Political and economic necessity will compel Iran to use sanctions relief for domestic priorities
The Rouhani administration was swept into power by voter frustration with the lagging Iranian economy, devastated by economic sanctions. The Iranian public is overwhelmingly in favor of the nuclear deal because it anticipates that any sanctions relief will be spent at home on domestic priorities and will hold Iranian politicians to that demand.
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Much of the money repatriated to Iran will have to be spent on addressing the government’s inherited problems. In addition, Iran needs an estimated $200 billion in investments for its dilapidated energy sector. But perhaps more importantly, at least some of the economic benefit from sanctions relief has to trickle down to the average Iranian. Rouhani was able to win his election because Iranians were desperate for change, especially economic relief. Of course, Iran is not a democracy, and the Guards and bonyads will take a large cut of sanctions relief, whether it is the repatriated money or wealth created through future oil export or investments. But the Rouhani government and the regime as a whole also have to pay attention to popular demands. After all, the regime faced a national crisis before Rouhani’s election: the 2009 mass protests that shook Iran were in no small part the result of the economic and social pressures faced by the population. The need to prevent future unrest had a role in Supreme Leader Ayatollah Ali Khamenei’s decision to support Rouhani’s nuclear negotiations. Of course, Khamenei also had to ensure the loyalty of the Guards and Iran’s traditional merchant class, both of which were hit hard by international sanctions.
None of this is to say that we view the sanctions relief Iran will receive if it complies with the JCPOA with indifference. As the agency with primary responsibility for sanctions against Iran over the last three decades, we are keenly aware of its nefarious activities in the region and have invested years in devising and implementing sanctions to frustrate its objectives.
That said, in gauging the impact of lifting these restrictions, we should be measured and realistic. These funds represent the bulk of Iran’s foreign reserves — they are the country’s long-term savings, not its annual budgetary allowance, and as a matter of financial management, Iran cannot simply spend them. Of the portion that Iran spends, we assess that Iran will use the vast majority to attempt to redress its stark economic needs. President Rouhani was elected on a platform of economic revitalization and faces a political imperative to meet those unfulfilled promises. Iran’s needs are vast — President Rouhani faces well over half a trillion dollars in pressing investment requirements and government obligations. And Iran’s economy continues to suffer from immense challenges — including perennial budget deficits, rampant corruption, and one of the worst business environments in the world. Put simply, Iran is in a massive hole from which it will take years to climb out.
In any event, we will aggressively target any attempts by Iran to use funds gained from sanctions relief to support militant proxies, including by continuing to enhance our cooperation with Israel and our partners in the Gulf.
Iran desperately needs this deal. The sanctions regime put in place by the U.S., U.N. and EU has devastated the Iranian economy. Sanctions have been essential in pressuring the Iranians to come to the table and negotiate away key parts of their nuclear infrastructure. As a CRS report by Kenneth Katzman demonstrates:
Sanctions caused Iran to suffer its first gross domestic product (GDP) contraction in two decades -- about 5% contraction in 2013... Iran's economy is 15%-20% smaller than it would have been had sanctions not been imposed. Many Iranian businesses have failed, the number of nonperforming loans held by Iranian banks increased to about 15%-30%, and many employees in the private sector have gone unpaid or underpaid. The unemployment rate is about 20%.
Sanctions drove Iran's crude oil sales down about 60% from the 2.5 mbd of sales in 2011, reducing Iran's crude oil sales revenue from100 billion in 2011 to about35 billion in 2013 and even less in 2014... The JPA caps Iran's crude oil exports at about 1.1 mbd.
Sanctions caused the value of the rial on unofficial markets to decline about 56% from January 2012 until January 2014. The unofficial rate is currently about 37,000 to the dollar, and the government has repeatedly adjusted the official rate (currently about 27,000 to the dollar) to reduce the spread between it and the unofficial rate.
The drop in value of the currency caused inflation to accelerate during 2011-2013. The Iranian Central Bank acknowledged an inflation rate of 45% in July 2013, but many economists asserted that the actual inflation rate was between 50% and 70%. The sanctions relief of the JPA has helped reduce the inflation rate to about 30% currently.
Mr. Rouhani, the president of Iran, was elected on an economic reform package. But in order to do that, he has to end the sanctions, and in order to do that, he has to make a deal. He's up for reelection in two years; there are important elections next year in the parliament and their government bodies. He needs this deal in order to kick start the economy, in order to aid his political faction in the complex Byzantine Iranian political system.
These challenges have strained not only Iran’s partners, but its domestic politics as well. Iran’s economy has been suffering under international sanctions – its GDP today is onefifth smaller than projections made in 2011 – exacerbating the financial strain of its efforts to bolster its allies.2 Its expensive foreign entanglements come even as Iran is in need of at least $500 billion worth of domestic investment, which will not be immediately forthcoming as nuclear sanctions are lifted.3 It is no wonder then that Iran’s leadership has struggled to build popular support for its policies – one poll found that only 37% of the Iranian public approves of their government’s military intervention in support of the Assad regime.4
Since the international community intensified sanctions against Iran in 2010, Iran has only grown more desperate. For example, the country’s oil sector now needs anywhere from $50 to $100 billion in investment to improve production, a point that Iranian officials, including Oil Minister Bijan Namdar Zanganeh, have emphasized repeatedly over the past two years. External investment was cut off by sanctions, and Iran has not had the spare capital to maintain, much less improve, its facilities. Nor has it enjoyed access to new technologies that could enhance oil field productivity.
