Rouhani Report Card: A Year of Economic Stabilization and Suspense

Editor’s Note: This is the fourth in a five-part SERIES assessing the track record of Iranian President Hassan Rouhani, marking his first year in office. Read the overview analysis

here

and an examination of his foreign policy

here

and domestic policy

here

.

Earlier this month, on the first anniversary of his inauguration, Iranian President Hassan Rouhani gave a speech in in southwestern Iran. He began with the Islamic Republic’s customary praise for the revolution and Iranian supreme leader Ayatollah Ali Khamenei and moved to the timely – and ideologically ripe – issue of the Israeli offensive in Gaza. Rouhani declared that “the work of the people of Iran is to support the Muslims whose children and wives are being killed by the most evil and bloodthirsty group, the Zionists, with bombs provided by the global arrogance.”

The response from his audience, however, deviated from the standard Iranian script; he was greeted with chants demanding that “the tunnel must be destroyed” – referring not to Hamas tunnels in Gaza but to local opposition to a major infrastructure project that the government is planning to undertake nearby.

The episode underscores the exquisite, interconnected challenges facing Rouhani: he must navigate Iran’s fractious domestic politics, extricate the country from a seemingly intractable impasse with the international community, all while fulfilling the needs and aspirations of a population whose primary focus is not Israel or the nuclear program but its own`prosaic concerns of jobs, inflation, and living standards. If Rouhani can succeed on each front, Iran will rise out of its post-revolutionary loneliness and near-pariah status to flourish in the global economy. However, if the nuclear negotiations run aground or his presidency becomes mired in factional opposition, the prospects for a prosperous, stable Iran will similarly founder.

Even before he officially registered as a candidate, Rouhani recognized Iran’s dire predicament. He has consistently articulated a national security perspective in which economic strength is an integral component of national power. And he was one of the first public critics of the policies of his predecessor, Mahmoud Ahmadinejad, raising alarms about the dangers of the government’s blithe disregard of the implications of intensifying sanctions and the 2008 global financial crisis.

In April 2013, as the campaign to succeed Ahmadinejad was just beginning to take shape, Rouhani remarked on the change in Iran’s fortunes under his stewardship. In 2005, he noted, “we had a quiet country with good foreign relations. We had a good economy with a relatively acceptable rate of unemployment and inflation. But whoever inherits this government will inherit the worst conditions of unemployment, inflation, value of national currency, social disputes, and unclear foreign policy.”

Since taking office, Rouhani has insisted that the situation was even worse than he previously understood. On his 100th day in office, he gave an address to the nation in which he described food shortages, epic inflation rates of 46 percent, and massive state debts of at least 2 trillion rials. He conceded that “the government that had the most revenues during its two terms” – Ahmadinejad presided over eight years in which Tehran earned more in petroleum exports than the previous century of production – “left the most debts as well.”

Working with an experienced group of technocrats and experienced economic planners, most of whom had been forced out of government by Ahmadinejad, Rouhani chose what Kevan Harris, a Princeton University scholar on Iran, described last fall as a “precarious balancing act” to rehabilitate the economy without adopting austerity budgeting. The goal is to impose enough fiscal and monetary discipline to control and reduce inflation, without triggering a deeper recession.

His success to date in balancing these contradictory requirements depends very much on where you sit – assessments by economists range from the pessimistic to the cautiously positive to the wildly optimistic. The International Monetary Fund recently issued an assessment that Iran’s “near-term outlook remains highly uncertain, with the distribution of risks becoming more balanced but still tilted to the downside.” The Fund expects that GDP contracted by 1.75 percent for 2013/2014, with projected modest growth of 1-2 percent this year.

Overcoming the Aftereffects of Ahmadinejad

Rouhani and his supporters continue to emphasize Ahmadinejad’s culpability for the country’s economic state –a position that has some political currency given the former president’s vilification among the Iranian elite. The critiques focus on his erratic and invasive management style, wildly indulgent spending, and massive corruption, as well as his failure to foresee the impact of international sanctions.

Former Tehran mayor Gholamhossein Karbaschi has charged that “Ahmadinejad’s government tried to run the country on the basis of a series of very propagandist and noisy moves and slogans. They imagined that they could resolve all the issues with a great deal of noise and ballyhoo, but today we see the consequences of their actions that have afflicted the people and all political spectrums.” For Karbaschi, like others in Iran, a return to Iran’s pre-Ahmadinejad state would represent a resounding success for Rouhani. “Of course, we hope that he will be even more successful than that and with the help of his friends he will be able to move the country forward,” Karbaschi added.

Apportioning blame to Ahmadinejad is fair, but within Iran’s Islamic system it inevitably raises awkward questions. Specifically, why was Ahmadinejad’s government permitted to run the economy in such dangerous and dishonest fashion? As Iran’s supreme leader, Khamenei wields ultimate authority over all policies and institutions of the state; therefore, he and the massive parallel bureaucracy that he commands bear final responsibility for the “astronomical” graft, colossal losses and wasted opportunities of the Ahmadinejad era. As Karbaschi lamented, “There is nobody to grab these people by their collars and ask them why they brought the country to a point that we had to import wheat from Brazil, America and the Soviet Union.” Of course there was somebody, but Khamenei and his lieutenants either didn’t know or didn’t care.

Several of Ahmadinejad’s signature economic initiatives have been abandoned, wound down, or — in the case of the much-needed but badly implemented subsidy reform program — modified significantly to reduce costs, improve efficiencies and avoid imposing new disruptions on the economy.

