February 4, 2015 | Memo
Iran’s Economy Will Slow But Continue To Grow Under Cheaper Oil and Current Sanctions
FDD - Roubini Report
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Co-authored by Jennifer Hsieh and Rachel Ziemba
Iran has escaped from the severe recession that threatened its economy in 2012 and early 2013. As previous Roubini Global Economics (RGE) and Foundation for Defense of Democracies (FDD) reports have assessed, Tehran has used the sanctions relief from the Joint Plan of Action (JPOA) interim agreement, reached in November 2013, and the resulting improvement in market sentiment to stabilize its economy and build up economic resilience against future sanctions pressure. This economic recovery comes as Iran and the P5+1 international negotiating teams are involved in another round of talks, extended for the second time to June 30, 2015, with the goal of reaching a comprehensive nuclear agreement. So far, however, Iran’s Supreme Leader Ali Khamenei has rejected all of the West’s compromise proposals.
With the recent 60%-drop in the price of oil—Iran’s most valuable commodity, which dominates exports and revenues—negotiators are hoping that this shock to the Islamic Republic will provide more meaningful economic leverage. As it turns out, however, Iran experienced its own asymmetric oil shock three years ago and has had time to adjust to the painful impact of decreased oil exports and restricted access to its overseas oil revenues. Beginning in 2012, U.S. legislation required Iran’s oil buyers to significantly reduce their oil purchases; Iranian exports dropped from about 2.3 million barrels per day (bpd) to just over 1 million. In February 2013, U.S. sanctions began locking up Tehran’s oil profits through a little-understood provision imposed by congressional sanctions legislation. The provision required countries buying Iranian oil to pay for their purchases in escrow accounts in a handful of countries: China, India, Japan, South Korea, Turkey, and Taiwan. The funds were then available to Iran, but only for purchasing local goods from those countries or humanitarian goods from others.
The scheme worked well for Iran’s main oil buyers, who could still buy approved quantities of Iranian oil without sanctions penalties (as long as they were significantly reducing those purchases over time) and at the same time boost their exports. It didn’t work so well, however, for Tehran. The Iranian government couldn’t repatriate any of the existing oil funds sitting in these overseas escrow accounts, estimated to be over $100 billion. The monthly oil revenues collecting in these accounts could not be spent down fast enough because Iran could not find enough non-sanctionable goods that it wanted to buy from those six countries (Europe, which was Iran’s preferred shopping zone, had become far more restrictive). In fact, the U.S. Treasury Department estimated that Iran could only spend about half of its recurring monthly oil revenues on imports in 2013, leaving the rest to pile up in escrow.
By 2012 and early 2013, as a result of sanctions that hit these oil revenues, curtailed Tehran’s access to the formal financial system including the SWIFT (Society for Worldwide Interbank Financial Telecommunication) global financial messaging system, and blacklisted key sectors of the Iranian economy (for example, automotive, petrochemicals, ports management, shipping, and shipbuilding), Iran’s economy was in a severe recession marked by negative growth, a plummeting currency, and hyperinflation. Iran’s fortunes, however, changed in November 2013 after Iran and the P5+1 reached an interim nuclear agreement. Under this agreement, beginning in January 2014, international negotiators agreed to return an average of $700 million per month to Iran from these semi-restricted oil escrow accounts. By June 30, 2015, when the current extension of the interim agreement is set to expire, Tehran will have received about $12 billion from these escrow accounts to spend however it desires. In addition to these payments and other forms of direct sanctions relief, the Obama administration also put the brakes on the further escalation of U.S. sanctions and helped Iran recover from its severe recession to reach modest growth, a stabilization of the currency, and a halving of the inflation rate.
To be sure, as this report assesses, the drop in the price of oil (and the supply shock it represents) will be a drag on Iran’s economy. Growth is estimated to slow in fiscal year 2015/16, and the new Iranian government will be forced to cut government spending and increase tax revenues. Lower oil prices could also diminish the enthusiasm of energy companies contemplating a return to the Iranian energy sector, even if the ongoing nuclear negotiations lead to permanent sanctions relief. Even black-market oil deals will look less attractive now that buyers can purchase cheaper oil without engaging in illegal sanctions busting.
Despite all of this, the recent growth in Iranian non-oil export earnings and overall better management of the economy by Iranian President Hassan Rouhani’s team will help cushion the economy against falling oil prices.