by Brian H. Hook
Special Representative for Iran and Senior Policy Advisor to the Secretary of State
Washington, DC, Council on Foreign Relations
Today, I will discuss the success of the economic pressure pillar of our Iran strategy by examining Iran’s economy, the regime’s budget, its access to foreign exchange reserves, and the role of corruption.
More than a year after the re-imposition of American sanctions, the United States is depriving this regime of historic levels of revenue. Our sanctions are meaningfully targeting the revenue streams the clerics rely on to foment violence and suffering in Iran, throughout the region, and around the world.
Our economic pressure is one of three core pillars of our Iran strategy, in addition to diplomatic isolation and our ongoing efforts to restore military deterrence in the region. Our objective remains a comprehensive agreement with Iran that reflects the 12 points Secretary Pompeo has laid out. This includes ending enrichment, the proliferation of ballistic missiles and the development of nuclear-capable missile systems, support to terrorist proxies and the detention of dual and foreign nationals.
Because of our pressure, Iran’s leaders are facing a decision they have not confronted seriously since the end of the 1980s: either pursue negotiations and compromise, or manage economic collapse. Our pressure will continue to deny this regime revenue and disrupt its financial networks until we have secured a comprehensive agreement.
Iran’s economy is opaque by design. The complex revenue schemes and shadow financial networks that the Supreme Leader oversees enrich the regime’s ruling class while undermining opportunity for everyone else. These networks divert resources away from the people and fund a range of illicit and destabilizing activities, from terrorist groups in Lebanon and proxy wars in Yemen to Iran’s threatening ballistic missile and nuclear programs.
The clerical establishment prefers the current system to meaningful changes that would benefit its people. Iran’s clerics have had four decades to build an economy based on transparency and free market principles. Yet they have deliberately chosen to take a different path.
They instead use the nation’s economy as a bank to finance their revolution, thereby exposing it to our financial pressure.
Recently, Iran’s clerics derailed efforts to adopt international anti-money laundering and counter terrorism-financing standards that would bring transparency to Iran’s banking sector. To almost every country in the world, these standards are normal and commonsense.
But Iran’s leaders view them as unnecessary and imposing. They continue to resist transparency because they know it will expose them to real scrutiny, which would confirm what we already know: that this regime uses the Iranian economy to finance and spread its violent revolution, and make the regime elite richer.
This is in part why President Trump re-imposed sanctions on Iran: to deprive the clerical rulers of revenue, disrupt their financial networks, and create the pressure necessary to compel negotiations.
When he did, many experts said that United States alone could not and would not bring sufficient pressure to bear on this regime’s economic interests. They also said our sanctions would cause protests against the US and that the Iranian people would rally around the flag.
These experts were wrong. The sanctions we have imposed on the Iranian regime are the toughest ever, they are working, and the Iranian people are blaming the regime.
Sanctions on Iran’s oil sector are the core of our economic pressure.
This regime has relied on oil more than any other export to support its destabilizing activities. Our sanctions on Iran’s oil sector, which were only fully imposed in May, have driven Iran’s oil exports to levels not seen since the onset of the Iran-Iraq War in 1980. Iran’s oil exports have decreased by more than two million barrels per day, driving down Iran’s revenue from oil by more than 80 percent.
This amounts to a loss of more than $30 billion per year, with a total loss likely exceeding $50 billion since May 2018.
Since Iran can no longer find legitimate buyers for its crude oil, it is turning increasingly to evasive practices such as falsifying documents and turning off AIS transponders. This strategy will fail to make up for its declining exports. The United States is working closely with nations and industry to educate the maritime and energy sectors about Iran’s evasive practices and potential exposure to U.S. sanctions if they fail to do their diligence. As we have said, if we see sanctionable activity, we will take action.
Iran is also running out of options to store the oil it is unable to export. This has forced the regime to shut in its production and increase the amount of crude oil and condensate it sends to refineries and petrochemical facilities.
