poses real risks to European interests in non-proliferation, security in the Middle East, and global energy supply. It is imperative that in the coming weeks and months European governments redouble their efforts to sustain the nuclear agreement and ease regional tensions.

Firstly, they should continue to explicitly warn the US and their partners in the Middle East that they will not support a strategy aimed at destabilising Iran internally or pursuing regime change in the country. Such an approach risks destabilising a country of 80 million people close to Europe’s border. At the same time, European governments should address their many areas of disagreement with Iran – most urgently, those involving regional security. As ECFR’s new report recommends, this should be done in a strategically careful manner that avoids fuelling further conflict in the Middle East.

Secondly, European governments must strive to fulfil their commitments under the JCPOA. They have made a good start by incorporating US secondary sanctions into the EU Blocking Regulation, due to be amended in August. But they need to quickly implement more practical solutions that will affect companies’ calculations on Iran (for a detailed list of recommendations, see the box below). Otherwise, there will be an exodus of European firms from the Iranian market.

European efforts to keep Iran in the JCPOA will face major challenges, including US attempts at sabotage. The Trump administration will look to use the JCPOA as a bargaining chip in its bilateral negotiations with Europe, China, and Russia on trade policy, tariffs, and sanctions. Therefore, European leaders must make important decisions about how far they are willing to go to secure a nuclear agreement borne out of more than a decade of diplomacy. They can only do so if they act collectively and firmly. Yet they must do so to prevent escalation between the West and Iran that will have disastrous consequences for global security.

Recommendations

1. The EU/E3 should accelerate measures to establish a foundation for sustaining financial channels (including SWIFT) with Iran before November, when the US will introduce secondary sanctions designed to hit Iran’s oil and banking sector. In this, European central and state banks will have act as a bridging mechanism. While there are ways of moving funds to and from Iran, state banks will have to engage in operations that provide settlement and clearing facilities. At the same time, European governments should remind Iran that their banking relationship can only continue if the country follows the Financial Action Task Force’s road map.

2. The EU and member states should devise a financial framework within which European companies (particularly small and medium-sized enterprises) can do business with Iran while complying with US sanctions. Technical experts have called for the creation of special purpose vehicles or “gateway banks” (supported by European state banks). These mechanisms will need to avoid direct links between Iranian entities and European private banks. Cooperation on this should extend into a larger structure that crosses a coalition of willing member states, thereby sharing risk between them.

3. The EU and member states (particularly leading importers of Iranian oil such as France, Greece, Italy and Spain) should increase their coordination with China and Russia on measures to minimise the impact of US secondary sanctions on Iranian oil exports. European countries should firmly reject any proposed US framework for significant oil reduction from Iran in return for waivers to continue limited oil exports. This would amount to legitimising the US secondary sanctions architecture. Russia and Iran are already in talks over significant Russian investment in the Iranian energy market, which could reportedly involve increased purchases of Iranian oil that could be reprocessed for global distribution via Russia. The E3 and China, together with other relevant private sector entities, should investigate whether it is feasible to offset potential reductions in Iranian oil exports through oil-swap arrangements with non-signatories to the JCPOA such as Turkey and Iraq.

4. The European Commission should incorporate clear guidelines for European companies into amendments to the EU Blocking Regulation. The regulation includes a compensation mechanism (Article 6) that allows European entities to seek compensation if they become subject to extraterritorial US financial penalties. As this mechanism has rarely been enforced, its limits remain unclear. The European Commission should work with member states, regulators and the private sector to clarify and facilitate access to compensation, particularly for small and medium-sized enterprises that do business with Iran.

5. The European Commission should mandate a competent body to facilitate legitimate European business with Iran. The body should provide comprehensive oversight of the US Treasury’s enforcement of extraterritorial sanctions. This should involve a reporting mechanism that assesses the legal and other tactics the US Treasury adopts against European companies, pursuant to secondary sanctions. The body should also assist European companies subject to US investigations.

