Comments on Iran: the Economy and Sanctions

A Talk to the The Middle East Association on 4th July 2013

By Martin Johnston, Director-General of the British-Iranian Chamber of Commerce

THE ECONOMY AND THE PRESIDENTIAL ELECTIONS

  • The Iranian economy is in dire straits. The consensus in Iran is that economic policy and management must change.
  • All candidates for President promised to improve the Economy and condemned President Ahmadinejad's stewardship.
  • Most candidates argued that progress on the nuclear negotiations is essential if there is to be a significant improvement in the economy.
  • Hardliners argued for internal solutions, such as improving management, increasing privatisation and combating corruption.
  • Reformers, such as Mohammad Reza Aref, criticised the hold of vested interests, for example, the Revolutionary Guards, in particular sectors of the economy and laid particular emphasis on improving relations with the rest of the World.
  • The electorate saw the economy as the most important policy issue, but the Election turn-out (72%) and Hassan Rouhani's majority (51%) underlined the desire for greater freedom generally.

IRAN - OIL AND GAS

  • Oil and Gas dominate Iran and its economic relations with other countries. O&G revenues account for 50-60% of Government income and 80% of export income.
  • Iran has the World's 4th largest proven oil reserves and 2nd largest natural gas reserves.
  • Although Iran is still among the Top 10 oil exporters, its export of crude oil dropped to 1.5million bbl/d in 2012 (lowest since 1986) from 2.5 million bbl/d, as a result of US and EU sanctions on the sector introduced in late 2011 and early 2012.
  • Tighter O&G sanctions included: exports to and investments in the O&G sector were prohibited; access to US and EU sources of finance were denied, dealings with the Central Bank of Iran (CBI) were prohibited; an EU embargo on the purchases of Iranian oil was instituted; a ban on the provision of tanker insurance (P&I Clubs) from the EU was imposed.
  • Sanctions on investment in O&G led to the cancellation of projects. But heavy investment in enhanced recovery rates of existing oil wells and the development of new wells is badly needed.
  • Although the World's 3rd largest gas producer, Iran is a net importer of gas to meet fast-growing domestic demand. Gas production is heavily dependent on output from the South Pars gas field and the vast majority of reserves are undeveloped.
  • The outlook for oil exports in 2013 is lower, for example, sales in May were only 700,000 bbl/d, even though waivers under US law are likely to continue to be given to China, Japan, S. Korea, India, Turkey and Singapore.

IRAN - THE ECONOMY IN TROUBLE

  • As a result of sanctions, both exports and imports have reduced dramatically in 2012. Exports, US$ 66 billion in 2012 (48% less than the US$ 128 billion in 2011); import, US$66 billion in 2012 (30% less than the US$ 93 billion in 2011).
  • GDP declined in 2012 for the first time in 20 years.
  • Unemployment is high at 15.5%. If the number of those in employment, but who haven't been paid for 3 months or more ( a fast rising number of people), it is thought that unemployment would be some 18%. Youth unemployment is 23%.
  • The government budget turned from a surplus into a deficit in 2012.
  • According to Iranian official figures, inflation has spiralled: 12.4% in 2010, 21.5% in 2011, 28% by December 2012 and over 30% in March 2013. Many economists consider the official figures understate inflation, believing it to be around 40%. Professor Hanke, John Hopkins University, in November 2012, calculated inflation, based on the free-market Rial/US$ exchange rate, to be 69% - this indicates a period of hyperinflation in import prices.
  • Such was the decline in the value of the Rial that the Authorities introduced a 3-tier exchange rate: Rial/US$ 12,260, the Official Rate; 25,480, the Official Dealers rate; and 35,000 (in October 2012), the free-market rate. The free-market rate improved temporarily in the immediate aftermath of the election, but has weakened again since.
  • The effects of inflation have been catastrophic for the population at large. The Statistical Center of Iran reported examples of price increases in the 12 months to April 2013 as: food and drink, 50%; tobacco, 80%; clothing, 35%; housing, 18%. Many industries, for example, pharmaceuticals, struggle to import raw materials, which leading to reduced production and lay-offs. Bankruptcies have been rising.
  • Disruption in the economy isn't just caused by sanctions, but is also the consequence of economic policy.
  • In speaking to BICC Members last Autumn, Professor Pesaran, a former Deputy Governor of the CBI and now a Cambridge Economics Professor, categorised the disruption in the economy as being 75% in efficiency and 25% sanctions.