The regime is hoping to compensate for the fall in crude exports by increasing its output of refined products, but here too our enforcement is adapting and we are confident that Iran’s refined product and petrochemical customers will continue to stay away once they are made aware of the risks. Even as Iran tries to increase its exports of refined products, the regime is facing serious logistical constraints. Iranian tankers are increasingly being used as floating storage, making them unavailable to transport refined products to begin with.
Our sanctions are also restricting investment in Iran’s oil and gas sector, which will have a lasting impact beyond the immediate loss of revenue from reduced exports. Both upstream and downstream investments in Iran’s oil and gas sector have stopped. Foreign investors have almost entirely pulled out of Iran due to the risks and billions in investment has been lost.
While domestic Iranian companies are taking over some of the projects left behind, they are not able to replicate the role of more experienced international oil companies and investors.
As time goes on, Iran will not be able to make the investments it needs to maintain long-term energy production. The longer the regime chooses to reject diplomacy, the greater the impact will be on its future oil and gas production and revenues.
The decline in energy exports has had profound secondary effects in three key areas, which I want to discuss in more detail: Iran’s economic growth, the regime’s annual budget, and its access to foreign currency.
First, on the economy. Last year, Iran’s economy contracted by about five percent. This year, Iran’s economy will likely shrink by at least 9.5 percent, according to the IMF. This would be the steepest single-year decline in more than 30 years. Some analysts have projected an even steeper contraction, possibly as high as 12 to 14 percent. This would put the economy on the verge of a depression.
The IMF and World Bank’s projections place Iran’s economy as the third worst in the world, behind only Libya and Venezuela.
However, the assumptions underlying these already dire projections may actually be overly optimistic. The IMF has assumed that Iran will average oil exports of 600,000 barrels per day. This vastly exceeds Iran’s oil exports since May, and is beyond what Iran will export under our sanctions.
The IMF, and others, have repeatedly revised down their growth projections for Iran over the course of the last year. This will almost certainly happen again.
Inflation has also increased and is currently running at 40 percent overall. This is affecting the price of essential household goods significantly. To make matters worse, while Iran manages an official exchange rate, the parallel open market exchange rate shows over 50 percent depreciation since May 2018.
The large gap between official and open market exchange rates creates corrupt arbitrage opportunities that well-connected importers exploit for private gain. Yet when ordinary Iranians seek to purchase foreign goods with their weakened currency, they are now paying a steep premium.
Iran’s declining growth is having ripple effects throughout the economy. Pension funds are coming under increasing strain. Of the 18 existing retirement funds in Iran, 17 are in the red. As Iran’s elderly population continues to grow and employment stagnates, these funds will come under greater pressure.
Many analysts have compared the current economic decline under this regime’s watch to the prior round of sanctions imposed before the nuclear deal was finalized. However, Iran’s recession is far worse today than in 2012, when its economy contracted by six percent. The more appropriate comparison, as the data suggests, is the opening phase of the Iran-Iraq War in 1980-81, which severely disrupted Iran’s oil production and export.
The second major impact of low exports is unprecedented pressure on this regime’s budget. Due to the staggering loss of oil revenue, it is nearly impossible for the regime to put a credible budget forward. Oil export revenues typically comprise at least 30 percent of Iran’s revenues. Our sanctions are bringing this figure closer to zero. After initially assuming oil exports would average 1.5 million barrels per day in fiscal year 2019, the regime later revised this figure down to only 300,000.
It is surprising then that the draft budget released just this month for Iran’s next fiscal year assumes oil exports will average around one million barrels per day. This is an unrealistic forecast. Iran’s budget proposal is so off base that it spooked the Iranian market. The rial hit a six-month low against the dollar shortly after the proposal was released.
Iran has attempted over the past year to respond to budget shortfalls by cutting spending and resorting to stopgap measures to raise additional revenue. These include raiding its sovereign wealth fund, issuing even more domestic debt, attempting to privatize additional state assets, and slashing subsidies.