6. The European Commission should address discrimination and overcompliance relating to trade and investment with Iran in the European banking sector. As this problem is a direct consequence of US secondary sanctions, European leaders should primarily address it through regulatory measures that set a burden of proof requiring company boards to certify that their decisions are legally grounded under European law. The Blocking Regulation can provide a foundation for such measures. European regulatory bodies should provide greater oversight of European commercial banks’ decisions to block the flow of funds relating to Iran, reducing the likelihood that such decisions will be arbitrary.

7. The E3/EU should not invest heavily in attempts to negotiate with the US administration on exemptions from secondary sanctions, given the Trump White House’s clear lack of interest in treating European allies amicably. The E3/EU should shift to a more firm and robust negotiating posture similar to their stance on US trade tariffs. They should warn the US about the costs for Western energy consumers of reducing purchases of Iranian oil at a time when Libyan, Venezuelan, and Nigerian exports have been disrupted, given that it remains uncertain whether Saudi Arabia and Russia will increase production to offset this disruption. European governments should limit the US Treasury’s space to demonstrate the power of sanctions in Europe. EU member states should urgently engage in private consultations to prepare countermeasures against US attempts to pressure SWIFT and its board members or to target European entities – using specially designated nationals lists – for doing business with Iran deemed legitimate under EU law.

Photo Credit: IRNA

They Want War With Iran, They’re Settling For Economic War

This article was originally published on LobeLog. 

On Tuesday, the U.S. Treasury’s Office of Foreign Assets Control (OFAC) sanctioned Valiollah Seif, governor of the Central Bank of Iran (CBI) as a “Specially Designated Global Terrorist,” accusing him of moving “ millions of dollars on behalf of the Islamic Revolutionary Guard Corps-Qods Force (IRGC-QF) to Hezbollah.” OFAC’s move opened a new front in the Trump administration’s accelerating conflict with Iran. The designation of a single individual, even the central bank governor, may not seem that significant. After all, Trump announced last week that he would reimpose all primary and secondary sanctions lifted as part of the Joint Comprehensive Plan of Action (JCPOA) as part of withdrawing from the nuclear deal. But targeting Seif may prove to be the pivotal moment in an economic war.

Iranian financial institutions have long been designated for suspected terrorist financing, and the Obama administration used such measures to isolate Iran’s economy in the effort to bring Iran to the negotiating table over its nuclear program. But the move to target Seif as an individual represents a significant escalation for two reasons. First, it reflects the direct targeting of a member of the Hassan Rouhani administration in a clear role of civilian leadership. Seif is not a rogue actor. He is a public figure, who travels regularly to Europe to engage in technical dialogue. Just recently, he welcomed Swedish central bank governor Stefan Ingves to Tehran. Seif also travels to the United States when invited for meetings at the International Monetary Fund and World Bank.

Moreover, Iran’s central bank is at the heart of an expansive effort to reform the country’s anti-money laundering (AML) and counter-terrorist financing (CTF) standards. Iran’s parliamentary research center recently concluded in a comprehensive report that “a considerable portion of the problems in Iranian banks’ correspondent relations with global counterparts is rooted in non-sanction reasons” including poor AML/CTF standards. Seif has been a central figure in the effort to improve these standards. Politically speaking, OFAC’s action could not be more different from the routine targeting of Iran’s military brass.

Second, the move represents an escalation because of who was likely behind it. It had long been assumed that OFAC was relatively immune to the more irascible political impulses in Washington. The application of sanctions was informed first and foremost by the need for restraint. As noted by former Treasury Secretary Jack Lew in a 2016 speech, OFAC was expected to “guard against the impulse to reach for sanctions too lightly or in situations where they will have negligible impact.” Lew advised his colleagues to be “be conscious of the risk that overuse of sanctions could undermine [America’s] leadership position within the global economy, and the effectiveness of [American] sanctions themselves.”

