US Weighing Sanctions to Cripple Iran Humanitarian Trade

The Trump administration is reportedly considering a new set of sanctions designations targeting 14 Iranian banks that are not currently subject to secondary sanctions. The new designations would be made under authorities associated with “terrorism, ballistic-missile development and human-rights abuses.” The targeting of these banks would cripple Iran’s already degraded channels for the importation of humanitarian goods—including food and medicine—at a time when the country is battling the COVID-19 pandemic.

This new proposal, spearheaded by the Foundation for Defense of Democracies, long-time opponents of the 2015 nuclear deal, would be the latest and most extreme in a series of sanctions moves intended to deliberately undermined long-standing protections for humanitarian trade. Proponents of the proposal believe that it will be “possible to mitigate the humanitarian costs, chiefly through so-called comfort letters from the Treasury Department.”

However, considering the precedent set by the Trump administration, there is no reason to believe that the humanitarian costs can be mitigated. In 2019, Iran imported over $1 billion of pharmaceutical products and over $3.5 billion in cereals. This trade is so sizable that no degree of licensing or special accommodations by the Treasury Department, nor any recourse to the still non-functional Swiss Humanitarian Trade Arrangement, will suffice to ensure that ordinary Iranians are not unduly impacted by the consequences of the move. In short, the Treasury Department lacks the means to designate these banks while ensuring that Iran’s imports of food and medicine remain routine and reliable.

The designation would have three distinct consequences:

1.     Iran’s rial would lose value.

The designation would serve as a supply-side and demand-side shock for Iran’s foreign exchange markets. On the supply-side, the closure of the few remaining correspondent banking channels between Iran and the global financial system would make it near-impossible for Iranian exporters to repatriate foreign exchange revenue. This makes it significantly more expensive for Iranian importers to purchase foreign exchange through the centralized NIMA exchange.

On the demand-side, ordinary Iranians will respond to the new uncertainty by seeking to convert more of their savings into foreign currency, pushing up the free market exchange rate, beyond its recent historic highs. The net effect will be that all Iranian imports become more expensive in the short-term, exacerbating the already significant inflationary pressures that have seen year-on-year inflation rise as high as 50 percent in recent months. Because Iran imports significant volumes of food and medicine products, these humanitarian goods will likewise become more expensive for Iranian households. 

2.     There would be a liquidity crisis around Iran’s humanitarian trade. 

While foreign currency within Iran would become more expensive, the foreign currency held by Iranian these banks and their Iranian clients in accounts outside of Iran will be frozen . Since the Trump administration hit Iran’s central bank with a new designation in September 2019, it has become increasingly difficult for the Central Bank of Iran to freely use its funds for the purposes of facilitating humanitarian trade as long allowed under US sanctions exemptions. In July of this year, Reuters reported on how these challenges were having a direct impact on Iran’s ability to make payments for purchases of food commodities such as grain and soybeans.

In the face of these challenges, Iranian pharmaceutical and food importers have increasingly used funds held by private sector banks and companies outside of Iran as means to make payments for goods. These funds are often held at accounts belonging to Iranian banks at foreign financial institutions in countries such as Turkey, South Korea, and China. If these Iranian banks are designated in a manner that eliminates the clear exemptions for the use of Iranian-origin funds for humanitarian trade, foreign financial institutions will be obligated to freeze the accounts of Iranian banks and their clients.

Such a situation, which is functionally the same as the situation facing funds belonging to Iran’s central bank, would contribute to a sudden liquidity crisis. Even if European and Asian companies remain willing to sell humanitarian goods to Iran, and even if the Treasury Department issues new licenses and comfort letters to try and reassure companies about the permissibility of these sales, Iranian importers will struggle to source the foreign currency needed to pay for these goods. This will likely contribute to significantly more delays in the importation of food and medicine which could lead to issues of scarcity and affordability.

Because of the restrictions imposed by sanctions on Iran’s banking sector, the financial transactions that enabled these imports are facilitated through an increasingly complex and fragile set of banking channels. Iranian importers and their suppliers are required to have multiple channels, knowing that new sanctions designations or financial circumstances could render any channel non-viable overnight. This byzantine system is the direct opposite of the simple, reliable banking channels countries need to ensure the availability of food and medicine. Targeting these key Iranian banks with new sanction will smash the remaining few reliable channels. 

