Iran’s economy is beset by a number of chronic problems. The country faces flat growth, high unemployment, rising inflation, a massive drop in the value of its currency and, more recently, falling oil revenues.

The Washington-headquartered IMF has forecast Tehran’s gross domestic product to expand by just 0.4 per cent this year, with only Yemen and Sudan expected to perform worse in the region.

In response to Iran’s continued development of its nuclear programme, the US in February enforced comprehensive sanctions against its financial institutions, including the Central Bank of Iran, further isolating the Islamic republic from the international banking system.

The Society for Worldwide Interbank Financial Telecommunication (Swift) in Brussels no longer allows any Iranian financial institution to change money, preventing people from wiring cash to and from the country.

Rampant inflation in Iran

“The most important measure from a human perspective is isolating Iran from the foreign exchange market,” says Fariborz Ghadar, senior adviser at the Centre for Strategic and International Studies in Washington.

“The Iranian rial has gone down by at least 50 per cent against the dollar on the open market [since December 2011], which means the price of imports has gone up substantially. Some of the buyers of commodities can’t get access to dollars because of the restrictions on fund transfer.”

In January, the Central Bank of Iran devalued the rial by 8 per cent against the dollar and in March recognised a dual market, allowing free market trading to co-exist with the official government rate. A third rate was introduced in July for imports of machinery and intermediate products.

The exchange rate devaluation and foreign cash flow restrictions, along with Tehran’s widespread subsidy reforms, have led to an enormous rise in the price of commodities, especially food.

The price of bread is reported to have increased as much as seven-fold, while the price of poultry rose three-fold between May and July, prompting the so-called chicken crisis. The local IRNA news agency reported in late July that people had taken to the streets in the northeastern city of Nishabur to protest against the steep increase in the price of chicken.

Hossein Askari, Iran professor of international business and international affairs at George Washington University in the US, believes there will be a tipping point, when food inflation becomes unsustainable for average Iranians.

“Random food riots are going to start in Tehran because of the rising food prices,” says Askari. “One of the problems with inflation is that if you are a producer and you think prices are going to go up, you keep products off the market and horde and then inflation becomes worse. Iran is about to embark on a vicious cycle and food price rises will become much more sustained and permanent.”

There will be a tipping point, when the level of food inflation becomes unsustainable for the average Iranian

Hossein Askari, George Washington University

The most ambitious economic scheme undertaken by the Iranian government in recent years is its subsidy reform programme, initiated in December 2010. The Islamic republic had long maintained significant subsidies on gas, petroleum products, power, water and basic food stuffs at considerable and increasingly unsustainable economic cost; the reform programme would push them towards global market levels.

The idea was to cut energy consumption and curb wasteful usage, while reducing public spending on subsidies and redistributing the country’s vast energy revenues to benefit the poorest sections of society and energy-intensive industries. Considering the price of fuel and related products jumped several-fold overnight, the subsidy reform programme is seen as one of the most radical policies of its type ever attempted.

A second phase of the programme was meant be pushed through this year, but has faced delays. Iran’s parliament, the Majlis, which is no longer loyal to President Ahmadinejad following the election in March, blocked the move.

Iran’s fuel prices

The government’s second phase planned to raise $106bn through the removal of subsidies for the fiscal year starting 20 March, which would mainly be used to compensate families for rising energy costs. “There were also unconfirmed rumours that most of the proceeds would come from a sharp rise in the prices of fuel,” says Tehran-based investment firm Turquoise Partners in a research note. “In particular, the price of petrol was expected to increase by 150 per cent.”

While there were no protests reported in Iran following the introduction of the first phase of the subsidy reform programme, the scheme was widely seen by analysts as an economic blunder and a large contributor to the escalating food crisis.

“I agree that you have got to get rid of these subsidies to stop waste and it is much more efficient if you give people a cheque,” says Askari. “But what Ahmadinejad did was absolutely the worst way to go about it. It has been a disaster because it has increased inflation and political turmoil. The second phase has been delayed, but it has been such a mess that it may even be abandoned at this point.”

According to official state news agencies, inflation in the Islamic republic hit 22.9 per cent in July, up from 21.8 per cent in April. However, most economists think that inflation is actually higher than this and food inflation has been estimated as high as 50-75 per cent.

