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                                        Volume. 12158

Why Iran can withstand the sanctions
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c_330_235_16777215_0___images_stories_feb02_21_14_iran12.jpgWith the U.S. and the European Union (EU) imposing one of the toughest sanction regimes ever on Iran’s economic and financial lifeline, the world is inching closer to a potential catastrophic war at the heart of the Middle East. Meanwhile, Israel is suggesting a pre-emptive strike if sanctions fail to deter Iran’s nuclear program, while Tehran has vowed to retaliate on an international scale if it comes under attack. 
 
However, determined to lift the economic siege and avoid a potential conflict, Iran has shown an increasing interest in reviving talks. Not only has Iran welcomed successive rounds of IAEA visit to its nuclear facilities, but it has also shown interest in engaging in substantive talks, with Turkey and Russia acting as primary interlocutors. It is high time for the West to re-think the sanctions track, and craft a real strategy byfinally giving true diplomacy a chance. This might be our last opportunity at avoiding tragedy. 
 
Punishing the Iranian People 
 
The economic sanctions are targeting Iran’s main exports, namely oil and gas, and increasingly freezing Iran’s central bank out of global financial markets. This has made it extremely difficult for Tehran to engage in large-scale, dollar-denominated international transactions, forcing Iran to rely on cumbersome and often uncertain third party financial institutions to undertake huge trade deals.
 
Crucially, the sanctionshave had a cascading effect on Iran’s international trade, with transactions costs rising exponentially and the flow of imports coming under tremendous strain. Around a quarter of Iran’s economy is reliant on oil exports, while the national budget is heavily tied to oil revenues. The domestic economy is already feeling the pinch, as the cost of imported products skyrocket. 
 
In addition, the sanctions are compounding an inflation conundrum, because Iran is in the midst of an unprecedented rollback in state subsidies, which has placed a significant upward inflationary pressure on basic commodities.  Inflation rates are already in the double-digit territory, while the multi-billion manufacturing sector is having immense difficulties in accessing intermediate and high-tech imports from abroad, especially the West. As a result, both the industrial sector as well as the Iranian main street is bearing the brunt of a tightening economic siege.  
 
What is clear is that the sanctions regime is hurting the Iranian middle class and increasingly embittering their view of the West. 
 
For many Iranians, the Obama administration has clearly backtracked from his initial promise of rapprochement. The sanctions, which are directly hurting the Iranian people, are a betrayal of President Obama’s promise for a mutually respectful, stable, and cordial relationship with the people of Iran. After three years of empty words and gratuitous Nowrouz (Persian New Year) greetings, the Iranian populace has little good will towards the U.S. government. 
 

The Economic Siege
 
The most vulnerable sector is the currency markets, because sentiments are a crucial factor in determining exchange rates. Amidst a speculative frenzy, the fear of tightening financial sanctions and currency shortfallhas placed downward pressure on the Iranian Rial. Within a month, Iran’s currency has lost more than 40 percent of its value, forcing the Iranian Central Bank, Bank-e-Markazi, to tighten its monetary policy, engage in capital control measures, and inject petro-dollar reserves into the domestic economy as to stave-off growing volatilities in the currency markets.  In fact, the government has engaged in an unprecedented crackdown on the foreign currency black market and has imposed strict measures to regulate the flow of dollar. 
 
Iran has around $104 billion dollars in foreign currency and gold reserves, giving the country some cushion against currency shocks. However, the sanctions are also targeting Iran’s huge pool of foreign currency reserves, which have been spread across major Western financial institutions, especially in Europe. Therefore, Iran has been forced to transfer most of its gold and foreign currency reserves to Asian and Latin American banks. 
 
To sustain its foreign currency accumulation and trade, Iran will need to rely on its major Asian oil partners. However, the sanctions have been coupled with an intense diplomatic effort to convince Iran’s major Asian trade partners, from South Korea and Japan to China, Turkey, and India, to sever oil imports. 
 
The Western strategy is two-fold: first, the West has rallied the support of major Arab oil producing countries such as Saudi Arabia and the United Arab Emirates (UAE) to supplant any actual and prospective shortfall in oil supply if and when Iran’s exports are squeezed out of international markets; and second, by pressuring Iran’s Asian oil partners, the West is trying to limit Iran’s pool of customers, therefore giving immense leverage to Tehran’s narrowing circle of buyers. 
So, very understandably, Iran has characterized the sanctions as a ‘declaration of economic war’, threatening to close the Strait of Hormuz if such measures continue to choke off its economy. 
 
Iran’s Economic Resilience 
 
Iran’s strength is its trade surplus, low gross public debt, and relatively large economy (17th largest in the world), which has benefited from structurally high oil prices in recent years. Having a low public debt and healthy trade balance means that Iran, at least in the meantime, can continue to issue bonds and rely on external financing to meet its needs. The state is at the center of the economy, so issuing government bonds carries little risk of crowding out the private sector. 
Moreover, growing geo-political uncertainty and rising demand for oil has placed an upward pressure on oil prices. So, Iran can still maintain its economic momentum as long as it sustains a relatively stable level of oil trade with alternative customers, once the E.U. embargo comes into effect in June 2012. Despite the sanctions, Iran is still expected to export around 80 percent of its oil, so the country will still be flushed with significant cash in coming months. 
 
There are also doubts with regards to the ability and the wisdom of alternative suppliers filling-in the shoes of Iran. Iran exports around 2.5 billion barrels of oil per day, representing around 70 percent of the Organization for Petroleum Exporting Countries’ (OPEC) spare capacity. Therefore, replacing Iran’s oil means a razor-thin flexibility in oil supply, further undermining the stability of global energy markets. With high volatility in energy markets in recent years, the International Energy Agency (IEA) has already used its strategic reserves in multiple instances in order to stabilize an increasingly jittery market. High deregulation in commodity markets also means that speculation and sentiments play a key role in determining oil prices, with any sign of geo-political uncertainty adding to the risk premiums on oil supply. 
 