3.     Many global pharmaceutical and food companies would quit the Iranian market.

Among the banks that may be targeted are those Iranian institutions that have gone to the greatest lengths to adopt anti-money laundering and counter terrorist financing policies, including those policies recommended by the Financial Action Task Force. While such policies have been only partially implemented across the wider Iranian financial system, these banks have instituted policies that exceed regulatory requirements in Iran in order to effectively serve Iranian importers and the multinational pharmaceutical and food commodities companies that supply them. These banks take an active role in helping these companies meet the stringent due diligence requirements necessary to successfully process Iran-related payments at banks in Europe and Asia. The impact of such a designation on these banks would be grave.

We know this because of the experience of Parsian Bank, a similar private sector financial institution which became subject to a terrorism-related designation in October 2018. As reported by the Washington Post, the designation of Parsian Bank left many multinational companies, including German drugs giant Bayer, scrambling to transfer their accounts to new Iranian banks in order to maintain their sales to Iran. But should the Trump administration move to designate all the remaining banks, there will be no alternatives available.

This will be a significant blow to the operations of many multinational companies which still maintain a local presence in Iran—companies overwhelmingly involved in the importation and production of food and medicine. Given these new operational restrictions, it is likely that many of the European and Asian companies still selling into Iran will either temporarily or permanently cease operations. As an employee at Bayer Iran commented to the Washington Post on the impact of sanctions on foreign pharmaceutical companies in Iran, “Many companies have started limiting their activities and laying off employees.”

Consequences for the US

What is striking about the proposed sanctions is the lack of any clear policy rationale for their imposition. The targeting of these banks in no way advances the Trump administration’s stated aims to curtail Iran’s “malign behaviors.” These banks are not significant vectors for money laundering and terrorist financing nor are they substantively linked to the Iranian government nor entities such as the Islamic Revolutionary Guard Corps. These banks have not been designated so far under the proposed authorities precisely because they are unlike most other Iranian banks. It is these distinct governance and operational characteristics that have enabled several of these banks to play a crucial role in humanitarian trade. As such, there is no national security justification for the designations—the only clear impact will be the further immiseration of ordinary Iranians as the supply of food and medicine becomes increasingly erratic.

Those who support targeting these banks have spoken openly about their intention to make future diplomacy with Iran more difficult in the event that Joe Biden wins the election in the next few weeks. This admission itself exposes the cynical thinking behind the proposal. But more consequentially for those individuals who have spent more than a decade developing US sanctions powers, the application of sanctions in the manner being proposed will no doubt damage the credibility of US sanctions as a tool of foreign policy.

Following significant concerns raised by governments, international organizations, and activists about the ability of sanctioned countries to respond to the COVID-19 pandemic, the Treasury Department issued a new fact sheet in April to clarify the exemptions and general licenses that govern humanitarian trade. At the time, OFAC director Andrea Gakci reaffirmed her office’s commitment to protecting “humanitarian relief efforts related to the COVID-19 crisis.”

The factsheet touted the launch of the Swiss Humanitarian Trade Arrangement (SHTA) as a model financial channel that would enable food and medicine to flow to Iran. SHTA has processed just one transaction during the COVID-19 crisis in Iran. One of the principle challenges facing SHTA and similar financial channels being considered is the failure of the Treasury Department to clearly permit the Central Bank of Iran, to access the foreign exchange reserves necessary to make payments through the channel. Such impediments will only get worse if Iran’s private sector banks are made subject to a similar designation as the central bank.

“Maximum pressure” sanctions are increasingly seen by US allies, and not least the Iranian public, as so poorly targeted as to intentionally harm the health and wellbeing of ordinary Iranians. Any move to designate the remaining Iranian banks at the heart of the country’s humanitarian trade would not only confirm this view of US sanctions policy, but also serve to directly undermine the commitments made by US officials, including Treasury Secretary Steven Mnuchin, who stated in April that his department was “committed to working with financial institutions and non-profit organizations in their efforts to mitigate risks and allow humanitarian assistance and associated payments to flow to those who need it.” Mnuchin should stand by his word and the US government should stand by its principles—the proposal to designate these banks must be rejected.

Photo: IRNA

Iran Resorts to New Financial Tools to Shore-Up Economy

The COVID-19 crisis has forced Iran’s government to turn to little-used financial tools to help stabilize the economy and address a widening fiscal deficit.

In the arena of monetary policy, the crisis is the first test of the new Open Market Operation (OMO) powers announced by the Central Bank of Iran (CBI) on January 18. To address the fiscal deficit, the Rouhani administration has pushed forward with long-planned privatization plans, conducting an Initial Public Offering (IPO) for SHASTA, the investment arm of the country’s largest social security provider. But the government faces hurdles as it resorts to largely unproven measures.

