‘Iran is broke’: How clerics crippled the Islamic Republic

‘Iran is broke’

Behind all of Iran’s posturing, there seems to be a backstop. Iran cannot afford all-out war because its economy is on its knees.

“Iran is broke,” says Simon Mabon, director of the University of Lancaster’s Sectarian, Proxies and De-sectarianisation project.

The country has been crippled by more than a decade of sanctions, which have hammered oil exports and wiped out the bulk of middle-class wealth. Corruption is at record levels, unemployment is high, government debt has ballooned, business investment is non-existent and social unrest is bubbling steadily under the surface.

Escalating conflict in the Middle East is only making the situation worse. The Iranian rial last week plummeted to a record low against the dollar.

“We are on the verge of an economic crisis in Iran,” says Mansour Anbarmoo, a lecturer at the Islamic Azad University in Tehran.

Iran used to be a prosperous nation. In the years after the 1979 revolution, it built up a large, well-educated, cosmopolitan middle class. Now, sanctions and high inflation mean much of this wealth has been wiped out.

The World Bank estimates that 9.5 million Iranians fell into poverty in the decade to 2020. More than a quarter (28.1 per cent) were living on less than $US6.85 per day (in 2017 money), a record high. A further 40 per cent were at imminent risk of becoming poor.

“Iran is in a very dramatic cost-of-living crisis,” says Esfandyar Batmanghelidj, chief executive of the Bourse & Bazaar Foundation.

“That has contributed a lot to frustration and the breakdown of the relationship between Iranian society and the state.”

Homelessness has become an increasing problem.

“Previously only men were seen as cardboard sleepers on the streets in Iran. In recent years, it is also women and children,” says Anabarmoo.

They know they couldn’t really win a war and they know a war would be devastating to the economy in a way that they can’t even imagine.

“The economic outlook for me as a citizen in Iran is very bleak. There is no government plan to solve these problems.”

The West has imposed various sanctions on Iran since 1979.

In 2010, the US took action against Iranian banks in response to warnings about Iran’s nuclear program. Then in 2012 the EU banned oil imports from the country.

In the four years from 2012 to 2015, economist Morteza Ghomi estimates that Western sanctions knocked 19.1 per cent off Iranian gross domestic product (GDP)compared with the growth trajectory if none had been in place.

In 2015 came a reprieve. The EU and US lifted sanctions in exchange for a nuclear agreement, the Joint Comprehensive Plan of Action (JCPOA). This also lifted a freeze on $US100 billion of frozen overseas assets. Iranian GDP climbed by 8.8 per cent in 2016.

But it would take a long time to reverse the toll of sanctions.

“I had PhD students from Iran around that time who were really struggling. They were the wealthy students who were able to study abroad. But they were having to take several jobs just to keep going,” says Mabon.

There was a new hammer blow in 2018. Then-US president Donald Trump pulled out of JCPOA and announced a policy of “maximum economic pressure” on Iran. He reimposed sanctions, which have been in place ever since.

“Living in Tehran, we saw the number of businesses that people who set up when the nuclear deal was signed – anything from shops to export businesses – they basically all closed up over the next couple of years. There had been a period of great optimism and then you could see a chill wind blowing,” says Rob Macaire, former ambassador to Iran from 2018 to 2021.

Economy in crisis

The multipronged blow from sanctions also triggered rampant inflation.

Oil exports slumped, with revenues dropping from 16 per cent of GDP in 2011 to just 7 per cent in 2020, according to the International Monetary Fund. This blew a hole in the government’s finances.

In December 2023, government debt as a share of GDP was nearly triple what it was in 2008, according to Capital Economics.

To fill the gap, the government effectively started printing money, says Batmanghelidj.

Iran was also unable to import vital parts needed for its manufacturing sector, triggering a supply shock.

At the same time, the currency tanked, increasing the cost of the goods that were possible to import.

In February 2011 the rial was worth 10,894 to the US dollar, according to Oxford Economics. By February this year, the exchange rate was 560,599 – less than one-fiftieth of the value it held 13 years earlier, before the wave of sanctions began.

More recent data from Bonbast shows the currency has fallen further in recent months in response to the escalating conflict with Israel.

After the Iranian missile attacks, it slumped to a new record low against the US dollar of 705,000.

On a per-person basis, real GDP has shrunk by 0.6 per cent in each year from 2011 to 2020 across this period, according to the World Bank.

Real wages fell in every sector between 2017 and 2020. In extractives (namely oil and gas) and health and education, real earnings plunged by 26 per cent and 22 per cent respectively.

“The middle class of the country was hollowed out. That decimated people’s savings. Since then, they have had no cash to rebuild the economy,” Mabon says.

Iran is classed as an upper-middle-income country, yet in rural areas just 1 per cent of households have access to modern sewage systems, according to the World Bank.

Only half have access to the internet.

The toll of sanctions was compounded by the pandemic. Iran was hit early by COVID-19 and had the highest death rate in the Middle East.

By February 2023, Iran’s cumulative COVID-19 death rate was 1635 per million people – nearly double the global average.

Political mismanagement

Since COVID-19, however, the Iranian economy was starting to look better. In 2022, GDP rose by 3.8 per cent, according to the World Bank.

