Calling for change

The recent historic telephone call between the presidents of the USA and Iran the other week represents a huge step forward for both countries and the wider international community. This first contact between the two nations’ presidents for decades was a forceful step away from the ‘Great Satan’ vs. ‘Axis of Evil’ rhetoric that has dogged diplomatic relations. There are reasons to be optimistic over this symbolic phone call – a call for change, if you will.

This optimism has emerged since the election of the moderate, reform-minded Hassan Rouhani as Iran’s new president. Although much of the optimism is being felt internationally, it is most acutely being felt in Iran. While their economy has been collapsing under the strain of international sanctions and economic mismanagement, there are hopes that the new administration will bring a new direction for the country.

Yet many are skeptical whether lasting change is indeed around the corner. People want more than a talkfest and hollow promises. Five minutes of economic sunshine simply won’t do – it has to be for the long-run.

And this sentiment is understandable when you consider that Iran’s long history has been beleaguered by economic and political false starts.

Throughout its history the Iranian economy has been subject to extreme economic variability – it is no stranger to economic shocks and hardship. Once thriving at the heart of the Silk Road trading route between Europe and Asia, the dawn of maritime commerce resulted in an extended period of a stagnant, primitive agrarian-based economy. It wasn’t until the UK and Russia competed for Iran’s oil reserves in the lead up to WW1 that there was any significant economic progress. Yet seeing that it had been an unfavorable, exploitative trade relationship, by 1951 the then Iranian Prime Minister seized and nationalized Britain’s oil installations, pushing the economy close to collapse. A couple of years later, however, a US-UK supported coup saw this reversed, and the Anglo-Iranian Oil Company (now renamed British Petroleum) was reinstated. Over the coming decades, despite the windfalls from the high oil prices, widespread cronyism and corruption resulted in a weakening economy and civil unrest culminating in the Iranian Revolution in 1979. Since then, under the stranglehold of the dominant conservative power institutions, the economy has ebbed and flowed.

In looking at Iran’s current economic malaise, it is impossible to look past the significance that their alleged nuclear weapons program has played and the international response (i.e. sanctions) it has received. Though a decisive factor, the challenges facing Iran’s economy stem not just from external pressures, but also from internal mismanagement.

Homegrown problems

During the recent presidential elections in Iran, former president Mahmoud Ahmadinejad was accused of ‘cooking the books’ with his populist, ultra-conservative presidency, missing the opportunity to make the most of a doubling of the price of oil, with windfalls during his rule being wasted on cheap imports and easy credit[1].

In a country where the hand of government reaches into nearly every corner of the economy, poor economic management has put the economy in a disastrous place. Price controls, subsidies and the shady activities of the Islamic Revolutionary Guards Corps (IRGC) in particular have been obstacles to progress. The IRGC, a militia answerable only to the Supreme Leader, is said to control a large portion of the economy, running quasi-government entities in key areas of the economy and working against efforts for reform[2]. The resulting suppressed economic activity has meant dwindling government tax revenue. This, on top of a decrease in oil revenues (which account for up to 80 per cent of government revenues), means the Iranian government faces enormous structural budgetary problems.

Unfortunately, initiating reform in Iran is an especially herculean task. The Supreme Leader, Ayatollah Ali Khamenei, essentially has the final say on everything, and the green light for any reform must come from him. The Supreme Leader is (naturally) of a conservative disposition and is keen to secure his hold over the nation, which makes things hard for a reform-minded president. Iran’s political structure seems an anathema to economic, political, and social progress. The relationship between Khamenei and President Rouhani is crucial.

Sanctions

Today, the tough economic sanctions are really starting to bite, and the economy’s condition has deteriorated significantly.  The International Monetary Fund has estimated that the Iranian economy will shrink by 1.3 per cent, after it contracted last year by 1.9 per cent[3]. Unemployment is 12 per cent and rising, food inflation is 55 per cent (!), the Iranian rial has collapsed by about 80 per cent in a year, and international sanctions on oil exports have reduced Iran’s main source of income by 65 per cent[4]. In short, the Iranian economy is on the verge of collapse.

What’s really pinched the Iranian economy recently though has been their barring from SWIFT (Society for Worldwide Interbank Financial Telecommunication), and a consequent cash squeeze. Businesses are shutting and executives have to cart suitcases full of cash through street-level money-changers to shady bankers abroad as part of the normal course of business[5]. The risks of doing business are enormous.

My opinion is that these sanctions will prove to be particularly damaging in the long-term because they might jeopardize the will for reform in Iran. For example, reforming Iran’s vast subsidies program (estimated to have been 27 per cent of GDP in 2007/2008) saw the implementation of the Targeted Subsidies Law (TSL) in 2010, which slashed government subsidies on energy and food. Although initially taken with relative ease, international sanctions, the lack of liquidity and the collapse of the rial has resulted in mounting resistance to the reforms as the compensatory direct cash transfers to people could potentially be seen to become a mocking gesture and a pathetic effort to ease the immense financial pressures faced by ordinary Iranians. This is, of course, not to mention the brewing anti-West sentiment.

But the fact that Iranians voted for a shift in direction earlier this year would suggest that people are still itching for change and that there remains a degree of alacrity for positive reforms and progress.

Unfinished Business

The election of Rouhani has seen the return of a number of important figures who served under the previous two reform-minded presidents from 1989 to 1997 under Akbar Hashemi Rafsanjani, and then under Muhammad Khatami from 1997 to 2005. The technocrats are back with their grand vision for a reformed, market-based economy. Ideas such as widening the tax base and being more generous with contracts to encourage foreign investment and foreign expertise and capital, are being thrown around in the open after a period of silence. Iran’s equivalent of an independent budget auditor is also being reinstated after being mysteriously closed by President Ahmadinejad in 2007.

If international sanctions are lifted, President Rouhani will have room to reform the economy. This means that it will be how Rouhani resolves the diplomatic dispute that will make the most difference to the Iranian economy. Whatever he decides to do, it will undoubtedly have implications beyond Iran.