Analysing the Economic and Political Fallout
Three months after the United States first announced it was withdrawing from the 2015 Iran Nuclear Deal, the Trump administration has imposed new sanctions on the Islamic Republic. The first set of sanctions targets Tehran’s purchase of US banknotes, trade in gold and other precious metals, as well as the use of graphite, aluminium, steel, coal and software used in industrial processes. They will also affect transactions related to the Iranian rial, the issuance of sovereign debts and the country’s automotive sector. Another round of sanctions, to be reinstalled on Nov. 5, will be on Iran’s port, energy, shipping and shipbuilding sectors, its petroleum-related transactions and business deals by foreign financial institutions with the Central Bank of Iran. The Trump administration will also re-list hundreds of individuals, entities, vessels and aircraft that were previously included on sanctions lists. Trump is hoping that this new round of sanctions will pressure the Iranian leadership to withdraw its military involvement in the conflicts currently raging in the Middle East. But, it could be a dangerous gamble!
The first round of renewed US sanctions on Iran entered into effect on Aug 07 as part of Washington’s strategy to apply “maximum pressure” on Tehran over its alleged malign activity. President Trump took to Twitter to announce, “The Iran sanctions have officially been cast. These are the most biting sanctions ever imposed, and in November they ratchet up to yet another level. Anyone doing business with Iran will NOT be doing business with the United States. I am asking for WORLD PEACE, nothing less!”
The sanctions prohibit Iran’s purchase of US dollars and precious metals, part of a larger move that attempts to cut the country off from the international financial system. Broad sanctions on Iranian industry, ranging from carpets and healthcare to the automotive sector, are also being re-imposed. In addition to prohibiting US persons and entities from doing business with Iran, the sanctions are also extraterritorial. This means that non-US firms and financial entities that do not comply with the sanctions could face fines and be cut off from the American-dominated global financial system. Let’s analyze the possible fallout of this Trumpian gamble:
Iranians have already been feeling the impact of the collapse of the rial, the country’s currency. In May, after Trump announced the US withdrawal from the nuclear deal, it fell to its weakest position against the US dollar in history. It has now lost more than 80 percent of its value since April. As the currency weakens, investors have been seeking to protect their wealth via physical assets such as gold bars and coins, demand for which has soared in recent days.
However, it is not for the first time that sanctions have been imposed on Iran; the Islamic Republic has faced them during 2012-14 as well. There’s no question that sanctions imposed during the Ahmadinejad administration hit hard the Iranian economy – they hit ordinary people massively via shortages of daily essentials and equipment, while a mushrooming black market brought exorbitant prices. Iran’s GDP contracted from a high of $600 billion in 2012 to a low of $385 billion in 2015. In 2017, two years after the signing of the nuclear deal, Iran’s GDP had grown to only $440 billion, largely on the back of oil sales.
Read More: The End of Iran Nuclear Deal
The rial’s rate of depreciation was similar to the current rate of depreciation. In 2012, the rial lost over two-thirds of its value-the same rate of loss that it has experienced so far in 2018. The exchange rate fell from roughly 10,000 rial to the dollar to about 36,000 by the end of the year. The primary cause of the decline was falling demand for Iranian exports which resulted in falling demand for the rial as well as limited access to global financial markets and, therefore, to foreign currency.
The government responded by restricting foreign exchange trading and creating an official exchange rate. The government then allowed importers in Iran to purchase critical goods like medicine and certain types of food at the official exchange rate, making these goods cheaper for importers. But it had to pay the difference using its foreign reserves, a policy that was unsustainable.
Iran has responded to the recent plummet in the rial’s value in a similar fashion. It curbed foreign exchange trading and set an official exchange rate of 42,000 rials to the dollar. One difference, however, is the depths of the rial’s fall this year. Today, the currency is hovering around 100,000 to the dollar. Iran has recently eased foreign currency rules in the hopes that it would stem the fall of the rial and limit its use of foreign reserves.
At first blush, Iran’s current foreign reserves may not seem particularly vulnerable. According to the International Monetary Fund, at the end of 2017, Iran had approximately $120 billion in foreign reserves, equal to roughly 15 months’ worth of imports. The IMF also noted that many of these reserves may be located outside of the Iranian banking system, in affiliated foreign banks that conduct transactions on behalf of Iranian institutions, limiting the country’s access to the funds.
