international analysis and commentary

At an economic crossroads, Iran hedges its bets between East and West

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From the very start, in the nuclear talks between Iran and the so-called P5+1, the stakes have been high for Iran’s economy, as well as for its alignment in an emerging multipolar world.

One of Tehran’s main objectives has been to break out of its economic isolation. However, while in the West it is commonly held that sanctions brought Tehran to the negotiating table, this is only partially true. The Iranian economy contracted in 2012 and 2013, in part because of sanctions, but did not come close to collapse.

As economic isolation toughened, starting from 2010, Iranian Supreme Leader Ali Khamenei more urgently prescribed the adoption of an “economy of resistance”, in an attempt to thwart the effects of sanctions and reduce the country’s reliance on oil revenues.

In 2012, as a consequence of an export boom facilitated by the free fall of the Iranian currency and by an increasingly diversified economy, non-oil exports covered 60% of the import bill.

Of course, this was not enough to prevent economic and social pain. Between 2011 and 2013, sanctions reduced Iran’s oil exports from 2.5 to 1 million barrels per day, leading to budget deficits and skyrocketing inflation.

President Hassan Rohani was elected in mid-2013 against this backdrop of economic hardship, but also in an atmosphere of Iranian recovery at the regional level. Tehran’s enemies were losing momentum in the Syrian civil war, and the survival of Bashar al-Assad’s regime was emerging as the most likely scenario.

The new government, accordingly, chose negotiations as a way to present Iran as a responsible actor in the region, at the same time capitalizing on its strengths.

Rohani nominated a cabinet starkly contrasting with that of his predecessor, Mahmoud Ahmadinejad. While the latter preferred advisers with Iranian academic backgrounds, the “market-friendly” and “business-oriented” government led by Rohani included at least six members holding advanced degrees from American universities.

The Rohani government reflected the ascent to power of a political class firmly believing in the need to open up the country to foreign trade and investments. According to this class, globalization made integration in the world economy an essential requirement for any country aiming to achieve development, wealth and international status.

It was these beliefs that brought Iran to the negotiating table. This meant, however, that the new government was ready to bargain, but not to surrender what it perceived as its “unalienable nuclear rights”.  

Khamenei, although not a supporter of neoliberal globalization, gave his approval to a more engaging approach toward the West, in accordance with a strategy he himself dubbed “heroic flexibility”.

There is nothing new in the emergence of this political orientation inside Iran. On the contrary, it is part of a dialectic that has been developing in the country since the 1979 revolution.

Several members of Iran’s business and political elite maintained a preference for economic partnerships with the West after the revolution. The first to open channels with Europe and the US was former President Akbar Hashemi Rafsanjani in the 1990s, followed by reformist Mohammad Khatami. Rohani fits perfectly into this groove.

This political camp is confronted by the more conservative supporters of the Supreme Leader, who view globalization as a vehicle for dissolving the Islamic regime into the international “materialistic” system. According to them, this in turn would lead to the loss of Iran’s economic independence. What they seek, instead, is an Iranian economy “resistant” to external shocks, including sanctions and global financial crises.

Since November 2013, when the Geneva interim nuclear agreement granted Iran partial sanctions relief, Rohani started a “charm offensive” reassuring the world about the peaceful intentions of Iran and forecasting that ties with Europe would be “normalized” as soon as possible.

In January 2014, Rohani went to the World Economic Forum in Davos promoting Iranian “constructive engagement” with the world, including through the exploitation of his country’s vast oil and gas reserves.

In the following months, European and US business delegations flocked to Tehran, striving for better positioning in the Iranian market in the event of a final removal of sanctions. This forced the White House to reiterate the message that Iran was “not open for business” yet. Nonetheless, the belief that a gold rush was just around the corner in Iran was not easy to dispel.

However, from ongoing negotiations gradually emerged that Teheran could obtain at most sanctions suspension, but not sanctions removal (because of opposition from the US Congress).

According to several Iranian observers, a mere suspension of sanctions would imply persistent turbulence in Iran’s internal market. It would also prevent long-term foreign investments in Iran’s infrastructure projects, since they require protracted stability and reduction of political risk.

In order to prepare for a possible failure of negotiations, Rohani himself began to hedge his bets on strengthening Iran’s ties with powers like Russia and China.

In recent months, there has been persistent talk of a $20 billion “oil-for-goods” deal between Moscow and Tehran that could strike a blow to the US sanctions regime. Although shrouded in mystery, the agreement became clearer in September, when the two countries announced that a Russian company will build seven thermal power plants by 2017 in return for Iranian oil. In early November, Moscow also signed a nuclear deal with Tehran, accepting to build up to eight nuclear reactors in Iran.

In October, Iranian news agencies reported a new deal between Tehran and Beijing under which China will commit up to $70 billion for Iranian projects. Iran is China’s third-largest oil supplier and, because of sanctions, Beijing still owes more than $22 billion to Teheran for its oil supplies, which cover 12% of China’s annual consumption.

Iran is also eager to establish financial and banking channels with both Russia and China, which in turn would ease pressure on the Iranian banking system from US and European sanctions.

To be sure, there is no organic alliance between Tehran on the one hand, and Moscow and Beijing on the other – and historical distrust still persists between Iran and Russia.

However, by strengthening ties with these two Eastern powers, the Rohani government was sending the message that Iran was not isolated, and was not intent on reaching an agreement at all costs with the West.

At the same time, by signing economic deals with Moscow and Beijing, Tehran was signaling its intention to maintain ties with both of them even in the event of a final nuclear agreement.

Iran has also tried to position itself in Europe as an alternative to Russian gas. But although Iranian interest in delivering gas to European markets is real, it depends on sanctions removal. Regardless, Teheran has tried to use gas supplies as a policy tool in order to extract maximum benefits from all players.

Meanwhile, Iranian leaders are aware of the shifting global balance of power. Knowing that the US on the one hand, and Russia and China on the other are advancing competing visions, Khamenei has repeatedly asserted that Iran must prepare to play a role in the emerging new world order.

The outcome of the nuclear negotiations will contribute to a great extent to define Iran’s future alignment. It will also determine which model prevails inside Iran, between the so-called “economy of resistance” and an economy integrated with the global system.