AIC Iran Brief: The Iranian Economy under President Rouhani and the Economic Implications of the Nuclear Accord

By Bradford Van Arnum, AIC Research Associate

Background

The Iranian presidential election in June of 2013 occurred against the backdrop of not only the issue of the country’s nuclear program, but also of an economy in crisis. The two were, in many ways, inextricably linked; the international sanctions regime at the time was significantly harming the Iranian economy, and unlike previous unilateral action by the United States, these sanctions had done much to block Iran’s access to the global financial system. With the election centered on these twin issues of addressing the nuclear standoff and restoring the economy, an opening was provided for more moderate leadership than that seen under President Ahmadinejad, who had not shied away from confrontation with the United States. Ultimately, it was Hassan Rouhani who won the election on the promise of ending the nuclear impasse and addressing the economic crisis. However, the economic challenges the new administration faced became abundantly clear as soon as Rouhani was inaugurated. When Rouhani took office in August of 2013, the inflation rate stood at a little over 40%, higher than initially thought.[1] He announced in a November 2013 speech that unemployment was over 12%, with youth unemployment double this rate [2], a major challenge in a country where more than 60% of the population is under the age of 30.[3]

Inflation and Unemployment

Until recently, Rouhani seems to have placed greater importance on controlling inflation than unemployment, and his administration has attempted a number of measures to reach its goal of bringing the inflation rate to single digits by March 2017.[4] For one, subsidy reform has become an important objective; during the Ahmadinejad years, cash handouts and subsidies proved popular, but promoted inflation and were seen as inefficient. From early on, the Rouhani administration has sought to modify cash handouts by offering non-cash benefits that would prove less inflationary.[5] However, ending or significantly changing Iran’s cash handout program has proven difficult, and initial steps towards reform have stirred political opposition.[6]

More successful has been Rouhani’s anti-inflation strategy of controlling spending and imposing budget restraint, which arguably had been lacking during Ahmadinejad’s time in office. Perhaps most importantly, President Rouhani has sought to provide greater political independence to the Central Bank of Iran in an effort to ensure more responsibility among policymakers. During times of budget deficit, administrations have borrowed from the Central Bank and even commercial banks, driving up the inflation rate. Preventing this practice can instill greater fiscal and monetary restraint, underscoring the fact that high levels of inflation in Iran have in part been a structural problem requiring spending and borrowing cuts.[7]

Unsurprisingly, these anti-inflationary measures have hindered unemployment goals, and while Rouhani’s efforts to stabilize the inflation rate at around 15% have been successful, they have also made reducing unemployment that much more difficult.[8] A tradeoff often exists between inflation and unemployment, and in Iran’s case, the fiscal restraint seen under Rouhani has perhaps hampered faster growth of the economy. Nonetheless, the president has moved to do what is possible on the unemployment front, namely by trying to empower Iran’s private sector; the Iranian economy has for many years been dominated by the state, a reality that Rouhani has tried to change. He has, for instance, brought individuals from the private sector into his administration, most notably appointing as his chief-of-staff Mohammad Nahavandian, a former leader of the Iran Chamber of Commerce.[9] In trying to create a more business-friendly environment, Rouhani has not only sought to introduce tax incentives and relax labor rules, but has also attempted to bring about deeper and more structural changes to Iran’s economy, such as reducing the economic role of the Islamic Revolutionary Guard Corps (IRGC).[10] However, these efforts do not appear yet to have brought down unemployment in a significant way, as the unemployment rate in 2013 stood at 12.9%, and was 12.8% in 2014, according to the World Bank.[11] With the unemployment rate still elevated and parliamentary elections taking place in February, Rouhani has in recent months shifted his focus to spurring growth, announcing a stimulus package, described below, this past October.[12]

