international analysis and commentary

The limits of deterrence with the Islamic Republic of Iran

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At the recent EU Foreign Affairs Council, sanctions against Iran were further strengthened, at the same time reaffirming the validity of the dual track approach and expressing the hope that Iranian authorities will soon decide to re-start nuclear negotiations with the E3+3.

This round follows the sanctions adopted after the EU Foreign Affairs Council of last January. The restrictions mainly target the trade, energy, transport and financial sectors. Great Britain, France and the Netherlands, with the active support of Italy and other EU member states share the conviction that tightening the grip on Iran’s revenues and financial transactions represent the best chance for the international community to push Iran toward a negotiated settlement on its nuclear program and to avoid an external military intervention.

The logic behind Western sanctions targeting several economic sectors (but far yet from being a full trade embargo) in Iran is straightforward: economic and financial isolation, the devaluation of the national currency, the rising inflation and unemployment will increase domestic pressure on the government and lead it either to capitulation in nuclear negotiations or to regime change if domestic unrest will be massive.

When the recession will become unbearable, Western leaders expect Iranians will turn against their leaders and at least partially blame them for the country’s economic decline and chaos.

According to EU data, oil revenues have slumped by 45% since the EU adopted an oil embargo, which entered into force last July. Europe bought 20% of Iran’s oil which has only partially been sold to other buyers. The situation has rapidly deteriorated; suffice it to think that oil revenues in 2011 had been higher than in 2010, increasing from $72 billion to $114 billion, despite a decrease in shipments of 8%, but thanks to a global increase in oil prices.

Last September, the deputy speaker of the Iranian parliament, Mohammadreza Bahonar, revealed that Iranian oil exports in July fell two thirds compared to the year before.

Even before the latest round of sanctions, the Iranian currency, the rial, had lost between 40% and 60% of its value, with inflation soaring to 30%, and according to some estimates even 50%. As inflation erodes the purchasing power of the national currency, the Central Bank will have to print more money, risking causing hyperinflation, with rising prices and rising volumes of money in circulation. As it stands, however, the Iranian Central Bank might not be able to print more money, which, according to several economists, would end up solving their most pressing challenge: inflation. With the country’s increasing financial isolation and the ensuing inability to defend the rial, the government is setting up an ”austerity” task force, a measure which is encountering broad opposition in the country.

The unemployment rate stands officially at 24%, whereas the real figure might double that number. This means that the once powerful and influential middle class is shrinking under huge pressure induced both by the impact of international sanctions and by domestic economic and financial mismanagement. Interestingly, protests are erupting in Iranian bazars, where even regime loyalists are voicing their opposition to national economic policies and distancing themselves from the current governing elite.

Recently, rumors have it that Iranian President Ahmadinejad might have signalled an opening to the US government for a meeting after the US presidential elections, scheduled for November 6th. While according to many, US foreign policy has boundaries and a defined set of opportunity costs which any president would be faced with, no matter what his ideology during the campaign has been, Iran might actually prove to be one of those few areas where a second Obama presidency or a Romney presidency would act in very different ways.

While the first Obama term has significantly differed from the electoral promises of engagement with Tehran and has steered towards a policy based upon the adoption of tough sanctions, many believe that a second term would see a greater willingness, on both sides, to strike a so-called “Grand Bargain”. Obama would have freer hands than in the past four years, and could testify to the limits of a now merely sanctions-based policy. Having Russia and most European partners eager to avoid an Israeli military attack, which nobody considers a solution, and an Israeli leadership which struggles to make a compelling case for intervention, would boost Obama’s chances of engaging in serious diplomacy with Tehran. On the other hand, a weakened Iran, both domestically because of the impact of several rounds of sanctions endorsed by six UNSC resolutions, and externally with its long-standing proxy and ally Assad’s Syria, in the midst of chaos and possibly destined to a non-Shia leader, would pave the way for increased debate within the country’s leadership on the rising costs of international isolation potentially leading to further cycles of domestic unrests, as in 2009, and the possibility to    building confidence with the international community and ease the pressure on the country’s economic and social fabric.

If all sanctions were lifted, this could represent a deal breaker in getting Iran to the negotiating table. The options for serious diplomatic negotiations include two alternatives, or maybe successive, scenarios: there could either be step-by-step negotiations and a mutually constructive tit-for-tat approach, whereby each party would accept some of the other’s demands in exchange for something, and thereby start to build confidence; or there could be a comprehensive settlement, whereby Iran could be allowed to produce and enrich uranium at low levels (5%) under international supervision. The diplomatic window will likely close next spring, with the upcoming Iranian presidential elections scheduled for June.