WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

By Mahdi Ghodsi

image credit: iStock.com/duncan1890

• Ebrahim Raisi, the new Iranian President, who took office at the beginning of August, was elected with the lowest number of votes of all presidential elections in the Islamic Republic. This indicates a major loss of legitimacy for the current regime.
• Iran is now more autocratic than ever, concentrating power in the hands of the highest-ranking authorities: the Supreme Leader Ali Khamenei and the new President Ebrahim Raisi.
• Discontent with the economy and frustration with four decades of social, political, and cultural suppression have led to the lowest turnout ever in a presidential election.
• During the rule of Raisi’s predecessor, Hassan Rouhani, Iran’s economy grew at its lowest rate since the war with Iraq in the 1980s.
• In Rouhani’s era inflation reached its peak since the eight-year reconstruction period after the war, which affected the poorest groups of Iranian society the most. This is a major blow to Iran’s social and economic capital.
• Iran’s average annual GDP growth has never been lower than under President Rouhani. U.S. secondary sanctions resulting in a reduction of net exports as well as slow growth in investment in his second term are the main reasons.
• At the same time, Rouhani implemented an expansionary fiscal policy of unprecedented proportions. Furthermore, shrinking household consumption has been the major factor behind protests and uprisings in the past few years.
• Ebrahim Raisi and his economic advisors have no plan on how to revive the economy. Instead of attracting foreign direct investment from the West, he will lean more on China, perpetuating Iran’s deep economic and social crisis.

On 18 June 2021 the Islamic Republic held its thirteenth presidential election. According to official sources, turnout was 48.8% - the lowest in the history of the Islamic Republic of Iran. Ebrahim Raisi was elected president with 61.95% of the votes and took office on 3 August. Many candidates were not vetted by the hardliner Guardian Council (Constitutional Council). The Guardian Council’s role in Iranian politics is to sustain Islamic values by controlling candidates running for public office as well as laws passed by the parliament (Majlis). Six of the 12 members of the Guardian Council are appointed directly by the Supreme Leader of the Islamic Republic, Ali Khamenei. The other six are appointed by the head of the judiciary, who was Ebrahim Raisi himself, until he became the new Iranian president at the beginning of August. While the vetting of candidates is interpreted as a rigged election that may have resulted in 14.4% of the votes being invalid, the low turnout is a sign of the shrinking legitimacy of the political system. Its main cause is the poor economic performance of the moderate President Rouhani, who mobilised voters by promising to restore good relations with the West and to carry out structural economic reforms in 2013 and 2017. As we will see, Rouhani could not deliver on his lofty economic promises. To understand the political and economic prospects of the Islamic Republic of Iran, it is important to understand how and why Iranians lost hope in their leadership.

Hassan Rouhani's disastrous economic legacy

The economic performance of President Rouhani (2013-2021), who left office at the end of July, is poor by any comparison. Figure 1 depicts Iran’s average annual GDP growth, the contribution of individual demand components, as well as the consumer price index (CPI) during the eight-year presidencies of the last five presidents of the Islamic Republic[i]. Using the average annual growth rate, Rouhani’s government had the worst performance despite an average annual growth rate of just 1.6%. With the implementation of the Joint Comprehensive Plan of Action (JCPOA), the historic compromise between the West and Iran on its nuclear program, Iran’s GDP grew by 14.2% with the calendar year ending on 20 March 2017. The main reason for this was a boost in oil exports. Obviously, the major driver behind this impressive growth figure was sanctions relief as a result of the nuclear deal that led to a surge in exports and improved business confidence in Iran.

During the eight years of reconstruction after Iran’s war with Iraq when Ali Akbar Hashemi Rafsanjani (1989-1997) was president, Iran’s GDP grew by an average annual rate of 4.7%, the best result ever for an Iranian president since 1979. During the two terms of reformist President Khatami, Iran’s GDP grew by an average annual rate of 4.5%. Even during the eight-year presidency of the hardliner Mahmud Ahmadinejad (2005-2013), Iran’s GDP grew by an annual rate of 2%. The government of Khamenei in the 1980’s enjoyed the third largest average annual growth rate simply because of one very good year (starting on 21 March 1982) when GDP grew by 31% - the highest growth rate since the revolution of 1979. This astonishing figure was the result of a major rebound in oil exports after the deep economic downturn during the chaotic period after the revolution of 1979. Trade with the outside world dropped significantly after the revolution. When it reached its bottom, a strong countermovement set in, resulting in this astonishing growth rate of 31%. The primary reason was the very low initial level of net exports. Thus the main driver of growth during the two terms of Khamenei’s presidency was surging oil exports. Obviously, Hassan Rouhani’s economic track record is by far the poorest of any president of the Islamic Republic and the worst since the war with Iraq.[ii]

