Analysis: Iran economy far from collapse as sanctions tighten

DUBAI (Reuters) - Hossein Ahmad, an Iranian who runs a jewelry shop in wealthy Dubai, marvels at the spending power he sees on show during his monthly trips to Tehran, a year after U.S. sanctions largely froze Iran out of the global banking system.

An Iranian pilgrim shops at a market in Kerbala , 110 km (70 miles) south of Baghdad January 23, 2013. REUTERS/Mushtaq Muhammed

Shops in the Iranian capital are crowded. Finding a seat at good restaurants can be difficult. And the ski resorts in the mountains north of Tehran continue to attract Tehran’s glamorous and well-heeled.

“The economy has problems with the sanctions, yes. But it’s still working,” he says. “It isn’t as bad as people outside the country think.”

Sanctions are clearly having an impact; the country’s oil revenue has been slashed and other trade disrupted; a weak currency has sent the prices of some imports soaring, destroying jobs as some factories using imported parts have folded.

But they are not close to having the “crippling” effect envisaged by Washington. The Iranian government has found ways to soften the impact, and Iran’s economy is large and diverse enough to absorb a lot of punishment.

So at talks next week with the world’s major powers in Almaty, Kazakhstan, Iran seems unlikely to feel under overwhelming pressure to back down on its disputed nuclear program, which the West suspects is a cover to make weapons.

“The government had a long time to prepare for economic war,” said Mohammad Ali Shabani, an Iranian political analyst based in London. “If you’re talking about collapse, that is not happening.”


Iran’s oil and gas exports, which previously accounted for three-quarters of total exports, plunged last year because of international sanctions, and they may fall further as Washington makes it even harder for Tehran to obtain payment for them.

The International Energy Agency estimated last week that Iran’s oil exports may have dropped below 1 million barrels per day in January from 2.2 million bpd in late 2011, costing the country over $40 billion in lost revenues last year.

That loss is manageable, however, for a nearly $500 billion economy, and Iran has taken steps in the past year to put the economy on an emergency footing, partially offsetting the drop in inflows of wealth with a reduction of outflows.

Imports of luxury goods including foreign cars and mobile phones were banned, state media said, while the government cut subsidies for students studying abroad. Gold exports were controlled to make capital flight from the country harder.

Most importantly, the government presided late last year over a slide in the Iranian rial, which lost about two-thirds of its value against the U.S. dollar in the free market before stabilizing in its current range around 36,500.

It is not clear whether authorities deliberately engineered the slide, which caused panic among businessmen and brief street protests in Tehran, but the end result suits a government that is hunkering down to resist more years of sanctions.

Since the state controls the oil sector, it can divert most of Iran’s remaining hard currency supplies where it wishes. It is using special exchange centers to sell dollars at cheap rates to importers of basic foods, medicines and other essentials.

Meanwhile, the mass of Iranians who want dollars for other purposes - to import luxuries, travel overseas or move their savings abroad - must buy them at the expensive market rate. This cuts demand to send money out of the country.

The outcome, analysts say, is that Iran may avoid an external payments crisis even if oil exports fall further. Its foreign reserves are estimated by private economists to have dropped to around $70-80 billion from just above $100 billion at the end of 2011; the fall may slow and eventually halt as the currency depreciation and other emergency policies take hold.

Iranian-born economist Mehrdad Emadi, of the Betamatrix consultancy in London, said statements by officials in Iran suggested they had identified $60 billion as a safe minimum level for reserves, and would take further steps to restrain imports if necessary to protect that level.

“We are not even in the neighborhood of a critical situation for the balance of payments,” he said.

Oil used to provide about two-thirds of government revenues, so the sanctions have hit state finances hard. But once again, the weak rial has come to the government’s aid, letting it make money by selling some of its petrodollars to the private sector at much higher prices than a year ago.

The International Monetary Fund estimated in October that Iran would post a general state budget deficit of 3.9 percent of gross domestic product this year - easily bearable for a government with gross debt of only about 9 percent of GDP.


The sanctions are, however, sapping Iranians’ living standards as the weak rial pushes up inflation through higher import costs. Chicken prices, for example, nearly tripled in a year as the cost of buying feed from abroad jumped.

The official inflation rate hit 27.4 percent at the end of 2012. Including imported goods, actual inflation is believed to be roughly twice as high. A small jar of Nescafe now costs about 230,000 rials ($6.30 at the free market rate) in a Tehran store, up from 120,000 rials a few months ago.

Higher import costs, as well as inefficient management, have made it hard to obtain some medicines. Hospitals have reported shortages of drugs to treat cancer, diabetes and other diseases.

The auto sector, which built over 1.6 million vehicles in 2010, has been devastated by more expensive imported parts. Output roughly halved in the past year, and thousands of people lost their jobs as some parts plants closed, local media said.

But the picture is more nuanced. Some companies such as home appliance makers, which were being undercut by cheap imports, are now growing strongly because the rial’s drop has made them more competitive, Shabani said.

Iranians seeking to escape inflation and unable to move their money out of the country are building new homes, boosting the construction and carpentry industries.

These mini-booms are reflected in flashy new cars cruising Tehran’s streets and luxury apartments going up in its affluent neighborhoods. The stock market hit a record high this week.

Emadi estimated that while some of Iran’s top industrial centers could hemorrhage jobs because of the sagging oil and auto industries, overall the economy was unlikely to shrink more than around 2 or 3 percent this year.

Meanwhile, government subsidies and handouts are expected to continue softening the impact of inflation on Iran’s poorer families by keeping staple foods such as bread, rice, sugar and edible oil affordable for them. Parliament agreed last month to allocate a further $2 billion to support low-income families.

The rial’s depreciation has halved the savings of the middle class and destroyed some of their businesses, but “those at the top and bottom of the pyramid haven’t seen a dramatic amount of change”, said Emad Mostaque, a strategist who follows Iran at London-based NOAH Capital Markets.

This uneven distribution of the pain of sanctions is why, for Washington, they could prove counter-productive: they are doing most damage to a group that might be expected to push for political change in Iran.

“The middle class, people with fixed incomes, pensioners are under a lot of pressure. They are too exhausted to rise up,” Shabani said.

Additional reporting by Zahra Hosseinian; Editing by Will Waterman