Iran has faced serious inflation before as well. Ahmadinejad tried to spark domestic investment by making credit cheap – by putting a cap on interest rates that banks could charge borrowers. As the rial fell, and prices increased, the real interest rate, i.e. the interest rate adjusted for inflation, fell into negative double digits as inflation exceeded 40 percent.
But one difference between then and now is that the Iranian economy was growing before 2010, which made it better able to withstand high inflation and a declining currency. In 2008, GDP per capita was the highest it had been since 1974-77. Investment was being used to purchase capital equipment, a sign that people believed the economy was on the upswing. Compare that to today, when Iranians are desperately seeking fixed assets – such as cars and property – as a way to hedge against the depreciating rial and their dwindling savings. In 2010, when one set of US sanctions were implemented, Iran was coming out of a period of relative growth. But-today, Iran is facing serious economic pressure, and it has been for nearly a decade, a brief period of sanctions relief notwithstanding.
Since Iran’s economic conditions are much worse than they were during the previous sanctions regime, the political consequences may also be more dramatic. When President Hassan Rouhani came to power in 2013, he focused specifically on revamping the country’s economy. He implemented measures that would cure some of the negative economic consequences of Ahmadinejad’s policies. Part of Rouhani’s plan to make this happen was to work with the West to seek sanctions relief. Expectations were high, and when sanctions were lifted, people believed the benefits would trickle down to the public at large.
But those expectations turned out to be misplaced. GDP growth stemming from sanctions relief came primarily from greater oil and petroleum sales, which benefited the small portion of the country that controlled oil-related assets, namely the Islamic Revolutionary Guard Corps and other elites. Profits were then used in part to intervene in conflicts throughout the Middle East. This is why protests in recent months against deteriorating economic conditions have featured slogans like “death to Syria” and “death to Palestine,” besides “death to inflation” and “death to unemployment.” Despite its best efforts, the government hasn’t convinced Iranians that the US is responsible for their economic woes. Since large-scale protests broke out at the end of 2017, demonstrators have instead criticized Tehran’s mismanagement of economy.
The composition and location of current protests point to another difference between the two sanctions regimes. In 2009, Green Revolution protesters rarely ventured outside Tehran, and they were nearly uniformly students and upper-middle class citizens. They didn’t have broad support throughout Iran, geographically or demographically. But the large-scale protests at the beginning of this year broke out even before it was clear that the sanctions would be re-imposed. People were already losing faith in Rouhani’s ability to make a real difference in their lives.
Public disaffection with Rouhani is aggravating the divisions within the government as well. The IRGC and many in the clerical establishment were sceptical of Rouhani’s conciliatory approach to the West from the beginning, and are even more so now. The president has lost support among conservative factions that once backed him, despite the fact that he was a reformer, and hard-liners are seeking greater control over the administrative apparatus. That power centres are competing against each other far more directly this time around may hamstring the government as it tries to respond to sanctions.
So, from a political perspective, the accumulated economic damage over a much longer period of time, coupled with growing dissatisfaction with the regime’s handling of the economy, are likely to make these sanctions more consequential. Although an overthrow of the regime is highly unlikely, the incumbent regime will struggle to maintain its presence in the Middle East at the current level, pay its security forces enough money to keep them loyal, and reform the economy to keep opposition to a minimum. There will be no shortage of challenges and there are few options at the regime’s disposal.
While the US has withdrawn from the Joint Comprehensive Plan of Action (JCPOA) — also known as the Iran Nuclear Deal — the EU, China, Russia and Iran continue to uphold the agreement. Now the EU wants to circumvent the current US sanctions which will also punish European companies that do business with Iran.
The EU Commission considers the ‘secondary sanctions’ imposed by the US on European companies illegal. The Americans are seeking to ban European carmakers, banks and energy companies from doing business with Iran. If they violate the ban, their assets in the US may be seized. Even American companies dealing with European companies, which, in turn, are engaged in Iran, face penalties.
For this reason, the EU has adopted the so-called ‘blocking statute’ in order to ward off the effects of American sanctions. The updated legislation came into force on August 07. With the new rules, European companies are granted the right to challenge US sanctions in European courts and seek compensation from the US government or American companies. In practice, this path promises to be cumbersome and costly and even the Commission acknowledged that there is no precedent in such cases.
The blocking statute has never been implemented, although one was issued for the first time in 1996 in connection to economic sanctions against Cuba and Iran. Back then, the threat was enough to persuade the US to suspend secondary sanctions.