ECONOMIC MANAGEMENT 2005-2013

  • The economy is marked by state-led policies. The state dominated economy was originated by the Pahlavis to channel the huge growth in oil revenues to quickly modernise Iran, it was extended further, after the revolution, during the war with Iraq. Most of the major sectors of the economy were nationalised including the private assets of the Pahlavis and other wealthy families, which were placed in semi-governmental organisation known as "Bonyads".
  • Price controls and subsidies hampered the economy, allowed the black market to flourish and corruption to become widespread.
  • During the two terms of the Ahmadhi-nejad Presidency (2005-2013) economic policy further disrupted the economy.
    1. Oil revenues were distributed liberally thought-out the economy , ostensibly to develop private sector businesses, which led to asset-value inflation and high bad-debt levels in the banks.
    2. In 2007, the President ordered public and private banks to cut interest rates to below inflation, causing panic on the TSE and undermining the banking sector.
    3. The planning bureaucracy was dismantled.
    4. The President openly feuded with the Majlis, cabinet ministers and succeeding governors of the Central Bank.
    5. Enforced and rapid changes of senior personnel and technocrats in government and in the private sector, throughout the last 8 years, have undermined economic management. Appointments have been based more on political alignment than competence, experience and intellectual fitness for the post.
  • Some policies during 2005-2013 were well intentioned, but failed in their implementation, such as:
    1. Further privatisation of state assets led to parties favoured by the government, such as Revolutionary Guards organisations, becoming significant controllers of the newly privatised assets.
    2. The Targeted Subsidy Law, passed in 2010 which aimed to remove subsidies on food and energy over 5 years (subsidies have been estimated to have cost the annual budget US$ 60-80 billion before this legislation) had to be held back as inflation reduced the value of the cash-handouts (US$45 per person) paid to compensate for the loss of subsidy.
  • Economic policy has undercut Iran's economic potential. However it still has huge potential for the future which can be enjoyed by the population and those from outside willing to play a part.

THE ECONOMIC POLICY OF PRESIDENT-ELECT Rouhani

  • Of course it far too early to know what will be President-Elect Rouhani's economic policy, but the auguries are for moderation pragmatism and the use of those skilled in economic matters to achieve a less political economy
  • Some of his pronouncements in the run-up to the election, and just afterwards, give hope for the future:

    • "...collective wisdom, cost-benefit analysis, and the rule of law will replace radicalism and rhetoric..."

    "...rationality and moderation will apply..."

    "...ethics and moderation will rule the country..."

    "...change will happen gradually and in consultation with experts: efficient managers will be hired..."

    "...it is important that the country operates well and that the wheels of industry are turning..."

    But

    "...there will be no quick-fixes for Iran's economic plight..."

  • Dr Rouhani, it is thought, will bring back some of the technocrats from the Rafsanjani and Khatami presidencies. It is rumoured that Dr Adeli, a former Ambassador to the UK, will be one of those called to return.

SANCTIONS

  • The EU, hence the UK, has extensive prohibitions on what can be exported to Iran. In general terms, food, humanitarian and medical products may be exported.
  • The exporting process has become bureaucratic, approval to export being required for the Iranian buyer, the product to be exported and for payment to be received. In the UK, the relevant approval organisations are: the Export Control Organisation (ECO) and HM Treasury (HMT).
  • In addition to legal prohibitions, an informal banking boycott applies to those who wish to trade with Iran. Even if an exporter has ECO and HMT approval, British banks will not process payments and may close a company's bank accounts (or the bank accounts of its directors or employees) if it is suspected that the company has dealings with Iran. Innovative payment arrangements, also requiring HMT approval, are needed.
  • But exporting to Iran still occurs.
  • 8 years ago, EU countries (and the UAE) were the leading exporters to Iran. But the effect of EU sanctions means that trade has gone to the East, to countries less fettered by sanctions, most notably China, but also Japan, Turkey, India, S Korea and Singapore. Chinese energy companies have been particularly active in replacing western companies in Iran's oil and natural gas sectors. However even those Eastern countries are feeling the collateral effect of US and EU sanction and the banking boycott.
  • China-Iran bilateral trade declined 18% in 2012, compared with 2011, and Chinese new investment flows declined 87% in 2012, according to Asadollah Askeroladi (President of the Iranian Chinese Chamber of Commerce and Industries), reported in Al Monitor. Askeroladi attributed the decline in investment to the impact of US and EU sanctions.

