US and Europe Are Running Out Of New Sanctions on Iran

Despite new European Union sanctions on Iranian oil that went into effect this week (July 1), the Islamic Republic has the experience and capabilities to survive and even prevail in the nuclear standoff because its adversaries are running out of new economic “bullets” to target the regime.

Sanctions imposed this year have hit the economy hard, depressing oil exports by 40%. A third of steel imports have been blocked and Iran has had a tough time even buying maize, the main animal feed, as well as other basic items such as palm oil.

Yet, such developments need to be put into perspective. Having trouble getting maize, Iran has turned to wheat, even purchasing some from the United States. Cut off from dollar transactions, Tehran is resorting to alternative currencies and gold as well as barter deals. High oil prices mean that even if oil exports were cut by 60% this year, they would still bring in about $40 billion -- roughly double what Iran earned when reformist President Mohammad Khatami was in office.

The Iranian merchant mentality is millennia old. This mindset informs the view that there is always a way around the system. It also nurtures recalcitrance in the face of punitive measures. Thus, Supreme Leader Ayatollah Ali Khamenei has dubbed this Persian year the “Year of National Production, Supporting Iranian Labor and Investment.”

Sanctions have hit ordinary Iranians far more than the state. According to a recent Gallup poll, almost half of Iranians at times in the past year lacked enough money to buy food for their families. That is triple the figure when the first UN Security Council sanctions on Iran over its nuclear program were adopted in 2006. Prices of both foreign and domestic goods have significantly increased.

Part of this is due to the devaluation of the Iranian rial since January. While most analysts say the the trigger was US sanctions targeting the Iranian Central Bank, for years, Iranian officials kept the rial overvalued for prestige and to keep down inflation. That led the market to be flooded by cheap Chinese goods to the detriment of local producers.

The government is thus both the real culprit – and the beneficiary – of the devaluation. The Ahmadinejad administration’s program to reduce blanket subsidies has led prices of basic services and goods to increase more than thirty-fold in some instances. Inflation topped 30% this month, according to official figures. Separately, the Ahmadinejad administration has stubbornly refused to allow the central bank governor to increase interest rates and kept them far below inflation, only relenting slightly earlier this year. This situation has led Iranian investors to escape to safe havens such as foreign currency, gold coins and property. For the government, the 8% devaluation of the official rial rate has allowed it to fill holes in its budget as it receives oil income in foreign currency.

Ordinary Iranians have been co-opted through cash payments totaling 455,000 rials per month ($37 at the official rate, $24 at the current market rate). This figure is set to increase to 730,000 rials once phase two of the subsidies plan is implemented. This means the average four-member household will soon receive 2,929,000 rials in cash in a country where the official minimum wage is set at 3,897,000 rials.

In sum, the sanctions have allowed the Ahmadinejad government to blame its shortcomings on foreigners, devalue the rial and benefit from the increase of citizens’ financial reliance on the state.

Meanwhile, in my conversations with former and current Iranian officials, it is evident that the perception in Tehran is that the West has little left to unilaterally target. In the words of a former senior diplomat, after the EU announced its impending oil embargo, “they are running out of bullets.” The military option is seen as unlikely in Tehran. The Iranian leadership’s reasoning is that the US simply cannot afford a war.

While crude exports make up a vast majority of Iran’s foreign exchange earnings, they make up just over half the government’s budget. To put the issue into further perspective, the IMF projected that Iran’s energy exports would comprise 21% of GDP in the 2011/2012 fiscal year. The corresponding ratio is 30-50% for most Arab states on the other side of the Persian Gulf.

With over $100 billion in foreign exchange reserves and gross government debt of less than 10% of GDP (compared to around 100% for most EU members and the US), the Iranian leadership feels it is in a sound position to fight a long economic war. This perception is boosted by the view that the EU and US economies are fragile and in general decline.

Calculating that the sanctions will weaken Iran and make it less recalcitrant, the EU and the US refuse to soften their positions enough to allow Iran to back down. This calculation is dead wrong.

Four points should serve as warnings to Western governments about the consequences of dragging their feet on the nuclear negotiations.

First, the sanctions on Iranian oil exports and shipping are forcing Asian and European refiners configured for Iranian crude to turn to other suppliers. This obliges them to make costly refinery alterations that they will have little incentive to reverse should sanctions on Iran be lifted. Thus world oil markets will not benefit as much as they could if the embargo on Iran is lifted.

Second, the Iranian leadership is convinced that further significant UN Security Council sanctions over the nuclear program are unlikely for the foreseeable future. Iran counts on America’s continued refusal to soften its position to induce the Chinese and the Russians to oppose additional sanctions. This view is reinforced by the belief that events in Libya and Syria will deter Russia in particular from backing new multilateral penalties against Iran.

Third, the Islamic Republic is counting on rising Asian powers’ resolve to put their national interests above American preferences. Chinese crude imports from Iran surged in May, hitting practically the same level as a year earlier -- despite the Barack Obama administration’s refusal to grant Beijing a sanctions waiver until the last minute. Separately, the Indian government has finally cleared rupee payments for a portion of Iranian oil imports, exempting them from taxes. Moreover, Japan’s provision of sovereign insurance for Iranian crude shipments suggests that the market is adapting to EU sanctions.

Fourth, Iran can change facts on the ground without, in its view, violating the Nuclear Non-Proliferation Treaty. Apart from expanding the number of centrifuge cascades at its underground Fordo enrichment plant, it can start constructing more facilities that are relatively immune to airstrikes. Furthermore, it can consider enriching uranium to weapons-grade for civilian purposes. While the Tehran Research Reactor is modified to run on 19.75% enriched uranium, it was once designed to run on weapons-grade fuel provided by the US. Iran arguably has the capability to construct a replica of the site and fuel it with uranium enriched above 90% to make Molybdenum-99, a substance used to produce the medical isotope Technetium-99m. Tehran has already hinted that it is considering enrichment above 90% with its announcement that it plans to build nuclear submarines, which run on weapons-grade uranium.

Having concluded that its adversaries are “running out of bullets,” Iran is set to become bolder. It will certainly act reticent in upcoming technical talks (July 3) in Istanbul -- though not enough to collapse dialogue. The Islamic Republic’s basic calculation is that in this marathon, the best route to secure its interests is to continue changing facts on the ground to gain terms as favorable as possible in an expected final accord.  The question is if President Obama will tolerate the escalation triggered in part by his own administration’s hard-line posture, and if he can deliver the concessions necessary to push dialogue forward, should he be re-elected.

Mohammad Ali Shabani is a Tehran-based political analyst. This article was originally posted on http://www.al-monitor.com on Monday, Jul 2, 2012.