Oil is, of course, only one part of Iran’s economy, which includes struggling industries like automobile and domestic manufacturing. To avoid an over-dependence on global oil markets, Iran has also made it state policy to build a diversified export economy. Given the prevailing low global oil prices, Iran is likely to continue trying to strengthen other sectors to maximize its growth potential and limit its vulnerability to an uncertain market.
Lest observers assume that Iran would have turned its entire economy into a terrorism-financing machine if only it had the money, consider the fact that the most intensive sanctions on the country are only 3 years old. Before January 2012, oil sales were bringing in nearly $88 billion a year, money that Tehran largely spent as any government would: on domestic priorities — not solely to back anti Western interests. If the LA Times is to believed, this is a conclusion that CIA has itself reached.
As with the effort to wean its economy off oil, Iran has also sought to reduce costly subsidies on everything from food, to housing, to energy, in order to improve the economy’s efficiency, reduce waste, and spur competitiveness. But sanctions targeting Iranian oil revenues hampered that effort, as the country lacked the hard currency — and political will — to forge ahead with subsidy reform, at least until Rouhani’s election. It is now struggling to complete this project, one that sanctions relief would undoubtedly boost by providing Iran with fresh revenue and reducing its citizens’ dependence on government handouts. This is particularly important for Rouhani, who will be looking to shore up domestic support in the run-up to parliamentary elections in February 2016 and to win reelection in 2017.
Iranians will demand their government spend a windfall from the lifting of economic sanctions on improving the quality of life at home, limiting the degree to which a future nuclear deal could fund Tehran's allies on Middle East battlefields.
Since 2012, Iran has given support worth billions of dollars to regional allies, funding and arming mainly fellow Shi'ite Muslims in conflicts that have taken on a sectarian dimension. Its enemies say lifting sanctions will provide it with the means to do even more.
Within months of financial sanctions being lifted, Iran will be able to collect debts from overseas banks that may exceed $100 billion, mostly from oil importers whose payments have been blocked, diplomats and analysts said.
But with the budget strained by last year's heavy fall in oil prices, and public expectations of improved socio-economic conditions in the event of a deal, the authorities will face pressure to invest new funds at home.
"The idea that Iran is going to have its pockets full of cash that it can use for discretionary purposes, I think is exaggerated," Charles Hollis, managing director for the Middle East at FTI Consulting, said.
Analysts said any cash windfall would probably be deposited initially in the Central Bank of Iran (CBI), making it relatively difficult for the Islamic Republic's secretive security officials to spirit it away to foreign battlefields.
"As soon as there is a sense that the money is there, every government department is going to start looking for flows," said David Butter, a Middle East economic analyst and associate fellow at Chatham House.
The establishment will also face pressure from Iran's large and vocal middle class, which turned out in force to elect President Hassan Rouhani in 2013, hoping his agenda of better management at home and pragmatic diplomacy abroad could improve their economic fortunes.
"I have to support a family of four. I don't have time to think about politics or the nuclear issue. What people like me need is an improved economy," said teacher Gholamreza Behrad in Tehran.
So, why should Washington free Iran from sanctions and allow it access to the $100 billion in oil revenues presently locked up in restricted accounts? While the thought of indirectly financing terrorists is, frankly, terrifying, this fear-laced argument assumes that Iran believes the money — which amounts to a little less than one-fifth of its 2013 GDP — would be best spent on proxy wars. But judging from the economic difficulties it faces, especially following the collapse in oil prices over the past year, that assumption seems especially dubious. This argument, irrational though it may be, is a very powerful one, given U.S.-Iran history, the volatile nature of the Middle East, and Iran’s past support of extremist groups (as the State Department reported, again, only two weeks ago). It does not take much to convince Americans that Iran will stop at nothing to support terrorism as vigorously as it can.
But Iran’s leaders know how much money is at stake, and how it can be used. It is implausible that, after the supreme leader allowed Rouhani to be elected president in 2013 on a platform pledging economic recovery — in part, through promises of sanctions relief — he would support initiatives that leave the Iranian population in the cold in order to protect foreign groups and leaders like Assad.
As with the effort to wean its economy off oil, Iran has also sought to reduce costly subsidies on everything from food, to housing, to energy, to improve the economy’s efficiency, reduce waste, and spur competitiveness. But sanctions targeting Iranian oil revenues hampered that effort, as the country lacked the hard currency — and political will — to forge ahead with subsidy reform, at least until Rouhani’s election. It is now struggling to complete this project, one that sanctions relief would undoubtedly boost by providing Iran with fresh revenue and reducing its citizens’ dependence on government handouts. This is particularly important for Rouhani, who will be looking to shore up domestic support in the run-up to parliamentary elections in February 2016 and win reelection in 2017.
But beyond this, any rosy expectations for Iran’s economy must be tempered by the reality that oil, still its primary economic driver, is worth less today than in years past and is predicted to stay that way for the foreseeable future. Iran simply won’t have as much money coming in on an annual basis, due to global economic conditions, until the rest of its economy picks up speed. Even if Tehran had wanted to spend $100 billion on nefarious side projects a few years ago (and let’s be clear: given $100 billion was more than the entire annual oil export revenue for Iran at the time, even when prices were high, this would hardly be credible), it makes even less sense today.