International Finance
In the News January-February 2019 Magazine

Iran – Middle East’s Resistance Economy

Iran - Middle East's Resistance Economy
It was one of Donald Trump's agendas upon becoming president of the United States, and within two years, he managed to snap economic sanctions back on Iran, only this time they are harsher. GPW's Florence Cahill speaks exclusively to International Finance on what Iran's future looks like

It has been a tumultuous time for Iranians as the US-imposed economic sanctions have fallen back in place, only this time harsher. What is the ground reality of the sanctions this time around?

The Iranian leadership has considerable experience in weathering tough economic sanctions from the US and EU during the previous regime enacted from 2012, when it implemented a strategy of economic self-sufficiency – the so-called ‘resistance economy.’ Rouhani has already warned Iranians to prepare for “difficult” times, while adding that the government will use its power to alleviate worsened economic conditions in the near future.

At the same time, Iran never experienced the increase in living standards envisaged as a result of sanctions being lifted, nor were underlying structural economic issues resolved. Even before Trump’s announcement that the US would withdraw from the deal, the economy was on an unsteady footing. There was a lot of internal frustration about economic problems such as high levels of unemployment and price rises – the IMF forecasts inflation at almost 30% this year – the highest figure seen since 2013. Devaluation of the currency has compounded the situation. The rial fell in value from IRR 40,000 to USD 1 at the start of the year to around IRR 145,000 to USD 1 at the beginning of November. Public discontent over these issues manifested in violent demonstrations across the country last December, the largest display of public disapproval of the Iranian regime since 2009’s Green Movement protests.

Florence Cahill , Analyst, GPW
Florence Cahill , Analyst, GPW

The mood on the ground is bleak – the situation is expected to get far worse before it improves. Prices for food and fuel continue to rise, and there are very real concerns about shortages of essential commodities resulting from the re-imposed sanctions. There have been lay-offs in factories, and there has been a recent uptick in demonstrations and strikes by unpaid workers. I’ve spoken to professionals in Tehran who are even trying to find ways for themselves and their families to get out of the country should demonstrations escalate into widespread civil unrest.

Saudi Arabia is significantly ramping up production of oil to offset the deficit from Iran in the future. What does this mean for the country’s oil industry?

The situation with oil production is difficult to comment on at the moment as OPEC negotiations over output cuts are ongoing – countries like KSA are changing tack on a seemingly daily basis. After all, oil prices have dropped nearly 30% from a peak in October, when crude prices reached a four-year high fuelled by fears that the Trump administration might cut off oil Iranian exports. That would have reduced global output by some 2.5m barrels a day, leading to a genuine physical shortage of oil for the first time in decades.

The waivers issued by Trump created uncertainty, and it is unclear whether they will be re-issued. At the time of writing, OPEC are on the verge of reaching an agreement on oil production cuts, but is unclear to what extent the cartel will curb output. Any agreement could also be stymied by internal OPEC divisions and reluctance from Moscow to limit output.

Against this backdrop, price volatility driven by politics seems inevitable. While there is uncertainty over the impact of the US sanctions on KSA’s oil production policy, crude prices will be volatile, meaning that neither a slump to US$50 nor even an increase to more than US$100 can be completely ruled out.

The best scenario for Iran in the short term is that OPEC cuts output and prices rise accordingly. Iranian officials have said that an increase in oil price will allow them to maintain revenues. In hopes of mitigating the immediate economic hit, Iranian authorities have implied that Iran may sell its oil at a reduced price to attract buyers going forward.

According to US President Donald Trump, India, China and South Korea can continue to buy Iranian oil, atleast for some more time – how can this benefit the industry, if at all?

The six-month waivers on trade of oil issued to eight countries to import oil will provide Tehran with some breathing room in the short term, particularly in light of higher crude prices compared to previous years. Waivers have been issued to some of Iran’s biggest purchasers of oil, including India, China, Japan and South Korea. Consequently, around half of Iran’s current trade will be able to continue. Although the US measures will probably trigger recession in Iran next year, Tehran will likely avoid an economic shutdown, with a reduced but still significant volume of oil exports continuing.

There is uncertainty as to whether new waivers will be issued after the 180-day period. Even without the waivers, Iran crude exports are unlikely to grind to a halt. Iran has reportedly already re-started unofficial oil exports like those during the previous US secondary sanctions regime. Most notoriously, to avoid detection by US authorities Iran makes deliveries through ‘ghost tankers’ that turn off their geolocation devices, allowing for ship-to-ship oil transfers and cash sales. At the end of October, Iran also began selling oil to private companies for export on Iran’s energy bourse, IRENEX.

Without the waivers, it remains to be seen which countries have the ‘risk appetite’ for Iranian crude. In the absence of European firms, Iran has little option but to turn eastwards for sustained investment. China – and, to a lesser extent, India – will become increasingly important oil purchasers, and seek to replace departing European companies such as Total.

