Brief n.5, December 2020

In the past two years, the Iranian economy has entered a period of crisis, which many Iranian economists and state officials assess as the worst since the 1980-1988 Iran-Iraq war. The main cause of the crisis is the sanctions imposed unilaterally by the United States following their withdrawal from the Joint Plan of Action to Address the Iranian Nuclear Problem (JPOA) in May 2018. However, there are other factors contributing to the crisis. They include structural economic and financial problems, poor governance and corruption. In 2020, the COVID-19 pandemic added difficulties to the ongoing crisis. International lockdown contributed to the slowdown of the global economy and decline in the world oil prices. These circumstances have become extremely painful for all oil exporting countries: Russia, Venezuela, Saudi Arabia and Iraq. However, for Iran, amid international isolation, this situation turned out to be twice as difficult. The continuation of economic crisis threatens to degrade the Iranian oil industry and, given the social protests, which already took place in November of last year, destabilize of the political situation in the country.

Economic decline and its indicators

The decrease in the volume of the Iranian economy is indicated by the following data: as of March 2020, for the period 2018-2020, Iran's foreign exchange reserves decreased by $40 billion and amounted to $73 billion. The decline in GDP in 2018-2019 (the Iranian fiscal year starts in March) was 4.6%, and for 2019-2020 it was projected at 7.3%. However, these forecasts were made even before the COVID-19 epidemic. Taking into account the recent negative developments in the Iranian economy, the decline in GDP, according to the forecasts of the World Bank, may reach 15%.

The last two years have seen a significant drop in the exchange rate of riyal (the national currency) against the dollar. Decline started in May 2018 and was primarily caused by two factors: the US withdrawal from the JPOA and the attempt of the Iranian government to introduce a single foreign currency exchange rate. Traditionally there were three exchange rates in Iran: the most preferential one for state foreign economic contracts, the intermediate one for Iranian import companies, and the exchange rate for individuals. The attempt to introduce a single exchange rate led to a rising demand for US dollars. As a result, during 2018-2019, the exchange rate rose from 43 to 139 tomans per dollar, and during the coronavirus epidemic jumped to 190 tomans (a toman is equal to one thousand riyals).

The most severe blow is felt by the energy sector, which is the backbone of the Iranian economy. First, there are sanctions that induced traditional buyers of Iranian oil to abandon it. Trump administration has sanctioned companies buying Iranian oil, insurance companies hedging oil deals, and shipping companies transporting oil. At the same time, Iran was excluded from the SWIFT system. As a result, in 2019, EU member states, Japan and India almost completely abandoned the import of Iranian oil, while China reduced its purchases to a minimum. Second, in March 2020 the "price war" between Russia and Saudi Arabia provoked decline in world oil prices. Third, global demand for oil dropped due to the COVID-19 pandemic. Oil production in Iran has declined to its lowest level in the past 40 years, leading to Iran's oil storage facilities to be overfilled. If in 2018 Iran produced over 3.5 million barrels per day, by June 2020 production dropped to 1.9 million barrels. Iranian oil exports fell from 2.5 million barrels per day in 2018 to 0.5 million barrels by the end of 2019. In the spring of 2020, Iranian oil exports fluctuated between 100 and 210 thousand barrels per day.

By July 2020, prices rose to $ 40 per barrel. However the Iranian budget was based on the projection of at least $ 50 per barrel. Sanctions hit Iran's non-oil export sectors as well. Their total volume has decreased compared to 2018 from $ 47 to $ 28 billion (primarily as a result of sanctions against Iran's petrochemical sector that had negative impact on other economic sectors). Iranian riyal fell against the dollar; country’s budget deficit went up 20%. In 2020, domestic consumer prices rose by 29.7%, the highest price hike in the past 30 years, and according to some observers it may reach 40%. The inflation lead to a decrease in purchasing power that can be as high as 70% over the past two years.

Social effect of economic hardship

The steady decline in the living standards, especially among the poor, cannot but cause social unrest. From 2011 to 2015 Iranian economy had already experienced a recession due to sanctions. The situation started to improve in 2016 following the signing of the JPOA. From 2015 to 2017 Iranian economy showed the signs of recovery: inflation was brought down from 30% to 8%, there were signs of economic growth. It could have been significantly higher if not for the structural issues, in particular weak tax discipline. By 2014 around 40% of Iranian businesses were tax-free. These were mainly companies owned by Islamic foundations (bonyads). According to Iranian law, they do not have to pay taxes if they donate a fifth of their income (khums) to the Islamic clergy. However, no one can reliably estimate the exact amount of these tax deductions. The Hassan Roukhani government reduced the number of such non-payers, but failed to eliminate the problem completely. Another factor is the poor technical equipment and lack of efficiency of many Iranian enterprises, coupled with the absence of an independent judicial system to regulate disputes between economic actors.