THE IMPACT OF SANCTIONS ON COUNTRIES EXPORTING TO IRAN

  • Sanctions impose huge damage on Iran's population, but they aren't costless to the countries imposing them.
  • In 2012 total EU direct exports were €7.4 billion, a fall of 43%, and a loss of €5.6 billion of export trade over the last 8 years. Most of the fall (35%) has been in the last two years. There are no estimates of the loss of EU jobs or company closures due to this large loss of exports.
  • The UK and France have seen the greatest fall in exports to Iran, 82% and 60% respectively: this may be due to their leading role in the EU in promoting the extension of sanctions.
  • With the closure of important payment routes to EU exporters, starting with the closure of EIH bank in May 2011 and the subsequent tightening of sanctions on banking, there has been a dramatic fall in exports, which is likely to escalate further in 2013. Iran has suffered from sanctions but so too have EU exporters.
  • The economic health of EU companies as well as Iran will depend in part on a successful Rouhani presidency, in nuclear negotiations and in Economic management.

THE BRITISH-IRANIAN CHAMBER OF COMMERCE

  • In the deteriorating picture of the Iranian economy, BICC still has a continuing relevance. BICC survives because of the support many Members, who believe, it is necessary to maintain close links with the Iranian business community for the day when political relations improve and when commerce between the two countries picks up.

APPENDIX A: IRAN - ECONOMIC STATISTICS

Crude OilProven reserves, 154.26 billion [A, 2013]. WR 4.
  Production, 4.2 million bb/day [A, 2012.]. WR 5.
  Exports, 1.5 million bb/day [A. 2012]. 2.5million bbl/d [A. 2011] WR 5.
Natural Gas Proven reserves, 1,187 trillion cu ft [A, 2013]. WR 2.
 Production, 5,360 billion cu ft [A, 2012 est.].
 Exports, 8.42 billion cu m [B, 2010 est.]. WR 25.
ExportsUS$ 66.37 billion [A, 2012 est.]. US$ 128.6 billion [A, 2011 est.]
 Commodities: petroleum, 80%; chemicals and petrochemicals, fruits, nuts, carpets
 Partners: China, 21%, Japan, 9%, Turkey, 9%, India, 8%, S Korea, 8%, Italy, 5%
ImportsUS$66.97 billion [A, 2012 est.]. US$93.57 billion [A, 2011 est.]
 Commodities: Industrial supplies, capital goods, foodstuffs, consumer goods, technical services
 Partners: UAE, 31%, China, 17%. S Korea, 7%, Germany, 5%, Turkey, 4%
GDP (PPP)US$1.016 trillion [A, 2012 est.]. US$1.035 trillion [A, 2011 est.].
 Real growth rate,  1.9% [A, 2012 est.]
 Per capita GDP, US$ 13,300. WR 100.
Unemployment15.5% [A, 2012 est.]. Youth Unemploymet, 23% [B, 2012 est.]
Inflation rate32.3% [D, March 2013.]. 28.8% [E, March 2013.]. 31.4% [F, March 2013]. 69.6%, Rate [E]. 2010, 12.4%; 2011, 21.5%
Budget Surplus 5% [C, 2012 est.] 7% [C, 2011 est.]
Market value of Publicly traded sharesUS$107.2 billion [C, December, 2010]. US$ 86.6 billion [C, December 2010]
Commercial Bank Prime Lending Rate16% [B, December 2012]. 12.5% [B, December 2011 est.]
Exchange RateIRR/US$ 12,260 [B, 2012 official rate.]. 10,616 [B, 2011 est.]. 9,864 [B, 2009 est.]
 3 exchange rates applied from October 2012: official rate (12,260), official dealers rate (25480), free market rate (35,000, in October 2012)

A - US Energy Information Administration. B - CIA, World Facts Book. C - Indexmundi. D - Central Bank of Iran. E- Statistical Center of Iran. F- Professor Hanke, November 2012, Global Asia, based on the free market Rial/US$ exchange rate.

APPENDIX B: EU TRADE WITH IRAN