Oil imports from Iran could be a particularly significant area of interest for China, for instance, as Tehran will likely be compelled to offer oil at discounted rates. Beijing has publically committed to honouring the nuclear deal, even as other Asian countries have ceased purchases to deliberate over their strategy in Iran moving forwards. In addition, US retaliation may be less of a concern for China as it has the second largest economy globally and is already in a trade war with the US. Beijing may also seize upon the opportunity to promote its own currency – the yuan – as an alternative to the US dollar.

Nevertheless, the threat of US secondary sanctions remains a deterrent. Although China has reiterated its intention to continue to import oil from Iran, it is also attempting to use this position as leverage against Trump in its ongoing trade war with the US. Beijing’s policy towards the Islamic Republic is not immutable, and could waver as a result of political uncertainty. We’ve heard that Washington and Beijing negotiated over the conditions for the waiver. In contrast, under the sanctions of the Obama administration, China reduced its purchases but reportedly neither negotiated the details with the US, nor credited sanctions pressure for these decisions.

The apparent negotiations with the US suggest that China may view Iran as a useful point of leverage in complex dialogue with Washington on other, more pressing issues – for instance, the ongoing trade dispute. Should the dispute ease, we may see China become more willing to offer the US concessions such as decreased oil imports from, or investment in, Iran. Conversely, a deterioration in relations may make China more willing to diverge from US policy.

US sanctions are not the kind to be ignored for the fear of economic consequences. Where does this leave Iran’s EU allies?

Since May, the remaining five signatories to the JCPOA – Britain, China, France, Germany and France – have been exploring ways to keep the deal alive. The US sanctions, however, have discouraged most major European companies and many international Russian and Chinese corporations, which have either already withdrawn or plan to do so imminently. For months the EU has led discussions about a special-purpose vehicle (‘SPV’) to avoid US penalties, but that plan still lacks practical details such as the location of the proposed SPV. Remaining companies will be under pressure from the US to cease operations in Iran or risk exclusion from US markets.

For foreign investors that do remain, trade financing will be a major obstacle. Even under the JCPOA, many foreign banks were reluctant to facilitate Iran-related transactions due to fear of accidentally flouting remaining sanctions. The cost of fulfilling compliance requirements was also a deterrent. Even European banks that previously began facilitating transactions with Iran after the repeal of international sanctions in 2016 have withdrawn under pressure from American regulators. For instance, Danske Bank – one of the institutions most visibly open to business with Iran – has decided to cease transactions involving Iran as a show of responsiveness to US regulators following a money laundering scandal at its Estonian subsidiary.

Iranian Foreign Minister Mohammad Javad Zarif has boasted of Iran’s plans to circumvent sanctions by selling oil in currencies other than the US dollar, but European financiers acknowledge having difficulty bypassing the American dollar-dominated banking system. Iran will likely pursue barter deals – in particular with non-European countries – while sourcing state-led financing from partners where feasible.

SWIFT, the Belgium-based global financial messaging system, has said it would fall into line with the US restrictions and is disconnecting Iranian banks – the majority of which are subject to US secondary sanctions. For now, a handful of Iranian banks that are not subject to designations will likely remain connected to SWIFT. While it is conceivable that OFAC may target SWIFT itself should it not block payments from all Iranian banks, we highlight reports in recent months that OFAC is pushing back against White House proposals to sanction SWIFT for maintaining ties with Iran.

Nevertheless, many of the proposed measures to circumvent the impact of US secondary sanctions present substantial technical and political obstacles given the hegemony of the US dollar in the global banking system, as well as the integration of the US and European banking sectors. As discussed, plans for an SPV to protect trade with Iran from sanctions have met delays because of difficulties finding a host country. Moreover, the SPV is primarily intended to be a payment mechanism for only small and medium-sized companies that are not deterred by exclusion from the US market, rather than for larger firms.

The EU has also responded to US sanctions with counter-measures such as a ‘blocking statue,’ which allows European businesses to recover damages from US sanctions and threatens them with legal action if they comply with the sanctions. The blocking statute – which came into force on 7 August – will have a limited impact, however, because it essentially forces European companies to choose between the US and Iran as a business partner. For the vast majority of companies, the former is far more significant and not worth sacrificing for the latter. Many European companies have historically limited relations with Iran because of other issues, for instance, restrictions on the US dollar, or the pervasiveness of the IRGC – long sanctioned by the international community – throughout the Iranian economy.

Above all, the EU cannot completely mitigate the impact of unilateral US sanctions on Iran. EU support for Iran for now will be more rhetorical than practical in nature, with the planned SPV demonstrating the EU’s independence from Washington, but not actually facilitating substantial amounts of trade. Rouhani and his government have accepted the EU’s conciliatory gestures for now; whether they are sufficient to keep Iran in the JCPOA in the long term will be dependent on other factors, for instance whether Trump secures a second term. Above all, the benefits of the deal will largely dissipate over the next few years, meaning that the deal will be viewed as increasingly redundant.

With compromised ties between Iran and the US, Russia could find itself at an advantage – do you agree? How do you think this situation will pan out for them?