The Strategy of Economic Warfare

Neither Trump nor his close advisors are averse to undermining America’s leadership position in the world. The decision to sanction Seif under a terror designation carries the hallmarks of the Foundation for Defense of Democracies (FDD). A 2016 policy brief by FDD’s Mark Dubowitz and Annie Fixler, written on the occasion of Seif’s visit to Washington for meetings at the IMF, identifies the central bank governor as “no stranger to illicit finance” and claims that CBI “stands out for its long rap sheet of financial crimes.” More recently, Richard Goldberg and Saeed Ghasseminejad argued that “the White House should re-impose sanctions on the Central Bank of Iran” in order to push Iran’s currency into a “freefall” and precipitate a deeper economic crisis. This later piece makes it especially clear that FDD is not interested in the application of sanctions to achieve economic coercion. It seeks economic destruction.

As a strategy to confront Iran, economic warfare has clear advantages for the White House. The strategy allows Trump to continue to claim to be a non-interventionist and does not require him to send American troops to die in another quagmire. Economic warfare also allows avowed interventionists such as National Security Advisor John Bolton to pursue their destructive ends without the disapprobation following their support of the Iraq War. By trying to force Iran to collapse from within, by goading the Iranian people to tear down their own state, and by portraying that process as a popular revolution, Bolton can achieve his messianic goal without the high risk of blowback that would certainly face this chaotic administration from a military conflict.

Acknowledging that the Trump administration is adopting a strategy of economic warfare towards Iran means recognizing that the long-held distinction between economic concerns and security concerns vis-a-vis Iran are collapsing. In recent months, European and Iranian officials have made an effort to clarify that the JCPOA is “not an economic deal” but “a very important deal in the field of the non-proliferation regime.” In this formulation, the economic component of the deal is only valuable insofar as it serves a security goal. But Trump’s move to reapply sanctions on Iran—despite the country’s compliance with its commitments under the deal and with the clear purpose of fomenting instability in Iran—transforms the effort to save the JCPOA into an effort to shield Iran from an unjust economic war.

Europe’s Response

Seeing the economic threat to Iran as a security threat should have a significant bearing on how Europe responds to Trump’s provocations. In its recent formulation of a diplomatic strategy to save the JCPOA, Europe is seeking to preserve the economic benefits of the nuclear deal to incentivize Iran’s continued commitment to its non-proliferation commitments. But in the aftermath of the U.S. snapback of sanctions, and the likely escalation of those sanctions beyond levels previously seen, the imperative must be to insulate Iran’s economy and the Iranian people. The U.S. is seeking to instigate instability by putting pressure on the Iranian people, who know all too well the pain of shortages in foodstuffs and medicines that sanctions portend.

Iran will likely be able to prevent internal instability, but doing so will entail securitizing larger parts of the economy and society as was the case during the Mahmoud Ahmadinejad administration. In such a scenario, the ascendency of the IRGC will risk regional conflict by exacerbating the security dilemma with Saudi Arabia and Israel. Europe must recognize that a strong Iranian economy is fundamental to both internal and regional security, especially in the face of sustained pressure from the United States.

On Tuesday, French officials convened a briefing for French business on possible responses to Trump’s reimposition of secondary sanctions. French Minister of Economy Bruno Le Maire reportedly cited the French parable that “money is the nerve of war” to describe what is at stake. Later that day, reports emerged that the foreign ministers’ meeting among the EU, France, Germany, the UK, and Iran focused on a “nine-point plan” devoted to “maintaining economic ties with Iran, continuing Iran’s ability to sell oil and gas products and protecting EU companies doing business in Iran.”

The limits of European independence in international relations and tradecraft have been exposed by the break with the United States over Iran. As described by Siemens CEO Joe Kaeser in a recent interview, the corporation’s decision to wind down operations in Iran is a reflection of the “primacy of [the American] political system. If that primacy says ‘this is what we’re going to do’, then that is exactly what we’re going to do.” As in the case of the primacy of American military might, Europe long relied on the primacy of U.S. sanctions enforcement, grafted as it were onto the primacy of the U.S. financial system, in order to lend power to the once cohesive foreign policy of the transatlantic partnership. Now, the primacy of the U.S. system is a liability for Europe and a threat to Iran.

Photo Credit: IRNA

Rouhani Government Unifies Iran’s Exchange Rates in Decisive Move to Stabilize Currency

In a decisive move intended to stop the further devaluation of the rial, the Rouhani government announced it would unify the official and free market dollar exchange rates, settling on an official rate of IRR 42,000.