However, not all of the aftereffects of the Ahmadinejad economy cannot be quickly or easily discarded in many cases. Rouhani’s economic team is forced to contend with extensive non-transparency in the government’s accounts as well as an array of makeshift mechanisms for coping with sanctions that impose ongoing or even increasing costs. Some of these were Potemkin arrangements with state-affiliated (and often Revolutionary Guard-affiliated) firms to mask the dramatic exodus of foreign investors; others were simply rash efforts fueled by panic and resource availability. Some oil technocrats believe that Iran’s slow pace in developing its offshore gas resources has cost it billions in unrecoverable revenues due to disproportionately higher Qatari production from its North Field, which is part of a geological structure shared by the two states.

Even seemingly sensible measures – such as the expansion of refinery capacity to mitigate Iran’s reliance on imported fuel, a key vulnerability that Washington and Europe targeted with bans on product exports – seems to have been undertaken by the Ahmadinejad government without any serious effort to establish a viable fiscal framework for their operation.. “I have no idea what’s happening,” Iran’s oil minister, long-time technocrat Bijan Namdar Zanganeh told an industry publication in January 2014. “They made refineries very quickly…We can’t stop supplying them, but how can we get our money?” Zangeneh also raised questions about their operating safety. “They haven’t been checked according to schedule, if something has a hole in it and it catches on fire, who is to blame?” Zanganeh queried.

An Economy Snared by Sanctions

Ultimately, Iran’s economy is caught in the cross-fire of the nuclear diplomacy. The sanctions regime erected since 2006 is viciously effective, halving Iran’s oil exports, precluding Tehran from repatriating its hard-currency profits from the sales, and impeding Iranian banks from transactions with the rest of the world. The interim nuclear agreement inked last fall by representatives of Iran, America and five other world powers did not meaningfully alter any of these hurdles. As many of us predicted at the time, the sanctions relief provided in the November deal has generated little new investment and only modest new avenues of trade for Tehran.

The interim deal has provided small benefits for Rouhani’s economic challenges: boosting local business confidence and returning a small fraction of Iran’s estimated $100 billion in assets that are held in foreign banks. The diplomacy intensified an already-rising arc of petrochemical exports and unofficially facilitated a slight surge in oil exports.

Thanks to the deal and the stabilization measures undertaken by Iran’s new economic team, some domestic industries, such as the automotive sector – which was exempted from sanctions for the duration of the nuclear talks, have begun to rebound from the precipitous slump experienced since 2012. The currency’s value is consistently higher than prior to Rouhani’s election and inflation has been tamed to less dire levels. However, Rouhani has not succeeded in staunching the ongoing retrenchment in jobs or consumption, as Brookings non-resident fellow and expert on Iran’s economy Djavad Salehi-Isfahani recently noted, and the challenges are likely to mount.

Tehran’s inability to deliver a deal by the initial July 2014 deadline only extends the state of limbo for economic planning. The announcement of a revised contract model for oil and gas investment which was intended to attract new interest from Iran’s former partners in the international oil companies was already pushed back to September, and may see further delays.

Resistance Instead of Revival?

While Rouhani has trumpeted the nuclear talks as an avenue to relieving the debilitating restrictions on Iran’s ability to interact with the international financial community, he has also insisted that the country’s economic rehabilitation cannot be made contingent on the outcome of the talks. In his first official press conference as president, Rouhani promised that his government “will start serious negotiations with the foreign parties and will demonstrate that we are serious about these negotiations. But, at the same time, we will not sit idly to see whether the foreign parties will respond positively or negatively. We have programs for the current condition, and will continue these… You name it what you may, whether you call it economic resistance or endurance, we will continue this path nonetheless.”

Khamenei has branded this the “economy of resistance,” and he maintains that strengthening Iran’s domestic capabilities can sustain the country without reliance on oil revenues or trade with the West. It is an aspiration that long predates the Islamic Republic; during the 1951-53 British embargo of Iran’s newly nationalized oil company, nationalist prime minister Mohammad Mosaddeq attempted the same feat. Rouhani and his advisors describe it in slightly more realistic terms; they hope to expand Iran’s revenue base by negotiating the end of the sanctions regime or, if negotiations fail, eroding it, while also optimizing Iran’s non-oil economy at the same time.

One of the key aspects of this strategy is the conviction among the technocrats on the Rouhani team that Iran can avoid some of the pitfalls that undermined its previous attempt to rebuild and restore its economy – notably, the post-Iraq war reconstruction program launched by then-president (and Rouhani mentor) Ali Akbar Hashemi Rafsanjani in 1989. Then, initial economic improvements were undercut by rapid growth in imports, which contributed to inflation as well as government difficulties in staying current on its quickly-expanding foreign debt burden.

Iran’s economic gurus appreciate that even the expeditious lifting of all international sanctions – an unlikely if not impossible prospect – would only create new dilemmas for the country’s economy. Masoud Nili, Rouhani’s senior economic advisor who has long experience in devising Iran’s economic plans, voiced a key uncertainty in May, questioning “if the sanctions are lifted and we get back to having enormous oil revenues again, will we behave again as we did in the years 85 through 90 and go in the same direction? Do we want to impose a new crisis on the nation’s economy by increasing imports, or can we use successful international experiences and start national wealth funds with revenues from our natural resources for the improvement of infrastructure and national development? If we take the same path again, in view of the unemployment situation we have, conditions in the economy will become deadly.”