Sanctioning Iran: Current Impact, Future Prospects

The sixth session of the Iran Working Group, jointly organized by the Saban Center for Middle East Policy at the Brookings Institution and the United States Institute of Peace, was held on December 16, 2008, at Brookings. The featured speakers were Robin Wright, Public Policy Scholar at the Woodrow Wilson International Center for Scholars, Stephen Sestanovich, Kennan Senior Fellow for Russian and Eurasian Studies at the Council on Foreign Relations and Davis Professor of International Diplomacy at Columbia University, and Erica Downs, China Energy Fellow at the John L. Thornton China Center at Brookings. They shared their expertise on the current state of sanctions against Iran – in particular, on the current measures targeting certain Iranian banks – and on the prospects for the incoming U.S. administration to achieve multilateral consensus on a diplomatic strategy toward Tehran, particularly from key actors such as Russia and China.

The session began with one participant providing an overview of the history of American sanctions on Iran, dividing Washington’s approach into four broad stages. The first, which began with the embassy takeover in Tehran in November 1979, was limited to the freezing of American-based Iranian assets. The measures intensified in the mid-1980s following Iran’s designation as a state sponsor of terrorism. In the mid-1990s, United States oil purchases were cut under Clinton, who also signed into law the Iran-Libya Sanctions Act. Among other goals, this act attempted to discourage international investment in Iran’s energy sector. The Bush Administration oversaw the most stringent sanctions on Iran. These began with unilateral measures first against Iranian industry, then against all activities of the Revolutionary Guard, and have culminated with the addition of the targeted measures against banks deemed to be involved in transfers to terrorist groups or the financing of Iran’s nuclear program, measures chiefly devised by Treasury Under Secretary for Terrorism and Financial Intelligence Stuart Levey.

It was noted that the dire state of the Iranian economy has sparked hope that economic pressure on Tehran will be more effective than it has in the past. One participant referred to the popular sentiment in Iran during the first half of 2008 as “a sense of heady wealth”, in which luxury and electronic imports were abundant and heavily consumed by Iran’s upper classes. But this bliss has been hit by a “triple whammy” of the oil price crash spurred by the global economic crisis, a badly bungled domestic economic policy, and, finally, the effects of the American-led banking measures. On the domestic front, the failure of President Mahmoud Ahmadinejad to hold to his campaign promises of bringing Iran’s oil wealth to the dinner tables of the people has been astonishing. From an estimated $80 billion in the Oil Stabilization Fund of foreign exchange reserves when he took office, the President has overseen rampant expenditures that have brought the official tally to $25 billion, which some experts think may be as low as $8 billion in reality. The official inflation rate of approximately 30% barely indicates the suffering of Iranian households, as produce costs tripled and housing nearly doubled in the span of one year. Former Ahmadinejad cabinet members, including Finance Minister Davoud Danesh-Jafari and Central Bank Governor Tahmasb Mazaheri, have slammed the president’s mismanagement of the economy, as have many prominent economists – most notably in a highly publicized open letter written by sixty experts in November. Still, Ahmadinejad has remained dismissive of his critics and replaced critical cabinet ministers, even as Iran’s estimated daily oil income has fallen from $300 million to $100 million, plunging the nation into what the International Monetary Fund has predicted as a situation of unsustainable deficits.

Against this backdrop of economic turmoil, the United States has launched and progressively expanded its banking sanctions regime. As one participant noted, the banking initiative receives less attention than more eye-catching sanctions, such as those against the Revolutionary Guard; however, it has been more effective than any past measures. In addition to penalties on certain Iranian banks, direct pressure on international banks to avoid deals with institutions on the blacklist has gained momentum, with now more than eighty major financial firms worldwide cooperating with the United States, including banks in nations like the United Arab Emirates, China, and Malaysia. The blacklist of Iranian banks has steadily expanded since late 2006, now including five firms: Bank Saderat, Bank Sepah, Bank Melli, Bank Mellat, and most recently added in October 2008, the Export Development Bank of Iran. Even the Central Bank of Iran, Bank Markazi, may not be safe from future additions to the list. The effects extend far beyond the banks on the list; given the opacity of the Iranian banking system, many international banks wish to avoid the possibility of inadvertently aiding Iran’s military programs and thus have curtailed most or all of their transactions with any Iranian bank.

