Last week at the World Economic Forum in Davos, Switzerland, President Hassan Rouhani tried to persuade world business leaders to invest in Iran, especially in its hydrocarbon and automobile sectors. 

Hassan Rouhani. Credit: Mojtaba Salimi/CC-BY-SA-3.0

His appeal is not likely to set off a gold rush; investors will wait to see if the nuclear agreement with the P5+1 is successfully concluded sometime this summer.

But broadening his call for engagement with the rest of the world beyond the nuclear deal indicates that his initiative is more than a charm offensive; it represents deeper social and economic change in Iran.

The implicit assumption behind the “charm offensive” discourse is that the Iranian leadership is only engaging in talks because it needs to gain some respite from sanctions to buy time to reach nuclear weapon capability.

But luring foreign investors into Iran does not fit well with that strategy because any gains would only become apparent after the nuclear deal is concluded and would be reversed as soon as the deal falls apart and sanctions are once again implemented.

From Rouhani’s perspective, an open invitation to foreign investors risks expanding the ranks of his domestic foes beyond the growing opposition to the nuclear deal. Why add Islamists and leftists opposed to the penetration of Western culture and capital unless he really believes he can turn Iran into a hospitable place for outside investment?

Mark Landler of the New York Times played down Rouhani’s appeal by noting its “eerie echo” to a similar pitch by former Iranian president Mohammad Khatami in 2004, which was followed by Mahmoud Ahmadinejad’s ascendance a year later and a decade of hostility.

Suggesting that Rouhani’s Davos promises might end similarly ignores several important differences between the two presidents and between the Iran of 2014 and that of 2004. Ignoring the obvious — in 2004 Khatami was on his way out while Rouhani is just starting his first term — there are at least two other distinctions.

Philosophically, Khatami and Rouhani share a moderate view of coexistence with the West, but when it comes to economic integration, they read from very different scripts.

Iran’s economy in 2014 bears little resemblance to that of a decade earlier. In 2004, thanks to a massive oil boom, Iran was bursting with economic optimism and feeling prosperous without foreign investment. Since the 1970s, except during the reconstruction period after the war with Iraq, Iran has not sought or depended on foreign investment for its economic growth. 

Higher oil prices nearly tripled the oil revenues in Khatami’s last budget in 2004 compared to his first in 1998. Unemployment had been declining steadily, from 14.3 percent in 2000 to 10.3 percent in 2004, and inflation seemed low by today’s standards — averaging 14 percent per year instead of 35 percent in the last two years.

Today, after several years of harsh sanctions, Iran’s economy is in deep trouble and the government is broke. While inflation is coming down, unemployment is still above 14 percent (above 25 percent for youth). The 4.2 billion dollars that the U.S. is releasing as part of the interim Geneva agreement adds only five percent to this year’s budget. It will not go very far in bringing public investment even close to its historical record of more than 15 percent of the GDP.

Public investment for the Iranian year starting this March is only 15 billion dollars, which is four percent of the GDP. It is not even enough to pay for the repair of — much less build new — public infrastructure or assist the private sector. The government actually owes private contractors about 20 billion dollars for work they have already performed on various public projects.

The private sector is also in a serious bind. In addition to unpaid government bills, the depressed economy has cut demand for its products, leaving many employers short of cash to even pay their workers. The auto industry, which was a focus of Rouhani’s appeal at Davos, is producing at less than half its capacity. The interim agreement restores the auto industry’s access to critical imports, but additional capital is what they need to create new jobs.

While financial necessity may be Rouhani’s reason for inviting foreign businesses to Iran, he also has reasons to be optimistic about the outcome of their engagement. First, he knows that more than three decades of revolutionary rhetoric and eight years of failed populist economic policies under President Ahmadinejad have tired out the general population and caused a major shift in the attitudes of Iran’s intellectual and technocratic classes.

There is now a wider consensus in favour of private enterprise and engagement with the global economy than during the time of the Shah. This is why Rouhani has the most pro-business economic team in Iran’s history.

Second, in the last 10 years, Iran’s workforce has become younger, better educated, and less expensive — all attractive features for foreign capital. The loss of value in Iran’s currency last year has brought labour costs in Iran below that of China. Were it not for their lower productivity, Iranian industrial workers would be able to outcompete East Asian workers. Foreign investment along with its superior technology and management is what Iran needs to raise its workers’ productivity.

