Economist Djavad Salehi-Isfahani was visiting relatives in Neishabour in north-eastern Iran in July when hundreds marched down the town’s main street protesting at a shortage of chickens at the official price.
While such protests are hardly new, Salehi-Isfahani, professor at Virginia Tech and a senior fellow at the Brookings Institution, believes this summer’s US and EU sanctions targeting Iran’s oil exports have hit the country harder than earlier measures. “These financial sanctions have seriously disrupted Iran’s trade, for which the authorities were ill prepared,” he tells Emerging Markets. “They’re still trying to figure things out after nine months that have brought a currency crisis and higher inflation as well as chicken protests.”
The rial has fallen to record lows against the US dollar with some reports suggesting it has lost more than 80% of its value since last year. In a news conference in Tehran early this month president Mahmoud Ahmadinejad blamed his country’s “enemies” for the depreciation of the currency and said nobody can put pressure on Iran.
The new sanctions have cut Iran’s oil exports to around 1 million barrels a day (b/d) in August according to data from the International Energy Agency. Although marginally higher than July’s exports, this is less than half the level a year ago, so curbing an income stream that nets 80% of foreign earnings and 50–60% of government revenue. But there is less agreement on the effect on the wider economy.
As tensions have increased over Iran’s controversial nuclear programme, with the US leading a drive to undermine the country’s economy as a means to make the Iranian leadership back down, the authorities in Tehran have become more secretive over economic data.
Keeping secrets
“There are no reliable numbers any more about the budget,” says Salehi-Isfahani. “The Oil Stabilization Fund [a windfall oil account for ‘rainy days’ and infrastructure investment] has been raided, and some say it’s down to zero. There is little transparency for obvious reasons: this is now a resistance – or war – economy, and the government has itself fumbled badly on several fronts.”
The lack of transparency has sparked speculation, encouraged by Iran’s opponents, that the economy is on the verge of collapse, and that this prospect brought Iran into renewed nuclear talks in the spring with the P5+1, the five permanent members of the UN security council plus Germany.
“They are increasingly isolated – diplomatically, financially and economically,” David Cohen, the US Treasury Department’s under-secretary for terrorism and illicit finance, said in August. “I don’t think there is any question that [the sanctions]...played a role in Iran’s decision to come to the [negotiating] table.”
But Salehi-Isfahani is unconvinced: “Overall, I would suggest the leadership does not believe it is staring into the economic or political abyss just yet.”
It is difficult to find data on the impact of sanctions on the economy because of the government’s secrecy and the unreliability of the figures, but Iqtisad Iran (Iran Economics), a Tehran business monthly that is trusted by many inside the country, has made its own detailed assessment of the effect of sanctions on gross domestic product. Two years ago, the magazine put the cost at a loss of 0.5% in GDP growth, but it has recently estimated it at 1%.
When GDP is measured in dollars, the effect is compounded by the inflation that has resulted from the depreciation of the rial and by expansionary monetary and budget deficit policies followed by the government to combat sanctions. Iqtisad Iran shows the value of GDP adjusted for the depreciation of the currency down by $55 billion from the Iranian year 1389 (March 2010–March 2011) to 1391 (March 2012–March 2013).
Subsidy plans
Calculations over the Iranian economy are complicated by the ambitious programme, begun in 2010, of phasing out subsidies of everyday items, especially fuel, which cost over $50 billion a year. The IMF welcomed the programme as one “expected to increase efficiency and competitiveness of the economy, improve income distribution, reduce poverty, and help Iran unlock its full growth potential.”
The removal of subsidies has, however, been mired in political calculations, partly because the Ahmadinejad government has tried to bolster its popularity and partly because the wider Iranian leadership, headed by rahbar (leader) Ayatollah Ali Khamenei, has been concerned not to alienate the wider public at a time of growing international pressure.
Hence, subsidies have been replaced with ‘targeted payments’, which have extended to almost all of Iran’s 75 million people. The current payment of 485,000 rials (around $27) per person a month is now worth less than it once was because of inflation, says Kevan Harris, a postdoctoral research associate at Princeton University who is of Iranian descent, tells Emerging Markets.
“If it is true that 95% of people are getting them, then this is not a ‘handout’ as the media likes to write. It is an income grant – and quite a large one compared to most developing countries. In Brazil’s poor region of Bahia, for instance, only 60% of households are enrolled in the country’s grant programme, Bolsa Familia.”
But critics are sceptical about the programme’s success, saying that liberalizing prices while paying cash subsidies instead is self-defeating. Iqtisad Iran has calculated that, from its introduction in December 2010 until last month, the subsidies programme incurred an overall deficit of $20 billion considering an average exchange rate of 13,000 rials to the dollar.
Nonetheless, Salehi-Isfahani judges the programme a relative success. “The one thing people [in Iran] feared most – riots – didn’t happen,” he says. “The government has paid too much in cash compensation – perhaps about a third too much – and this has contributed to inflation. Their friends at the IMF should have known better and given better advice on the numbers; the government people in Iran are not the best on figures.”
