The international sanctions against Iran have been effective. However, they also made the Iranian elite more practical and cynical by teaching it how to survive under external economic pressure. This is the first of a two part series.

International reports on the economic and political situation in Iran prepared by different respected analytical institutes and consultancies, state that sanctions adopted against Tehran by the US, EU and their partners in 2010-12, not only appear to be very effective but will inevitably put the Islamic Republic on the fringe of economic collapse. Meanwhile, diplomats and businessmen often travelling to the country draw a different picture: They describe Iran of the early-2013 as a fast developing country with intensively growing cities and actively improving living standards. Foreigners are especially impressed by the number of expensive boutiques and top-class restaurants emerging in the streets of northern and central Tehran, as well as by exclusive cars driving these streets. This difference between consultancies’ reports and stories of eyewitnesses raises a just question: Who is lying about the economic situation of modern Iran and why? However, the answer is as simple as unexpected: all of them speak the truth and, yet, fail to give a comprehensive picture.

Yes, They Work

First of all, it is necessary to disappoint those who repeat the traditional Iranian slogan about the futility of sanctions: the punitive economic measures adopted by the US, EU and their allies work. Moreover, after 2010, the effectiveness of these measures has substantially increased. Iran is almost cut off from the international banking and insurance system. Tehran’s access to foreign investments, advanced technologies and international sea carriage services is restricted. Its options to sell oil in external markets and import gasoline are limited. By April 2013, the Iranian leadership (both the supreme leader and the president) was compelled to acknowledge that the economy of the country was seriously damaged by sanctions. Moreover, in one of his speeches, Mahmoud Ahmadinejad stated that Iran was struggling against an economic war initiated by the West. This is quite obvious even from official statistics distributed by the Central Bank and Statistical Centre of Iran.

According to these sources, during the period of January 2012 and March 2013, the volume of oil production and its export abroad fell from 3.8 and 2.4 million barrels per day, to 2.7 and 1.3 million barrels per day respectively. As stated by the Iranian Minister of Economy and Finance, Shamseddin Hosseini, on December 15, 2012, the volume of Iran’s oil income in 2012 was 50% lower than those received in 2011. This substantial drop inevitably caused the deficit in the Iranian budget which is heavily dependent on the inflow of petrodollars. Thus, in October 2012, Ahmadinejad stated in his speech that the authorities are compelled to cut some budget items by 25% or, in certain cases, almost stop financing them. Moreover, one month later, Iran was compelled to halt the implementation of the second phase of economic reforms aimed to ease the indirect subsidies burden of the country’s budget. Under these circumstances, the growth rate of the Iranian GDP in 2012 was estimated as 0.36% with the official inflation rate at 32% in March 2013 (compared to 21.5% in early 2012), and the consumer price annual growth rate at 32% in November 2012.

During 2012, the fluctuations of exchange rates at the foreign exchange market of Iran were probably one of the most serious stress tests for the country’s economy. The dollar exchange rate grew from 18000 rials in January 2012, to 33500-34500 rials in March 2013 (in the free market). Moreover, the growth of the dollar’s price was not steady: during the last 15 months, it suddenly hiked at least four times causing serious socio-economic shocks. One of the most dangerous situations emerged in early October 2012, when another plunge of the rial-to-dollar exchange rate at the free market not only caused the deficit of dollar banknotes in Iran, but led to the closing of the Grand Teheran Bazaar and civil unrest in the capital. These events compelled the Iranian authorities to undertake a number of steps. The introduction of the multiple exchange rates system, restrictions on imports of luxury goods, and the ban on the export of gold and silver were among the first and most important steps of the Iranian authorities.

Under these circumstances, social indicators were also bad. Thus, according to different sources, by 2012, up to 60% of the population lived either on or under the poverty line. The social stratification was huge and kept on growing. The income of three richest deciles of the population was 15-16 times higher than that of the three poorest deciles. In 2012, the official rate of unemployment reached 12.2% (more than 19% in unofficial calculations). The shutdown of industrial projects requiring foreign technologies, investments and equipment only sped up the growth of this indicator.

Not Only Sanctions

However, it would be wrong to explain all Iranian economic problems only by sanctions. Moreover, as believed by experts, the above-mentioned sudden confessions by the Iranian authorities on the negative effect of economic sanctions were caused by the necessity to divert people’s attention from the failures of the government’s economic policy. By 2013, traditional attempts of the authorities to persuade the public that existing problems are a result of the unlawful activities of Iranian tycoons, inner enemies of the regime or government officials misusing their power did not work anymore. As a result, since probably December 2012, Ahmadinejad and his team began accusing the sanctions as the reason for Iran’s economic misfortunes. Nevertheless, all the above-mentioned negative trends existed long before the adoption of the sanctions between 2010-2012. As it becomes obvious even from official Iranian statistical data, high rates of inflation, unemployment and liquidity have been the main negative characteristics of the Iranian economy at least for the last six years. Sanctions only aggravated the situation.             

