How Oil Sanctions Spurred Iran to Reconsider Regional Trade

15 Jun 2020

How Oil Sanctions Spurred Iran to Reconsider Regional Trade

For those seeking pathways to stable economic growth in the Middle East, developments in Iran may serve as a model – Iran represents the first major oil producer in the Middle East to transition to overall dependence on non-oil exports.

By Esfandyar Batmanghelidj

The Arab Gulf States Institute in Washington

June 15, 2020

https://agsiw.org/how-oil-sanctions-spurred-iran-to-reconsider-regional-trade/

 

Iran has spent over 18 months in the grip of the Trump administration’s maximum pressure sanctions. The reimposition of secondary sanctions on Iran in November 2018 led to myriad economic pressures, the net effect of which has been the devaluation of the rial, high inflation, and a significant deficit in the government budget. By any reasonable measure, Iran’s economy has been in a state of crisis, triggered by sanctions, but worsened by mismanagement. It is ordinary Iranians, their purchasing power eroded, who have suffered the most.

But while the administration of President Donald J. Trump may have hoped that Iran’s economic crisis would snowball into an outright collapse, the maximum pressure tactics appear increasingly to yield only marginal gains.

While Iran’s economy contracted by 7% in the Iranian calendar year 1398 (March 2019 to March 2020), marking the second consecutive year of steep contraction, that decline was primarily due to the fall in Iran’s oil exports and subsequent contraction in the oil sector, which shrank by 35%. But in the largely overlooked non-oil sectors of the economy, the picture was far more positive. While sectors such as agriculture, manufacturing, and services faced a challenging readjustment following the secondary sanctions, data from the Statistical Center of Iran revealed surprising resilience last year, with growth of 3%, 0%, and -2% respectively – a far less dramatic picture than the negative growth rate of the overall economy might suggest.

Most remarkably, by the last quarter of the year, Iran’s manufacturing sector had returned to growth, expanding by 2.4%. The manufacturing sector, which employs just under one-third of Iran’s workforce of around 24 million people, has also helped keep Iran integrated into the global economy, even as sanctions isolated Iran from global oil markets. The coronavirus has hammered Iran, leading to nearly 9,000 confirmed deaths and derailing the country’s economic recovery as authorities imposed a nationwide lockdown. Iran’s government, like many worldwide, has opted to prioritize the country’s economic well-being over public health. Factories are reopening and trade is resuming, despite the human toll, and the machinery of Iran’s economic resilience is beginning to turn once again.

Iran earned $41 billion in non-oil export revenue from March 2019 to March 2020. In the same year, oil exports amounted to just $9 billion, down from a peak of $119 billion just a few years ago. Around half of the total value is attributable to manufactured goods. The non-oil export revenue has bought time for Iranian policymakers to engineer a revamping of the country’s budgets and general economic structure to minimize dependence on oil revenue – a long-stated goal.

That Iran has developed a strong manufacturing sector is perhaps unsurprising, considering the country boasts a domestic market of 80 million people. But what is surprising is the strong regional dimension of Iran’s non-oil export growth and, by extension, the country’s economic resilience.

While China was the top destination for Iranian non-oil exports from March 2019 to March 2020, earning Iran $9.5 billion in export revenue, the next four largest destinations are all in Iran’s immediate neighborhood: Iraq ($9.0 billion), Turkey ($5.0 billion), the United Arab Emirates ($4.5 billion), and Afghanistan ($2.3 billion).

Growth in regional trade began in earnest around 2008, driven by several factors. First, in the early 2000s, Iran underwent a period of advanced industrialization. European firms established joint ventures in the automotive, steel, and consumer goods industries, among others. As the quality of “made in Iran” products improved, Iranian-manufactured commodities were able to compete more directly with imports. As the domestic market share grew, Iranian manufacturers needed to seek new markets for growth.

This transition began just as multilateral sanctions were first imposed on Iran in 2008 and accelerated as severe financial sanctions were imposed in 2012. While sanctions complicated the operation of Iranian industry, there was an important silver lining. The devaluation of the rial triggered by economic uncertainty and pressure on Iran’s foreign exchange revenue made Iranian goods, which had improved in quality, more affordable in regional markets. Eager to earn more foreign exchange revenue to offset the rising cost of imported raw materials and other inputs, Iranian manufacturers sought to expand their exports.

The focus on regional markets reflects both the simple fact of Iran’s geography, which gives companies easy access to several large consumer markets, as well as the fact that regional trade, with its reliance on simpler logistical and financial channels, was more insulated from the efforts of the administration of former President Barack Obama to use secondary sanctions to throttle Iran’s economy. While containerized trade with Europe, India, Japan, South Korea, and other key markets fell – a consequence of the Obama administration’s success in cutting Iran’s oil exports as well as direct pressure on transportation companies and banks – the more atomized trade in the Middle East thrived, with small trucks, small ships, and small banks slipping through the sanctions net.

Proponents of maximum pressure perceive the regional dimension of Iran’s non-oil exports as a challenge, as evidenced by the Trump administration’s recent efforts to target Iran’s manufacturing sector.

But for those seeking better pathways to stable economic growth in the Middle East, the developments in Iran may serve as a model, insofar as Iran represents the first major oil producer in the Middle East to transition to overall dependence on non-oil exports. It did so reluctantly, and at immense cost, but assuming that non-oil exports continue to sustain Iran’s economy, this represents a fundamental improvement in the country’s political economy, with growth generated by sectors of the economy where the private sector and millions of blue collar workers enjoy greater influence.

Moreover, regional trade gives Iran and its neighbors a strong economic incentive for regional security that has not previously existed. Whereas Middle Eastern states have for decades competed in international oil markets, content to see instability across their borders that might suppress oil production and exports from OPEC rivals, the recent shift toward intraregional non-oil trade may mean the pursuit of prosperity in the region is more aligned with the pursuit of peace.

Iran’s turn to regional trade should, therefore, be seen as an opportunity for a new push toward economic diplomacy in the Middle East, in which freedom of navigation, trade harmonization, and even cross-border investment become important areas of dialogue. To date, Western powers have made no concerted effort to support economic development in a regional context, and the conflict prevention benefits such efforts would likely deliver have failed to materialize. Opportunity knocks.

 

Esfandyar Batmanghelidj

is the founder of Bourse & Bazaar, a think tank focused on issues of economic diplomacy and development in the Middle East and Central Asia, and particularly Iran.