by Djavad Salehi-Isfahani
The decision by the Trump administration not to renew the temporary waivers that had allowed eight countries to continue to import Iranian oil will further reduce Iranian oil sales and worsen Iran’s already difficult economic situation. But it is very unlikely to force Iran to renegotiate the multilateral nuclear deal that the administration unilaterally abandoned last May.
For the Islamic Republic, resistance to Washington has become a cultural norm, and it considers independence (esteghlal) as the main achievement of the 1979 revolution. According to Secretary of State Mike Pompeo, Iran would have to meet 12 conditions before the United States will renegotiate the nuclear deal and consider removing its sanctions. These conditions, which are nothing short of surrender on Iran’s part, are either set to force Iran out of the nuclear deal and therefore trigger the return of UN sanctions, or they are a thinly veiled call for regime change.
Further cuts in Iran’s oil exports are unlikely to bring about economic or political collapse. Like the listing of Iran’s Revolutionary Guards as a foreign terrorist organization, its impact is more psychological than real. It seems intended to strengthen the hand of those in Iran who criticize President Hassan Rouhani for trying to save the nuclear deal.
Between oil sanctions and sanctions that limit Iran’s access to global banking and trade, the latter are much more important in determining the outcome of the current standoff.
Since the re-imposition of U.S. sanctions last May, Iran’s oil exports have fallen by half, from about 2.5 to 1.3 million barrels per day. Ending the waivers is likely to reduce them by another 50 percent, bringing government revenues from oil to under $30 billion in 2019. This level of oil revenues by itself is not a game changer for Iran. What matters is what Iran can do to stimulate its domestic economy to fill the gap left by lower oil income. That, in turn, depends heavily on sanctions on banking and trade.
To understand the complicated role of oil in Iran’s economy, consider the fact that between 1998 and 2004—President Mohammad Khatami’s first term in office and before the oil boom of the last decade was fully underway—Iran’s average level of oil exports was about $20 billion per year while the economy grew by 5.2 percent and added 600,000 jobs per year. During the next six years, 2005-2011, under President Mahmoud Ahmadinejad, when oil exports ballooned to an average of $80 billion per year, the economy grew more slowly (3.2 percent) and added only 14,000 jobs per year. Iranians imported and consumed more but worked less.
In both periods that preceded the tightening of U.S. sanctions in 2012, Iran’s economy was operating under relatively mild sanctions. What distinguished the two episodes was the level of oil exports and differences in government policy. Khatami’s partial opening toward the rest of the world and embrace of Iran’s youthful population and growing middle class led to economic optimism and economic growth with modest oil revenues. In contrast, under Ahmadinejad, higher oil prices further opened up the economy to the rest of the world, the economy became more dependent on imports, and employment suffered. Furthermore, his anti-business domestic policies and confrontational foreign policy hurt investment and led to international isolation and sanctions that drove the economy into recession.
During the last six years, 2012-2018, oil revenues averaged about $50 billion per year. But the country was mostly under severe sanctions, so economic growth averaged 2.2 percent per year only. The economy added more jobs, especially during a brief period when sanctions were partially lifted, in 2016. Even when oil revenues hit their lowest level ($30 billion) in 2015 as a result of the collapse of oil prices, the economy contracted but continued to add 600,000 jobs.
The basic economic insight here is the well-known notion of oil as a mixed blessing if not a curse. High oil revenues raise consumption but discourage production and employment because they cheapen foreign currencies and make domestic production unprofitable. By reverse logic, low oil revenues can be good for growth because they increase the price of foreign currencies and thus make domestic production more competitive both at home and abroad.
Of course, replacing lost oil revenues with greater non-oil exports requires access to global markets. Thus, to make good of a bad situation also needs sound economic policies, in particular allowing the exchange rate to depreciate. In the case of Iran, neither condition is met. U.S. sanctions restrict Iran’s access to global banking and trade, and exchange rate policies favor consumption over production.
The Rouhani administration, like other Iranian governments in times of crisis, has favored consumption over production. In a futile attempt to keep food prices down, it has allocated more than one-third of its scarce foreign currency at less than half the market price to the import of essential goods, only to find those imports on sale at high prices in shops while the currency finds its way into the parallel market.
On the other hand, to its credit, it understands the value of remaining in the nuclear deal. Despite Trump’s attempts to provoke it to leave the deal, Iran has so far stood by its side of the bargain, thus allowing the European powers to set up a special trading mechanism, known as INSTEX, which is expected to facilitate trade between Iran and international firms that do not have much exposure in the U.S. market and therefore do not fear disregarding U.S. sanctions.
In 2013, as oil exports headed toward zero under the weight of sanctions, Iranian leaders saw the possibility of reaching a deal with President Obama and decided to go for it. The hard task of restructuring the economy to live without oil did not seem necessary. Today, with the possibility of a deal with the Trump administration quite remote, the Iranian government seems more determined to travel down the road not taken. The “resistance economy,” once the catchphrase of Iran’s Supreme Leader and the country’s hardliners, has now replaced talk of globalization and foreign investment in government circles. Although what a resistance economy means and how to reach it remain vague, Iran’s political factions may discover that remaining in the nuclear deal and maintaining some level of international support are still essential ingredients for the economy to function in the new age of sanctions.