An underdeveloped interbank lending market will hamper OMOs. The interbank lending market in Iran was first established in June 2008. Despite the fact that the number and volume of transactions has grown substantially in recent years, with over 20,000 transactions registered in the last Iranian calendar year, the market remains hampered by the fact that Iranian banks do not maintain large reserves, meaning there are often too few banks with surplus liquidity in the market. As a result, it will be difficult for OMOs undertaken by CBI to influence the interest rate in the interbank market, limiting the central bank’s capacity to enact monetary policy through the bank-lending channel.

Iran’s interbank lending market also presents instrumental limitations. The most common mechanism by which needy banks secure liquidity is by direct borrowing from surplus banks, or, in times of emergency, turning to CBI as a lender of last resort. These loans are typically made without collateral and sometimes even without a formal contract. But given the prevalence of unsecured loans, there remains the possibility that the borrower might default.

While this possibility is generally understood to be low, it has likely increased given the current economic crisis. Iranian businesses will be seeking cheap financing to help them get through the difficult times. But given that Iranian banks struggle to determine the creditworthiness of their clients, any rapid expansion in lending could lead to greater issues with non-performing loans, particularly among the weaker banks.

The Central Bank of Iran had intended to use OMOs to adjust the inflation rate in accordance with its target for the current financial year, which is set at 20 percent—the annual inflation rate reached 41.2 percent in 2019-20.

On one hand, if the central bank aims to enable the country’s banks to lend to ailing businesses, the shift to the expansionary use of OMOs will be at odds with the inflation goals. On the other hand, now that the government is facing a record fiscal deficit, some Iranian economists are worried that the central bank may be pushed to use OMOs as a tool to generate government revenue, issuing bonds to finance expenditures. At a time when markets need clear leadership from regulators, the central bank’s priorities remain unclear.

While the central bank pursues new tools of monetary policy, the Rouhani administration has sought to tackle a fiscal deficit. The government’s IPO of SHASTA, also known as the Social Security Investment Company, was the largest IPO in Iranian history by market capitalization. The public offering of 10 percent of the company’s shares on April 15 generated USD 437 million in revenue for the government.

The strong performance of the Tehran Stock Exchange over the last year, despite the overall economic malaise, suggests that privatization of state-owned enterprises is a viable means for the government to generate much-needed revenues.

The Rouhani administration has long-pushed privatizations as a means to improve the finances of currently state-owned enterprises, to increase transparency, to improve corporate governance, and to reduce the footprint of the government in Iran’s economy. But any rush to privatize enterprises may lead to the loss of a “golden opportunity” as the government pursues public offerings to compensate for budget deficits without ensuring that the companies and their management become fully accountable to the public markets. 

Iran has been grappling with serious challenges in the areas of ​​fiscal and monetary policy in recent years. The Rouhani administration and the Central Bank of Iran have smartly sought to create new tools and establish new policies in response. But as the economy reels from the impact of COVID-19, these challenges have reached a point of crisis—the new tools may not be enough.

Photo: IRNA

Iran’s Currency Begins to Shrug Off Trump’s ‘Battle Rial’

Over the last 18 months, the Iranian rial has lost nearly 70 percent of its value, hammered by the Trump administration’s decision to reimpose secondary sanctions on Iran in violation of the  Joint Comprehensive Plan of Action (JCPOA).

A darkening economic outlook and rising inflation led Iranians to rush to exchange bureaus in order to purchase dollars, considered a safe-haven asset. Iranian companies struggled, or in some cases refused, to repatriate their foreign currency earnings, constraining supply in the foreign exchange market and leaving the market vulnerable to shocks.

Each time the Trump administration announced a new aspect of its maximum pressure campaign; the value of the rial would fluctuate. When the Trump administration took the dramatic step of targeting the IRGC under a new terrorist designation, the rial lost 4 percent of its value in just a few hours.

But there is a growing sense in Tehran that the currency market may have stabilized. When two oil tankers were attacked in the Sea of Oman on June 13—attacks widely attributed to Iran—the United States vowed a forceful response. But there was surprisingly little movement in the value of the rial.

Two weeks later, when the Islamic Revolutionary Guard Corps (IRGC) shot down a US spy drone near the strategic Strait of Hormuz, ordinary Iranians and currency speculators again braced themselves for a free-fall in the rial’s value. But the foreign exchange market barely moved—even after news broke that the US had been minutes from executing a retaliatory strike. 