In the medium term, sanctions are reducing the leadership’s room for manoeuvre because of their effects in three important areas: higher inflation, lower oil revenue, and less productive investment. But in all these fields, government policy has compounded Iran’s problems, although the inter-relationships are complex.
In a speech on state television in August, Ayatollah Khamenei urged the Ahmadinejad government to address “inflation and reduced buying power”.
The official Statistics Committee reported to parliament that inflation reached 26.2% year-on-year in July, with foodstuffs up 44.8% and bread up 10.2% on June, while the central bank reported inflation at 22.9% in July. The IMF puts consumer price inflation at 21.8% in 2012 and projects 18.2% for 2013.
High government spending, sanctions and the falling rial have all driven up prices, but there are no easy solutions. “Iran is selling half as much oil, but the rise in the price of oil means the budget is around 25% in deficit this year,” says Harris.
“This is bad, but given the increased level of government spending in recent years, there is room for reductions. The problem is that reducing state spending could drive the economy into recession, as it’s the only pump driving things at present. Expect the government to keep spending as high as it can for as long as it can.”
Crucial here is the level of foreign exchange held by the central bank, a figure it has long refused to reveal. Newer is the secrecy over the Oil Stabilization Fund (OSF), which was established under the previous president Mohammad Khatami to protect oil income for increased investment in the economy to stimulate growth and create jobs.
Shortage of funds for productive investment may be the greatest medium-term problem facing Iran. For many years, popular pressure has grown for direct, immediate benefits from oil wealth.
The gold rush
“Ahmadinejad is a populist and not a builder, except of low-cost housing, and he has raided the investment budget – some say the OSF is down to zero,” says Salehi-Isfahani, but he advocates caution. “This does not mean the government does not have foreign reserves, and it may for example have used the money to buy gold.”
Iran has become Turkey’s top export market this year, largely due to $6.2 billion of gold sales, according to the government statistics agency in Ankara, with gold exports in the first seven months of 2012 five times the total for 2011. The EU has introduced a ban on gold exports to Iran, but Turkey has been denied EU membership and has insisted, even to Washington, that it is not bound by the embargo.
Analysts say that booming demand for gold in Iran may reflect the central bank accumulating the precious metal for the government and private businesses to pay for imports without the problems of using dollars, but also ordinary Iranians, who, with a banking system offering limited options, have long bought gold coins as a safe haven.
As well as curbing government investment, sanctions have hit private-sector investment, with some blaming uncertainty and unfulfilled hopes that subsidies will go to businesses as well as individuals.
Trade with China
A further consequence of sanctions is Iran’s growing dependency on China. Beijing’s purchases of Iranian crude, now around half of Iran’s 1 million b/d exports, are crucial to Tehran’s whole fiscal position. China was already Iran’s leading economic partner last year, with trade of $30 billion up from just $2.5 billion in 2000. As western companies over the recent years have left the Iranian energy market, so the Chinese have moved in to tap Iran’s sizeable reserves of 150.3 billion barrels of oil and 33.1 trillion cubic metres of gas.
But progress in energy development has been slow, despite the signing by a Chinese company of a contract to develop part of the South Pars field, which belongs to the world’s biggest natural gas field.
For years there has been disquiet expressed in the Iranian parliament and media over dependence on China. Iranians buy cheap Chinese goods but resent the way they have undermined domestic manufacturers.
Politicians are wary as the only two lifters of Iranian crude – Unipec, the trading arm of Sinopec, China’s largest producer and supplier of oil, and Zhuhai Zhenrong – are both state-run. Politically, China has stood with Russia in the UN security council against further sanctions, contributing to the tensions seen in secretary of state Hillary Clinton’s visit in September to Beijing.
But China has fine-tuned an approach reflecting its geopolitical and business interests both in Iran and in the US, while driving a hard bargain with Iran over oil prices.
Facing vociferous domestic political pressure, the US administration has gradually targeted China over Iran. Last year Washington blacklisted 20 Hong Kong shipping companies it said were fronts for the Islamic Republic of Iran Shipping Lines (IRISL), earlier censured by the UN over Iran’s nuclear and military programmes, and in January the US sanctioned Zhuhai Zhenrong, allegedly Iran’s largest supplier of refined petroleum products.
This was a signal to Beijing rather than a blow, as Zhuhai Zhenrong has little or no business in the US, and therefore little to lose from being sanctioned, while other Chinese companies have extensive US interests, including Sinopec, which trades in New York.
In Iran, many look forward to sanctions ending and ties with the West resuming – but not at any price. In a revealing interview in June in the magazine Mehrnameh, Asadollah Asgaroladi, a highly influential businessman in Tehran dealing in the export and import of items such as pistachios, fruit, caviar and sugar, said: “We chose China because of the way America treated us.”
Asgaroladi even advocates an Iran-US Chamber of Commerce. “My own pistachios are being sold on the streets of Tel Aviv; they import via third parties,” he said. “We already have told the Chinese not to have any doubt – the day sanctions against Iran are lifted, our cushy relationship will be over. The Iranian taste and temperament is close to that of the western countries. I do not believe the sanctions will be permanent; one day they have to be lifted. However, the side that resists the longer will emerge as the victor.”
—Additional reporting by Golnoush Niknejad