Unemployment is also widespread in Iran and is rising. The IMF forecasts it will climb from 16.7 per cent this year to more than 20 per cent by 2015. Youth unemployment is estimated to be about 25 per cent.

Lost oil revenues due to sanctions

Tehran’s economic troubles will only be exacerbated by the drop in oil revenues following the introduction of an EU ban on insuring tankers carrying Iranian crude on 1 July. Crude production has already been cut from more than 4 million barrels a day (b/d) to under 3 million b/d.

Hillary Clinton, the US secretary of state, said at the end of June that Iran’s crude exports were estimated to have dropped from 2.5 million b/d in 2011 to 1.5 million b/d, which would cost the government about $8bn a quarter in lost revenue.

In Tehran’s budget for the fiscal year starting on 20 March 2012, the average sale price of crude was projected at $85 a barrel, with total oil revenues forecast at $49.8bn.

Oil revenues are budgeted to make up 37 per cent of Iran’s total income and with actual sales twice as high as budgeted in the last fiscal year, it is likely that crude accounts for well over 50 per cent of government funds.

Nearly all aspects of the economy will be impacted by lost oil revenues as the sanctions isolate Iran further from global trade. Supreme Leader Ayatollah Khamenei warned on 30 July that Iran was too reliant on oil, saying crude sales were “a trap which we inherited from the years before the [1979 Islamic] revolution”.

Although crude exports remain the cornerstone of the economy, Iran does have a more diverse industrial footprint than other Gulf countries. In many ways, the long-term international sanctions have helped the Islamic republic build up its non-oil industries.

“Tehran’s non-oil exports have grown substantially in the last decade,” says Ghadar. “The industrial sector has grown and the currency has gone down, so Iranian products are becoming competitive. The automotive industry just after the revolution was a minimum, but right now they produce 1.1 million cars a year, which is about 10 per cent of [the size of] the US market, while petrochemicals production has grown significantly as well.”

Many farmers and industrial groups have actually benefited from the sanctions as the drop in imports and reduced competition from more efficient foreign producers have given them a captive domestic consumer base.

Iran also has relatively strong foreign currency reserves, which support imports, giving the economy some cushion against the sanctions. At the end of the last fiscal year, reserves were estimated to be about $90bn-95bn, compared with $65bn the year earlier.

Today’s estimates of the Islamic republic’s foreign currency reserves vary widely. In early July, the governor of the Central Bank of Iran, Mahmoud Bahmani told state media that Iran had $150bn in reserves, which could be utilised to deal with the sanctions.

“We are implementing programmes to counter sanctions and we will confront these malicious policies,” he told reporters in Tehran on 1 July, saying the foreign reserves would provide Iran with the liquidity to pay for its imports. 

But Askari believes the government overestimates its foreign currency reserves to prevent panic among the business community.

“[I estimate] that Iran has under $40bn in foreign exchange reserves, plus the oil stability fund, which they are not going to touch apart from under certain conditions,” he says. “But there is no transparency. If it was revealed to be only $10bn for example, everyone in Iran would panic and every dime would flow out.”

Iran and the US have made little progress on negotiations over the nuclear power programme, which Washington believes is being used to develop atomic weapons, and sanctions have been tightened further since July.

Fresh sanctions for Iran

On 2 August, the White House introduced measures to deter the Islamic republic from setting up new payment mechanisms to circumvent existing sanctions on the purchase of Iranian oil.

The US also imposed sanctions against China-based Bank of Kunlun and Iraq’s Elaf Islamic Bank for acting on behalf of Iranian banks that have links to “Iran’s illicit proliferation activities”, President Barack Obama said in an official statement.

Washington is coming down harder now on any company found to be doing business with the government in Tehran and its institutions. A US regulator accused UK-based lender Standard Chartered of illegally laundering as much as $250bn in Iranian money over nearly a decade, calling it a “rogue institution”.

Businesses worldwide increasingly fear repercussions from the US over any perceived dealings with Iran, giving the Islamic republic fewer options to circumvent financial sanctions.

While Iran does have instruments it can use to fight the range of stifling measures taken against it by the US and its allies, its economy will continue to suffer in isolation. Barring a swift resolution of the nuclear dispute or a full-scale conflict with the US, Iran’s economic growth is likely to remain stagnant for the foreseeable future.