Economic resilience and ‘snapback sanctions’

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On December 7, 2015, Posted by , In News, With No Comments

With the implementation of the July-14 nuclear deal with the P5+1, sanctions on Iran’s crude oil export transactions are likely to be suspended, as will embargoes on key sectors of the Iranian economy including upstream energy investment and energy-related technology transfers, auto, petrochemicals, and shipping, as well as trade in precious metals.

Sanctions on Iran’s central bank are also likely to be waived; many of Tehran’s previously sanctioned banks will be de-designated; and, with the coordinated lifting of European banking sanctions, these banks will find their way back onto the SWIFT financial messaging system. Finally, European economic sanctions, almost exclusively based on Iran’s nuclear-related activities, will be terminated leaving Iran free to sell its oil, access insurance services, re-engage with European banks, and expand trade in many key sectors.

We seek to elaborate on the impact of sanctions relief on Iran’s economy. Iran experienced a moderate bounce-back in growth in FY 2014-15, which has been confirmed by Iranian officials at just over three percent. We believe, if Iran receives the sanctions relief as outlined above, the country is likely to experience moderate growth in FY 2015-16 followed by an acceleration of economic growth in FY 2016-17 as domestic investment begins to pick up. We forecast that Iran’s economic growth will average about 3.5-4 percent after the initial two years of the agreement, suggesting it will slowly begin closing the output gap.

Short-term impacts of sanctions relief

We assess the impact of sanctions relief on Iran’s economy in the next 18-24 months and how it might change Iran’s resilience to future sanctions pressure over the longer term. The impact of a deal depends not only on its composition, the sequencing of sanctions suspension, and the subsequent business decisions of Iran’s trading partners, but also on Iranian government policy choices on foreign investment and its use of increasingly accessible reserves and revenues.

• The economic impact of sanctions relief will start slowly after an agreement and build up over time. Iran will benefit from regained access to its foreign assets, reduced transaction costs that facilitate first greater imports, then some increase in oil export volumes, and finally investment at home and from foreign players. Under this scenario, after growing around 3.2 percent in 2014-15, Iran’s economic growth is likely to moderate at around 2.6 percent in FY 2015-16 (which ends in March 2016) and accelerate in 2016-17, as domestic investment picks up, consumption remains the key growth driver, and net exports become less of a drag as oil export volumes begin to pick up. Iran’s GDP growth could reach a 4-percent-plus pace as early as FY 2016-17 as its economy continues catching up from years of stagnation and recession and should remain at that pace in FY 2017-18. Should the government choose to save more of its foreign assets rather than spend them or should foreign actors be sluggish in picking up Iranian oil inventories or starting to invest, the pace of growth would be somewhat slower.

• More meaningful reforms to improve the business environment would be necessary to increase output growth beyond a 4-percent pace. Inflation will likely remain contained below 20 percent (admittedly high compared to global peers but sharply reduced from 2012-2013 period of sanctions escalation). The rial will be relatively stable as oil export volumes partly offset the import surge, and an improvement in sentiment increases the willingness of local actors to hold Iranian assets.

• With the reported deal based on a plan to provide Iran access to its frozen assets and suspend rather than lift several of the most impactful sanctions, the initial effects of the deal will be skewed toward supporting imports and improving Iran’s purchasing power by reducing transaction costs. Investment will lag, and will likely only become more pronounced in FY 2017-18 when foreign investors move beyond an initial phase.

Looking Ahead: Future Resilience and ‘Snapback Sanctions’

The following policy decisions will have a meaningful effect on the Iranian economy’s resilience to new sanctions:

1. Asset allocation: Should Iran’s government choose to save the newly freed-up funds — perhaps in foreign currency onshore (within Iran) or in jurisdictions less likely to comply with snapback sanctions in order to reduce the risk that its assets could be frozen in any future sanctions process — the economy would be more resilient to future sanctions.

2. Choice of spending versus savings: Iran’s $150 billion in FX reserves, a number suggested by the US government, are still relatively small compared to GDP (and to Iranian infrastructure and bank recapitalization needs) but more than seven times the estimated size of Iran’s fully accessible FX reserves prior to the JCPOA (Joint Comprehensive Plan of Action) and equal to about two to three years of oil revenues at the current price and pace of production. Should the Iranian government choose to deploy more of its revenue to local projects, it could result in stronger near-term growth, but it would reduce capital available for future projects or reduce the cushion against future shocks.

3. Investment terms for Iran’s energy sector: Should the terms be attractive enough to convince international oil companies and other national oil companies to begin investing significant sums of money in Iran’s energy sector, these returns on capital and domestic labor could form a significant deterrent to governments that might otherwise re-impose sanctions in response to Iranian non-compliance with its obligations under the nuclear deal. International companies that reinvest in Iran are likely to put pressure on national governments not to re-impose measures that would increase sanctions on both their Iranian counterparts and foreign players and limit their own ability to do business with Iran. Furthermore, as European companies reinvest in Iran, the United States may be less likely to re-impose sanctions that penalize its European allies in a snapback scenario.

4. Fiscal reforms: A combination of sanctions and lower oil prices in 2012-14 encouraged Iran’s government to first increase its revenues from non-energy sources and to scale back government spending to levels that it could afford. The government has also reduced transfer payments and subsidy payments. Should the government further rationalize spending or diversify financing sources domestically away from energy, its resilience to sanctions would change.

By: Seyed Noureddin Moosavi (MA Economics)

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