Six months after the US sanctions came into effect, Iran’s economy appears to be struggling. Efforts by the international community to salvage the nuclear deal and provide an economic lifeline to Iran to dampen the fallout of the sanctions have not borne fruit so far and recent devastating floods in the oil-producing southwest of the country have only exacerbated the situation.
Even before the recent decision by the United States government not to extend waivers provided to eight buyers of Iranian oil, the Islamic Republic was able to sell no more than 1.3 million barrels per day (bpd). Now its oil exports are expected to drop even further, which means the deficit gap in the state budget this year will be larger than expected.
At the same time, the measures the Iranian government is taking in order to minimise the effect of the sanctions are unsustainable and unlikely to work, as they do not address any of the major structural problems the economy suffers from.
The Islamic Republic continues to resort to inefficient stop-gap economic policies because giving up on its promise of social provision, which constitutes a major part of its post-1979 social contract, could endanger its survival.
A raging economic crisis
When preparing the budget bill for this year, President Hassan Rouhani’s administration planned for oil exports to be around 1.5 million bpd, sold at a price of $54 a barrel or above. Thus the budget submitted to parliament earlier this year was set at 4.8 quadrillion rial (around $47bn at the current unofficial exchange rate) and up to 33 percent of it was supposed to come from oil revenue.
Earlier this year, before the Trump administration took the decision to stop US sanction waivers was announced, the oil sector was estimated to shrink between 26 and 31 percent. With this announcement, the slump in the oil industry is expected to be even bigger.
Even if the US fails to bring Iranian oil exports to zero, sales will definitely collapse way below the government-projected 1.5 million bpd (and even below the 1.1 million bpd estimated by market experts), leaving Iran with a large financial gap.
This comes amid an already raging economic crisis which the Iranian authorities have struggled to contain. As inflation hit 40 percent earlier this year, consumer prices went up by 40 to 60 percent, putting additional strain on the already impoverished lower-class Iranian households.
Key industries – like the petrochemical, car and construction industries, which are highly dependent on imported equipment, spare parts and raw materials – are also suffering from the depreciation of the Iranian currency, which last year lost more than 100 percent of its value, significantly decreasing the purchasing power of Iranian companies on the international market.
Overall, Iran’s economy in 2019 is expected to go even deeper into recession, with estimated negative growth of 5.5 percent or higher.
New problems, old fixes
In the face of a looming economic disaster, the Iranian government is paradoxically adopting policies that do not address any of the major structural problems burdening the national economy.
The budget voted in March envisions an increase in current expenditures by 16 percent to maintain existing social programmes, boost state employee salaries to compensate for the negative effect of inflation and provide cheaper foreign currency to companies importing essential goods and raw materials. Some $14bn has been allocated to maintain the low prices on basic food products and medicines.
The government is also seeking to regulate domestic prices by directly demanding from some producers to accept lower profit margins. It also offers low prices for the produce of local farmers so it can provide foodstuffs at minimal cost to the general public.
It continues to subsidise fuel and electricity and is even considering the reintroduction of the coupon system it used to run during the 1980s Iran-Iraq war to allocate cheap basic goods to Iranian household.
But these policies are neither sustainable nor efficient. Iran’s financial capacity has already been overstretched by the substantial social spending the government has undertaken in recent years. Currently, annual subsidies and social programmes cost the Iranian government up to half of the total budget.The fact that oil exports will slump below what was planned for in the state budget means that the government will simply not have the money to implement some of these policies.
In fact, it is already struggling to fulfil some of the plans it has made to provide additional assistance to struggling sectors. As of mid-March, the Iranian authorities had already failed to provide 20 percent of the loans they promised to car makers and car spare part producers.It also had to cancel a programme supplying bread producers with cheap wheat flour in order to reallocate the funds to cover the guaranteed purchases of grain from local farmers.
Tehran’s attempts to control consumer prices are also not working. Providing importers with cheap foreign currency is unlikely to produce the desired results. The Majlis Research Center, a think-tank affiliated with the Iranian parliament, recently found that in 2018 a similar measure had little effect on consumer prices and inflation, as the recipients of cheap foreign exchange currency tended to either sell it on the black market or sell the goods they imported at inflated prices.