Recently, Iran’s financial desperation forced the government to raise gasoline prices in an effort to save money and increase exports. As the protests last month demonstrated, it will be difficult for the regime to implement further subsidy cuts without sparking even greater frustration among Iranians. So where will the regime find money?
It would make more sense for the regime to close the revenue gap by plugging holes in tax collection from Iran’s wealthy elite or expanding the tax base to include religious and IRGC-linked holding companies that dominate Iran’s economy, yet pay no taxes. The regime is choosing instead to shift the burden onto the middle class.
The regime must also grapple with how to keep its subsidized industries afloat as it struggles to find revenue. Iran is one of the most heavily subsidized nations in the world. More than 70 percent of Iran’s budget expenditures are allocated to underperforming state-owned enterprises, which make up the bulk of Iran’s so-called ‘diversified economy’.
An audit by the Supreme Audit Court for 2016 to 2017 showed that 162 of Iran’s 377 State Owned Enterprises were ‘economically unviable.’ The real number is likely higher. This suggests that as Iran’s oil sector shrinks, the Iranian regime will be unable to continue subsidizing its vast sector of underperforming non-oil industries, just as it is struggling to subsidize gas prices.
The government is running out of emergency measures to take or off-budget funds to raid. Moving forward, it will be less able to respond to continued pressure. No creative number crunching can change the fact that this regime’s coffers are running dry. Short-term fixes will exacerbate inflation and do nothing to address structural deficiencies in the economy.
If the regime insists on continuing to divert resources to fund terrorist activity or ballistic missile development, ultimately it will be forced to choose between printing money or delaying spending on development, salaries, and benefits.
The Iranian people have been demanding for a long time that the regime stop investing in wars and terrorism abroad, and start spending more at home. Now is an opportunity for the regime to do that, or face even greater pressure from its own people.
Finally, as exports decline, the third major impact on the regime has been reduced access to foreign currency. The regime is already struggling to acquire the foreign currency it needs to procure imports such as machinery, industrial inputs, and consumer goods.
Prior to the re-imposition of sanctions, Iran relied on oil exports for around 50 percent of its foreign currency earnings. Much of the remainder came from petrochemicals, metals, and refined petroleum products. All of these exports are now subject to sanctions.
According to U.S. government analysis and newly declassified information I am able to share with you, Iran currently has around $100 billion in foreign exchange reserves. Of that, only about ten percent (or $10 billion) is immediately accessible to Iranian authorities. Many experts have failed to appreciate the difference between reserves and access to reserves. That difference is $90 billion. Given the current sanctions on all of Iran’s top revenue generating exports, this is simply not sustainable for the regime.
The fact that Iran’s access to foreign currency is declining is all the more dire given last year’s collapse in the rial’s value. The rial has fallen over 50 percent at the market exchange rate since May 8, 2018.
Authorities may be compelled to spend reserves to prevent further depreciation as pressures mount on the rial, even as the regime is increasingly seeking to protect its dwindling accessible foreign currency reserves. By the end of October, Iran’s Commerce Ministry had banned the import of over 1,500 goods, ostensibly to reduce pressures to spend foreign currency.
The Iranian regime, not the United States, is responsible for the systemic deficiencies in its economy that rob the Iranian people of their wealth and enable Iran’s clerics to spread terror around the world.
Although Iran’s clerics promised economic prosperity and social equality after the Revolution, the Iranian people know all too well that neither have been delivered.
Massive clerical hedge funds, or so-called charitable foundations, worth tens of billions are just one aspect of Iran’s dark economy. Iran’s Islamic Revolutionary Guard Corps has its tentacles in nearly every sector of the country’s economy. This is despite a strong declaration from the regime’s first Supreme Leader, who cautioned that the IRGC should stay out of politics and the economy. Quite the opposite has happened.