First Vice President Eshagh Jahangiri made the announcement last night, declaring that trading dollars above the new rate would be a serious crime.  "Just like the smuggling of drugs, no one has the right to buy or sell [above the new rate]... If any other exchange rate is formed in the market, the judiciary and security forces will deal with it," he warned.

"There should not be such incidents in an economy that always has a surplus of foreign currency. Some say interference by foreign hands is disrupting the economic climate and some say domestic machinations are spurring these things in order to destabilize the climate in the country," added Jahangiri.

Earlier in the day, the Economic Commission of Iran’s parliament had summoned Minister of Economic Affairs Masoud Karbasian and Central Bank Governor Valiollah Seif for an emergency meeting regarding the careening value of the rial, which had reached a record low of IRR 60,000 to the dollar.

Speaking to reporters after the meeting, Karbasian continued the government line that the devaluation was not a reflection of the true state of the economy. Rather, he obliquely suggested that the “security agencies” ought to be summoned to explain the real cause for the fluctuations. His comments were an apparent reference to rumors that certain actors opposed to the Rouhani government, likely in the security establishment, were hoarding dollars in order to exacerbate speculation and undermine confidence in the government’s economic management.

However, in the face of this significant political pressure, the Rouhani administration made a bold move, instituting a policy that has eluded the country’s economic planners since the 1979 revolution. Rate unification has long been considered a necessary step to introduce more stability in Iran’s monetary policy and foster a better business environment for the country’s enterprises.

Iran's last major currency crisis of a similar scale took place in 2012. Then president Mahmoud Ahmadinejad similarly blamed psychological factors for the rout, arguing in a speech, "Are these currency fluctuations because of economic problems? The answer is no. Is this because of government policies? Never … It's due to psychological pressure. It's a psychological battle." His government similarly tried to unify rates at IRR 12,260. But sanctions made it difficult to generate sufficient supply of hard currency in Iran, and the unified rate collapsed after just a few months. 

During this most recent currency crisis, the rial had lost about one-third of its value against the dollar over the last Iranian new year, which ended on March 20. The devaluation accelerated beginning in December, and the rise in the free market price of the dollar tracked closely with that of gold. Both gold and the dollar have been typical “safe-haven” investments for Iranians wishing to hedge against inflation and general economic uncertainty. However, inflation had remained flat over the previous twelve months, and real estate prices were relatively stable, suggesting little change in the purchasing power of the rial. The net effect was a rampant devaluation more akin to a bubble, fueled by rising doubts among Iranians about the survival of nuclear deal.

Though clearly responding to the recent turmoil, the Rouhani government had already begun the groundwork necessary for such a unification. In March of last year, Catriona Purfield, a senior economist at the IMF, suggested that Iran could perhaps unify the rates earlier than expected, stating, “Half of imports have been put on the market rate and most of the goods are now at the flexible rate. Interbank FX market has been reestablished. Therefore all the elements are there, so an early move is possible.”

The new rate of IRR 42,000 is closer to the rate economists expect would be necessarily for unification. Economists Mohsen Bahmani-Oskooee and Sahar Bahrami looked at exchange rate data from 1979 to 2015. They concluded that had Iran’s rial been allowed to depreciate in accordance to changes in purchasing power parity, the exchange rate in 2015 would have been around IRR 47,000. The rial’s purchasing power has been relatively stable in the last few years and so this is likely a fair estimation of the current dollar rate in PPP terms.

Yet, despite the clear economic rationale behind the rate unification, it will remain to be seen whether the political gamble pays off for Rouhani. The official exchange rate presented a lucrative arbitrage opportunity for quasi-state actors, who could purchase dollars at the lower official rate then sell the hard currency on the black market. These entrenched interests will no-doubt see the unification as a direct challenge by Rouhani, and a further example of his administration's continued efforts to reign-in rent seeking in the economy.

