The choice made by Iran in the period after the signing of the nuclear agreement will entail a reassessment of US policy not only towards this country, but towards the region as a whole.
Kill two birds with one stone
Iranian strategy aims to balance between:
- domestic goals for sustainable economic growth while maintaining the political structure;
- external challenges to ensure a favorable regional strategic position.
If earlier these goals were achieved thanks to income from the sale of energy resources and religious zeal, today, when the assumption that Iran will flood the world with oil has not materialized, conflicts between these goals will become inevitable. Given the new economic restrictions, despite the lifting of sanctions, the Islamic Republic's greater focus on domestic growth will, in the long run, strengthen the position of the country's national economy in a way that is consistent with the approach of cooperation rather than confrontation in the Middle East.
The pursuit of regional dominance, on the other hand, would be counterproductive as it would lead to an inefficient use of resources. Such a scenario, in addition to deepening internal political divisions in Iran, requires a significant revision.strategies of local players, as well as the policy of the United States. Actions that push the country to strengthen its economic growth potential, rather than pursuing a costly Middle East strategic advantage, will be more beneficial to most Iranians, as well as to regional stability.
After sanctions
Iran's economy is at a crossroads. With the changing international environment and the global outlook for oil, the country faces difficult choices. Lifting sanctions after the signing of the nuclear deal has the potential to revive growth. Steps taken over the past few years have helped curb inflation, reduce subsidies and achieve exchange rate stability and even appreciation.
Yet the economy remains weak. Unemployment, especially among the younger generation, remains high. The outlook for the current year looks better in light of the easing of financial restrictions after the release of large foreign exchange reserves, an increase in oil production, and rising market confidence, which are leading to increased investment. The country's fiscal position is likely to continue to strengthen if planned revenue-raising measures, including VAT increases, tax breaks and subsidy cuts, are implemented, which, combined with higher domestic production and imports, could further reduce inflation..
The situation facing Iran is unfavorable: oil prices are falling sharply today. This is exacerbated by the requirementlong-term and costly investments to revive the pre-sanction production level of 4 million barrels per day and increase domestic demand. While rising Iranian oil production and related investment will boost GDP, lower export prices are likely to weaken the external stance and the budget. With limited prospects for any meaningful deal to contain major producers, oil revenues over the next 3-4 years could be 30% lower than projected assuming a strong recovery in 2016. In addition, the accumulation of foreign exchange reserves, which would serve airbag for an uncertain future, will be negligible. In this case, there will be no room for an expansionary policy of activating growth. Thus, the risks of further improvement have grown.
Constraints
At the same time, Iran's economy is burdened by significant structural distortions that continue to hold back its growth outlook. Critical prices, including exchange rates and interest rates, have not yet returned to normal; the financial sector is saddled with large non-performing loans; the private sector faces weak demand and inadequate credit availability; government debt has increased and subsidies remain large. Public sector entities control much of the economy and access to bank credit. The management of the private sector and the business environment is inadequate and non-transparent, which undermines private investment. Increased regional instability, as well as uncertainty about the implementation of the nuclear agreement, further increase the risks.
Priorities: domestic versus regional
Broadly speaking, Iran seeks to accelerate economic growth within the existing political structure while strengthening its local strategic position. The political elite of the country, however, is divided into two groups. One of them is represented by the reformists and the technocratic government of President Rouhani, which prioritizes economic growth. Thus, it is more inclined to seek regional strategic balance and closer cooperation with external forces for the sake of its economic program. If the authorities decide to liberalize the national economy through large-scale reforms, as well as reduce the role of the inefficient public sector, the course towards internal development will most likely outweigh in their favor.
The second force is represented by the hardliners, the ruling clergy and the Islamic Revolutionary Guard Corps (IRGC), who would prefer to keep the current economic structure as they own a large share of the economy.
Conservatives vs Reformers
If additional resources are directed to the public sector, and more broadly to the IRGC and the clergy, with the structure of the economy unchanged, then the growth rate will f alter after the initial spurt. These forces will keepits major share in the national economy and its significant influence on the politics of Iran, thus leading to an assertive regional and foreign policy at the expense of domestic economic development. Such a stance will generate further instability in the region without increasing the welfare of the country.
It is important to note that it remains unclear whether the current administration of Rouhani, who came to power with the aim of liberalizing the economy, has sufficient capacity to implement the necessary major reforms. He did well in recent elections but faces powerful and ingrained hardliners. So far, he has been successful in the following areas:
- stabilizing the foreign exchange market,
- cutting some subsidies,
- contain inflation.