Unexpected Economic Results and Side Effects

The punishing measures adopted by the US, EU and their partners during 2010-2012 were, and still are, a serious blow to the Islamic Republic of Iran. They drastically changed the international environment, making Iran’s living conditions extremely hard. Nevertheless, when changing the rules of the game, it is naïve to think that other players will retain their old habits and stick to their traditional style of playing. The same works for sanctions. The punitive measures of 2010-2012 would have probably strangled Iran and made it more obedient to the external powers if Tehran had preserved its pre-sanctions domestic and external economic policies. Meanwhile, sanctions launched deep structural changes in Iran which allowed it to adjust to new conditions. This process of adjustment took, at least, a year and brought first results by November-December 2012.

By that moment, it became clear that the negative influence of sanctions achieved its climax: a further decrease in exports of Iranian oil (less than 1-1.3 million barrels per day), as well as the adoption of qualitatively new sanctions were hardly possible. At the same time, Tehran became used to living under existing pressure.

First of all, apart from using multiple tricks and grey measures to evade sanctions, the Iranian government learnt how to live on existing income. As stated by researchers, the new Iranian budget for 1392 (March 2013 to March 2014) was designed by the authorities with an assumption that the volume of oil exports will stay under 1.33 million barrels per day with the average price of $90-91 per barrel. According to a recent article, “Iran Beyond Oil?,” written by the director of research of the Washington Institute for Near East Policy, Patrick Clawson, Iranian calculations are “largely reasonable: It will be difficult for the West to reduce Iran's exports below the current 1.3 million b/d or drive its earnings below $91 per barrel.” All in all, petrodollars are expected to fund only 40% of the budget, which is considerably lower than the share of oil income in previous budgets (usually from 60-65% to 80%).

Under these conditions, sanctions triggered what was previously considered as hardly achievable: they compelled the Iranian government to turn their promises to diversify the sources of the budget’s income into practical steps. Thus, in December 2012, the Iranian government declared that, during 2009-2012, it managed to create a modern fiscal system in the country, including the working mechanism of value added tax collection. Subsequently, officials in Ahmadinejad’s cabinet stated that it is high time to start using this system and increase the fiscal burden. Although these statements caused the immediate negative reaction of the majlis, in 2012, the Iranian government had already increased its budget incomes from taxes by collecting up to $14 billion (one fourth more than in 2011, calculated at the exchange rate of 33500 rials per US Dollar).

It is noteworthy that the diversification process was not limited to taxes. During the last two years, Tehran boosted the development of almost all economic activities which could not be hurt by sanctions or where sanctions had a minimum effect. Thus, over the past two decades, Iran has positioned itself as an important regional transit hub, connecting Turkey, Russia, China, the Caucasus and Central Asia with the markets of the Persian Gulf and Southeast Asia. However, the effort has never been more concerted than during 2010-2012, as Tehran reacts to (and against) sanctions applied by the rest of the world. According to The Gulf States Newsletter, Iranian customs data from 2010-2012 shows that each year, around 10 to 11 million tonnes of goods, worth $30-35 billion and from 100-110 countries, pass through Iran, generating $3 billion income. The plan is to raise this exponentially in order to see transit revenues of up to $12 billion by 2025. As a result, since 2011, Iran has intensified the development of its transport infrastructure, promptly finishing projects that in the past would have taken years, if not decades. In February 2012, for instance, the government reported the start of new works intended to extend the country’s road network by 2000km, and the railroads by between 8,000 and 12,000 km.

Although transit is unlikely the most profitable of available options, it is one of the most obvious examples of diversification processes taking part in Iran. Apart from road construction, Tehran intensified the development of its basic non-oil industries such as steel, cement and energy production, as well as mining during 2010-2013. For instance, in 2012, Iran produced 64.1 million tons of cement and 64.4 million tons of clinker, which were 5.6 and 4.7% respectively more than in 2011. According to different estimations, up to 14 billion tons of cement were exported; at least two of Iran’s neighbours – Iraq and Afghanistan – represent a very appealing consumer market for Iranian construction materials. Deputy Energy Minister Mohammad Behzad stated in February 2013 that, during recent years, the production capacities of the electric industry of Iran have been growing by 7% annually. By the mid-2013,they were supposed to reach 70000 MW. It is not a secret that Tehran sees electricity as one of its export items. Iran is already selling electrical energy to Armenia, Azerbaijan, Afghanistan, Iraq, Pakistan, Turkey and Turkmenistan. According to recent statistical data, in 2012, the volume of Iranian electricity exports hiked by 29% as compared with 2011.

*Read the final part of “Unilateral Economic Sanctions Against Iran: Unexpected Implications” on May 21, 2013.

The views expressed in this article are the author's own and do not necessarily reflect Fair Observer’s editorial policy.

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