But for the general public, such a confidence-inspiring move should serve as an indication that the Rouhani cabinet, despite the claims of infighting and mismanagement, remains capable of the kind of coordinated policymaking necessary to reform the economy.

Photo Credit: Vahid Salemi

Iranian Protests And The Working Class

This article was originally published in Lobelog. 

In February of 2017, I wrote about Iran’s “forgotten man,” the member of the working class who seemed invisible in the talk of the country’s post-sanctions recovery:

What has been lost is an appreciation that the “normalization” of relations between Iran and the international community is as much about elevating “normal Iranians” into a global consciousness, as it is about matters of international commercial, financial, and legal integration. While there has been progress in building awareness of Iran’s young and highly educated elite, whose start-ups and entrepreneurial verve play into the inherent coverage biases of the international media, a larger swath of society remains ignored. By a similar token, the rise of the “Iranian consumer” with untapped purchasing power and Western tastes has been much heralded, but the reporting fails to appreciate that Iran’s upper-middle class rests upon a much larger base whose primary economic function is not consumption, but rather production.

With the new wave of protests sweeping Iran, it seems that the country’s forgotten men and women may be mobilizing to ensure their voices are heard in Iran and around the world. There is a growing consensus that the protests are comprised primarily of members of the working class, who are most vulnerable to chronic unemployment and a rises in the cost of living.

The idea that these are working class protests has explanatory power. First, if the protests are indeed a working-class mobilization, then they are less surprising, and can be seen as akin to the regular “bread riots” that took place during Ahmadinejad’s second term, when Iran’s economy suffered its sharpest contractions.

Second, a working class outlook may explain why the political slogans and imagery of the Green Movement have not been deployed by the protestors. The Green Movement was a predominately middle class movement focused on civil rights, which emerged in response to a chosen candidate being fraudulently denied an election victory. Solidarity with lower class voters was limited and economic grievances were not a central focus.

Third, such a demographic composition may explain the support conservative political groups in Iran have given to the protestors, despite the spectacle and soundtrack of anti-state slogans that have marked many of the gatherings. Conservative politicians are being careful not to alienate members of their base, while trying to cast the protests the predictable outcome of Rouhani’s economic policies. Moreover, a working class composition of the protests can explain how exactly Iran witnessed a successful presidential election with historic turnout and a clear victor just six months before mass mobilizations in cities across the country to protest the government. It may be that those turning to protest now feel their voice was not heard in the May elections.

A simple comparative review of upper-middle income countries such as Iran—including Brazil, Mexico, Thailand, and Russia, among others—demonstrates that while protests end with political expressions, they usually begin with economic motivations. That Iran’s working classes are ready to mobilize, and that the mobilization was so quick, makes sense within the context of Iran’s current economic malaise.

It is generally overlooked when discussing Iran’s post-sanctions economy that Rouhani has operated an austerity budget since his election in 2013. Some even describe his policies as “neoliberal.” While an imperfect descriptor, his administration’s economic approach does broadly correspond to the neoliberal “Washington consensus,” which seeks economic reform through trade liberalization, privatization, tax reform, and limited public spending, focus on foreign direct investment, among other policies.

Such an economic approach is in many ways understandable. Rouhani is seeking to correct the populist excesses of the Ahmadinejad administration while also addressing longstanding structural issues in Iran’s economy such as its overextended welfare system,  a reliance on state-owned enterprise, and cronyism and corruption. But these are, by dint of difficulty, long-term reform projects, which may not fully cohere until after Rouhani’s tenure has ended. In a way, it is laudable that the administration is applying such an outlook for the benefit of what Homa Katouzian has called a “short-term society.” But the near-term political costs are becoming clear.

Rouhani’s budget is ultimately ill-suited to addressing the economic imperative of job creation, which is urgent and at the heart of popular dissatisfaction. As economist Djavad Salehi-Esfahani has written in response to Rouhani’s most recent budget:

One of the main stated goals of this budget is to create jobs, but it is hard to see how it can do that by slashing the development budget at a time that interest rates are very high (they exceed inflation by 5 percentage points or more).  The unemployment rate has been rising in the five years that Rouhani has been in office, mainly because of increased supply pressure, but low demand has been an equal culprit.  With unfavorable news about the future of the nuclear deal and the removal of sanctions, thanks to the 180-degree turn in US policy toward Iran, the prospects for a foreign-investment driven recovery are dim.  With public patience running low, the debates in the parliament over this budget should be more serious than the usual haggling over the needs of special interests.