That the rial has strengthened about 13 percent since the first week of May, corresponding to a period in which the United States revoked waivers permitting purchases of Iranian oil and in which Iran announced it would begin loosening its compliance with the JCPOA, has led some economic commentators in Iran to conjecture that the Iran’s foreign exchange market has developed an immunity to the escalating political tensions. The rial may be shrugging off the Trump administration’s “maximum pressure” campaign.

One possible explanation for the newfound stability in Iran’s currency markets is that while the Trump administration has nearly maxed-out its own maximum pressure sanctions campaign, the Central Bank of Iran has only recently begun to assert its control over the foreign exchange market. Late last month, Abdolnasser Hemmati, the governor of Iran’s central bank, struck a confident tone in an interview with state broadcaster IRIB, stating, “I promise to strengthen the value of the national currency—the situation is improving, the recovery can be felt.”

To defend the rial, the Central Bank has made several interventions. It has implemented a central marketplace to increase transparency and reduce arbitrage in Iran’s foreign exchange market. The Integrated Foreign Exchange Deals System, known by its Persian acronym, NIMA, has improved the reliability with which Iranian importers in need of foreign exchange can purchase currency, taking advantage of a rate slightly lower than the free market rate. Iranian exporters are required to sell their foreign exchange earnings through the NIMA system, ensuring that vital foreign exchange is not sold to currency speculators on the free market. Additionally, the central bank has for the first time engaged in open market operations, in an attempt to try and slow the inflation that has fed demand for foreign exchange.

While some of the stabilization is likely attributable to these interventions, it is also possible that the rial has stabilized due to the fact that the current exchange rate better reflects the relative purchasing power of the rial and the dollar. The rial had long been kept artificially strong by the Iranian government.

Looking at the demand side, it may be the case that the Iranian public has been inured to the economic uncertainty brought about by the reimposed US sanctions or that there is greater confidence in the management of the foreign exchange market by authorities. In both cases, individuals and companies are less inclined to flock to the dollar as a safe-haven asset, even if Iran’s general economic malaise—marked by high unemployment—persists.

The stability of the currency is all the more remarkable as the Trump administration drives down Iran’s oil exports. The revocation of waivers covering imports of Iranian crude has left China and Syria as Iran’s sole customers. Iran’s oil minister, Bijan Zanganeh, has insisted that Iran has the means to get its oil to global markets, though it is clear that exports have fallen sharply. While the Trump administration has crowed that reduced oil sales deprive Iran of vital foreign currency, it is worth considering that under the waiver system that governed Iran’s oil exports for much of the last decade, Iran had a limited ability to repatriate its foreign currency earnings. In that sense the current circumstances are not new.

There remain measures that the Trump administration can pursue to try and spur a new devaluation episode in Iran. Reports that the White House may finalize the designation of Iran as a “primary money laundering concern,” a move that could cut the country’s few remaining correspondent banking links, reflect one such measure. But for now, as economist Djavad Salehi-Esfahani has recently written, “Fears of ‘Venezuelaization’ of the Iranian economy (collapse) have subsided, allowing the government to revive its long neglected public investment program, which could boost employment and production.” The Iranian public, made weary by a year of economic hardship, will certainly hope that the stabilization of the currency is the first step to a broader recovery.

Photo: IRNA

Iranian Bankers Fear IRGC Terrorism Designation Dooms Vital Financial Reforms

Reform-minded Iranians, especially those inside the ailing banking system, are worried that the US government’s step to designate Iran’s Islamic Revolutionary Guard Corps (IRGC) as a terrorist organization has doomed a years-long effort to get the Islamic Republic off a consequential global blacklist.

The administration of Iranian President Hassan Rouhani has been working hard to meet the requirements of the action plan set by the Financial Action Task Force (FATF), the intergovernmental organization established with the mandate of combatting money laundering and terrorism financing.

The required reforms have caused deep political divisions, with opponents arguing that Iran will be compromising its sovereignty should it appease the FATF, while porposents argue that failing to pass the required legislation will eliminate final links Iran maintains with foreign financial institutions while under US sanctions.

Undaunted even as death threats were made against them, a majority of Iran’s parliament voted to pass all four FATF bills over the course of several months. The supervisory Guardian Council then ratified two of the laws, while two others were considered deficient. The council and parliament have failed to find a consensus on adjustments to these two bills, which pertain to regulations that deter terrorist financing and organized crime. Now the powerful Expediency Council must vote to break the deadlock on ratification.

