6 June 2018

Iran's Strategy for Surviving U.S. Sanctions

Now that the United States is piling on sanctions, Iran's government is preparing for an inevitable economic decline. Iran's political factions are in relative agreement about how to handle the economic pressure, at least over the next several months. Tehran's goal will be to keep its head above water long enough to outlast the current U.S. administration. It will try to increase non-oil exports to make up for the loss of oil sales, implement financial reforms and slow the depreciation of its currency. Iran's key priorities while it is coping with sanctions will be to keep prices for food and other goods down, minimize protests against the government, and make foreign exchange reserves last as long as possible. One big question is how long Iran's discouraged population will trust the government's survival strategies before they start to protest against inflation and increasing wealth inequality. 

Iran is preparing for major economic and financial challenges now that the United States is ready to implement tough oil-specific sanctions in November. The government in Tehran is unwilling to heed Washington's demands, which include halting its missile program and ending its support for regional militias, because it considers these basic components of the country's defense strategy. So Iran is managing its economy for the long haul, hoping it can insulate itself against the effects of sanctions long enough to outlast the current U.S. administration.

Iran's government will try to manage its finances in a way that protects its population from the most tangible effects of sanctions, employing what it calls a "resistance economy." But even with members of the Iranian government relatively united in their efforts to prevent economic disaster, the U.S. sanctions are powerful enough that Iran's economy is all but guaranteed to go into recession. And though the government will try to prevent unrest, the economic situation will only worsen existing wealth inequality issues, inevitably leading to protests.

The Big Picture

In preparation for Stratfor's upcoming 2018 Third-Quarter Forecast, we are releasing a series of supporting analyses, focusing on critical topics, regions and sectors. These assessments have been designed specifically to contextualize and augment the quarterly global forecast.

Since Iran's 1979 revolution, its government has been debating strategies for how to deal with financial hardship, planning for a "resistance economy" that ideally could insulate the country from the U.S.-dominated global economic system. New U.S. sanctions against Iran, including some previously lifted under the nuclear deal, are likely to put severe pressure on its economy. Because the Iranian government is more coherent today than it was in 2012 — the last time it faced a wave of damaging oil-related sanctions — Iran will be able to make some progress on financial and economic reforms that will help slow the inevitable recession. Internal reform certainly won't be enough to stave off recession, but it will be enough to help the government in its goal of outlasting the current U.S. administration.

Harkening Back to 2012

One way to understand Iran's current situation is to look back to 2012, the last time the country faced such concerted sanctions. In the years leading up to the 2015 Iran nuclear deal, formally known as the Joint Comprehensive Plan of Action (JCPOA), the United States and United Nations issued waves of sanctions, while the European Union implemented an oil embargo in 2012. Throughout 2012, Iran's economy shrunk by 1.9 percent, and its oil exports had been reduced by more than 1 million barrels per day (bpd).

Things got worse between early 2012 and mid-2013, when Iran's currency, the rial, lost more than two-thirds of its value and unemployment peaked at around 14 percent. These factors were compounded by inequality and social justice issues, such as a crisis over skyrocketing prices for chicken, which prompted Iranians to protest against a government that could not provide basic food for them.

At that point, various factions of Iran's government were already decades into a debate over how to position the country in the global economy. The populist president at the time, Mahmoud Ahmadinejad, championed the economic demands of the poor while also adjusting the country's privatization program to favor his own allies, mostly in the Islamic Revolutionary Guard Corps and hard-line government factions. Both moderate and hard-line clerics in the government rejected Ahmadinejad's perspective, viewing him as disruptive, imprudent and economically dangerous. And in a sign that governmental division was particularly sharp, Iran's supreme leader even directed the Ministry of Intelligence Services to investigate internal corruption in 2012.
What's Different in 2018

In early 2016, the JCPOA rolled back the sanctions that had hit Iran so hard, but now that President Donald Trump has withdrawn the United States from the agreement, Tehran must prepare for an onslaught of penalties once again. On May 8, the United States reinstated all secondary sanctions against Iran, saying it would punish any country whose central bank engages in oil transactions with Iran's central bank. By steadily layering on additional sanctions, the United States is showing that it is willing to target a broad range of Iranian activities and sectors, just as it and its allies did years earlier.

But there are some major differences between where Iran finds itself today compared with 2012. To start, this time, the United States is the main force driving sanctions against Iran. The European Union is less committed to the U.S. plan, and there is no significant sanctions regime from the United Nations, as there was prior to the JCPOA.

