The resurgence of Iran

Major economic changes could be in store for both Iran as well as much of the Middle East as a result of the 17 July landmark nuclear agreement that includes the eventual removal of the economic sanctions that have plagued Iran in recent years.  Recent opposition from within the United States threatens to derail the agreement, which could have significant implications for the economies of the country and the Middle East.

Iran’s economy during the sanctions

The implications that a potential lifting the sanctions on Iran are enormous for both the country and the region. The Iranian economy has been seriously affected by the economic sanctions implemented by the European Union, the United States and the United Nations after the Persian country refused to stop its nuclear program. Sanctions include a ban on oil and gas exports, freezing of overseas assets, and disconnection from the SWIFT mechanism, among others.

The most significant effect of the economic sanctions was a dramatic reduction in oil production and, therefore, a widespread shortage of foreign exchange, as well as soaring inflation and weaker growth. Nevertheless, the consequences of the sanctions were not all negative as they prompted the government to accelerate its import substitution strategy and diversify the economy away from oil. As a result, the country enjoys a relatively diversified economy compared to its regional peers.

Economic benefits of lifting the sanctions

The recent agreement paves the way for Iran to be reintegrated into the world economy, and with this come huge economic and geopolitical implications. Despite having been isolated due to sanctions since 1979, Iran is the second largest economy in the MENA region and trails only Egypt in terms of population. The country has the world’s fourth-largest proven oil reserves and ranks second in gas reserves. Moreover, the country enjoys a relatively diversified economy due to the effects of the economic sanctions and the government’s import-substitution strategy. While Iran cannot immediately return crude production to pre-sanctions levels of about 4.0 million barrels per day (currently 2.8 mbpd)—the country requires massive investment to upgrade its infrastructure—analysts estimate that it could release the approximately 30 to 11 million barrels it has in storage relatively quickly.

Impact on the MENA economy

Given Iran’s size and importance, the normalization of relations between it and the international community will have a profound economic and political impact in the MENA region. Iran is expected to boost oil supply in the mid- to long-term, which will add to a global supply glut and exert downward pressure on prices. Low oil prices will likely put an additional strain on the budget and the current account of some oil-export–dependent economies. On the other hand, those economies less reliant on crude will benefit from a reduced oil import bill.

The gradual removal of sanctions after decades of economic isolation will boost Iran’s demand for imported goods and services. The United Arab Emirates stands to be the principal beneficiary as it has a large Iranian community and already has strong commercial links with the Persian country (the UAE accounts for around 36% of total Iranian imports). Moreover, with Iran returning to the international community, the Ayatollah’s regime could help to stabilize the political situation in the Middle East given that it plays a pivotal political role in the region.

A challenging road ahead for Iran

The agreement has come under heavy criticism from the Republicans in the United States; the party controls both houses of the U.S. Congress and vowed to sink the nuclear pact. Although they are still short of the two-thirds majority required to override a presidential veto, some Democrats have spoken out against the deal, adding to the uncertainty regarding the final outcome of the vote scheduled for mid-September. In Iran, hardliners, which had benefited from years of isolation, could maneuver to derail the process in order to retain their privileges. Although it will not be smooth sailing for Iran, the outlook for Iran and the region is promising if both parties fulfill the agreement and Iran gradually reintegrates into the global economy.

Written by: Ricard Torné, Senior Economist

Author: Ricard Torné, Lead Economist

Date: August 28, 2015