Social unrest that took place in Iran in November 2019 was a result of the deterioration of economic conditions of the poorest strata. The official reason for the unrest was a threefold increase in fuel prices, which meant that the government cancelled the fuel subsidies introduced during the Iran-Iraq war of 1980-1988.(1) According to independent observers, one hundred thousand people took part in protests; semi-official internet portal "Javan," close to the Islamic Revolutionary Guard Corps (IRGC), estimated the number of protesters close to eighty thousand. The protests were relatively quickly suppressed and did not have serious consequences for the political situation in the country. Very few representatives of the middle-class joined the protests.(2) The protests hardly touched Iranian capital Tehran except for the poor eastern districts of Piruzi and Tehranpars. However, they demonstrated that the patience of the Iranian most disadvantaged was running out, and if the economic situation worsens, the protest may spill over to more prosperous social strata.

Possible ways out of the crisis: real solutions or palliatives?

Significant deterioration of economic conditions in Iran is pushing the Iranian government to seek solutions to remedy the situation. However, the practice shows that internal tools for radical improvement are not sufficient. One of the instruments to improve the economic situation is the trading of shares on the Tehran Stock Exchange (TBS). Despite the decline of global stock markets, securities’ trading on the TBS is flourishing. In March-July 2020, the TBS trading volume increased by 625%. TBS registered five hundred thousand active traders. Twelve million Iranians have bought or sold market shares at least once in their lives. Such active involvement in the stock market trading is explained by the people’s desire to hedge their savings against constant inflation and the rise of the dollar. In the face of the apparent shortage of US dollars, money is invested in real estate, gold or stocks. Under President Mahmoud Ahmadinejad (2005-2013), Iran started the program of privatization. However, this privatization was very peculiar. State-owned enterprises and firms were corporatized, but the shares were sold not to private owners or foreign investors, but to state-controlled companies and Islamic funds (bonyads), such as Bonyad-e-Mostazeffin, Astana-e-Kods Razavi, etc. Their efficiency or productivity did not increase as a result of privatization. Speculative growth in the securities valuation and the rise of cash flows gave a short-term growth effect, but did not solve the problem of the economic downturn as a whole.

Another possible way of improving the economic situation is finding foreign investment. Under the existing circumstances, only China can become a source of such investment. In July 2020 rumors began to spread about the new Iran-China agreement on economic cooperation in the making. The importance of a treaty, regulating special economic relations between Iran and China, increased after the United States quit the JPOA and resumed the regime of sanctions

According to media reports, the new agreement project stipulates Chinese investments in Iran's oil, gas and petrochemical industries to the amount of $ 280 billion over the next 25 years. China will invest $ 120 billion in Iran's transport and industrial infrastructure. In return, China receives the exclusive right of access to the Iranian energy sector. The Chinese side acquires the right to buy oil, gas and petrochemical products with a 12% discount. Chinese companies are also eligible for a 6-8% discount on transactions considered risky. At the same time, Chinese companies are entitled to installment payments for up to two years. Most importantly, they have the right to pay Iran in soft currencies earned in commercial transactions in Africa and the CIS. In this case, the money will be converted into hard currencies by Iran-friendly Western banks. Iranian sources say that depending on the rates at which this exchange will take place, the Chinese hope to get a discount of another 8-12%. Thus, the total discount will be up to 32%. Chinese companies will build industrial facilities in Iran to manufacture goods under Chinese brands; these goods will then be sold on in the West. China plans to develop Iran's transport infrastructure and include it in the One Belt, One Road program.

Iran and the European Union

It seems that further economic and political isolation of Iran does not play into the hands of Europe. EU’s passive position reduces the chances of European companies to work successfully in Iran after the sanctions are lifted. Following the signing of the JPOA in 2015, Tehran pinned its hopes of economic cooperation on the European Union. In 2016, Iran, France and Italy signed memorandums of understanding worth 16 billion euros. Deals defined in these memorandums included the participation of France’s Total in the development of Iranian oil fields, the purchase of Airbus aircrafts by Iran, and the access of French and Italian companies to the Iranian infrastructure projects. After the Europeans reneged on their obligations, Iranians opted to work with China.

Further deterioration of Iranian economy leads to weakening of the Iranian reformists in the government and strengthening of the IRGC and conservative groups. China has a chance to establish a long-term economic and political presence in the Persian Gulf and the Caspian Sea region. In given circumstances, the EU states may not want to wait for the new Washington administration to change its approach to Iran and start reviving their economic and business ties to Iran. Introducing the INSTEX payment system may be the first step in this direction.(3)

  1. Every year 69 billion dollars were allocated for fuel subsidies (about 15% of the GDP). Given the continuous sanctions and dropping revenues, it seemed reasonable for the Iranian leadership to subsidize fuel.
  2. The Green Movement, which unfolded in the summer of 2009, was dangerous for the government due to the participation of the middle-classes and women.
  3. The INSTEX (Instrument in support of Trade Exchanges) is a payment system that was created on January 31, 2019 at the initiative of the European Union. Its mission is to encourage transactions that are conducted without using US dollars or the SWIFT system for commercial transactions with Iran. INSTEX is headquartered in Paris. Its CEO is Per Fischer, one of the leaders of the German Commerzbank in 2003-2014. In May 2019, it was announced that the use of INSTEX would be limited to Iran’s procurement of food supplies and medicine. Until the spring of 2020, the payment system was virtually inactive, likely due to political pressure from the United States. On March 31, 2020, the first very limited transactions took place.

Copyright by ICSE, 2020