The legitimacy and stability of the global sanctions framework against Iran largely rests in the dominance of the U.S. dollar as the primary reserve currency for international trade. Although the U.S. dollar will likely continue to stay strong in the foreseeable future, other trends may signal growing weaknesses within the sanctions regime.
If negotiations fail to produce an agreement by the end of March, the U.S. will likely tighten sanctions against Iran’s energy, automotive, construction, and mining sectors, while increasing pressure on countries to reduce oil exports to “de minimis” levels, which the U.S. has been quite successful in accomplishing thus far. China, Japan, South Korea, and India—Iran’s top oil importers— are all global leaders in petroleum consumption, and although these countries receive sanctions waivers in exchange for reducing Iranian oil imports, it will be increasingly difficult to make any further reductions given growing energy demands. This could present an upper bound in terms of maximizing impact from reducing global Iranian oil imports.
The last five years have seen a remarkable increase in the use of financial sanctions to limit Iran’s access to the international banking system. In 2012, for example, the EU imposed a ban on Iranian banks from using the Belgium-based global financial messaging system, SWIFT. While this move severely reduced Iran’s ability to conduct transactions, Iran has adapted, in part, by using alternative messaging systems, albeit at a slower and costlier pace. The SWIFT ban is believed to be so severe, that Tehran supposedly requested the ban be one of the first sanctions lifted, should negotiations succeed in reaching an agreement.
Emerging alternatives to SWIFT, however, threaten to undermine the leverage that financial sanctions provide, and may be further indicative of growing weakness within the overall sanctions framework. Recently, Russia’s central bank created an alternative to SWIFT, which is scheduled to be fully operational by this Spring. Based in part on fears of Western sanctions stemming from the escalating crisis in Ukraine, Russia’s new financial messaging system may provide a legitimate alternative to SWIFT that may see a growing customer base as financial sanctions increasingly become the go-to economic weapon of choice. As relations between Tehran and Moscow continue to grow, Russia’s alternative payment system may provide Iran the necessary clout to hobble the effectiveness of Western financial sanctions.
In the optimistic months after the November 2013 Joint Plan of Action, which provide Iran with limited sanctions relief in exchange for freezing its nuclear enrichment program, private industry began clamoring for a seat at the table if and when sanctions were to be lifted.In February of last year, groups representing U.S., Canadian, and French engineering, telecommunications, and automotive manufacturing companies visited Tehran to discuss returning to Iran’s markets should nuclear negotiations prove successful. Later, in October, London hosted an international conference to promote business ties between Europe and Iran, and to begin laying the foundation for post-sanctions trade and investment. Although these initial discussions may be overly optimistic, it does clearly signal a desire to return to normal trade relations with Iran, which may hint at shrinking capacity to sustain legitimacy within the sanctions framework.
Lastly, over the last five years, U.S. banks have seen a willingness on the part of U.S. regulators to impose massive fines for violating sanctions. In June 2014, the U.S. Department of Justice slapped BNP Paribas—France’s largest bank—with a $9 billion fine for violating sanctions against Cuba, Iran, and Sudan. Just months prior, in testimony before the Senate Foreign Relations Committee, the Treasury Department’s Under Secretary for Terrorism and Financial Intelligence, David S. Cohen, warned would-be violators, “…who thinks now might be a good time to test the boundaries and challenge our resolve to think again.” In response, international banks are shutting down relationships in geographic areas deemed to be high-risk—pushing illicit transactions into alternative venues and leaving the U.S. and EU without a vital source of information to enforce sanctions.
Tehran’s Economic Reforms Will Not be Enough
Beginning in 2006, the U.S. and EU have incrementally tightened sanctions against Iran’s nuclear, missile, energy, shipping, transportation, insurance, and financial sectors, and although the implementation of this global framework is somewhat fractured, sanctions have throttled Iran’s economic growth, contributing to two years of recession, significantly decreased oil revenues, and runaway inflation. Moreover, sanctions have only compounded problems caused by years of economic mismanagement and corruption, which peaked under former president Mahmoud Ahmadinejad.
