Co-authored by Rachel Ziemba, Roubini Global Economics
Download the report here (PDF).
- Iranian nuclear physics continues to beat Western economic pressure. Iran is less than a year from reaching critical nuclear capability, despite international sanctions designed to prevent this outcome. While its accessible FX reserves have fallen sharply, Iran has sufficient reserves, and “off-books” assets, to painfully muddle through for at least 12 months, if not longer. However, Iran’s domestic political timeline may be considerably shorter given the considerable pressure on Iranian president Hassan Rouhani to deliver on his commitment to lift sanctions and stabilize the economy as quickly as possible. The Iranian government may fear that, without a short-term nuclear deal, further sanctions pressure could tip the economy into an unmanageable economic and political crisis before reaching undetectable nuclear breakout in mid-2014.
- Iran is moving steadily toward critical nuclear capability, defined as the point of “undetectable breakout,” where Iran could produce enough weapons-grade uranium or separated plutonium for one bomb so quickly that the IAEA or Western intelligence services would be unable to detect the breakout. Iran is on track to reach this point in mid-2014, if not sooner. At this point, Iran will have considerable leverage even if it decides not to breakout to a bomb.
- Iran’s foreign currency reserves, which are critical to the Iranian government’s ability to withstand sanctions pressure, are being depleted and, in large part, impeded. We estimate that its FX reserves have fallen from $100 billion in 2011 to $80 billion by mid-2013, and more importantly that the Iranian government has unencumbered access to only $20 billion of those funds. Declines in the oil price, exports or output, restrictions on non-oil exports or further restrictions on access to funds would lead to a more rapid decline in total and accessible reserves.
- Although Iran’s government is building up surpluses in accounts in China, India, Japan, South Korea and Turkey, these funds that can only be used to purchase humanitarian and non-sanctionable commercial goods as required under the “February 6” provision of the Iran Threat Reduction & Syria Human Rights Act of 2012. According to public reporting, almost half of the $3.4 billion in Iranian monthly oil revenues ($1.5 billion) is accumulating in these semi-accessible accounts, which reflect Iran’s inability to find enough non-sanctionable goods on which to spend this money.
- We divide Iran’s FX reserves into three categories: 1) fully inaccessible accounts (less than $10 billion); 2) semi-accessible accounts in countries that are currently buying Iran’s oil (over $50 billion and rising as unspent oil revenues accumulate); and 3) fully accessible accounts (less than $20 billion and likely falling).
- Instead of eight months of import cover provided by its total reserves, Iran’s fully accessible reserves cover less than three months of imports (2.5), just above levels economists would consider a warning sign of impending crisis. Over time, Iran could shift its imports to rely on its semi-accessible funds; however, it remains vulnerable to further restrictions on the use of these funds, and more dependent on its dwindling fully accessible foreign exchange reserves to purchase goods from Europe and other trading partners.
- Iran scores poorly on Roubini Global Economics’ systematic country risk screening: Its external and fiscal cushions, as well as the health of its banking system, have deteriorated sharply since 2010. Iran’s economy has become less flexible, reducing the government’s ability to cope with shocks, resulting in a sovereign risk score well below the averages for Middle East and North Africa (MENA) countries and emerging markets (EMs). Levels are consistent with economic or debt crisis. These weaknesses are only partly offset by an increase in flexibility in Iran’s exchange rate.
- Other pools of domestic capital could cover Iran’s rising fiscal gap in the short term to avoid sharp fiscal cuts. Iran likely has tens of billions of dollars of off-books assets controlled by Supreme Leader Ali Khamenei, the Islamic Revolutionary Guard Corps (IRGC), the Quds Force, and other regime elements. It remains to be seen if these regime actors would be willing to part with these funds to help President Rouhani manage Iran’s balance of payments and fiscal challenges.
- Steps the U.S. and its allies could take to put further pressure on Iran’s FX reserves and its balance of payments include: 1) sanctioning any financial institution that provides Iran access to, or use of, its foreign reserves; 2) dramatically reducing permissible imports of Iranian crude products; 3) requiring countries buying Iranian crude to dramatically reduce their exports of non-humanitarian commercial goods to Iran; 4) requiring a specified percentage of Iran’s escrow funds be spent only on humanitarian goods; 5) blacklisting additional sectors of the Iranian economy owned or controlled by the government of Iran and/or the IRGC, including the mining, engineering and construction sectors; 6) vigorously enforcing gold sanctions to deny Iran access to gold to replenish its FX reserves; 7) imposing tighter sanctions on non-oil Iranian commercial exports; 8) expanding the definition of crude oil sanctions to include all oil products; and 9) imposing additional sanctions against the holdings of Iran’s bonyads and investment funds, and entities owned and or controlled by the IRGC, the Quds Force, the Supreme Leader and other entities.