The fate of global engagement for the Islamic Republic is not solely determined by these economic calculations. Many in the highest position of political power in Iran view rapprochement with the United States, which Rouhani considers a condition for meaningful global engagement, with deep suspicion.

They fear that hostility toward the Islamic Republic runs deeper than the nuclear issue. They point to new sanctions legislation before the U.S. Senate that requires Iran to make concessions unrelated to the nuclear dispute. A New York Times editorial did much to justify their fears by recommending that “Iran’s full reintegration into the international system” should depend on its “ending the hostility toward Israel.”

For Rouhani, after Davos, the path to global engagement remains uphill.

*Djavad Salehi-Isfahani conducts research on the economics of the Middle East and is currently a professor of economics at Virginia Tech. He is a nonresident senior fellow at the Brookings Institute and is also serving as the Dubai Initiative fellow at the Belfer Center for Science and International Affairs at Harvard University’s John F. Kennedy School of Government.

The transition team of Iran’s President-elect Hassan Rouhani was busy last week lowering expectations for a quick economic recovery, saying that things are far worse than they had thought.

At the same time, the outgoing economy minister was briefing Iran’s Supreme Leader Ali Khamenei with a rosy picture.

Politics aside, it is hard to exaggerate the difficulty Rouhani faces in turning Iran’s economy around, especially without some relief from the international sanctions.

The numbers

The Mahmoud Ahmadinejad administration stopped publishing national income data in 2008 as part of the annual balance sheet of the Central Bank of Iran (CBI), placing in doubt the most important indicator – the rate of economic growth. 

Its reporting on inflation and unemployment has been more regular but lacked credibility because the reports were often cryptic and framed in the most positive light.

Last week, the CBI announced a rate of inflation of 35.9 percent for the Iranian month that ended on Jun. 21, averaging the increase in the consumer price index over two 12-month periods.

In reality, the index had increased by 50 percent during the last 12 months.

Government reports have shown unemployment to be rather steady in the 11-12 percent range. This provided an image of a stable jobs situation while the government’s own survey data indicated rising unemployment.

Iran’s last two censuses of 2006 and 2011 show a substantial increase in the unemployment rate of prime-age (20-54) workers from 11.5 to 15.4 percent.  For obvious reasons, these figures were not part of the economy minister’s report to the Supreme Leader.

Challenges and opportunities 

Perhaps the biggest surprise for Rouhani’s team came from the government budget, which they will inherit in two weeks. Rouhani’s senior advisor and head of his transition team, Akbar Torkan, said that he was not able to find reliable sources of revenue for 38 percent of government expenditures.

This presents the incoming government with its most immediate challenge – how to control inflation with public finances in such a dire state.

While he inherits an economy in deep crisis, there are a few things that Rouhani can be thankful for from his predecessor.

The first is Iran’s subsidy reform.  Three years ago, Iran was the least efficient user of energy because it had the lowest energy prices in the world. Roughly four million barrels of oil and gas equivalent per day (twice what it exported) were distributed to domestic consumers with huge subsidies, mostly benefiting the rich.

In January 2011, President Ahmadinejad embarked on a bold reform that sharply reduced energy subsidies and distributed the savings as equal cash transfers.

Despite the fact that prices have been frozen since 2011, the programme has curbed energy consumption and saved Iranians from queuing for gasoline despite international sanctions that prohibit such imports.

More importantly, the cash transfers, which cover 97 percent of the population, have been an important supplement to the country’s leaky safety net, softening the blow from the sanctions to the poor.

Rouhani can do well to remove the programme’s deficit and better target its transfers, but its bitter pill has been already swallowed.

Another painful adjustment came last September when the value of Iran’s currency, the rial, collapsed following the tightening of sanctions against Iranian oil exports. Just two weeks ago, the rial was officially devalued by more than 100 percent, making it easy for Rouhani to start his tenure with a more realistic exchange rate.

Before devaluation, cheap foreign currencies hurt Iranian production, which caused Iran’s dismal job growth.

Iranian producers are now in a better position to compete, but their limited access to the global economy, caused by sanctions, is a huge obstacle.