There is no doubt that sanctions have had damaging effects on Iran’s economy. Since 2010, Iran has consistency underperformed compared to its economic peers, primarily due to significant declines in oil production, oil export revenues, and GDP. To mitigate sanctions impact, Iran has found alternative payment systems, including barter agreements, and has begun accepting alternative foreign currencies for oil payments. Additional oil is sold at discounted prices, using methods to obfuscate its origin, such as ship-to-ship transfers, while exports of gas condensates, which are not subject to U.S. sanctions, are up compared to prior years. Of course, these methods are not ideal, are expensive, and ultimately limit Iran’s ability to use the revenue for anything other than purchasing goods and services from those countries. True, these methods help Iran, but it is unlikely that Iran has been able to offset the reductions in oil imports from its main trading partners—primarily South Korea and Japan.
Changes to Iran’s monetary policies are contributing to a stunted recovery, but for how long? To stabilize crippling inflation that averaged an annual rate of 30% from 2011 to 2013, Akbar Komijani, Rouhani’s choice to lead the Central Bank of Iran, set about a strategy of maintaining high interest rates, which so far has kept inflation at bay. Although Rouhani aims to limit inflation to 15%, most analysts forecast inflation to be held closer to 20%, which is still a far cry from the runaway inflation in prior years. Also, in July 2013, the Central Bank of Iran devalued the rial to a rate of approximately IR 25,000 to the U.S. dollar—a level much closer to the actual market rate. Such policies are successfully reducing the monetary base and keeping inflation at bay, but deprive a growing manufacturing industry of much needed liquidity. If Tehran truly wants to lessen its reliance on oil exports, it must find a balance.
Iran’s economy, however, is showing promising signs. According to the Economist’s ViewsWire, Iran’s GDP has grown 4.8% year-on-year in the second quarter of 2014/2015 of the Iranian calendar year. This comes on the heels of two years of economic recession, where Iran experienced a GDP collapse of almost 7% in 2012 and 2% in 2013. Oil sales are hovering at around 1.2 millions barrels/day, which is slightly above previous years.
Other positive indicators include a low external debt to GDP ratio, and a relatively stable supply of foreign exchange reserves. Will Rouhani be able to capitalize on this momentum? Rouhani’s 2015 austerity budget does not account for a comprehensive nuclear deal, and projects that 30% of the government’s revenue will come from oil exports and the remainder from an estimated 20% increase in non-oil exports and increased taxation. Low energy prices and continued sanctions could curtail any chance for economic recovery and growth.
The growing cracks in the international sanctions regime will not be enough to stave off economic hardship for Iran in the near term, especially if energy prices continue to stay low. Tehran’s doctrine of a “resistance economy,” which relies on reducing its dependence on oil and increasing efforts to liberalize its largely state-run economy will not be enough without sanctions relief.
If negotiations succeed, Iran will want the U.S. and EU lift the harshest of financial and economic sanctions first. Given the current political climate in the U.S., this may be next to impossible. In the event of a partial agreement, however, it is unlikely that President Obama will carry enough political capital to obtain concessions from Congress, and will have to rely on rolling six-month waivers, which leaves Iran vulnerable. Regardless, Iran will still need to contend with the humanitarian and terrorism-related sanctions that will likely not go away.
If negotiations fail, the U.S. will tighten sanctions on Iran’s energy, mining, construction, automotive, and financial sectors. Under the current version of the Kirk-Menendez bill, this could include limiting U.S. banks from managing correspondent accounts with foreign institutions that have conducted “significant” transactions with sanctioned Iranian banks and increasing pressure to further reduce oil imports from Iran to “de minimis” levels —thus further isolating Iran from the global economy. In the short-run, any meaningful economic recovery and growth will be lost. In the long-run, however, depending on how the sanctions regime maintains its legitimacy, Iran may be able to overcome its global financial isolation.
Regardless of whether or not negotiations succeed, a number of regulatory challenges will still impede Iran’s access to international banking. In 2009, for example, the Financial Action Task Force, an international body responsible for setting banking standards, concluded that Iran lacked the necessary legal frameworks to prevent money laundering and terrorist financing. Despite implementing reforms since, FATF maintains that Iran’s failure to address risks poses a serious threat to the international financial system, and in aFebruary 2015 statement, FATF, “…reaffirms its call on members, and urges all jurisdictions, to advise their financial institutions to give special attention to business relationships and transactions with Iran.” Given the rash of large fines against financial institutions, most will remain weary of facilitating business with any Iranian bank.