Global Economics

Iran's Economy Can Take the Pressure—for Now


Just after 3 p.m. on Nov. 29, about 200 demonstrators ransacked the British Embassy in Tehran, chanting “Death to England,” setting fire to the Union Jack, carting off a portrait of Queen Elizabeth, and detaining staff as Iranian security officers stood by. It bore all the marks of a state-orchestrated provocation.

What aroused Iranian leaders’ ire were stiff financial penalties imposed on Nov. 21 by the U.K., the U.S., and Canada. The European Union was also expected on Dec. 1 to impose trade and travel bans on almost 200 Iranian individuals and companies. The sanctions punish Iran for clandestine nuclear weapons work and follow dozens of earlier measures intended to make leaders choose between prosperity and the bomb.

The latest penalties were spurred by a Nov. 8 United Nations atomic inspectors’ report contradicting Iran’s claim that it seeks only peaceful nuclear energy. The British sanctions hit the Iranian financial system, including its central bank: The move makes it difficult for any company that has banking operations with a U.K. financial institution to trade with any company with banking operations in Iran, says Jeanne Archibald, a former general counsel for the U.S. Treasury. The Obama Administration has declared the Iranian banking system guilty of money laundering, which means U.S. financial institutions must step up reporting requirements on foreign correspondent banks that may be doing business with Iran. The requirements may prove so onerous that more banks and companies stop dealing with the Iranians.

Earlier sanctions have already hurt, says Matthew Levitt, a former U.S. Treasury official now at the Washington Institute for Near East Policy. “Other than oil, the economy is in very bad shape. People have money, they have enough to eat, but they don’t have jobs,” says Djavad Salehi-Isfahani, a professor of economics at Virginia Tech. Iran has suffered inflation of at least 50 percent in the last two years, he says, and the currency has depreciated by 30 percent in the unofficial market. “The economic welfare of the Iranian people has never been a top priority of the Islamic Republic,” says Karim Sadjadpour of the Carnegie Endowment for International Peace.

Iran would seem to have no choice but to abandon its nuclear program. The reality, however, is more complex. Iran has $80 billion in annual revenues from its crude oil output of about 3.5 million barrels a day, according to the Iranians and production estimates from the International Energy Agency. Its near-total reliance on energy sales is a vulnerability—if oil prices crash. So far they haven’t, and Iran continues to have steady customers in China, Japan, India, and South Korea. Surprisingly, it has European customers, too: Italy, Greece, and Spain are especially important. With prices around $100 a barrel, Iran has, by some estimates, foreign reserves of $60 billion. Its economy may grow 4 percent this year, says Kenneth Katzman, an Iran specialist for the nonpartisan Congressional Research Service.

Mark Dubowitz, director of the Iran Energy Project at the Foundation for the Defense of Democracies and co-author of a confidential report on Iran circulated on Nov. 29 to the Administration and Congress, says oil and natural gas sales represent about 80 percent of Iran’s hard currency export earnings. That suggests sanctions on energy exports could deliver a body blow to Iran. “Nobody with any sense is trying to impose an oil embargo on Iran,” he says. The challenge is “to target Iran’s oil sales without spooking markets.”

Iran has evaded sanctions before. In June it made a deal to barter Chinese goods and services in exchange for oil, circumventing payment difficulties set in place by sanctions. In September, India paid off an oil debt through a Turkish bank to get around similar restrictions. Some analysts wonder what damage the new sanctions can do. “The Iranians have locked sanctions into their strategy,” says Kevan Harris, a researcher at Johns Hopkins University who visits Iran often. “It’s going to hurt. But if you live there, you deal with all kinds of problems.” The regime in Tehran has used sanctions as an excuse to boost self-sufficiency by phasing out costly subsidies on gasoline. That has reduced gasoline consumption and Iran’s reliance on refined gas imports, saving the regime billions of dollars.

Sanctions could achieve their purpose given the right circumstances. If the price of oil slid to about $65 a barrel, Iran’s oil dependence could leave it struggling to meet government budgets. Dubowitz’s idea is to pressure law-abiding companies to sever business ties with Iran, allowing the remaining players to negotiate for deep discounts. So if Europe, Japan, and South Korea abandoned Iranian oil, customers such as China could push for discounts as big as 40 percent, Dubowitz’s group estimates, starving the regime of funds needed for its nuclear and missile programs. Iran is a tough rival. Yet it’s a few short steps away from crisis.

The bottom line: With reserves of an estimated $60 billion, Iran won’t cave easily to sanctions. That could change if oil prices slide.

With David Rocks, Ladane Nasseri, and Flavia Krause-Jackson
Lakshmanan is a reporter for Bloomberg News in Washington.

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