Iran’s Economy, Sanctions and key Scenarios

On October 7, I was pleased to join the Middle East Institute and Amwaj Media for a discussion about Iran’s economy under sanctions and the trend ahead. The discussion coincided with stalled nuclear talks, as maximum pressure sanctions remain mostly in effect, Iran has built up additional nuclear capabilities.

Read on or watch the video below where we talk about economic outlook, Iran’s adjustment to sanctions and the all important policy choices by the Iranian government that shape its resilience to sanctions and scenarios ahead. My copanelists Bijan Khajehpour and Mohammad Ali Shabani share interesting insights including economic scenarios and key sectoral trends respectively.

We all highlighted the importance of some of the policy choices ahead. These policy choices (including attempts to comply with money laundering regulations) will shape Iran’s economy regardless of a deal. Failing to make structural and financial reforms would limit the upside from any sanctions relief and concentrate the benefits in select sectors such as energy. While policy choices might mitigate and allow some economic adjustment if sanctions remain in place, (especially as economic actors adjust to shocks), growth rates will be capped as long as sanctions remain in place and Iran remains reliant on barter arrangements, struggles to pay for and receive funds and lacks access to the global financial system.

What is the state of sanctions? Iran is one of the most sanctioned countries – rivaling Russia with largest numbers of sanctioned entities and individuals, and with targets accounting for a much wider swath of the economy and financial system. In 2020 Iran was by far the most prominent target of U.S. sanctions 43% of designations targeted Iran-linked individuals and entities—vs 27% in 2019. Of course the number of designations does not correlate directly to the economic impact and in Iran’s case, some of the number of sanctions reflected closing of loopholes and redesignations of individuals to lock in sanctions.

These include sanctions on Iran’s nuclear program, counter-terrorism sanctions, those related to specific regional programs among others. In some cases entities are listed for multiple reasons, suggesting that if nuclear sanctions were lifted, some entities would remain under pressure. Currently sanctions target Iran’s oil and product exports, key minerals such as the gold and metal trade. Iran’s central bank and most of its state banks are all sanctioned, all of which complicates global transactions and leaves Iranian banks cut off from correspondent bank relationships. 

The economic impact has been meaningful. Iran’s economy has survived but is far from thriving. Typically, when major sanctions are imposed there is a shock and then economic actors adjust, growth at a lower level than potential but growth nonetheless. In both recent phases of sanctions tightening, non-oil exports have been an important source of resilience and the government has used some of its policy space. Iran lacked foreign currency liabilities, and has been able to reduce its reliance on imports, including energy imports and has been adding more value to its oil exports via increasing refined product exports.

Still, this resilience implies missed opportunities – smaller businesses often suffer from lack of access to finance, Iranian individuals may be price takers, paying for goods internationally or being paid for them is challenging. Moreover, Iran lags behind counterparts in attracting investment including the chance to take part and attract green finance etc. Mohammed has highlighted the resilience from energy sector and its persistent role in the economy.  These are a reminder that policy choices in Iran as well as outside are critical for the outlook. 

The  suggest that even in the case of sanctions relief, there could be sufficient measures that remain in place that limit access to the global financial system. This reflects both global and Iranian policies, but also the inertia effect. 

What has Biden administration done on sanctions policy? Its kept almost all of the Trump sanctions in place, added some regional sanctions and made only a few delistings. It has also, more recently put more pressure to crack down on those involved in smuggling oil. The extensive sanctions have left Iran trading indirectly with China with small shell companies.  Recent US threats about the Chinese energy smuggling are a restatement of existing policy but also an effort to increase Chinese involvement in the talks and to encourage them to incentivize Iran to return to table. The US has little appetite for targeting systemic Chinese entities at this point – and indeed most of the smuggling operations are smaller companies. However political pressure might shift – sentiment in Congress is hardening and putting pressure on the administration. Further efforts to tighten sanctions would likely require tightening petrochemical, gas and oil product exports which would disproportionately impact neighbors such as Iraq, Turkey among others.

The few delistings aim at ensuring listed entities are still involved in sanctionable activities and allowing for some humanitarian trade. Humanitarian trade (food, medicine, essential goods) is supposed to be exempt from sanctions but in practice in a highly sanctioned country like Iran this is very difficult to accomplish as private actors, NGOs and others are reluctant to take on the risk – they see it as a negative risk-reward calculation. The UST has issued several waivers, especially around access to Covid related equipment, access to graduate education. These are useful on the margin. 

Looking ahead. There are several elements of sanctions relief, on the table, tied to nuclear concessions. 

First and most important to Iran would be access to Frozen assets – these are proceeds of past sales of oil abroad that can not be repatriated and can only be modestly used to buy goods. 

Lifting or phase in or energy related sanctions and lifting of those on other sectors. 

Iran is asking for all Trump admin sanctions to be lifted, whether nuclear or not. Both the sequencing and scale of those measures make this near impossible. 

There are two main economic scenarios-> no deal – in this scenario, current sanctions remain, some loopholes closed, some humanitarian waivers, especially relating to covid are implemented but Iran continues to find it hard to pay for goods, and is increasingly reliant on barter arrangements with smugglers. At the same time, the US would likely continue to crack down on energy smugglers. Congress might mandate new sanctions and derisking would likely to increase. Chinese trade remain a lifeline, but inability to transact would limit even Chinese investment.

There are not a lot of new entities to target.  This is a weak growth scenario and one where high inflation supports asset prices but not economic activity. 

Partial deal- access to some assets, phased re-entry of energy exports and perhaps some greater ability to pay for goods. There are t wo risks implicit in this scenario – growth could additionally be primarily on the energy trade, reducing the incentive to improve operating environment for local and foreign business 2) European and asian banks could remain reluctant to operate and might require a positive affirmative government supported measure or entities to facilitate access and limit derisking.

In all these scenarios policy choice of Iranian policy makers matter – concerning the choice around banking system, FATF, use of government funds for infrastructure, assigning contracts to private sector, trying to tap into energy transition funds etc. In the partial deal scenario there is greater policy space and thus some different sorts of risk. 

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