December 10, 2013 | Policy Brief

The Costs for Iran of Walking Away from Nuclear Negotiations

December 10, 2013 | Policy Brief

The Costs for Iran of Walking Away from Nuclear Negotiations

The U.S. Senate is working on new legislation that would impose sanctions on Iran if it cheats on its obligations under the Joint Plan of Action (JPA) reached last month in Geneva between the P5+1 and the Islamic Republic. Even though this proposed “sanctions-in-waiting” legislation wouldn’t violate the terms of the JPA, Iran’s Foreign Minister, Mohammad-Javad Zarif, has threatened to walk away from the nuclear negotiations if Congress passes the new legislation. Is Zarif bluffing?

Iranian President Hassan Rouhani has said he would seek to ease the international sanctions that are crippling Iran’s economy. Secretary of State John Kerry has attributed Iran’s willingness to negotiate to the intense pressure of international sanctions.

If Iran walks away from the table, new congressional sanctions are passed, and the international sanctions coalition holds, Iran’s economy will suffer significantly. A recent economic analysis by the Foundation for Defense of Democracies and Roubini Global Economics estimates that new sanctions could precipitate a major trade shock that leads to a significant depreciation of Iran’s currency, which will fuel inflation and asset bubbles, force fiscal austerity, and send Iran back into a deep recession.

Iran’s economy would risk further deterioration in the following areas:

1.     Iran would lose all of the sanctions relief promised under the JPA. The Obama administration values this relief at $7 billion; FDD values this much higher at $20 billion or more (see FDD analyses here, here, and here).

2.     Oil exports would fall to 500,000 bpd, which would be a reduction of approximately 500,000 bpd from current levels, or a loss of about $9 billion in revenues over six months.

3.     New sanctions would also hit Iran’s fuel oil, natural gas, and condensates exports, which are valued at about $1.6 billion per month. This would be a further loss of $9.6 billion in revenues.

4.     The accelerated depletion of revenues and reserves would likely precipitate another currency devaluation as Iran runs out of reserves. This would fuel inflation beyond its current 2013 average rate of 40%, with recurrent asset bubbles and busts destabilizing the economy further.

5.     Wages would fall sharply in real terms as housing and cost of living expenditures continue to rise.

6.     A new recession is likely. As output falls and the government cannot support further economic expansion, Tehran would need to cut government spending.

7.     Across the board, cuts would become necessary in the development budget, just as Tehran effected in 2012 in non-salary current spending. Subsidy cuts would be likely in the top three high-income deciles of the Iranian economy.

8.     Oil income would remain limited to only bilateral arrangements, with most oil revenues effectively locked up by sanctions.

9.     Deficit funding through internal loans would be likely, as well as an attempt to use foreign exchange reserves and to loosen monetary policy, particularly if other deficit funding tools don’t work.

10.  With sanctions relief negated, there would be an estimated 50 percent decrease in annual petrochemical exports from $12 billion to $6 billion; at a minimum, Iran would lose the $1 billion based on what the administration estimates Iran will earn in sanctions relief over six months under the JPA.

11.  Iran would also lose potential automotive sector sanctions relief, with a failure to make gains in exports, production, wages, GDP, and other key indicators. This includes a loss of the administration’s projected $500 million increase from auto sanctions relief over the next six months.

12.  Other strategic sectors would suffer as a result of new sanctions legislation. This includes engineering, construction, mining sectors and others.  

13.  Imports would decrease to $25-$30 billion from about $40 billion, given budget and hard currency restrictions.

The international community could very well blame the United States for the failure of negotiations. This could possibly lead to the erosion of the international sanctions regime.  However, it is difficult to envision a complete collapse.  As long as tough U.S. secondary sanctions remain in place, global financial institutions, in particular, are not likely to take the legal and reputations risks of giving Iran access to its locked-up foreign exchange reserves or transacting with designated Iranian banks.

Given the state of the Iranian economy, Tehran needs relief from the toughest U.S. financial and energy sanctions. Otherwise, Iran faces continued stagnation or a renewed recession. For Iran to avoid those consequences, Tehran needs a final agreement  or, at a minimum, a series of six-month renewable interim agreements that yield direct sanctions relief and a change in market psychology that increases consumer and investor confidence in the Iranian market.  Without this, international companies are unlikely to resume business with Iran.

In other words,  walking away from the negotiating table will carry significant costs for the Iranian regime. And the longer Iran stays away, the higher the economic costs.

Zarif may walk away for show. But unless Zarif and Iranian president Hassan Rouhani believe that they can rescue the economy through nuclear escalation, their no-deal option is less attractive economically than a negotiated settlement.

Mark Dubowitz is executive director of the Foundation for Defense of Democracies. This analysis is the sixth in a series from FDD’s Iran Sanctions Project’s ongoing assessment of sanctions relief on Iran’s economy. Previous reports include “The Real Value of Auto Sanctions Relief to Iran,” “The Geneva Joint Plan of Action and Iran’s Petrochemical Sector,” “The Dollar Value of the Proposed Sanctions Relief at Geneva,” “Iran’s Golden Loophole,”(co-authored with Roubini Global Economics), and “When Will Iran Run Out of Money?”(co-authored with Roubini Global Economics).


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