Maximum Pressure May Bring Iran Back to the Table After All
Combined with the COVID-19 pandemic, the country is struggling to stay afloat.
Iran has not faced such severe economic pressure since the Mongol invasion in the 13th century. At least that’s the view of Saeed Laylaz, a prominent Iranian economist, whose quip was evidently an attempt to shock the Iranian policy elite into action over the country’s teetering economy.
Whether or not the Islamic Republic is under as much duress as its medieval predecessor, there is little doubt that the country does face a dire economic situation. The economy will likely shrink by 6 percent this year, according to the International Monetary Fund (IMF). Inflation is officially 26 percent and rising, and the rial has reached a historic low against the dollar. Meanwhile, the government has been unwilling and unable to take more decisive steps to stem the coronavirus pandemic, which has officially claimed more than 19,000 lives, although the actual death toll is likely much higher.
The combined effect of U.S. sanctions and the coronavirus pandemic has left the Iranian economy in a highly vulnerable position. And things are likely to get worse as the government comes to terms with the fact that its strategy for funding the budget will come up short. Although the economy is not the only factor in play, the deteriorating conditions certainly raise the odds of talks with the West in the medium term.
Starting in May 2018, the United States’ “maximum pressure” campaign severed Iran’s financial ties to the outside world and devastated its oil exports. Iran sank into recession, inflation soared, and the foreign exchange market shuddered. The economic pressure compounded the corruption and economic mismanagement that are endemic in Iran.
About a year after the sanctions were implemented, though, the economy began to show signs of stabilizing. The government and central bank had brought the rial’s value under control, and non-oil trade improved. Iranian officials and traders focused their attention to their neighbors, on the logic that cross-border trade with countries like Afghanistan, Iraq, and Turkey would be very difficult for the United States to stop. The economy was not out of the woods, but by the end of 2019, Iranian leaders could conclude that they had some hope of withstanding U.S. pressure.
But the pandemic dealt the regime a serious blow; the United States might not have been able to compel Iran’s neighbors to shut their borders, but the virus did. As Afghanistan, Iraq, Turkey, and others took public health precautions and closed border crossings, Iranian businesses suddenly had very limited means for exporting goods. That reduced the government’s access to foreign currency and sent shockwaves through domestic markets.
The pandemic’s effects have rippled across Iranian society. The government projected confidence in the early days of the crisis, but countering the virus proved much harder. BBC Persian reported last week that the death toll is likely nearly triple the official numbers, with the number of infections likely twice as large. The economic impacts have been significant. As domestic consumption fell and businesses shuttered, hundreds of thousands of Iranians lost their jobs. The rial has lost 40 percent of its value against the dollar this year and 20 percent since early June, driven by trade disruptions and corruption.
This spring, the Hassan Rouhani administration rolled out a fiscal stimulus package of about 6 percent of GDP. That figure is above average for developing countries but is still not up to the task. The government was unable and unwilling to do more financially: unable, given the state of the country’s finances and lack of much external aid, and unwilling, given the prioritization of other spending. In the midst of the coronavirus outbreak, Tehran ramped up military spending by 9 percent compared with last year (accounting for inflation), with the Islamic Revolutionary Guard Corps receiving the lion’s share of the funding increase.
The pandemic has further exposed the vulnerabilities in the government’s budgeting. Tehran funds its annual expenditures from three main sources: energy exports, tax revenue, and privatizations/bond issuances. All three are on shaky ground. Iran built its budget on the deeply unrealistic expectation that it would be able export 1 million barrels per day at $50/barrel. In reality, it will likely export about half as much oil at around half the price, accounting for the steep discounts Iran offers its buyers. Tax revenue will almost certainly fall short as well, given the unexpected impact of the coronavirus.
With limited oil and tax revenue, Tehran is doubling down on a privatization scheme, relying on its overheated stock exchange to raise cash. State-owned companies like Shasta, the massive investment firm, have recently offered shares on the Tehran Stock Exchange to citizens, who have flocked to the promise of high returns. Egged on by Supreme Leader Ayatollah Ali Khamenei and Rouhani, the exchange’s value has skyrocketed, doubling between mid-March and early June. And between June and this week, its value doubled again, making it both the best-performing market in the world and likely a bubble that could burst, wiping away the savings of many Iranians. The government will also try to cover the deficit through a huge amount of bond issuances this year, saddling it with a mountain of debt. If there is not enough interest, especially given other attractive investments, the central bank may lend money to government-owned banks to buy the bonds, exacerbating inflationary pressures.
The government could, of course, try to cut expenditures or raise revenues in other ways, such as increasing taxes. But that would be risky even in better circumstances, and the government does not appear to have the political will to pull it off. The last time the state tried to decrease subsidies, in November, nationwide demonstrations erupted. Security forces killed hundreds of protesting citizens.
With the economy under extreme pressure, Iranian policymakers are using short-term strategies to make ends meet. They have little choice, given that the political leadership has almost certainly decided to wait until the U.S. election in November before deciding what to do next.
Regardless of who wins the U.S. presidency, any further economic pressure would be difficult for Iranian leaders to stomach. The United States has assessed that only 10 percent of Iran’s foreign currency reserves are accessible, which would mean that Iran has less than $10 billion in its emergency fund, equivalent to about four months of imports. Iran has also sought a $5 billion loan from the IMF, to no avail. As international trade picks up in the coming months, pressure on the trade deficit will likely ease somewhat, reducing the imminence of a balance-of-payments crisis. Iran also has untold sums of off-the-books cash collected over the years in religious foundations and the supreme leader’s various organizations. This can provide a cushion, but it’s not a sustainable solution.
Whether to negotiate with the United States is ultimately a political, not economic, decision. Tehran will be highly averse to talking if the attitude from Washington is one of unremitting hostility. Still, if the U.S. president in January 2021 decides to consider a credible diplomatic path with Tehran, he will find significant economic leverage at his disposal.
Henry Rome is the senior Iran analyst at Eurasia Group, the global political risk research and consulting firm.