Iran sanctions: How deep will they bite?
Iran is facing hard times as the latest tranche of US-imposed sanctions come into operation. While it is difficult to predict how far the economy will shrink and whether it will bring the current administration under Hassan Rouhani down, it is clear that some remedial measures will help. Among these are bringing inflation under control and ensuring that the burden of the economic shock arising from the sanctions is shared equitably so that the poor do not pay too high a price. Djavad Salehi-Isfahani explains.
FOR anyone watching the Asian Football Confederation (AFC) Champions League final, hosted in Tehran's Azadi stadium on 10 November, the only disappointment was the nil-nil score that denied Iran's team first place in Asia. The stadium scene was energised by a musical performance similar to the half-time show of the US Super Bowl as well as the cheers of 100,000 fans, including hundreds of women. This ebullience was in sharp contrast to the gloom elsewhere in Iran that has descended since the United States withdrew from the Iran nuclear accord (the Joint Comprehensive Programme of Action or JCPOA) and reimposed sanctions.
In Iran, officials blame the sanctions for the economic crisis, while in the United States, officials blame the Iranian government. There is no denying that Iran's economy has serious problems that have nothing to do with sanctions, but there is no doubt that the current crisis is the result of the sanctions. The same economy was able to expand by 18% in the two years when sanctions were partially lifted as a result of the 2015 nuclear deal. During the Iranian year that ended in March 2018, household incomes increased by 6%, after adjusting for inflation. This year and the next, the economy is expected to contract by 2% and 4% respectively.
Regime-change advocates in the United States who hope that sanctions will precipitate economic collapse will be disappointed, however. Economies do not collapse - they shrink. How far Iran's economy will shrink and how Iran's leaders and its people respond to the contraction are the real questions. Will the economy bottom out in 2019 or continue to slide for several more years?
2012 vs. 2018
These questions cannot be answered definitively. But looking at the impact of the 2012 round of sanctions is a good place to start. There are remarkable similarities between the two crises in how they started - with the collapse of the rial currency and rapid inflation - despite the sharply differing philosophies of the governments in charge. In 2012, the populist Mahmoud Ahmadinejad was at the helm, while the moderate and pro-market Hassan Rouhani is the current president. In both cases, when the crisis started, Iran had an overvalued exchange rate and loose controls on capital flight, which exacerbated the impact of the sanctions on Iran's currency.
Starting in May 2012, President Obama ratcheted up US sanctions against Iran's oil exports and banking. By early October, the rial had lost two-thirds of its value. The devaluation increased the price of imports, which quickly spread to the rest of the economy, raising the rate of inflation to an annual rate of 50% for six months before slowly coming down. The crisis forced the economy into a recession that lasted for two years and reduced national output by about 5% per year. The loss of output from this episode alone has been estimated at over $1 trillion in Purchasing Power Parity (PPP) dollars.
In a parallel fashion, starting in January 2018, as the threat of US withdrawal from the JCPOA gained momentum, the rial came under intense pressure and lost 70% of its value in the free market. Inflation has so far followed the 2012 pattern, jumping from a historically low (for the Islamic Republic) figure of less than 10% per year in 2017 to an annual rate of over 60% during the first six months of this Iranian year (21 March-20 September 2018). This was a faster rate of increase than in 2012, and it dealt a larger shock to the economy. Not surprisingly, output is already on a downward trajectory. The International Monetary Fund (IMF) forecasts that output will fall by 1.5% this year and another 3.5% in 2019.
How these shocks will affect personal incomes in the next year or two depends on how quickly inflation is brought under control and how the economy performs under sanctions.
The course of inflation depends on how much the government will try to protect incomes through direct assistance to the poor and how generous it will be with adjustments to the minimum wage and compensation for public employees. But the course of the economy is not under its control and depends to a large extent on how successful the United States will be in enforcing its sanctions.
The fiscally conservative President Rouhani is unlikely to risk taking Iran down the Venezuelan path of economic chaos. In 2012, the possibility of Venezuela-like hyperinflation was not completely moot because the populist Ahmadinejad was in charge. Today, the risk is from political rivalry in Tehran, where Iran's conservatives have been energised by the US departure from the JCPOA. Like Trump, they are betting that popular discontent may bring down Rouhani's government. If the going gets tough, Rouhani may decide to fight his way out of the jam by printing and spending more money.
Although printing money may seem helpful in fending off the conservative challenge, it is ineffective in protecting incomes. A large external economic shock, such as the one Iran is experiencing now, will, one way or another, translate into lower average incomes. The most the government can do is to make sure that the burden of the shock is shared fairly and that the poor do not pay a high price. Doing so would go a long way towards minimising the adverse political impact of the sanctions.
In this regard, Rouhani is in a more difficult position than Ahmadinejad, whose large cash transfer programme, started in 2010, deposited $90 (PPP) worth of cash per person each month in individual bank accounts. The programme was designed to replace highly unequal energy subsidies with uniform cash transfers that not only protected the poor but actually reduced poverty.
Rouhani has opposed this approach, preferring to leave energy prices alone and let the cash transfer programme die out. He has tripled the cash assistance to the three million families who are already under the protection of the two large national welfare programmes. Besides continuing wasteful energy subsidies - the largest in the world - this policy will risk alienating a large segment of the population, the lower middle class, who do not qualify for such assistance.
The one significant improvement in Iran's prospects for resisting sanctions in 2018 relative to 2012 is its superior moral position. In 2012, a globally popular US president, the UN, the European Union and most of Iran's trade partners considered Iran in the wrong. In 2018, Iran is facing an unpopular US president and an EU that is actively trying to set up a mechanism to enable Iran to continue to trade with the rest of the world. Given this more sympathetic global environment, Iran should be able to make better use of the lessons it learnt in evading US sanctions.
To take advantage of this more sympathetic environment, President Rouhani and his tireless Foreign Minister, Javad Zarif, need to convince the sceptics in Iran's leadership that the economic benefits of what remains of the JCPOA still beat the benefits to Iran of resuming nuclear enrichment.
Djavad Salehi-Isfahani conducts research on the economics of the Middle East and is currently a professor of economics at Virginia Tech in the US. He is a non-resident senior fellow at the Brookings Institution and research associate of the Iran Project at Harvard Kennedy School's Belfer Center for Science and International Affairs. The above article is reproduced from the LobeLog website (lobelog.com).
*Third World Resurgence No. 333/334, May/June 2018, pp 46-47