Rouhani’s promise to reduce sanctions will therefore be essential for Iran’s economic revival.

Relief for insolvent banks

Last year, the Ahmadinejad government quietly reversed itself on interest rates, letting banks charge rates above the earlier strict limits set by his own administration of 12-14 percent.

The low interest rates on deposits compared to inflation is the main reason why depositors have flocked to foreign currencies, gold and real estate to protect their savings.

As deposit rates increase, Iran’s liquidity-starved banks will attract more money and can begin to lend to liquidity-starved businesses.

Rouhani has promised a government of “experience and hope”, one that has “the keys to unlock closed doors”. There is reason to expect improvements in Iran’s economy during his first 100 days as president, but beyond that all bets are off.

Rouhani’s moderate posture has already paid off in terms of lower expectations of inflation, which has stabilised the foreign exchange markets and is gradually returning private savings to the banks, thus alleviating the liquidity crisis that has immobilised Iran’s businesses.

Unlocking hope

Rouhani’s economic team, to be announced in the next week or two, is expected to include experienced economists, which will further boost confidence among Iran’s economic actors.

But to restore hope, Rouhani needs to do more; he must create jobs.

Jobs can only come if Iran’s producers can export or invest in the production of goods that substitute for imports. However, their ability to do so is seriously hampered, if not made impossible, by international sanctions that have closed the gates to the global economy for Iranian producers.

The keys to these locks are, unfortunately, not in Rouhani’s hands.

They are with Western leaders and the Supreme Leader, who will decide if and when the nuclear agreement is resolved and sanctions can be removed.

Rouhani has a short window of less than two years to prove to the Iranian people that Iran’s moderates, who are willing to engage with the outside world, can run a better ship than the radical isolationists.  He has a historic opportunity to deliver a lesson that is not just important for Iran but for the entire Middle East.

Pushing for stricter sanctions against Iran, as some in the West are doing, risks harming this historic opportunity.

*Djavad Salehi-Isfahani is a Professor of Economics at Virginia Tech and Non-resident Senior Fellow at the Brookings Institution. Find more of his IPS work here.

Photo: The campaign headquarters of presidential hopeful Mohammad Baqer Qalibaf in the Iranian city of Neishabour. Credit: Djavad Salehi-Isfahani/IPS

By Djavad Salehi-Isfahani
TEHRAN, Iran, Jun 12 2013 (IPS)

Talking to ordinary people in Neishabour and Tehran about Iran’s Jun. 14 presidential election, economic issues seem foremost on their minds. But whom they will vote for is based more on vague promises to pull the economy out of its deep crisis than on well-defined economic programs.Significant differences on economic philosophy divide a confused public about how to end economic stagnation and high inflation.

In the last three decades of the Islamic Republic’s history, Iranians have experienced both market-based economic growth and populist redistribution.

This election cycle would have been a good time to debate which of these two economic development strategies should be used in moving forward.

However, the decision by the Guardian Council to eliminate two important candidates, Ali Akbar Hashemi Rafsanjani and Esfandiar Rahim Mashaei, from the list of those eligible to run has sharply limited the value of this election as a space for vibrant public debate about the issues that are of greatest daily concern to most Iranians.

These two politicians could have represented the contrasting economic strategies and turned the election into a referendum on the past eight years of populist economics practised by the Ahmadinejad administration.

Mr. Rafsanjani, the former two-time president, is well known for his preference for market-based economic growth as a solution to poverty and equity issues.

Early on in Mahmoud Ahmadinejad’s tenure, Mr. Rafsanjani rejected Mr. Ahmadinejad’s populist policy of cash distribution as “fostering beggars”.

His elimination from this election has deprived voters of a critical assessment of Mr. Ahmadinejad’s populist program that has inflicted serious damage on Iran’s economy.

A further blow to a meaningful debate on populism came from the elimination of Mr. Mashaei, who was Mr. Ahmadinejad’s close associate and in-law.

It would have been highly interesting, if not very informative, to watch him debate Mr. Rafsanajani on such important issues as the record of the government’s three ambitious populist programs – low-interest loans to small and medium producers, low-cost housing and cash transfers.

What this election should be about is how to achieve a key promise of the Islamic Revolution.