Increased demand from post-COVID-19 China, higher oil prices and less stringent sanctions enforcement under Biden boosted oil exports.

Iranian crude production in March averaged 3.2 million barrels per day, up from a low of 1.9 million in 2020, according to Goldman Sachs.

Biden did not lift economic sanctions but he put a coherent offer on the table to do so in exchange for Iran’s nuclear compliance, says Macaire.

“There was apparently an understanding of Iran backing down a bit on its nuclear program in return for tacit acceptance of more oil exports.”

But the toll of sanctions was about much more than oil and the issues have been compounded by massive political mismanagement.

“The real problem with the Iranian economy is that it is completely opaque. There’s very little accountability and certainly no transparency,” Ansari says.

“The economy is essentially run by a bunch of non-accountable religious foundations who bear no relation to the regular government.”

Foreign businesses cannot invest because they are not able to look at company accounts, he adds. “Nobody in Iran invests in Iran.”

‘Standing firm is falling behind’

Under president Akbar Rafsanjani, who ruled from 1989 to 1997, and Mohammad Khatami, who took over until 2005, the economy was fairly well run, according to Ansari. But this changed under president Mahmoud Ahmadinejad, who was in charge from 2005 to 2013.

“Ahmadinejad was the one who transferred a lot of assets away from regular government and into the more revolutionary organs of government between 2005 and 2013. The country has never really recovered from that,” Ansari says.

Ahmadinejad abolished the organisations that audited the economy and handed many assets and financial legal power to the Supreme Leader, Ali Khamenei, and the Revolutionary Guards (IRGC).

Today, about 40 per cent of Iran’s economy is estimated to be effectively under the control of the IRGC in some form.

This opaqueness was a major block to international investment even during the years of the JCPOA, Ansari says.

Although sanctions were lifted, the US had banned business relations with the IRGC and it was impossible for businesses to navigate this.

“There is no Companies House in Iran,” he says. “Nobody knows what is going on. It is very difficult to do your due diligence.”

From the mid-1990s to 2012, annual investment in Iran more than tripled. In the decade after 2012, it halved.

This means Iran’s manufacturing sector, the lifeblood of its economy, is on the brink of decline, Batmanghelidj says.

Iran’s economy managed to stay afloat despite Western sanctions because of the resilience of its non-oil manufacturing sector, which makes up 32 per cent of Iran’s GDP, nearly double that of the oil and gas sector, says Batmanghelidj.

The sector survived by adapting. Iran shifted from European to Chinese suppliers, or sourcing goods through Turkey and the UAE.

Firms build up stocks to weather future shocks. Companies began to build more machinery at home. This is how Iranian GDP returned to growth.

But sanctions killed investment and technological advances. In the decade up to 2012, Iranian industrial production was growing at an average rate of 13 per cent per year. In the following decade, growth averaged just 1 per cent per year.

“When it comes to economic development, standing firm is falling behind,” Batmanghelidj says.

Iran Khodro, the largest state carmaker, is still producing a Mercedes Benz truck that was designed 62 years ago after a new deal with Daimler collapsed when Trump withdrew from the JCPOA.

Writing for the Financial Times in March 2022, Iranian Finance Minister Ehsan Khandouzi said he would reverse the “recent mushrooming” in the budget by increasing tax revenues and government investment.

But any economic policy has merely been lip service, Ansari says. “It just hasn’t been effective at all.”

Record corruption

Corruption has intensified in Iran after sanctions were imposed, says Mohammad Farzanegan, professor of economics of the Middle East at the Marburg Centre for Institutional Economics. According to the World Bank, it hit record levels in Iran in 2021.

The resulting loss of public trust in the political machinery has increased participation in the shadow economy, Farzanegan says, reducing the government’s ability to plug its budget deficit through an increase in the tax base.

Iran also seems unable to capitalise on an increase in its oil exports to China.

United Nations Comtrade data shows Iran’s imports of capital goods, such as the machinery it needs for industry, slumped by 60 per cent between 2011 and 2022 to less than $US8 billion.

Iran has been trying to fill the gap by increasing its imports from China, but this is nowhere near enough.

In fact, it appears to be operating a trade surplus with China, despite the fact that manufacturers are struggling with supplies of raw materials.

“Iran needs more goods from China. For some reason it’s not purchasing them and that suggests to me that there is a breakdown in what it can pay for,” Batmanghelidj says.

Iran may be getting paid into accounts in the UAE and Malaysia in money that Tehran cannot move freely, he says.

Either way, the system is not working as it should.

Iran cannot afford a war

Although Iran is a key aggressor in the conflict in the Middle East, it is taking pains to avoid a full-scale war because it cannot afford one.

“While things have improved, they do not have the financial resources to go into a war, and the ramifications if they did could cripple the economy further,” says James Swanston, a Middle East specialist at Capital Economics.

“I think the economic weakness at home is constraining them. They’re not keen on escalation, they don’t want a war. They know they couldn’t really win a war and they know a war would be devastating to the economy in a way that they can’t even imagine,” Ansari says.

