Iran’s economic decline seems bottomless. Its currency has lost half its value since April. Inflation has surged, and with the reimposition of sanctions, its export potential will be severely weakened. The first round of sanctions, which the U.S. reinstituted this week after pulling out of the nuclear deal in May, include limitations on Iran’s purchase of U.S. dollars, trade in gold and precious metals, and the sale of a number of vehicle and aircraft parts to Iran. The second and arguably more consequential round is set to be imposed in November and will restrict Iran’s export of oil and other petroleum products, one of Iran’s biggest sources of revenue and one the nuclear deal allowed for.

But Iran has been in a similar situation before. President Mahmoud Ahmadinejad restarted Iran’s uranium enrichment program in 2005, and the United States and the United Nations responded by implementing a variety of sanctions. The U.S. introduced even harsher restrictions in 2010 with the passage of the Comprehensive Iran Sanctions, Accountability, and Divestment Act, severely restricting Iran’s ability to conduct business internationally. Unsurprisingly, the rial fell and inflation soared. And yet the government endured. So the question is: Will the current regime also manage to weather the storm?

Economic Fallout

There’s no question that sanctions imposed during the Ahmadinejad administration were bad for the Iran’s economy – it’s just difficult to trace and to quantify. Iran’s gross domestic product contracted from a high of $600 billion in 2012 to a low of $385 billion in 2015. In 2017, two years after the signing of the nuclear deal, Iran’s GDP had grown to $440 billion, largely on the back of oil sales. Of course, the fluctuation of the price of oil affects these figures, and the lag between the imposition of sanctions and the reporting of GDP data makes it difficult to pin down the exact date on which things turned south. But turn south they did, much as they are now.

The rial’s rate of depreciation was similar to the current rate of depreciation. In 2012, the rial lost over two-thirds of its value, the same rate of loss that it has experienced so far in 2018. The exchange rate fell from roughly 10,000 rial to the dollar to about 36,000 by the end of the year. Over the course of just one week, it fell from 25,000 to nearly 40,000. The primary cause of the decline was falling demand for Iranian exports – which resulted in falling demand for the rial – as well as limited access to global financial markets and, therefore, to foreign currency.

The government responded, to no avail, by restricting foreign exchange trading and creating an official exchange rate. The government then allowed importers in Iran to purchase critical goods like medicine and certain types of food at the official exchange rate, making these goods cheaper for importers. But it had to pay the difference using its foreign reserves, a policy that was unsustainable.

Iran has responded to the recent plummet in the rial’s value in a similar fashion. It curbed foreign exchange trading and set an official exchange rate of 42,000 rials to the dollar. One difference, however, is the depths of the rial’s fall this year. Today, the currency is hovering around 100,000 to the dollar. Earlier this week, Iran eased foreign currency rules in the hopes that it would stem the fall of the rial and limit its use of foreign reserves.

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At first blush, Iran’s current foreign reserves may not seem particularly vulnerable. According to the International Monetary Fund, at the end of 2017, Iran had approximately $120 billion in foreign reserves, equal to roughly 15 months’ worth of imports. (Given the rial’s decline, that figure is likely lower now.) The IMF also noted that many of these reserves may be located outside of the Iranian banking system, in affiliated foreign banks that conduct transactions on behalf of Iranian institutions, limiting the country’s access to the funds. (When the sanctions were lifted, Iran was able to access approximately $100 billion in frozen foreign assets.) According to a Reuters report, which cited anonymous bankers familiar with the Iranian financial system, Iran’s foreign reserves might actually be between $35 billion and $55 billion.

Iran has faced serious inflation before as well. Ahmadinejad tried to spark domestic investment by making credit cheap – by putting a cap on interest rates that banks could charge borrowers. As the rial fell, and prices increased, the real interest rate (that is, the interest rate adjusted for inflation) fell into negative double digits as inflation exceeded 40 percent.

But one difference between then and now is that the Iranian economy was growing before 2010, which made it better able to withstand high inflation and a declining currency. In 2008, GDP per capita was the highest it had been since 1974-77. Investment was being used to purchase capital equipment, a sign that people believed the economy was on the upswing. Compare that to today, when Iranians are desperately seeking fixed assets – such as cars and property – as a way to hedge against the depreciating rial and their dwindling savings. In 2010, when one set of U.S. sanctions were implemented, Iran was coming out of a period of relative growth. But today, Iran is facing serious economic pressure, and it has been for nearly a decade, a brief period of sanctions relief notwithstanding.