Meanwhile, the clock is ticking for Iran to show progress on the FATF action plan. At the end of its February plenary sessions, the FATF announced, “If by June 2019, Iran does not enact the remaining legislation in line with FATF Standards, then the FATF will require increased supervisory examination for branches and subsidiaries of financial institutions based in Iran.”

When the Trump administration took the controversial move to designate the IRGC a Foreign Terrorist Organization (FTO), the first time the FTO designation had been applied to a part of a foreign state, the condemnations in Iran came swiftly.

As Rohollah Faghihi reports for Al Monitor, hardliners opposed to engagement with the West pointed to the FTO designation to show the futility of the FATF reforms. The day after the FTO designation was announced, Expediency Council member Gholamreza Mesbahi-Moqadam said the designation has decreased the chances that the FATF bills woild be ratified. “The move has strengthened the council’s [unfavorable] stance about the FATF and the chances of the bills not being approved has increased,” he said. Others have even placed the chances of ratification at zero.

Members of Iranians banking community, who have been advocating for FATF reforms for years as part of a larger drive for modernization of the financial sector, share in this pessimism. A senior Iranian banker speaking to Bourse & Bazaar on condition of anonymity agreed that the FTO designation has harmed the odds of the bill passing, by shifting the environment away from constructive discussion and cooperation towards sloganeering.

“The designation has major political implications, the full scope of which has yet to become clear, but I find it unlikely that the bills will be approved under current circumstances,” the banker said. “Essentially whenever the situation gains an emotional aspect, decisions also become largely emotional.”

Several high-level Iranian officials have also confirmed that the FTO designation will have an impact on the FATF bills. Secretary of the Expediency Council Mohsen Rezaei, who counts himself among those opposed to the bills, has said the FTO designation will be factored in forthcoming decisions based on “national interests.”

Meanwhile, Laya Joneydi, Iran’s Vice President for Legal Affairs, suggested it was a mistake to conflate decision-making about the FATF bills and the FTO designation since the two issues are “fully separable.” She did, however, point out that the designation will prompt the Rouhani government to consider any new “reservations” about the two bills.

A source inside the Central Bank of Iran also confirmed to Bourse & Bazaar on condition of anonymity that the IRGC designation should be expected to have an impact on the FATF bills.

“The central bank has always been in favor of having the bills pass into law, but we have already concluded all expert reviews of the bills and now everything depends on the views of the Expediency Council. At at the moment it seems the number of council members opposed to the bills is higher,” the source said.

Central Bank Governor Abdolnasser Hemmati has on multiple occasions voices his support for enacting the bills into law, saying Iran needs to do more to comply with international financial standards. In his latest remarks in early March, he said safeguarding and strengthening what little international banking ties Iran retains is a “necessity.”

In late February, Rouhani mounted his strongest support yet for the bills, saying “we cannot give the country to 10-20 people and say we follow your decisions”. The president called on the Expediency Council to facilitate passage of the bills lest Iran lose its already tenuous link to the global financial system.

But not everyone inside Iran’s isolated banking system is pessimistic about salvaging the FATF action plan.

“The bills will certainly face delays, but we predict that they will ultimately be signed into law,” a senior member of a banking sector association told Bourse & Bazaar on condition of anonymity.

The official likened the situation surrounding the issue to the Iran nuclear deal, noting that many analysts thought such a multilateral agreement could never be reached given opposition from hardliners.

“I believe some members of the Expediency Council harbor doubts about some of the contents of the FATF bills but are not opposed to them outright. Those doubts will be cleared in time,” the official said.

The question remains whether the FATF will continue to show patience as Iran’s complex domestic politics slow the pace of reform even further.

Photo: IRNA

Confronting Failure, Iran Government Mulls New Currency Policy

Despite mounting evidence that the Iranian government’s policy of allocating subsidized foreign currency for the importation of essential goods has failed, the Rouhani administration has signaled that it plans to maintain the policy for at least another year. But lawmakers and Rouhani’s own cabinet ministers may force the administration to change course.

On March 2, Iran’s parliament approved the allocation of USD 14 billion in oil export revenues for the import of essential goods, including food and medicine, during the upcoming Iranian year (beginning March 20). In doing so, MPs gave the green light for the Rouhani administration to continue to make foreign exchange available to importers of essential goods at the subsidized rate of IRR 42,000 to the dollar.