As far as experts are concerned, Iran’s missile attack was designed to not cause harm to Israel because Iran cannot afford further escalation in the conflict.

“I think it was a hugely performative thing. They gave advance notice so that they could be intercepted but so that they could still be seen to be responding to the Israeli attack on its consulate,” Mabon says.

Similarly, Iranian state media was swift to downplay the Israeli strikes on Friday. Analysts say the state wants to avoid any suggestion that further retaliation is necessary.

In Macaire’s view, Iran’s ultimate objective is not war but turbulence.

“I think Iran has a long-term objective to disrupt the situation in the Middle East, particularly in ways that harm Israel and that make life uncomfortable and more costly for the United States in the region,” he says.

“Iran is an anti-status quo power. Its interest is in destabilisation. In empowering its resistance front to attack Israel, attack the US, attack its allies, it can show that without Iran being part of the picture, other people aren’t going to have a comfortable life.”

Hamas’ attack on Israel in October has disrupted the prospect of Saudi Arabia’s rapprochement with Israel.

“These things play to Iran’s advantage. I think what they want to do is keep the pot boiling but below a level that provokes a serious attack on them,” Macaire says.

Iran is likely to continue to direct any escalation through its proxies, says Nomi Bar-Yacov, associate fellow in the International Security Program at Chatham House.

“Iran will be reluctant to engage directly, given that the response will be so forceful that they wouldn’t be able to defend themselves,” she says.

It does not have the defensive capabilities for all-out war and it does not have time to build them.

However, a group of zealous revolutionaries close to the Supreme Leader known as the Resistance Front, are particularly aggressive and may yet tip the region into all-out war.

“They have even less connection with reality than their predecessors,” Ansari says.

Logic may not prevail.

Social unrest

Iran’s ailing economy also presents new dangers for the government at home.

At the end of 2022, the country was wracked by massive protests as the Women, Life and Freedom movement erupted in the wake of the death of Mahsa Amini, a Kurdish woman who died in police custody as part of the government’s crackdown on women not wearing the hijab.

The protests were about women’s rights, but public discontent is closely tied to economics.

“The fact that women have been disempowered is related to the fact that they’ve been economically disempowered,” Batmanghelidj says.

Female labour force participation was a major casualty of the pandemic.

Two-thirds of the one million jobs lost during the first year of the pandemic were held by women. School closures and greater childcare responsibilities locked many out of the workforce.

The female labour force participation rate fell from 18 per cent in 2018 to 14 per cent in 2020.

“The underlying discontent is really being shaped by the economy. They know the economy is being mismanaged. Lots of festering problems haven’t been dealt with and they are coming home to roost,” Ansari says.

But just as Iran’s economic problems may constrain its military aggression, it appears to be using the conflict to increase its control of the population while the West is preoccupied.

In recent days, the government has renewed its policing of women.

“They have used the excuse of the attack on Israel to clamp down very heavily on the women’s veiling again and actually now the people doing it are wearing bulletproof vests,” Ansari says.

“They are heavily armed. Obviously we’re not paying attention, so they are taking the opportunity.”

The crackdown is more violent this time, he says.

“They’re dragging women off, they’re beating them. It’s so savage and so vicious that I’m quite dubious that it won’t result in some sort of protests.”

At the same time, however, the population’s low opinion of its rulers did not prevent general approval of the regime’s retaliation against Israel.

The regime lacks legitimacy, but Iran is still nationalist, Macaire says.

“People are proud of their country,” says Macaire.

Many are genuinely loyal to Qasem Soleimani, the powerful commander in the IRGC who was assassinated by the US in 2020, he adds.

But even Iran’s proxy warfare tactics are unpopular.

“People are loyal to their country, but they don’t understand why the regime is putting all of its money and efforts into fighting wars across the region using proxy forces,” Macaire says.

Ansari estimates Iran sends about $US200 million ($310 million) a year to Hamas and around $US1 billon to Hezbollah.

During the Mahsa Amini protests, a popular chant was “Neither Gaza nor Lebanon, my life for Iran”.

The West has no levers left

What’s next in the Middle East? There is a catch-22. While sanctions have crippled Iran’s economy, they also mean the West has little left that it can threaten Iran with.

“One of the challenges about having a maximum pressure policy is that once you are at maximum pressure, it’s difficult to go much further. I don’t think there’s an easy lever to pull that would massively increase the pressure on Iran,” Macaire says.

One option could be imposing secondary sanctions on nations that trade with Iran, namely China, which in theory could in turn put pressure on Iran.

But this would be geopolitically explosive, Batmanghelidj warns. It would effectively be an attack on China’s energy security and could spark major retaliation.

And China would be unlikely to play ball.

“China isn’t remotely interested in getting too deep into Iran. It sees it as a sort of a useful stick to beat the Americans with,” Ansari says.

America’s fatal flaw is its political system does not have a way to offer inducements without being seen as weak at home, says Batmanghelidj.

“We actually do need some carrots here. And the problem is it has been only sticks,” he says.

Economic pressure and surging inflation may be enough to prevent a full-blown war. But – crippled though the regime may be – it shows no sign of wanting a reset in relations with the West.

The Telegraph London