Figure 1 – Iran's average annual GDP growth, its composition as well as inflation during the eight-year presidencies of the last five presidents

Highest change in CPI over eight years of presidencies under Rouhani since the post-war period

Furthermore, one can observe the change in the consumer price index (CPI) depicted on the right-hand-side (rhs) axis during the terms of the last five presidents. The largest change in the CPI over eight years of presidency occurred during the two terms of President Ali Akbar Hashemi Rafsanjani (1989-1997), with a price-level increasing up to 470%. The second largest eight-year change in the CPI occurred during the two terms of Hassan Rouhani (2013-2021), when the CPI grew by 350%. Also during the two terms of President Mahmoud Ahmadinejad (2005-2013), the CPI increased by 344%. Inflation was the lowest during the two terms of reformist President Mohammad Khatami (1997-2005) at 171%. In the 1980’s, during the war with Iraq, the CPI grew by 200% over the two terms of President Ali Khamenei (1981-1989). The high growth of CPI during the mentioned periods was caused by excessive borrowing from the Central Bank of Iran to finance the large public sector, government expenditure and fiscal policy. When Mahmoud Ahmadinejad was president from 2005 to 2013, inflation was exacerbated by cash-handouts to the public starting in November 2010. At the time of Rouhani, reduced oil revenues as a result of U.S. sanctions limited fiscal policy space. In his second term in office, to finance the government while GDP was shrinking, heavy borrowing from the Central Bank by Rouhani’s administration caused the money supply to rise, boosting inflation.

Investment as the major pillar of economic growth in Iran

GDP growth in Iran is highly correlated with the growth of gross fixed capital formation (GFCF) or investment. One important reason for slow growth during Ahmadinejad’s presidency (2005-2013) was a reduction in GFCF, or the demand for investment. It shrank by an average annual rate of -0.2% and therefore GDP also grew very little. During the period 1982-1990 GFCF was shrinking annually by -0.5% on average, which was mostly due to the depreciation of capital, physical destruction during the Iran-Iraq war, disinvestment by the private sector and a lack of foreign direct investment. This also led to recession and low GDP growth. Investment grew the most during Khatami’s governments, at an average annual rate of 1.6%. Khatami’s policies and legal reforms resulted in a surge in inward foreign direct investment (FDI) during the 2000’s. This resulted in GFCF that was 13.9% higher at the end of Khatami’s second term in 2005 compared to his first one. This contributed to persistent GDP growth during Khatami’s presidency. After Ahmadinejad and during Rouhani’s first term in office, GFCF again recovered with an average annual growth rate of 1.5%, which also resulted in GDP growth. However, in Rouhani’s second term in office business confidence dropped significantly due to geopolitics resulting in an average annual contraction of GFCF of -0.6%, thus exacerbating the recession.

Rouhani expanded fiscal policy the most in 43 years

Hassan Rouhani’s reformist government, which some – at least at the beginning – compared to Khatami’s rather successful administration, increased government consumption excessively. It expanded by an average annual rate of 1.4% during Rouhani’s two terms as president – the highest rate in 43 years. At the same time, the government lost significant oil export revenues due to secondary U.S. sanctions. The resulting deficit was financed by the Central Bank and the sale of government assets as well as shares in public companies via the Teheran Stock Exchange.

Shrinking household consumption is the major factor behind protests and uprisings

Household consumption under Rouhani grew at the slowest pace since the war with Iraq (Khamenei’s presidency), averaging 0.61% per year. Most of this growth occurred during his first term in office. In his second term (August 2017-July 2021), final household consumption shrank by an annual average rate of -0.5%. Depressed household incomes triggered nationwide uprisings in January 2018 and November 2019. In July 2021 protests also erupted in the oil-rich but economically deprived province of Khuzestan on the border with Iraq. Due to drinking water shortages resulting from a severe drought in the region, one of the protesters’ slogans became ‘I am thirsty’. One major reason for the reduction of final household consumption under Rouhani was deteriorating consumer confidence due to several years of recession and high inflation. As the minimum wage set by the government each year increased less than inflation, the real wages of workers in the private sector shrank substantially. Furthermore, wage adjustment for public workers and pensioners did not compensate for the losses through inflation. Finally, with the policy of cash-handouts which began in November 2010 under President Ahmadinejad, the consumer price index increased by 760% up until April 2021, which suggests that these transfers shrank significantly in real terms.