Political Fallout

In some ways, therefore, Iran’s economic conditions today are more dire than they were when the sanctions were imposed the first time around. And so the political consequences may be more dramatic. President Hassan Rouhani came to power in 2013 as a reformer, focused specifically on revamping the economy. He promised to implement measures that would cure some of the negative economic consequences of Ahmadinejad’s policies. (Indeed, inflation rates have dropped under Rouhani, though they remain high overall.) Part of Rouhani’s plan to make this happen was to work with the West to seek sanctions relief. Expectations were high, and when sanctions were lifted, people believed the benefits would trickle down to the public at large.

But those expectations turned out to be misplaced. GDP growth stemming from sanctions relief came primarily from greater oil and petroleum sales, which benefited the small portion of the country that controlled oil-related assets, namely the Islamic Revolutionary Guard Corps and other elites. Profits were then used in part to intervene in conflicts throughout the Middle East. This is why protests in recent months against deteriorating economic conditions have featured slogans like “death to Syria” and “death to Palestine.”

Protests in the past few days have also featured chants of “death to inflation” and “death to unemployment.” Despite its best efforts, the government hasn’t convinced Iranians that the U.S. is responsible for their economic woes. Since large-scale protests broke out at the end of 2017, demonstrators have instead criticized Tehran’s mismanagement of the economy.

The composition and location of current protests point to another difference between the two sanctions regime. In 2009, Green Revolution protesters rarely ventured outside Tehran, and they were nearly uniformly students and upper-middle class citizens. They didn’t have broad support throughout Iran, geographically or demographically. But the large-scale protests at the beginning of this year broke out even before it was clear that the sanctions would be reimposed. People were already losing faith in Rouhani’s ability to make a real difference in their lives.

Public disaffection with Rouhani is aggravating the divisions within the government as well. The IRGC and many in the clerical establishment were skeptical of Rouhani’s conciliatory approach to the West from the beginning, and are even more so now. Conservative factions are increasing the pressure on Rouhani, forcing him to replace a number of government officials and answer questions from lawmakers. The president has lost support among conservative factions that once backed him, despite the fact that he was a reformer, and hard-liners are seeking greater control over the administrative apparatus. That power centers are competing against each other far more directly this time around may hamstring the government as it tries to respond to sanctions.

From an economic perspective, the sanctions will have similar effects as when they were first implemented. But from a political perspective, the accumulated economic damage over a much longer period of time, coupled with growing dissatisfaction with the regime’s handling of the economy, are likely to make these sanctions more consequential. (It’s still unclear exactly how far China, Europe, Russia, Turkey and India will go in cooperating with the sanctions and if they can get waivers from the U.S. for certain products.) We don’t think an overthrow of the regime is likely – it’ll continue to spend money on the IRGC and intelligence agencies to keep dissatisfaction within the security apparatus at a minimum. But even IRGC soldiers will be affected by the falling rial – everything from cars to food will be more expensive for all Iranians, including military personnel. The regime will struggle to maintain its presence in the Middle East at the current level, pay its security forces enough money to keep them loyal, and reform the economy to keep opposition to a minimum. There will be no shortage of challenges and few options at the regime’s disposal.

Xander Snyder
Xander Snyder is an analyst at Geopolitical Futures. He has a diverse theoretical and practical background in economics, finance and entrepreneurship. As an investment banker, Mr. Snyder worked in corporate debt origination and later in a consumer-retail industry group at Guggenheim Securities, participating in transactions ranging from mergers and acquisitions, equity and debt capital raises, spin-offs and split-offs to principal investing and fairness opinions. He has worked on more than $4 billion worth of transactions. He subsequently co-founded and served as CFO for Persistent Efficiency, an energy efficiency company that used cutting-edge technology to create a new type of electricity sensor for circuit breakers and related data services. In his role, he was responsible for raising more than $1.5 million in seed capital and presented to some 70 venture capital and angel investors in the process. He also signed four Fortune 500 companies as customers, managed all aspects of company accounting, budgeting and cash flow, investor relations, and supply chain and inventory management. In addition to setting corporate strategy, he helped grow the company from two people to a 12-person team. As an independent financial consultant, Mr. Snyder wrote an economics publication for a financial firm that went out to more than 10,000 individuals and assisted in deal sourcing for a real estate private equity fund. He is an active real estate investor and an occasional angel investor. Mr. Snyder received his bachelor’s degree, summa cum laude, in economics and classical music composition from Cornell University.