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Iran's economic woes loom larger than sanctions

BEIRUT (Reuters) - Iran’s home-grown economic ills pose a knottier challenge for its hardline leaders than possible new United Nations or U.S. sanctions over its nuclear program.

Even so, the world’s fifth biggest oil exporter is far from collapse, despite its economy underperforming and simmering discontent 11 months after a disputed presidential election.

Sanctions raise the cost of trade for Iran and are deterring Western companies from investing or doing business there, but they also give President Mahmoud Ahmadinejad a scapegoat for economic woes that his critics blame on his own mismanagement.

“I do not think his team is up to the serious challenges that Iran’s post-oil boom economy faces,” said Djavad Salehi-Isfahani, professor of economics at Virginia Tech.

“Sanctions are secondary in terms of negative influence on the economy, but they do make recovery much harder.”

Iran’s economy will grow 3 percent this year and 3.2 percent in 2011 after 1.8 percent in 2009, the International Monetary Fund says, compared to growth for the Middle East and North Africa region of 4.5 percent in 2010 and 4.8 percent in 2011.

The Economist Intelligence Unit forecasts oil export revenue at $63.4 billion this year from output of 3.82 million barrels per day (bpd), up from $53.9 billion last year, when Iran produced 3.74 million bpd. Crude oil is trading at around $85 a barrel after averaging $62 in 2009.

“With a regional recovery in oil prices and output, Iran should really be leading the way with much stronger growth,” said independent Abu Dhabi-based economist Mohammed Shakeel.

The United States and its European allies are seeking a fourth round of U.N. sanctions on Iran, proposing a ban on new energy sector investment, more curbs on Iranian banking and shipping, a full arms embargo and penalties against members of the Islamic Revolutionary Guard Corps and firms they control.

The West suspects Iran is seeking nuclear weapons. Tehran says it only wants fuel for power stations and medical reactors.


The Western sanctions draft stops short of seeking to block Iran’s imports or exports of oil or gas products. Russia and China are expected to try to water it down further.

Iran produced 7-8 million bpd before the 1979 revolution and the 1980-88 war with Iraq, but has never regained those levels. Sanctions have braked its quest to expand capacity by gradually scaring away major oil companies with the best technology.

“Iran is hoping that East Asian, Russian and Chinese firms will fill the gap, but they lack the expertise that Total or Shell could provide,” Shakeel said. “Iran can survive, but nowhere to the point where its growth reflects its potential.”

Having lived with some form of sanctions for three decades, most Iranians worry more about rising prices and scarce jobs.

Central Bank figures show inflation creeping up for a third straight month to 10.6 percent year-on-year in March, still well down on a peak of nearly 30 percent in late 2008.

Unemployment officially hovers around 11 percent, but Salehi-Isfahani said young people accounted for a worrying 70 percent of the jobless total. Iran needs to create about half a million jobs a year to absorb newcomers to the labor market.

“It is officially denied, but Iran’s economic situation is in a mess,” Shakeel said. “It has a very youthful population who look across the water at Abu Dhabi and Dubai, and say, we have resources which are phenomenally greater than these micro-states and yet we lag substantially. The social pressures are there.”

Oil earnings still account for four-fifths of state revenue, showing how far Iran has to go to diversify its economy. A surge of consumer imports under Ahmadinejad has hit local industries and forced some plants to close in the last two years.


Ahmadinejad, a populist leader who won office in 2005 vowing to put oil wealth on the table of every Iranian family, now wants to dismantle Iran’s hugely costly subsidy regime.

He is keen to reduce the country’s vulnerability to any future sanctions on petrol imports by reducing consumption. A lack of refining capacity now means Iran needs to import 30-40 percent of its needs, but it hopes to be self-sufficient by 2013.

Parliament has resisted Ahmadinejad’s plans to cut $40 billion off a subsidy bill put at $100 billion a year, or a third of Gross Domestic Product. But it still approved half that amount, despite critics who say the measure will fuel inflation.

“Every faction in Iran came round to the idea that lifting subsidies would lead to an economic transformation,” said Kevan Harris, a sociologist at Johns Hopkins University.

“There is consensus on the theory. The battle is over implementation, administration and control.”

Ahmadinejad has promised to compensate the needy for the removal of price supports on petrol and other refined products, natural gas, electricity, water, food, health and education.

Details of the reform plan, to be implemented over five years, remain sketchy and the changes have yet to start.

For Ahmadinejad tackling subsidies is a high-risk strategy.

“The immediate impact of subsidy reduction is that prices will rise. That adds to popular sentiment against the government because it is such a presidential-led move,” Shakeel said.

A popular backlash against cost of living increases could prompt Ahmadinejad to delay or even scupper the reform.

“I doubt he will do it if it is politically costly,” said Salehi-Isfahani. “Rising unemployment is a much bigger challenge in the medium term than the subsidy issue. The recession is much less under his control, so it is more dangerous.”

While Ahmadinejad strides the world stage defending Iran’s nuclear program and denouncing the United States, his conservative rivals in parliament attack his economic policies.

“They are hammering away at him with allegations of financial mismanagement and targeting some of his advisers,” said Scott Lucas, professor of American studies at Birmingham University.

“It’s getting really messy there. He may not actually be deposed, but the real push is to curb his authority.”