The discussion turned to an analysis of the effect of the sanctions on Iran, which one participant characterized as extensive. The primary effect of the squeeze on Iranian banks has been a lack of credit, especially for imports, forcing Iranian businesses to strike more cash or advance deals. An estimated 20% of import costs are said to be due to financing difficulties. The longer term effects may include difficulty in developing the energy sector. Borrowing for this purpose has become difficult, and firms including ENI, Statoil, Total, and Royal Dutch Shell have all either cut back projects in the massive South Pars Gas Field or pulled out entirely. The United States efforts have also influenced international bodies to caution foreigners against conducting financial transactions with Iran. The Financial Action Task Force has issued two warnings against deals with Iran due to the opacity of Iranian banks, while the Organization for Economic Cooperation and Development has lowered Iran’s credit rating to the second-lowest level of its 7-point scale.

One participant acknowledged that despite the successes of the sanctions regime, some financing loopholes exist that lessen their impact. While America’s position as a world financial center affords Washington great leverage in pressuring foreign banks to avoid deals with Iran, some of Iran’s banking business has been shifted to smaller boutique banks in Asia without American business. Further, Dubai, which handles $14 billion in trade with Iran annually and has a substantial Iranian population, has become a center for concealment of finances entering the Islamic Republic. In addition, the traditional informal hawala system of money transfer has played a significant role in helping Iranian businesses to subvert the sanctions and obtain financing from abroad.

It was suggested that the banking measures are the aspect of our current Iran policy most likely to be retained by the Obama Administration, as they are relatively devoid of political controversy. It was noted that the specifics of Obama’s Iran strategy remain unclear, but that there are ways he could expand the system of banking measures. One possibility would be to target insurers doing business with Iran, which would serve to make the shipment of suspect goods significantly more difficult. One participant cautioned that adding the Central Bank of Iran to the blacklist, however, would likely be seen as excessive by the international community and might reduce the world’s willingness to cooperate on the banking sanctions.

It was noted that, in spite of their popularity, the sanctions’ ultimate success in affecting Iran’s behavior is by no means certain. A recent publication by four scholars of the Peterson Institute for International Economics, Economic Sanctions Reconsidered (3^rd Edition), argued that even the most targeted sanctions will be unlikely to keep Iran from crossing the nuclear threshold. Furthermore, those most vulnerable to the financial squeeze that the sanctions exert on Iran are private business owners, who control 20% of Iran’s economy. Not only would the United States desperately wish for them to exert their influence against their regime’s actions, but they already tend to be more likely to oppose the regime, and the pain of the American-led banking measures may breed anti-Washington resentment. While it is likely that the anger of these business owners and other citizens will be focused on their own leadership, there is the potential for a backfire in which the sanctions help Ahmadinejad’s rhetoric of resistance to American oppression find resonance. The participant who mentioned these problems, however, still prognosticated that the sanctions will be sufficiently effective to bring Iran’s leadership to the negotiating table within 12-18 months to discuss security and economic issues. Success on the nuclear front was judged as being less realistic. There also exists the possibility that if the economic pressure is strong enough, the regime may put forth an alternate candidate instead of Ahmadinejad in advance of June’s presidential election.