Discontent with the economy and frustration with four decades of oppression

Recurring nationwide protests and shrinking social capital are the results of several crises in Iran. One is a geopolitical crisis that intensified after the U.S. administration of Donald Trump withdrew from the JCPOA and imposed painful secondary economic sanctions against Iran. Another severe crisis is the COVID-19 pandemic which hit Iran the hardest of all countries in the Middle East because the government did not implement sound and rapid policies to impede the pandemic at its early stages. It also lacked the financial resources to tackle the economic downturn and trade impediments caused by the pandemic and import vaccines. The third crisis is a social one, caused by rising poverty rates due to the ongoing recession and increased inflation. These multiple crises have poured salt in the wounds of a nation whose social, political, and cultural liberty has been suppressed by Islamic laws enforced for more than four decades.

More autocratic than ever, concentrating power in the hands of Supreme Leader Khamenei

The vetting system on the political level through the Guardian Council, mentioned at the beginning, works as an instrument of political control in the hands of Supreme Leader Ali Khamenei. This system has ensured the desired result of the election, with another cleric becoming the new president of Iran. The ultraconservative Ebrahim Raisi is responsible for the execution of thousands of political prisoners in 1988 and is renowned for his unscrupulousness. Over the last couple of years, as the head of the judiciary, he has imprisoned activists and protesters and has had many Iranians executed, such as wrestling champion Navid Afkari and the journalist Rouhollah Zam. He also has very close ties with the commanders of the Islamic Revolutionary Guards Corps (IRGC), the paramilitary sword and shield of the Islamic revolution, which now controls the Iranian parliament as a result of low turnout in last year’s parliamentary elections. His new cabinet demonstrates the political influence of IRGC commanders and ultraconservative hardliners, who lack government experience and policy visions for the country but pursue policies reflecting their hostile view of the U.S. and its allies. Nevertheless, in a press conference soon after his election Raisi called himself the ‘defender of human rights’ in response to a question about his previous career. Many observers argue that Raisi was picked as the successor of Ali Khamenei, who is 82 years old and in poor health, since his loyalty to the Supreme Leader will facilitate a smooth transition as Raisi’s views are very much in line with Khamenei’s.

While in Iran the rent-seeking hardliners around Supreme Leader Ali Khamenei have monopolised power in their own hands, less attention and resources have been directed to the majority of the population. This suggests, that, while a coup d’état from the top by powerful hardliners and the Revolutionary Guards is rather unlikely today, an uprising from the bottom is becoming ever more likely. One can argue that the reformist President Mohammad Khatami performed best in achieving sustainable growth and low inflation as well as in increasing household consumption by increasing employment. However, the political system in Iran has become immensely autocratic, pushing the reformists ever more into the corner. Over the years, by means of the Guardian Council, Supreme Leader Ali Khamenei has distorted the political scene in favour of the most loyal hardliners close to him and has disqualified many reformist figures. This has made the Islamic Republic more autocratic and ultraconservative, impeding further reforms that society demands.

Economic and political prospects under the new President Raisi

Finally, what are the economic prospects under newly sworn-in President Ebrahim Raisi? As during Ahmadinejad’s era, investment is very unlikely to rise under Raisi. This could lead to a prolonged economic crisis. The main reason is that Raisi’s proposed cabinet, which was approved (except for the pick for the ministry of education) by the parliament on 25 August, consists of revolutionaries who may perpetuate the multiple crises without decreasing the political risk connected to Iran’s activities and geopolitics. Also business confidence may not improve with the existing political risks. Moreover, Raisi’s economic advisors, who will be Ehsan Khandouzi for the Ministry of Economics and Hojjatollah Abdolmaleki for the Ministry of Labour and Social Affairs, and most importantly Raisi’s Vice President on Economic Affairs, the former IRGC commander Mohsen Rezaee and the Secretary of Expediency Discernment Council, are all Islamic economists who do not believe in a market economy but advocate a ‘resistance economy’. This means that they may pursue increased self-sufficiency through inefficient semi-public companies controlled by the Supreme Leader, his powerful religious foundations, and the IRGC which controls about 60-70% of Iran’s GDP. This will make Iran’s economy more isolated than before as it is unable to compete with foreign multinational companies which would like to invest in Iran in a riskless environment. Furthermore, Khandouzi promises to regulate the Teheran Stock Exchange, which will allow the government to use public assets held by these semi-public companies as a financial instrument to help finance the government budget. This appears similar to the failed and opaque privatisation at the time of Ahmadinejad (Ghodsi et al., 2018, pp. 7-8[i]) that transferred public companies to religious foundations and IRGC-affiliated companies. This will not promote investment or FDI but will likely increase corruption.