Of course, even by themselves, U.S. sanctions are quite powerful. In order to qualify for possible sanctions exemptions, once every 180 days countries will have to prove that they are reducing oil trade with Iran. And though the European Union isn't on board with enacting new sanctions against Iran, it won't be able to stop European companies from avoiding investment in and trade with Iran — especially if the United States decides not to issue waivers to countries that wish to trade with Iran even if they reduce their oil imports.

In the wake of such heavy U.S. sanctions, Iran simply cannot stave off recession. Its currency crisis is only getting worse, with the rial half as strong as it was six years ago and continuing to depreciate. But Iran's economy still has a better foundation than it did in 2012. Unemployment is around 11 percent — 3 percent lower than in 2012. And gross official reserves are at roughly $130 billion, giving the government a bit more of a cushion than it had in 2012, when reserves hovered around $100 billion. Most importantly, though, there is a new level of political coherence in Tehran, which means the government will be both willing and able to pursue reform efforts.

Moderates, conservatives and hard-liners within the Iranian government have been increasingly committed to finding common ground when it comes to managing the economy, at least for the next several months. The political factions may diverge on certain details of policy decisions, such as how to deal with corruption, but they agree overall about the need to stabilize the economy for the sake of national security. Of course, there will still be major arguments over such issues as how to divvy up funds. And political factions will remain engaged in ongoing fights over how each can take advantage of the situation. (The security-focused hard-liners are likely to gain influence over time.) But compared with 2012, Iran's government in 2018 is far more unified, and it will only grow more so as U.S. pressure intensifies.

The Government's Plan For Iran

Moderates, conservatives and hard-liners with the Iranian government have been increasingly in agreement about how to prepare for renewed sanctions. They will focus on implementing financial reform to help the country gain economic independence, restructuring and refinancing banks, and working on fixing nonperforming loans.

Additionally, without the economic protection of the JCPOA, the Iranian government will be putting more emphasis on cultivating domestic production and exporting non-oil products, which are likely to include saffron, pistachios and plastics. Since President Hassan Rouhani took office in 2013, Iran has seen an increase in non-oil exports, which account for just over 11 percent of the country's GDP. Indeed, the fiscal year that ended in March 2018 saw a 6.6 percent rise in non-oil exports year over year. Iran will also seek to refine oil products at home to make up for some of its lost oil export revenue. Already, the government has announced that it is redistributing 300,000 bpd to be refined for the domestic market.

Another crucial method for Iran to ensure it can survive sanctions is to implement contingency plans for shipping, seeking out countries willing to risk U.S. secondary sanctions for port access. Likely options include Pakistan, Oman, Qatar and southern Iraqi ports like Basra. All these countries have increased their trade activity with Iran over the last year, while other major powers have decreased theirs. And since the United States abandoned the JCPOA, Iran has been more actively working to solidify agreements with them.

But smuggling through countries willing to risk sanctions will be harder now than it was in 2012. Iran relied heavily on the United Arab Emirates in the past, but the Emirati government has been willing to work with the United States this time around and does not want to risk being sanctioned. And Qatar may also prove unwilling to cooperate with Iran, as it seeks to remain in the good graces of the United States amid the ongoing rift with other Gulf Cooperation Council nations. These complications increase the likelihood that Iran will eventually have to barter oil for goods as sanctions pressure intensifies.
Holding It Together

More than anything, Iran will strive to prevent its economic strain from translating into currency problems for its populace. The worse the economy gets, the more likely it is that the price of goods will increase and that income inequality will grow. Historically, food prices and unemployment — especially in rural areas — have been the major factors prompting protest and unrest in Iran. So the government will make sure to keep the price of goods in check, even if this means implementing sacrificing funds for short-term solutions such as buying shipments at a loss or making cash payments so that Iranians can afford food. Already, its central bank has issued a directive that allows merchants to directly purchase foreign currencies from money exchanges, even though exchange houses had previously been banned. Regarding unemployment, Tehran will try to spot-treat the issue by offering cash and job training, while also working on long-awaited tax reform and welfare/subsidy payment reform.

Many of these efforts are not designed for the long-term benefit of Iran, and the government does not intend for them to last for decades. Rather, Tehran is hoping that its resistance economy can hold the country together until Trump and his administration are no longer running Washington. Unfortunately for the government, Iranians are more pessimistic than they've been in years. The JCPOA, which Rouhani promised would bring $50 billion in foreign direct investment, had delivered only $3.4 billion in 2017. Across Iran, patience will likely run out before a new U.S. leader enters the White House, meaning economically motivated protests are inevitable.

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