Rouhani’s Opposition

Compounding Rouhani’s challenges in improving the economy has been a political opposition that has proven skeptical of his efforts. Most notably, Iran’s parliament contains a majority of conservatives, who have stymied a number of Rouhani’s initiatives and reforms that might have also helped to boost Iran’s moderates and reformists politically. At the beginning of Rouhani’s term, for instance, parliament blocked several of the president’s proposed ministers during multiple rounds of confirmation hearings.[13] Additionally, to the extent that conservatives tried to block Iran’s approval of the nuclear accord, they have complicated Rouhani’s efforts to have Iran rejoin the global economy.[14] Perhaps more critically, Rouhani has also had to deftly navigate the Islamic Revolutionary Guard Corps, which represents both a major political and economic force in Iran. Prior to Rouhani, the IRGC had for a number of years been gaining influence and greater control of the Iranian economy through its projects; following Iran’s war with the Iraq, President Rafsanjani made the IRGC responsible for rebuilding the country, and more recently, from 2006 to 2013 (much of Ahmadinejad’s time in office), it was awarded an estimated 10,000 projects.[15] However, in his efforts to encourage more private control and investment, Rouhani has called for the IRGC to take on only a few national projects, rather than have a presence across the entire economy. Though Rouhani has Supreme Leader Khamenei’s approval in this approach, the IRGC remains an important counterweight to Rouhani’s larger plans, having arguably benefited from the international sanctions that prevented competition with foreign capital and in turn increased their influence.[16]

Overall, Rouhani’s strategy in managing Iran’s economy has been one marked by balance. On one hand, he and his team have attempted to navigate the inflation-unemployment tradeoff by imposing some measure of discipline while avoiding excessive austerity that would risk creating a recession.[17] Simultaneously, as a relative moderate, Rouhani has had to tread carefully when going against the wishes of conservatives not only in parliament, but among the IRGC and other parts of the government. The Supreme Leader himself has remained wary of some of Rouhani’s actions, particularly his overtures to the United States.

The JCPOA, Sanctions, and Iran’s Economy

For the Rouhani administration, resolving the nuclear issue represented one of the most important means of improving the economy. Under the nuclear accord, formally known as the Joint Comprehensive Plan of Action (JCPOA), Iran must dismantle key components of its nuclear program, ship spent fuel out the country, and allow international inspectors managed access to both declared and non-declared sites, among other provisions.[18] In exchange, the P5+1 countries have promised sanctions relief, though the United States will only lift nuclear-related sanctions on Iran. Left intact will be a variety of sanctions, including those related to human rights, terrorism, and the Islamic Revolutionary Guard Corps. Even under the JCPOA, Iran will remain among the most-sanctioned countries in the world, and the U.S. maintains the ability to impose sanctions in response to Iranian behavior outside the nuclear issue.[19]

Despite the expectations surrounding the historic accord, the months since the JCPOA’s signing have remained challenging for Iran’s economy. Rouhani admitted in the fall that the economy may contract, and since the summer, he has moved to focus more on stimulating the economy rather than controlling inflation. For example, as part of his recent stimulus package, he cut the reserve requirements of banks and increased government spending on development projects, both of which could inject money into the economy, though at the cost of higher inflation.[20] At worst, Rouhani’s efforts at economic stimulus might prove too little to help prevent another recession, but significant enough to increase inflation moving forward, making the goal of 14% inflation by March 2016 unattainable.[21]

In the longer term, if sanctions relief under the JCPOA occurs in early 2016, there is more reason for optimism concerning the economy.[22] The IMF noted in an October report that although Iran’s economy may contract this year, conditions should improve in 2016 once sanctions are lifted.[23] Specifically, the IMF points out that real GDP growth could be around 5%, driven in large part by higher oil production, as well as the lower costs associated with trade and financial transactions.[24] More so, to the extent that Iranian consumers are delaying major purchases until sanctions are lifted, the economy may show stronger signs of improvement later this year.[25]

Although the lifting of sanctions may do much to help the Iranian economy, there are pitfalls to be avoided. For one, it must be recognized that international sanctions were only part of the challenges facing Iran’s economy; there remain deep structural problems, ranging from excessive state control of the economy to a lack of fiscal and monetary restraint. For example, with respect to the country’s bureaucracy, initiating business activity in Iran remains a cumbersome task, with a permit and approval process that may involve multiple organizations.[26] In addition, corruption has been a major concern of President Rouhani’s, though his administration has met with political resistance on this issue, especially when accusing past government officials of wrongdoing.[27] To hope that sanctions relief will be a panacea for these various issues would be a mistake. Even more, the supposedly positive results of the JCPOA could themselves prove troublesome. Specifically, a surge of imports could trigger inflation and foreign debt, as happened under President Rafsanjani during the recovery period from the war with Iraq.[28] For these reasons, Iran must carefully manage its foreign trade following the lifting of sanctions, and continue to implement economic reform. Indeed, to do otherwise would be to possibly squander the benefits of sanctions removal under the JCPOA.