Most governments in Rouhani’s position pursue expansionary monetary policy and boost public spending to try to drive investment and economic growth. But Iran faces a series of economic challenges that complicate such a response. For example, the principle economic achievement of the Rouhani administration has been to bring inflation under control. The International Monetary Fund expects inflation to sit below 10% this year, down from 40% in 2013. Controlling inflation is critical to bringing stability to prices in Iran’s basket of goods, where other market forces continue to drive up prices. Any attempt to pump money into Iran’s economy to spur investment risks undermining the success on inflation.

Additionally, in the face of low-growth, central banks commonly lower interest rates to make it cheaper to finance new investment. But Iran’s interest rates are being slowly rolled back from a high of 22% to the present level of 18%. Slow adjustments are necessary due to Iran’s banks being overleveraged. Reducing the interest rate too drastically, especially as inflation remains stubborn, would have two effects. First, savers would see their deposits lose value. This would predominately hurt lower-income savers who have a less diversified range of assets. Members of the middle class still benefit from asset appreciation in still robust categories like real estate, stocks, or even gold. Middle class fortunes have improved somewhat following the nuclear deal for this reason. On the contrary, members of the working class rely on interest-bearing deposits accounts to conserve wealth and are therefore very vulnerable to fluctuations in interest rates. The controversy over the unsustainable interest rates offered by unlicensed savings and loan institutions, which spurred protests in cities across Iran in the summer 2017, is indicative of the vulnerability.

Second, a lower interest rate would threaten the financial wellbeing of many of Iran’s banks, which have long skirted reserve ratios and amassed toxic debt. Any attendant drop in deposits would make it even harder for banks to shore up their reserves, making politically fraught recapitalization by the central bank more likely. In the recent assessment of Parviz Aghili, CEO of Iran’s Middle East Bank, it would cost as much as $200 billion to bring Iran’s $700 billion balance sheet in compliance with Basel III standards, which call for a minimum leverage ratio of 6%. By comparison, Rouhani’s total budget for the next Iranian calendar year is $104 billion.

In the face of limited options, the Rouhani administration believed that post-sanctions trade and investment, made possible by the sanctions relief afforded under the Iran nuclear deal, would enable the country to kick-start growth and investment that supports job creation. But the economic dividend of the nuclear deal has not materialized as anticipated. The majority of business leaders believe that this is primarily due to external factors, namely President Trump’s threats to re-impose sanctions on Iran, rather than Iran’s own challenging business environment. The nuclear deal has been so central to Rouhani’s economic plan, with the nuclear deal and investment deals basically conflated in much of the discourse, that the concern around the future of the nuclear deal has also hit confidence in Rouhani’s economic management at large.

Overall, Rouhani is running an austerity budget because he is between a rock and a hard place. The policies he is adopting are economically sensible and necessary—so much so that the budgets have been passed despite pushback from parliament and other corners of the Iranian power structure as to the approach, neoliberal or not. But the policies are politically costly, testing the patience of a people who feel that the hopes for a better livelihood slipping away as the years pass. As Mohammad Ali Shabani writes, the circumstances in Iran can be described by the concept of the J-curve, which posits that mobilizations occur “when a long period of rising expectations and gratifications is followed by a period during which gratifications … suddenly drop off while expectations … continue to rise.”

We cannot fault Iranians for their rising expectations, for they are a people who know their immense potential. This is especially true of the working classes, who have built Iran’s diversified economy with their labor and the country’s rich culture with their values. As Iran has grown richer and more advanced, the burgeoning middle class has come to represent the future. But the recent experiences of wealthier economies offer a cautionary tale about “forgetting” the working classes, and sacrificing their expectations to protect the gratification of others.

Photo Credit: IKCO