The IRGC’s economic network thrives on opacity and malfeasance. It distorts the Iranian economy and diverts public wealth and resources to terrorism, missile development, missile proliferation, and regional wars. Estimates suggest that a majority of Iran’s economy is controlled by a small number of entities linked directly to the regime. The IRGC alone generates tens of billions in revenue through Iran’s shadow economy. How much of this do you think makes its way to the Iranian people?
The Iranian people have had enough. Hundreds of thousands of them recently took to the streets in one of the largest protest movements in the Islamic Republic’s history. In cities around the country, Iranians joined to demand accountability, reform, and transparency. Many were killed, many were injured, and many were jailed.
The Supreme Leader dismissed the protestors as “thugs”, but the real thugs are the security officials who fired on unarmed protestors and committed massacres. The Iranian people understand better than most that their government’s policies are the root cause of Iran’s economic stagnation. When they peacefully demand a better life and a more representative government, they are mowed down and brutally silenced.
The regime has simply lost all credibility. Again, it has only itself to blame. Rather than root out corruption and champion reform, the Islamic Republic rewards corrupt officials and continues its shady self-dealings.
Mohammad Baqer Qalibaf is a perfect example. As a former IRGC commander and three-time Tehran City Mayor, he has stolen from Iranians with impunity. During his 12-year tenure overseeing Tehran’s municipal affairs, he has been accused of significant financial corruption, including diverting municipal funds towards his presidential election bids and selling valuable city properties and land at a fraction of their cost to regime insiders.
Iranians have even paid with blood for Qalibaf’s corruption; many hold him responsible for the collapse of Tehran’s iconic Plasco building in 2017, which killed dozens. When he was voted out of as Tehran Mayor in 2017, rather than being held accountable for his long-record of suspected corruption, he was instead appointed by the Supreme Leader to the Expediency Council.
In this position, he has been able to influence the parliament’s legislative bills with no transparency. And now, after three failed presidential campaigns, he is running for the February parliamentary elections in a rigged process where the regime pre-determines the pool of acceptable candidates.
In another example, Labor Minister Ali Rabiei was impeached in August 2018 amid widespread allegations of corruption, falsifying unemployment statistics, and bribing officials to keep his post. Several months after he was ousted, Rouhani appointed him to serve as the government spokesperson.
These officials were all appointed to positions of authority despite allegations of corruption. This gets to the heart of the problem: the regime’s failure to root out corruption because its leaders benefit from it.
After 40 years, the autocratic rule of the ayatollahs is proving to be an economic catastrophe for the Iranian people. It has robbed Iranians of what should have been decades of progress and prosperity.
To summarize, exports are down, the economy is in deep contraction, the budget is facing unprecedented pressures it cannot fix, and access to foreign reserves is minimal. Meanwhile, corruption runs rampant.
Iran’s leaders – and they alone – bear responsibility for how they choose to spend the Iranian people’s money and for the state of their nation’s economy and the stagnation of the Iranian people’s livelihoods that result.
Our economic pressure is holding this regime accountable to its people and for its actions. With the ultimate objective of creating the conditions for negotiations, our pressure is exposing this regime’s corruption, revealing its gross mismanagement, and holding accountable those privileged insiders who have for decades profited on the backs of the proud Iranian people.
Only once we seriously and credibly threaten this regime’s economic interests, as we are now doing for the first time, can we build the leverage needed for meaningful negotiations. This regime will not change its behavior or stop weaponizing the Iranian economy to advance its expansionism absent pressure from the United States.
All nations must recognize this reality and take their own actions to hold the Iranian regime accountable. Rather than contemplating bailouts or even greater investments, which will only fuel Iran’s support to terrorism or its destabilizing missile development, nations must target the resources that this regime uses to fund the activities we all oppose.
Now is not the time to make accommodations for Tehran; we have done that for 40 years without success. Now is the time to challenge its behavior.
Continuing to provide economic benefits to the Iranian regime at a time when its own people are calling for a change in its behavior is irresponsible. It undermines their trust and misses an historic opportunity to comprehensively address the many threats posed by Iran.