Conclusion

President Rouhani inherited an economy that in late 2013 was beset by international sanctions, high inflation, and significant unemployment. In dealing with the latter two problems, Rouhani has had to contend with a classic economic tradeoff, as his efforts to reduce inflation have made his goals of lower unemployment more difficult to realize. At the same time, Rouhani has needed to operate deftly in a political system that remains wary of major reform, and that made the completion of the nuclear accord in July 2015 a major challenge. Having used much political capital on the nuclear issue, Rouhani must now hope that the lifting of sanctions will bring quick improvement to the lives of Iranians, though he simultaneously needs to recognize that Iran’s economy faces hurdles that run deeper than sanctions. How Rouhani manages the expectations and realities of a post-sanctions Iran will help shape the outcome of elections in February and the remainder of his time in office.

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Sources

[1] http://www.brookings.edu/research/testimony/2015/09/17-beneficiaries-of-iran-deal-maloney

[2] http://iranprimer.usip.org/blog/2013/dec/02/rouhani%E2%80%99s-next-test-empty-coffers

[3] http://www.worldbank.org/en/country/iran/overview

[4] http://www.al-monitor.com/pulse/originals/2015/10/iran-economic-stimulus-package.html

[5] http://www.cipe.org/blog/2013/10/24/irans-new-government-moves-ahead-with-economic-reforms/#.VkUIzV7lGkN

[6] http://www.al-monitor.com/pulse/originals/2015/10/iran-cash-payments-reform.html#

[7] http://www.al-monitor.com/pulse/originals/2015/06/iran-inflation-management-debt-banking.html#

[8] http://www.brookings.edu/research/testimony/2015/09/17-beneficiaries-of-iran-deal-maloney

[9] http://www.cipe.org/blog/2013/10/24/irans-new-government-moves-ahead-with-economic-reforms/#.VkUIzV7lGkN

[10] http://www.cipe.org/blog/2013/10/24/irans-new-government-moves-ahead-with-economic-reforms/#.VkUIzV7lGkN

[11] http://data.worldbank.org/indicator/SL.UEM.TOTL.ZS/countries/IR?display=default

[12] http://www.al-monitor.com/pulse/originals/2015/10/iran-economic-stimulus-package.html

[13] http://www.atlanticcouncil.org/publications/articles/rouhani-s-first-one-hundred-days-cautious-domestic-reforms-as-nuclear-crisis-continues

[14] http://www.al-monitor.com/pulse/originals/2015/10/iran-parliament-nuclear-deal-illegal.html

[15] http://carnegieendowment.org/sada/?fa=60999

[16] http://www.atlanticcouncil.org/publications/articles/rouhani-s-first-one-hundred-days-cautious-domestic-reforms-as-nuclear-crisis-continues

[17] http://www.brookings.edu/research/testimony/2015/09/17-beneficiaries-of-iran-deal-maloney

[18] http://www.theguardian.com/world/2015/jul/14/iran-nuclear-deal-key-points

[19] http://www.niacouncil.org/iran-sanctions-after-the-jcpoa-terrorism-human-rights-conventional-weapons-and-ballistic-missiles-sanctions/

[20] https://lobelog.com/changing-course-on-economy-in-iran/

[21] http://www.al-monitor.com/pulse/originals/2015/10/iran-economic-stimulus-package.html

[22] http://www.worldbank.org/en/country/iran/overview

[23] https://lobelog.com/changing-course-on-economy-in-iran/

[24] https://www.imf.org/external/np/sec/pr/2015/pr15458.htm

[25] http://www.al-monitor.com/pulse/originals/2015/10/iran-economic-stimulus-package.html

[26] http://www.al-monitor.com/pulse/originals/2015/12/iran-deregulation-committee-business-perform-reform.html

[27] http://www.al-monitor.com/pulse/originals/2015/09/iran-corruption-postsanctions.html#

[28] http://www.brookings.edu/blogs/markaz/posts/2014/08/07-rouhani-report-card-iran-economy-sanctions-oil