Like the EU, Russia has criticised the ultimatum on Iran issued by the US and continues to support the sanctions relief specified in the JCPOA. Russian energy minister Alexander Novak has pledged to continue trading Tehran’s oil, potentially emulating an oil-for-goods scheme signed in 2014, under which Russia sells Iranian oil to third party counties. In return, Iran uses the revenue to pay for Russian goods and services.

At the same time, there are limitations on the extent to which Russia will maintain business relations with Iran. Russia was never a major trading partner of Iran in the first place. Moreover, despite Moscow’s promises there are indications that Russia will, in practice, diminish its presence in Russia rather than stepping in to fill the vacancy left by Europe. Several major Russian firms quit Iranian projects following the US’s announced withdrawal, including Zarubezhneft and Lukoil. There are also reports of Russia withdrawing from major deals in other sectors. For instance, IranAir was seeking to purchase Russia-built Sukhoi Superjet 100 airliners as it seeks planes from companies not requiring US sales permits. These plans, however, have reportedly been scuppered because the aircraft are partly produced with US-made components.

In addition, a potential oil bartering deal between Russia and Iran could be stymied by a lack of demand as potential purchasers of repackaged Iranian oil are deterred by sanctions. Russia may also brake away from OPEC and seek to increase crude production in order to compensate for losses in Iranian output. Russia concentrating on its own production may reduce the urgency of negotiating a deal with Iran.

There is likely to be some collaboration between Russia and Iran for now. However, given that Iran is not critically important to Russia, at least from a business perspective, it could become a bargaining chip for Russia in negotiations with the US about more pressing issues – for instance, US sanctions on Russia, or Syria. Moscow may offer to help the US enforce its sanctions on Iran if they can secure concessions in higher-priority areas.

What does Iran’s future look like now? What can the country expect to happen geo-politically and economically?

The Trump Administration says that it wants to bring Iran back to the bargaining table to create a new deal better suited to US interests than the JCPOA. Among its key policy aims are permanently preventing Iran from obtaining nuclear weapons – the JCPOA only delays Iran’s nuclear ambitions – and curbing Iran’s “malign influence in the region,” including its ballistic missile programmes and involvement in Syria. To this end, Washington has adopted a tough rhetoric on enforcement, with US treasury secretary Steven Mnuchin stating that the US will lead a “maximum-pressure” campaign to stop global funds from flowing to the Iranian regime.

However, the US’s issuance of waivers suggests that its rhetoric may be stronger than its actions. The US’s aim may be to gradually increase pressure on Iran rather than putting it under maximum pressure from the outset.

Following the midterms, the White House is likely to continue exerting pressure on Iran. US National Security Advisor John Bolton has hinted that there will be further sanctions on Iran, as well as tighter enforcement of pre-existing sanctions. The White House will likely be criticised by Republicans in Congress for not taking a tougher stance in implementing the sanctions, while being criticised by the Democrats for risking a potentially costly confrontation with the Iranian regime. At the same time, both sides are not much at odds over Iran.

Iran will probably adopt a ‘wait and see’ approach, weathering the tough economic conditions brought about by sanctions. Although arguably not viable in the long term, this strategy may give Tehran time to glean a better idea of Trump’s chances in 2020. If there is a slim prospect that Trump will secure a second term in 2020, Tehran may have less incentive to engage in new negotiations or depart from the JCPOA, particularly if the new leader is more sympathetic in their policy on Iran. It is likely to loosely comply with the terms of the JCPOA ‘nuclear deal’ – while seeking to maintain its regional influence – so as not to preclude cooperation with the US (not to mention EU countries) in future, in hope of a transfer of power to a more sympathetic leader in the US in 2020.

At the same time, more conservative elements of the Iranian leadership may reject this approach. Indeed, the re-imposition of sanctions has strengthened the position of more conservative factions of the Iranian leadership and weakened President Hassan Rouhani’s politically moderate platform. Hardliners may weaponise the perceived failure of the JCPOA and public discontent with the Rouhani administration to push for the removal of senior officials from office, as well as bolstering support for a hardline candidate in the parliamentary and presidential elections in 2020 and 2021.

Hardliner gains increase the likelihood that Iran pulls out of the deal in its own right and ramps up its nuclear programme. In this scenario there is a chance that US sanctions on Iran could be reinforced by similar measures from the UN and the EU, adversely impacting the economic outlook for Iran.


Florence Cahill is an Analyst in GPW’s Political Risk practice, specialising in political, economic and regulatory issues in Iran and Central Asia. In addition to undertaking tailored studies for clients operating in both regions, maintaining our corporate stakeholder maps and travelling to Iran for research, Florence provides support and analysis to the Business Intelligence team. Her work in this area encompasses reputational due diligence assignments, dispute resolution investigations and asset traces. Although primarily focused on Russia and the CIS, Florence has been engaged in investigations further afield in regions such as MENA and sub-Saharan Africa

What's New

ROSHN: Shaping Saudi’s Urban Vision


Regulation around AI is needed: iQmetrix Senior VP of Revenue Jason Raymer

IFM Correspondent

The battle against SIM card theft

IFM Correspondent

Leave a Comment

* By using this form you agree with the storage and handling of your data by this website.