Price controls on local producers could also backfire. They could further discourage local businesses from expanding production given the rising cost of raw materials and shrinking profit margins and encourage the excessive export of goods out of the country, adding to the market deficit. Temporary export bans on selected items such as poultry, sugar, certain types of fruit, and more have only stimulated the smuggling business.
Meanwhile, the government is pulling funds out of long-term development and infrastructural projects. In this year’s budget, the allocated funds to the National Development Fund which is supposed to help decrease the dependence of the Iranian economy on oil are inadequate. The fund has also lost part of its reserves which were reallocated to cover military and civilian expenditures.
Iran’s ideological woes
The main reason behind the Iranian leadership’s failure to improve the country’s economic situation is its tendency to focus on dealing with the consequences of economic problems (such as high inflation rates, rising prices, illegal economic activities etc) rather than their sources. In order to find sustainable solutions to Iran’s economic challenges, Tehran will need to make some structural reforms including cutting down or, at least, optimising the unjustifiably large social programmes and indirect subsidies.However, the Iranian leadership is reluctant to take such steps because it goes against its self-declared social protection agenda.
In 1979, Ayatollah Khomeini and his followers declared the protection of the downtrodden, or mostazafin, as one of the main tasks of the newly created Islamic Republic. By doing so, they not only secured the support of the lower classes and guaranteed the durability of their regime, but also unwillingly chained their success to problematic and hard-to-sustain policies such as consumer subsidies.
Arrogance, fanaticism and the prospect of a US-Iranian war
Tensions between the United States and Iran have flared up since the Trump administration withdrew from the nuclear deal with Iran last year and began ratcheting up sanctions on the Islamic Republic.
Earlier this month, tensions turned into threats, as Washington refused to extend sanctions waivers for buyers of Iranian oil, designated Iran’s elite Revolutionary Guards (IRGC) a terrorist organisation, and began military preparations to deter Iran.
These measures are pushing the Iranian economy to the brink. Oil exports, which have already dwindled from 2.5 million to less than 1.3 million barrels a day since last year, could drop even further, crippling the state budget. Ordinary Iranians, who are already suffering from the raging inflation (currently at 40 percent) and skyrocketing prices of goods, will likely bear the brunt of Washington’s push to bring Iranian oil exports to zero. And this is only the beginning.
The Iranian leadership has been defiant. Supreme Leader Ayatollah Ali Khamenei has said this “hostile measure” will not be left “without a response”, while President Hassan Rouhani has threatened to disrupt oil shipments from Gulf countries. Foreign Minister Mohammad Javad Zarif has cautioned that Iran could walk away from the nuclear deal and warned against a potential escalation to war.
If the past three Gulf wars of the 1980s (Iraq-Iran), 1991 (US/UN-Iraq) and 2003 (US/UK-Iraq) are anything to go by, a confrontation between the US and Iran would prove far more devastating. So why are Washington and Tehran ignoring the lessons of war, and marching eyes wide shut towards another armed conflict? And can anyone stop them?
Even before he was elected president, Donald Trump famously branded the Joint Comprehensive Plan of Action (JCPOA) negotiated by the Obama administration “the worst deal ever” and once he took office, he embarked on dismantling it.
In May last year, his administration withdrew from the JCPOA and issued 12 demands to Iran. It was one of those impossible lists, designed to provoke and humiliate.
The US wants Iran to end all its nuclear and missile programmes, withdraw its forces from Syria, stop its “destabilising” policies in Iraq, Afghanistan and the Gulf, and cease its support for armed groups like Hezbollah, Hamas, and the Houthis in exchange for negotiating a new nuclear deal.
No one would have been more surprised than the US itself if Iran had said yes to any of it. These demands basically constitute total Iranian surrender, not only to the US but also to Israel and Saudi Arabia, Trump’s key regional partners and principle drivers behind the new Iran policy.
National Security Advisor of the United States John Bolton made this crystal clear on the sidelines of the UN General Assembly session last September, when he said: “If you cross us, our allies, or our partners; if you harm our citizens; if you continue to lie, cheat, and deceive, yes, there will indeed be hell to pay.”