More than three decades ago, a vast majority of Iranians supported the revolution, expecting that it would divide Iran’s oil wealth more equitably.

Early on, Ayatollah Khomeini, the revolution’s leader, tried to limit these expectations by famously saying that “economics is for donkeys”.

But the failure by two previous administrations (Mr. Rafsanjani and Mohammad Khatami, each serving for eight years as president) to reduce inequality has kept the issue of income and wealth distribution at the forefront in recent elections.

Mr. Ahmadinejad came to power in 2005 promising to take the “oil money to peoples’ dinner table”, which he tried to do.

The last two years for which we have survey data, 2010 and 2011, show falling poverty and inequality, but the economy is in shambles.

Prices rose by 40 percent last year according to official figures, and the same surveys show unemployment at about 15 percent overall and twice as high for youth.

It would have been valuable for the public to learn if Mr. Ahmadinejad’s redistribution policies are responsible for the current economic mess, or something else, like incompetence in execution or international sanctions.

What the candidates have said in the short time they have had to campaign is that they will do something different. What and how is not clear.

The four frontrunners, Saeed Jalili, Mohammad-Baqer Qalibaf, Hassan Rowhani and Ali Akbar Velayati, have expressed their differences on how to deal with sanctions.

Sanctions loom large in voter minds, but few believe that whoever is elected will be able to influence Iran’s nuclear policy, which is being tightly directed by the Supreme Leader, Ayatollah Ali Khamenei.

What seems to distinguish these candidates most clearly at this point is social rather than economic issues.

They all promise to reduce inflation, increase employment and run a less corrupt and more efficient administration. The differences exist in emphasis rather than specifics.

Mr. Jalili is the most conservative candidate in the race and closest to Mr. Ahmadinejad in economic philosophy but has also been careful to neither defend nor criticize the latter’s policies.

He has defended Iran’s stance in the nuclear negotiations with the P5+1 group (the United States, Britain, France, China, and Russia plus Germany), which he led in recent years, with the usual anti-Western rhetoric.

By saying the least of any candidate about the economy, he has clearly indicated that economic issues are not his top priority.

In the televised debates, Mr. Jalili made it clear that a more effective enforcement of cultural values was the right way to solve the country’s economic problems.

More specifically, he seemed to reject compromising with the West over Iran’s nuclear program in order to lessen the pain of Western sanctions on ordinary Iranians.

If Mr. Jalili is Mr. Ahmadinejad’s favorite candidate, Mr. Ahmadinejad has not said anything.

He has not made any public statement regarding the candidates so far, except to request time on national television to respond to their criticisms, which was denied.

Word on the street in Tehran is that Mr. Ahmadinejad secretly roots for Mr. Jalili because he believes a President Jalili would be the most likely to make him look good, not by defending his policies, but by taking the economy further into the deep end.

Mr. Rowhani, the only cleric in the race, is the most moderate candidate among the four frontrunners.

In the eyes of liberal voters, following this week’s departure of reformist candidate Mohammad-Reza Aref (after an explicit request from the popular former president, Mohammad Khatami), Mr. Rowhani has inherited the reformist mantle of Mr. Khatami as well as Mr. Rafsanjani’s pro-business legacy.

Mr. Rowhani energized Iran’s young voters after the second televised debate in which he criticised the heavy hand of security forces in social affairs.

He appears to have gained the same lift that former presidential candidate Mir Hossein Mousavi achieved four years ago upon declaring he would end police enforcement of public chastity.

However, like Mr. Mousavi, Mr. Rowhani has not offered clear economic policies to address the youth’s more serious problems of unemployment and family formation.

A formidable challenge to Mr. Rowhani comes from Mr. Qalibaf, the current mayor of Tehran and a moderate conservative.

During a recent televised debate, they clashed over how the police should treat student protests, but they have not tried to distinguish themselves on how they would help university graduates get jobs.

If the election goes to a second round run-off between these two candidates, which now seems likely, there is a chance that voters will hear more about their approach to revive the economy.

But then the candidates may find it easier to appeal to voters’ emotions than to their pocketbooks.

*Djavad Salehi-Isfahani is a Professor of Economics at Virginia Tech and Non-resident Senior Fellow at the Brookings Institution. Read more of his IPS work here.