How Sanctions Affect Iran’s Economy

Iran is set for a second round of talks with international negotiators in Baghdad on May 23 on its nuclear program. Some experts and U.S. officials believe that recently imposed sanctions on the country’s financial and oil industries are taking an economic toll and encouraging Iran to negotiate. However, Hassan Hakimian, director of the London Middle East Institute and an economics expert, says Iran’s economy seems to be doing better than some believe, and that "it remains to be seen" whether the sanctions’ bite will impact negotiations. He also says Iran’s government, like other governments under sanction, may find ways of shielding itself from the worst economic effects. "Iran has been expecting these sanctions for quite a while, so they are, in a sense, better prepared than most people might realize," he says.

How do you think Iran’s economy is doing overall, given the sanctions?

There isn’t a lot of data and information that is being produced regularly on Iran’s economy, and there’s been significant gaps in information, and there’s also some question over the credibility over official [Iranian] data, so that doesn’t make it very easy to judge performance. But if you look at somewhat more recent reports--for instance, by the IMF on Iran’s economy last August--what you see is not exactly the sort of creaking economy on its knees in the face of sanctions. Sanctions have created pressure on Iran, but Iran is also a large regional economy with a relatively diversified structure--oil is very important, but it’s not entirely dependent on oil.

Iran’s economy is facing a lot of challenges, and these challenges have been accentuated by the sanctions. The main challenges are (and have been for a while) unemployment, especially amongst youth, and inflation, which is likely to get worse partially because of the depreciation of Iranian currency and partly because of the abolition of the subsidies scheme, which the government put in place about a year ago. These included some sixteen essential items, including energy and bread and sugar. That’s now [been] in place since December 2010, and the government is already talking about a second phase where they hope to improve the targeting [of] the so-called "price correction." The abolition of subsidies was combined with a cash-income transfer to compensate for the rising prices. And in the first phase, the targeting was quite widespread--something like 70 percent. The government has been talking about reducing the coverage and possibly improving the terms of the cash transfer for the more needy families.

So as they’re facing economic uncertainties from greater sanctions, the Iranian people are paying more for essentials?

There’s no doubt [that] the immediate effect of sanctions is to create hardships, and the ordinary people are not immune from that. When the Central Bank of Iran was blockaded by both the U.S. and Europe, the range and scope and severity of the sanctions would be far more pervasive. Whether that is going to make a real difference to the behavior and policy of the central government remains to be seen.

The impact on ordinary Iranians is not in itself going to be enough to bring about a change in the administration, because as we know from the experience of sanctions, there’s a wedge between what ordinary people in a country under sanctions experience and what the elite do. If push comes to shove, the elite and the administration can find ways of shielding themselves from the harshest impact of sanctions.

In the Iranian media, leading up to the last round of international talks, some Iranian officials said sanctions needed to be on the table and that they want them to end, but others dismissed their economic impact.

I suspect that there is a division of opinion on how seriously sanctions are impacting the economic situation. Given the factional nature of Iranian politics, I’m not surprised if there’s no consensus on how serious sanctions and their impacts are. And we can’t forget that before sanctions began to bite, the domestic situation in Iran was such that there were factions within the government, which actually welcomed sanctions. [They argued] that being more disengaged from the international economy is actually beneficial to Iran’s economy, because it gives the domestic sector the protection that enables it to grow and prosper.

The Iranians have come back to the negotiating table after an aggressive posture, especially on the Strait of Hormuz. How much are sanctions playing into this new willingness to negotiate?

It is very difficult to tell. What we have had has been one rather encouraging round of negotiations recently, [but] the Iranian side has certain expectations--they feel singled out in this nuclear debate, they feel they have been put in a rather difficult and asymmetrical situation whereby they have to prove their innocence, and they also feel that until now there hasn’t been any smoking-gun sort of evidence that they have broken their international commitment. To the extent that those issues are not addressed yet, it would be premature to [say] that we’ll definitely see a rolling back of Iran’s so-called nuclear ambitions.

There are two mechanisms, as far as I can make out, that exemplify why sanctions might impact official policy. One is that creating hardships places pressure on people who would then try to bring about change in their government and behavior. But that doesn’t quite stand up to scrutiny. The uprisings in the Middle East in recent times haven’t always coincided with the business cycle. It’s not like whenever you have a recession or downturn, people rise up against their governments--in fact, some of the more notorious uprisings have happened when the economies seemingly have been doing well. The Iranian revolution in 1979 is a good example--it happened after an unprecedented oil boom.

The other and more serious mechanism is that sanctions by design are meant to alter the balance between costs and benefits of certain types of foreign policy, and they’re meant to raise the costs to the target government and reduce the benefits of pursuing a particular course of action (in this case, pursuing nuclear ambitions). Now, if we look at, again, historical experiences of sanctions, not in all situations this sort of psychological, rational thinking seems to work. First of all, there’s no evidence to suggest that this rational cost-benefit analysis is what ultimately determines foreign policy behavior. Secondly, for a very strong ideological state like Iran, maybe the pain threshold is very high.

One of the things central to this debate is oil and how sanctions affect the Iranian Central Bank. How is this going to play inside of Iran in terms of its ability to sell its oil?

This will make it difficult for the Iranian government in the short- to medium-term. Certainly, the European embargo means Iran has to find customers who are at about half a million barrels of oil a day [to replace loss of European oil sales], and secondly, even when it continues to sell oil, it experiences difficulties in laying its hand on the proceeds of the sale of oil because of the expensive nature of the financial sanctions. So this has kind of pushed Iran in two or three directions: a) find new customers, b) offer discounts to maintain customers, and c) enter into barter arrangements or conduct transactions in terms of local currencies, like [the] rupee with India, which reduces the range of imports that Iran can get from trading partners.

It creates difficulties. But you have to bear in mind that other regimes have survived even stricter sanctions than the ones we currently see in Iran, and they have lasted. Look at Cuba, look at Zimbabwe, and look at North Korea. Three of the four countries that have developed nuclear capabilities since the 1970s have done so under sanctions. Iranian sanctions are pretty hefty, but as I said, Iran’s economic structure is relatively diversified. Iran has been expecting these sanctions for quite a while, so they are, in a sense, better prepared than most people might realize.

Iran’s rather generous oil revenues in the last ten years or so have enabled it to build up rather generous foreign reserves. The IMF’s last report mentioned foreign reserves around [the] 80 billion dollar mark; the Iranian sources have mentioned figure of 120 [billion] plus 20 [billion] in gold they have accumulated. So Iran’s ability to import essentials in the coming months and years shouldn’t be underestimated.

You’re saying that they could be in it for the long haul, essentially.

Yes. This is a long and complicated road. There are structural reasons why Iran feels singled out unfairly in this equation. They would not back off from certain positions simply because the economic equation has changed. And any meaningful negotiations will also have to make clear what criteria would have to be met by Iran for sanctions to be lifted. So it’s not just the punitive measures of sanctions, it’s what positive way would allow Iran to get out of this rather difficult situation.

Say that tomorrow, some deal is reached and Iran is back in the international fold. What does the Iranian government need to do to improve its economy as a whole?

The Iranian economy is well-resourced by standards of similar countries elsewhere, but it’s badly managed. It needs essential reforms; it needs much better management, greater transparency, and accountability. And a lot of those are internally rooted. Even with sanctions lifted, the challenges of Iran’s economy will not go away. But it is up to the Iranians to make sure those challenges are confronted, rather than deflected by the shadow of sanctions.