However, lawmakers also encouraged the government to consider an alternative approach that would require essential goods importers to purchase foreign exchange at the IRR 90,000 rate available on the centralized NIMA marketplace. The government would then redirect the savings from the elimination of the currency subsidy towards programs that directly assist Iranian consumers and manufacturers.

Despite the nudge from parliament to consider a new approach, it appears that the administration is intent on maintaining the subsidy for at least another year. The head of the Management and Planning Organization, Mohammad Baqer Nobakht, confirmed this to be the administration’s position in an interview just prior to the parliamentary vote.

The Rouhani government “unified” the country’s dual foreign exchange rates at IRR 42,000 to the dollar in early April as the rial hit new lows due to political uncertainty surrounding Iran’s nuclear deal and the possible reimposition of sanctions by the United States. The foreign exchange rates diverged again shortly thereafter, but the Rouhani administration has persisted in using the “unified” fixed rate for the importation of essential goods.

Rouhani recently claimed that he personally disagreed with the fixed rate when it was first proposed and only consented to rate unification after dozens of top economists backed the move. His administration has since maintained that the allocation of subsidized foreign exchange continues to be the best policy to stabilize prices of essential goods.

Meanwhile, high levels of inflation have dimmed prospects for Iran’s middle and lower classes. The Iranian public has felt the pressure of price hikes, and essential goods have not been spared, despite Rouhani promising otherwise on national television.

Beyond the lived experience of Iranians, new research has also cast doubt on the effectiveness of subsidization. On February 22, the Parliament Research Center published its findings of the government subsidized currency allocation policy. According to the PRC, the price of essential goods as a category increased by 42 percent during the first three quarters of the current Iranian year that ended on December 21.

By comparison, the price of imported goods not eligible for the subsidized rate increased 73 percent in the same period. However, the consumer price index increased by nearly 40 percent, meaning that the increase in the price of essential goods still outpaced general inflation by a significant margin. The question for policymakers is whether this minimal impact on the price of essential imports is worth the many adverse side effects for the wider economy.

At time when Iran’s foreign exchange revenues are being squeezed by  the Trump administration’s “maximum pressure” policy, the Iranian government cannot afford to misallocate USD 14 billion in oil revenue to a subsidization program that may serve to increase corruption and rent-seeking.

Iran’s central bank governor Abdolnasser Hemmati also admitted as much in a frank statement. “In effect, allocating subsidized currency to essential goods has failed to prevent their price hikes in the medium term due to the nature of market in the economy and the weakness of the distribution and supervision systems,” he wrote in a March 9 Instagram post. “Therefore, in most cases the subsidies have gradually moved away from consumers and benefited importers.” Hemmati signaled that a change in the policy may be in order by stating the government will “make the best decision.”

Economy minister Farhad Dejpasand later echoed Hemmati’s view, stating that “The government is currently studying several policies, and we definitely will adopt an approach to minimize the pressure on the poorest sections of society.

“Based on competitive open market principles, any fixed rates that diverge from the open market rate, such as the subsidized IRR 42,000 dollar exchange rate, are a mistake,” Mohammad Mahidashti, a macroeconomic analyst currently serving as an advisor at Iran’s Ministry of Economic Affairs and Finance told Bourse & Bazaar.

“There is simply no positive aspect in this subsidized currency allocation by the government, perhaps save for giving it a justification and a populist slogan to show that the administration is trying to decrease prices of essential goods,” he said.

Mahidashti believes the way forward is for the government to cut its losses as soon as possible by eliminating the subsidized rate and moving toward true rate unification, which he considers both doable and absolutely necessary.

Indeed, the PRC report also called on the Rouhani administration to either fully eliminate subsidized currency allocation or significantly trim the list of essential goods eligible to receive cheap currency. Even in the event of choosing the second route, the parliamentary think-tank said the subsidized rate must be higher and the IRR 42,000 rate is no longer justifiable.

Iran’s private sector, which has for years called for true rate unification would surely embrace such a move. Shortly after Hemmati’s admission of the failure of the subsidized foreign exchange policy, deputy president of the Iran Chamber of Commerce Pedram Soltani welcomed the announcement as a sign that things may be changing. He tweeted, “Subsidized currency is the source of rent and misuse. Let’s stop the flow!”

Photo Credit: IRNA

Facing a Damaging Ban, Iran’s Crypto Community Seeks Policy Breakthrough

For decades, Iranians have had to contend with almost complete isolation from international payment systems due to US sanctions. The situation has only worsened following President Donald Trump’s decision to withdraw from the Iran nuclear deal and embark on a “maximum pressure” campaign that targets average Iranians.

