Iran’s Deteriorating Economy: An Analysis of the Economic Impact of Western Sanctions

Iran’s economy is rapidly going downhill, but where resentment will be channeled remains uncertain.

By Sabrina M. Peterson
Managing Editor

On July 1, a ban went into effect that prohibits the 27 members of the European Union from purchasing Iranian oil or insuring oil tankers that carry it. Only days before, the United States imposed a new round of sanctions that punish most foreign countries that buy Iranian oil. And while experts disagree as to how effective the sanctions will be, one thing is clear. The new sanctions are wreaking havoc on the Iranian economy, which relies on oil exports for about eighty percent of its public revenue. But while the economic impact of sanctions is becoming apparent, the political impacts have not yet crystallized.

One of the most pressing problems in Iran today is inflation. Inflation is not a new problem in Iran, due in part to sanctions in recent years that have resulted in disrupted supply chains and higher operating costs. But spiraling inflation is being felt by ordinary Iranians like never before. In late June, Iran’s Central Bank reported inflation to be at 22.2 percent, although economists say this figure is grossly underestimated. In one week alone, the price of chicken rose 30 percent and the price of vegetables almost 100 percent. Prices are unstable, budgets are being stretched thinner and thinner, and people are seeing the value of their savings quickly disappear.

To make matters even worse, under President Mahmoud Ahmadinejad’s subsidy reform plan implemented in December 2010, the government has withdrawn subsidies on food staples, electricity, water, and gas, further pushing up prices and affecting companies and households alike. Compounding these struggles is mounting unemployment, soaring to an unofficial rate of 35 percent as factories and businesses must lay off workers because they are unable to import vital goods and raw materials.

The value of the Iranian rial, which had already fallen in value by about half against foreign currencies since last year, has depreciated even more rapidly since the beginning of July. The situation is exacerbated by the presence of a growing speculation market. Iranians increasingly demand U.S. dollars because sanctions have obstructed the transfer of money to foreign banks.

Furthermore, because the U.S. dollar is increasingly seen as a stable investment in the face of the rapidly depreciating rial, more and more Iranians demand dollars to hedge against future rial depreciation. Yet Iran’s Central Bank limits the supply of dollars to individuals traveling abroad and well-connected importing companies. This has led to a growing black market for foreign cash. The large amounts of currency traded on the black market have created an unofficial, albeit widely accepted, source of foreign currency exchange rates in Iran; while until late July, the official rate was held at 12,260 rials to the dollar, the black market rate was approximately19,600 rials to the dollar.

The great demand for the dollar on the black market, indicative of rising panic amongst Iranians, simultaneously means even further depreciation of the rial. This in turn contributes to inflation, as retailers set prices based on the market price of the dollar. In late July, however, Iran put in place its newest currency restriction, prohibiting trading rials to dollars at the artificially low rate in most cases. This newest measure is indicative of Iran’s dwindling supply of foreign cash.

Though for a time the Iranian government tried drastic measures to shut down the black market, including threatening the death sentence for currency speculators, in March the regime relaxed its currency exchange policy, allowing dollars to be traded at the unofficial rate. Currency speculators, many of whom were connected to the government, profited immensely, as they were able to buy dollars at the official exchange rate and sell them on the black market at a higher price. As some have profited greatly from the poor economy, others have suffered more and more; blue-collar workers in downtown Tehran can barely afford meat, while luxury cars are ubiquitous in the neighborhoods of North Tehran. The widening gap between the haves and have-nots could lead to growing resentment for the sanctions.

The efficacy of sanctions is a contentious subject in general, and there is much debate as to whether the current sanctions will be enough to change the Iranian regime’s tune regarding its nuclear program. Many think that a state as ideological as Iran will manage to convince its citizens to withstand the hardship. Some insist that the sanctions are causing Iranians to blame the West, rather than their own government, for economic hardship. Others argue that the Iranian regime is resilient enough to not buckle under Western sanctions and that the government is unlikely to back down in the face of domestic pressure.

One of the many lessons of the popular revolts that swept through the Middle East in 2011 is that domestic stability and economic conditions are inextricably linked. Both Tunisia and Egypt, the first two states to rise up against authoritarian regimes, had experienced high unemployment and inflation. Economics were arguably the primary drivers behind the first two revolts. The jury may still be out on the question of whether the sanctions against Iran will achieve the desired goals. Yet as the economy of Iran deteriorates further, growing discontent is inevitable. Where it will be channeled, whether toward the regime and its policies or toward the West, will determine whether or not the sanctions will be effective. The West should monitor public opinion in Iran closely to ascertain whom the Iranians are blaming for their economic pain; if the sanctions engender frustration toward the regime, then they should be continued and even made more dire. If, however, they are merely fueling anti-American sentiment in Iran, another course of action should be considered.

Photo courtesy of zerega via Flickr.

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