As one of his promises in the recent presidential election, Raisi’s new Vice President on Economic Affairs, Mohsen Rezaee – a candidate in several rounds of presidential elections – will certainly advocate increasing cash handouts to the bottom deciles of income distribution to reduce the poverty rate which is officially estimated to be at about 33%. However, financing this policy will only be feasible if and when Iran brings its oil exports back up to levels prior to U.S. secondary sanctions in 2017. Nevertheless, as experienced at the time of Ahmadinejad, such a policy will have an immediate impact on rising prices, immediately reducing citizens’ purchasing power[CK1] . Instead, Iranian policymakers should advocate policies to increase employment and reduce the population’s dependency on such subsidies, which could be achieved by promoting investment, FDI, and finally by improving the competitiveness of Iranian industries in order to stimulate export revenues.

Raisi will continue to use targeted planning as a macroeconomic policy tool. Unlike central planning in the Soviet Union, in Iran planning is only focused on the aggregate and country level without detailed blueprints on how to implement policies. It is important to note that of the previous six five-year development plans of the Iranian government, none was able to achieve its set macroeconomic goals completely. As a consequence, Iran’s large population growth in the 1980’s was not accompanied by a sustainable economic growth policy that could provide sufficient jobs and incomes for those born in the 1980’s. Hence, unemployment is painfully high, discouraging many people from the labour force.

Due to its incompetence, poor policies and imprudent stance against the U.S. and the West, the Iranian leadership has failed to develop sound macroeconomic policies to properly manage the economy. The country has been and is currently being hit by crisis after crisis. These crises are becoming more and more frequent. Ongoing electricity shortages, a lack of money to vaccinate a population of 83 million against COVID-19 and the exacerbating problem of climate change with poor infrastructure planning and mismanagement of water resources resulting in a severe drought throughout the country have frustrated the population. Iranians have forgotten their power in the strife for political change since they carried out a revolution in 1979, as they have been politically, culturally, legally, and socially oppressed by their rulers ever since. However, Iranian society is finally recognising the unbalanced distribution of rents in favour of the loyalists of Supreme Leader Khamenei. Iranians are gradually recalling their forgotten power, which was demonstrated by the low turnout in the presidential elections in June and is yet to be fully reincarnated to confront the theocracy and its security apparatus. Frequent social protests may further catalyse this process. The new president and his team of ultra-conservative judges and Revolutionary Guard commanders were chosen to suppress the expected social unrest that is the result of the ever-deepening economic crisis.

Obviously, the indirect negotiations between the U.S. and Iran in Vienna did not lead to a conclusive deal on the issue of a renewed nuclear deal before Raisi took office at the beginning of August. However, Raisi urged the U S to return to the nuclear agreement of 2015, which indicates his willingness to comply with the JCPOA. Because of the current monopolisation of political power through the hardliners in Iran, it could be easier for the U.S. to reach a deal with Raisi. Hardliners had been sabotaging Rouhani’s policies wherever they could. Now, a uniform front of hardliners in all factions of power is more likely to reach a renewed nuclear deal and harvest the economic dividends of sanctions relief. However, after the return to full compliance with the JCPOA, Raisi has no intention to continue negotiations with the U.S. over other issues of concern such as Iran’s ballistic missile program, regional tensions or ongoing violations of human rights.

As a result, Iran will likely become economically more dependent on China and Russia. Unlike the reformists and moderates, Raisi has no specific policy to attract FDI from the West. As there will remain other unresolved issues with the U.S., western multinational companies may hesitate to invest in Iran’s market due to the remaining geopolitical risks. However, as many hardliners praise Russia and China instead of resolving problems with the main opponent – the United States – Raisi’s policy will focus on strengthening economic relations with China. This is in line with the recent strategic partnership signed between the two countries, which can be implemented fully after secondary U.S. sanctions are removed.

 

[i] The beginning of each period is the first Persian Calendar year after the president is elected for his first term, and the end of the period is the first year after the second term of the president is finished.

[ii] It is important to note that the data obtained from the World Bank using the Gregorian calendar gives different figures of growth in Iran, while the rankings remain the same.

[iii] Ghodsi, M., Astrov, V., Grieveson, R., & Stehrer, R. (2018). The Iranian economy: Challenges and opportunities. Vienna Institute for International Economic Studies. No. 429. wiiw Research Report, 2018