The discussion then turned to the position of key actors Russia and China and the prospects for attaining their cooperation in stricter sanctions regimes against Iran. One participant began by noting that Russian leaders, including President Dmitri Medvedev, Prime Minister Vladimir Putin, and Foreign Minister Sergei Lavrov, have all said that they are against Iran obtaining nuclear weapons. As Russia cannot expect to be a likely Iranian target, their antipathy – albeit one far less pronounced to that expressed by the United States – could be due to fears that Iranian nuclear weapons would trigger a regional arms race, prompt greater American involvement in the region, or enable reckless Iranian behavior. This participant characterized the Russians as willing to cooperate, as evidenced by their voting in favor of many Security Council Resolutions against Iran, even Resolution 1835 in the midst of their anger with the United States over the Georgia conflict.

However, the Russians’ reluctance to strengthen sanctions could be attributed to several possible reasons. First, one participant posited, they may be reluctant to destroy their relationship with Tehran for sanctions that may well fail. Russia may also be reacting in principle against the possibility of being a junior partner in a Washington-led coalition. Some may think that rising military sales to Iran – a four-fold increase in the last five years – make Russia unwilling to put pressure on Iran, but Iran can be characterized as a disappointing market for Russian arms, as it buys significantly less weaponry and machinery than even nations like Bulgaria and Hungary. In addition, the participant dismissed talks of Russia leading a new anti-American coalition including Iran, suggesting Moscow viewed such brinksmanship as against its goals and interests.

Russia’s options for cooperation with the United States on Iran were then analyzed by one participant, who categorically ruled out Russian support for the use of force on Iran. Most likely will be support for modest, incrementally stronger Security Council Resolutions, which would also provide cover for Washington’s independent banking measures. Russia might also revive lapsed efforts to lead a multi-lateral administration program to provide Iran with nuclear fuel that could be used for civilian purposes. There also exists the intriguing possibility of a compromise between Moscow and Washington, which could potentially include the dismantling of the American missile defense shield in Eastern Europe in exchange for greater cooperation from Russia on Iran. This would, however, be seen as a major concession by the United States.

One participant then analyzed China as also being genuinely opposed to Iran obtaining nuclear weapons, noting that Beijing in 1997 pledged to cancel future cooperation with Iran on nuclear energy. China’s worries on Iran, stemming from its disbelief in Tehran’s assertions that its nuclear program is solely peaceful, are likely grounded in fears that a regional arms race could spark instability that would threaten China’s energy supply. China’s top oil supplier, Saudi Arabia, also strongly opposes Iran’s nuclear activities, and China would certainly want to avoid jeopardizing its close ties to Riyadh.

At the same time, it was argued that China sees Iran as a great underdeveloped prize with vast investment opportunities that its oil companies could profit from – thus, China does not wish to risk future relations with Tehran by leading efforts for harsher sanctions. In general, China does not embrace sanctions, due to its beliefs both that they violate nations’ sovereignty and that they are an ineffective tool of statecraft. China need only look at its own history to justify the latter belief, as it developed nuclear weapons while under a sanctions regime. That said, one participant suggested, Beijing believes that limited sanctions have the potential to bring Iran to the negotiating table.

One participant surmised that, in the end, China will be cooperative with modest incremental sanctions increases, much like Russia. To best coax China along this path, the United States can ensure that the other members of the P5+1 (the five permanent members of the Security Council and Germany) are of agreement on measures to be taken, although this may be difficult given Russia’s unpredictability. This consensus-seeking approach may work at the firm level as well. If Washington succeeds in pressuring international oil companies to pull out of Iran, China would likely follow suit due to the reputational risk associated with doing business there. One participant argued that in spite of popular perceptions of China’s quest for energy in its dealings with Iran, it has moved much more slowly to develop Iran’s oil and gas resources than most think, a $2 billion deal signed by Sinopec in December 2007 to develop the Yadavaran field – reportedly still pending approval from Iran – notwithstanding. Thus, targeted pressure from the United States, perhaps in the form of informal requests to China along the lines of the current banking initiative, may achieve the greatest results. As one participant noted, although China wishes to maintain good relations with both nations, its ties to the United States are far more valuable to Beijing than its ties to Iran.