Assuming Iran’s oil is totally embargoed, the ultimate threat is the total collapse in energy markets, and the rise of crude oil to around $250 per barrel, as countries start rationing and hording oil supplies. This would not only choke-off fragile economies in the North, but it will also compromise the growth trajectory of many emerging economies, which are already struggling with declining demand in Europe and America. Iran’s oil is just too indispensable to global economic stability, and there are no reasonable alternatives in the foreseeable future. No wonder, Turkey, India, and China will continue to buy Iranian oil, while Korea and Japan will try very hard to convince America to grant them exemption waivers to continue their Iranian oil imports. 
 
In retaliation for the E.U. measures, a relatively confident Iran has already threatened to pre-empt the embargo by cutting-off its oil supply to Europe. Iran’s top European oil customers, from Italy to Greece and Spain, are the continent’s most fragile economies, thus, any pre-emptive Iranian measure would be a huge blow to the E.U. economies. A ‘supply-shock’ could further erode market confidence in troubled eurozone members, driving down credit ratings, which, in turn, raises borrowing costs. Europe is actually undermining its own stability by targeting Iran. 
Ultimately, the sanctions will not be enough to cripple the country. It is doomed to fail and backfire. The sanctions could at best target around 10 percent of Iran’s economy, but the country will have all necessary funds to pursue its nuclear ambitions. In fact, the government has proposed a$443 billion budget for 2012, and it plans to more-than-double military expenditures in coming months. Therefore, the sanctions are simply hurting the Iranian people and implanting further distrust towards the West. 
 
Reviving Talks 
 
With frictions embittering ties between Iran and the West, the onus of reviving talks has been squarely placed on the shoulders of countries such as Turkey and Russia, which have maintained strong ties with their Persian neighbor.
 
Russia and Turkey have a direct interest in Iran’s stability, because any conflict between the West and Iran could compromise regional security and adversely impact huge commercial ties with Tehran. While Russia detests any Western military adventurism close to its borders, Turkey’s booming economy is highly reliant on Iranian energy exports. Any conflict in Iran could also undermine Turkey’s national security and extinguish any hopes for E.U. membership.  
So the stakes are high enough for both Russia and Turkey to channel growing tensions in the direction of talks.Since the closure of the British Embassy in Tehran, Iran’s communication channels with the West have been hampered, thus Moscow and Ankara are the last meaningful bridge between Iran and the West. 
 
On its part, Iran seems to be interested in going back to the negotiation table, with Iran’s top officials constantly visiting Moscow and Ankara to lay-down the ground for talks. The Iranian economy is feeling the pinch, while Tehran does not seem to be interested in engaging in any military confrontation, and instead preferring to re-engage substantive talks. 
 
The pragmatists are pro-actively pushing for a diplomatic resolution. Both Iran’s President MahmoudAhmadinejad and Foreign Minister Ali Akbar Salehi have recently reiterated their country’s interests in reviving talks with the so-called (P5+1), composed of Germany and the five permanent members of the United Nations Security Council (UNSC). To prove its sincerity, last month, the Iranian leadership welcomed a technical visit by the IAEA representatives. Both sides have characterized the visit as very constructive, with a mutual agreement to have a following IAEA visit as soon as possible. Iran is also finalizing the contents of its response to the E.U.’s request for nuclear talks, with Istanbul as the prospective site for the negotiations. 
 
However, Iran has beforehand rejected any demand for suspending nuclear enrichment, but there is a high probability that Iran will agree to a concrete confidence-building measure within the framework of a Russian-proposed ‘step-by-step’ approach, whereby in exchange for Iran’s transparency in every stage of negotiations, there will be a corresponding rollback in sanctions. 
 
The West Should Rethink its Strategy 
 
The strategic alternative to diplomacy is war, because sanctions are only a tactical maneuver to achieve strategic ends. However, sanctions, especially in the case of Iran, do nothing but to punish the innocent majority, embitter the society, and embolden the hawks at the expense of pragmatists. 
 
Technically, Iran’s economy is just too big to cripple, without risking a global energy shock, and the Iranian’ nuclear complex is just too advanced to dismantle. Iran will be able to withstand heavy sanctions, because the country will still have billions of dollars to prop-up its military and advance its nuclear program. Therefore, it is crucial for the West to give diplomacy a chance and recalibrate a futile emphasis on sanctions
 
War is an unthinkable alternative, because any conflict between a regional powerhouse such as Iran and the West could spark an international crisis. The world economy is too fragile to take any major shock, and it is in the interest of the international society to find a peaceful and diplomatic solution to the Iranian nuclear program lest we risk an even deadlier global economic recession. Negotiations are not supposed to resolve outstanding ideological and strategic differences, but they are a crucial and necessary step in building confidence and overcoming deep sense of mutual distrust between parties. 
 
If the West welcomed the 2010 Tehran Declaration, we would have been in the second year of confidence-building, dialogue, and substantive negotiations by now. Yet there is still hope. Iran’s pragmatists are sensing the urgency of the issue, while interlocutors such as Turkey - undeterred by the West’s snobbery to the Turkish-Brazilian-brokered breakthrough over Iran nuclear program – are tirelessly seeking to avoid a disaster. 
 
The status quo is simply unsustainable. Iran has shown its interest in reviving talks, Turkey and Russia have supported such move, therefore the ball is in the West’ court now.  Let’s hope that reason will once again prevail over passions.

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