Given these restrictions on traditional banking, it should come as little surprise that Iran is home to a vibrant and passionate cryptocurrency community. Iranians are increasingly turning to bitcoin and other cryptocurrencies to transact with the outside world. Soheil Nikzad, a board member of the Iran Blockchain Community, recently estimated that USD 10 million worth of bitcoin transactions are conducted in Iran on a daily basis.

The decentralized and anonymous nature of cryptocurrency payments means that the Iranian government has so far proven unable to stop adoption of the new technology. But regulators are trying to exert greater control as made clear when the Central Bank of Iran (CBI) published its draft regulatory framework on cryptocurrencies in late January.

The “version 0.0” framework asserts that “using global cryptocurrencies as methods of payment inside the country is forbidden.” Even though the framework recognizes global cryptocurrencies and allows them to be traded in official exchanges in accordance with the country’s foreign currency rules, the proposed ban on their use for payments has disappointed many in the local “crypto” community.

“I don’t view CBI’s framework as remotely adequate because they’ve forbidden many things and in doing so, they’ve created barriers for people trying to develop valuable projects,” blockchain researcher Hamid Babalhavaeji told Bourse & Bazaar, referring to CBI’s ban on the issuance of rial-backed tokens as an example.

Babalhavaeji’s frustration is shared by many in the community. Twitter feeds and Telegram channels are abuzz with debates and sharp criticism of the CBI framework. But there are nuances at play.

“Within the existing legal frameworks, including sensitive rules concerning foreign currencies and money laundering, it was perhaps the best that could be proposed at the moment,” Babalhavaeji acknowledged.  

In this vein, many in the community believe it would be unproductive to simply dismiss the proposed framework as just another instance of overbearing regulations. The community understands the pressures faced by the government, which is grappling with what senior Iranian officials have referred to as an “economic war” being waged on Iran by the U.S.

Reimposed US sanctions have contributed to the rial losing more than 60 percent of its value in 2018. Naturally, at a time when public trust in the national currency is at a low, CBI wishes to keep a tight leash on the currency markets.

Authorizing several dozen global cryptocurrencies as methods of payment inside the country, some of which are pegged to global currencies, could further weaken the rial, threatening the livelihoods of millions of Iranians as inflation worsens due to currency volatility.

On one hand, businesses would be tempted to establish payment gateways to accept cryptocurrencies pegged to the US dollar or other stable globally currencies. As wealthier Iranians begin to earn and spend cryptocurrencies, those in the working class, still paid in rials, would see their meager wages lose even more purchasing power.

On the other hand, fully eliminating the prospect of using global cryptocurrencies as a local method of payment could hurt Iran in other ways. It would create a stigma around a promising new technology, stalling innovation and deterring would-be enthusiasts from employing cryptocurrencies to meet Iran’s need for robust and legitimate payment solutions.

The central bank has given the community one month to offer feedback and has vowed to review and reevaluate its framework in six-months. The crypto community is hard at work trying to devise practical solutions.

One proposal would see cryptocurrency payments connected to the rial, meaning that certified gateways would accept cryptocurrency payments, but the actual clearance would be made in rials. Another proposal would see the payments cleared using Iran’s forthcoming official rial-backed cryptocurrency. Community members aim to arrive at a consensus soon, which they will present to the central bank.

“At the end of the day, it’s about coming up with creative ideas to make the best out of a restrictive framework. We don’t want to create any potential legal challenges for the central bank,” Babalhavaeji said.

Despite the payments dilemma, some have welcomed CBI’s draft framework as a step forward. The proposed regulations recognize cryptocurrency mining as a legitimate industry, authorize digital wallets and cryptocurrency exchanges, and allow issuance of tokens that are not backed by rials, foreign currencies, or gold and other precious metals. Furthermore, the new framework is slated to replace the blanket ban on cryptocurrencies that was issued in April 2018 in the early days of the currency crisis.

“In 2017 when cryptocurrency prices were soaring and new investors were pouring into markets, strange rumors circulated that purchasing and holding cryptocurrencies is illegal in Iran and at times the central bank would be referenced as the source,” explained Tina Kheiri, a young crypto and blockchain educator with Iran Blockchain Academy.

“At least people active in this field now have the reassurance that their activities don’t violate any laws, and this alone should encourage more newcomers to enter the industry,” she added.