But the President may have difficulty speeding up the process. For the authorities, it is important to have room for movement, which will allow you to get public support for the continuation of reforms. International encouragement and pressure could be decisive.
Iran, oil and politics
In the current environment, the authorities of the country can pursue three broad strategies:
1) Maintaining the status quo.
2) Implementation of wide-ranging and concerted reforms.
3) Implement moderate politically neutral reforms.
The third option would ease some restrictions on private sector investment and fiscal consolidation in a situation where Iran sells oil at a lower yield but keepseconomic and political structure as a whole unchanged.
Sustaining the status quo will generate a growth spurt to 4-4.5% in 2016-2017. from near zero in 2015–2016, with additional resources being used to reduce deficits, pay for outstanding commitments, and launch suspended public sector projects. However, with oil prices declining, the recovery will slow in the near and medium term to a level that will increase unemployment. An unchanging internal balance of political power will allocate resources to regional strategic goals at the expense of domestic economic goals, and this will have negative consequences for growth.
Cursing for reforms
Under the second broad reform option, liberalizing the economy and correcting structural distortions early would enable sustainable growth, even with lower-than-expected energy revenues, with a strong recovery in the medium to long term. Such dynamic development will increase the capacity to manage the risks faced by Iran. Oil has become cheaper and its price less stable. The success of this strategy will depend on a shift in the domestic political balance of power away from public-sector command economy advocates towards market-oriented equity holders. Experience has shown that sustained exposure to the market, on its own, helps create the necessary shift.
The third scenario, although politically the least disruptive, will quickly transition into the firstoption. Steps to address the politically correct issues, such as fiscal consolidation in a low-income environment and easing barriers to private sector activity, could temporarily calm dissatisfaction with the state of the domestic economy. Uncertainty and increased competition for political power, which will affect the distribution of oil revenues, will be counterproductive.
Iran: oil and foreign investors
If Iran stops at the first policy option, the US will have to make it clear that regional aggression will be reliably rebuffed by the US and the region. In addition, if major players are squeezed out of direct investment in the country's oil sector, this could help convince the authorities to change their strategy to be more adequate in relation to domestic economic problems and pursue a balanced foreign policy.
In order to push Iran towards the second option, the US and international organizations should support this approach. Cooperation with other neighboring oil-exporting countries will ensure a stable and realistic world oil price, restore traditional interdependence, helping to guide the Islamic Republic towards a foreign policy of regional cooperation and cooperation. Increasing interdependence with the world market and increasing foreign capital inflows will encourage Iran to pursue a less confrontational policy at the local level, thereby contributing to the stability of the region.
In the case of the third optionlocal and global stakeholders may need to take action to push the authorities towards a more active political stance. In particular, the easing of trade restrictions and investment cooperation in the non-oil sector may be driven by domestic reform policies. Another avenue for pressure on Iran - oil freezes by major producers to prop up prices - could spur bold political change.
The right choice
All actors involved in regional dynamics are interested in pushing Iran to choose the second scenario and pursue appropriate economic policies and structural reforms. Decentralization of decision-making and an increase in the role of the market in the allocation of resources, along with a decrease in the role of the public sector, are crucial. These steps will promote growth, enhance employment opportunities, and support Iran's integration into the regional and global economies. This will further expand the potential of the moderate part of society, which elected Rouhani in 2013 and won the recent parliamentary elections.
Major trading partners, backed by the United States, international investors and multilateral lending institutions, can play an important role in this process. While internal forces will dominate the debate over a less-than-expected focus on oil revenues, external forces may influence the direction of resource allocation and help the state achieve its dual purpose.
Regions where it will be preservedthe need for external investment in Iran - oil and the development of knowledge-intensive activities in other sectors needed to address the growing unemployment of a more educated young population. It is in the interests of foreign investors to maintain appropriate market policies in partnership with local investors less burdened by excessive regulation and control.
International cooperation
Multilateral economic and financial institutions and major investor governments can play an important role in the reform process. Organizations such as the IMF and the World Bank can and should advise the Iranian authorities on the necessary policy reforms. Their position can have an important positive effect on private investment decisions. Accelerated membership in the WTO, as well as access to world markets, will complete the cycle of economic liberalization and integration. A decisive move to change the regional strategic balance will take a long way to influence decisions about resource allocation and reprioritization towards domestic growth.
At the local level, Iran's interests include cooperation with other producers in order to stabilize the situation on the oil market. Closer policy coordination with major energy producers in the Persian Gulf would not only help improve Iran's economic prospects, but also reduce tensions in the region. Experience of informal cooperation with Saudi Arabia and other major producers on regional oil policy in 1990years is a good role model.