But Kheiri also believes the proposed framework ought to be more flexible. She would like to see more straightforward initial coin offerings (ICOs) for businesses and greater use of cryptocurrencies for routine transactions—such as when selling tickets for her courses.

Kheiri also thinks she might have a solution for the threat posed by cryptocurrencies to Iran’s currency markets. “Boosting the mining industry could encourage major players to invest in Iran due to its cheap electricity, something that could actually attract foreign currencies and increase the value of the rial,” she explained.   

The community is not short of innovative ideas, but it remains to be seen whether it will achieve a policy breakthrough with the central bank.

Photo Credit: Bourse & Bazaar

Bankless Task: Can Europe Stay Connected to Iran?

This article is re-published with permission from the European Council on Foreign Relations. 

As part of the effort to salvage the Iran nuclear deal, European governments have vowed to sustain their economic ties—not least their banking connections—with Iran. From 4 November, American sanctions targeting Iran’s banks will make it extremely difficult for European companies to engage in transactions with firms in the country. Many of the pathways to reducing the secondary impact of US secondary sanctions on the European financial sector present significant technical and political challenges—which stem from the US financial system’s global dominance and the integration of the US and European banking sectors. Moreover, the Iranian financial sector must take several proactive steps to ensure it meets the international compliance standards European banks require.

The Banking Blockage

With the incoming US sanctions, European companies face an even greater struggle to engage in transactions with Iran. For instance, Swedish automaker Volvo is leaving Iran because, as one of its spokesman put it, “with all these sanctions and everything that the United States put [in place] ... the [banking] system doesn’t work in Iran … We can’t get paid.”

This problem has driven most of the multinationals once active in the Iranian market to suspend their operations there, ahead of the new round of US sanctions. There is a widespread expectation that several Iranian private banks and the Central Bank of Iran will be designated entities under the measures.

Some European companies, such as Airbus and Total, require a licence or waiver from the US authorities to continue their operations in Iran, as they work in sectors subject to targeted sanctions. Many areas of Iranian trade, such as that in basic goods, are either unsanctionable or will be exempt from the measures. Yet US sanctions have adversely affected even these areas, as outlined in a recent ruling of the International Court of Justice.

Such restrictions on trade arise from the contamination risk that US secondary sanctions pose to European financial institutions, which generates unique pressure on the Iranian banking sector. This risk combines with Iran’s current shortfalls in meeting its commitments under a Financial Action Task Force (FATF) action plan – although the recent passage of the Combating Financing of Terrorism Bill suggests that Tehran is raising its compliance standards. Until the FATF changes Iran’s designation as a high-risk jurisdiction, global financial institutions will limit their dealings with Iranian banks.

Since President Donald Trump withdrew the US from the Iran nuclear deal in May this year and announced the re-imposition of secondary sanctions on Iran, banks in Europe have come under growing direct and indirect pressure from American regulators. Following the repeal of international sanctions on Iran in 2016, many large European banks began quietly facilitating transactions involving Iran for their largest industrial clients, especially those with long-standing operations in the country. Among these institutions, Danske Bank was the most visibly open to business with Iran, even opening a €500 million line of credit to support Danish firms’ expansion in the country. But as it falls into disrepute over suspected money laundering at its Estonian subsidiary, Danske Bank has opted to cease transactions involving Iran as an immediate show of responsiveness to US regulators. More broadly, banks tend to jettison their business with Iran if regulators exert pressure on them, even in the absence of a direct compliance issue.

Meanwhile, small European banks are coming under pressure from their larger competitors. When these institutions, which have relatively limited exposure to the US financial system, engage in Iran-related transactions, their routine SEPA transfers – payments to other banks within the Single European Payments Area – are often refused outright. This isolates the banks and complicates other aspects of their business. And the refusals extend beyond Europe. Asian banks have shown increasing concern about dealing with small European financial institutions that engage in business with Iran, understanding that they too could fall foul of the US authorities.

Europeans banks have been reluctant to engage with Iran due to fears about the response from their shareholders and creditors. This is most clear in the case of the European Investment Bank (EIB), which has refused to invest in Iran. European governments (which number among the bank’s shareholders) encouraged the EIB to consider lending to Iran, but the bank’s leadership felt that investing in the country would jeopardise its ability to raise capital from American institutional investors in the bond market.

Europe’s Possible Solutions

Despite their efforts to sustain economic channels with Iran, European governments have been unable to ease this pressure on banks. With US sanctions on Iran’s banking sector due to come into effect soon, European countries are now considering measures that would facilitate trade transactions with Iran through a new legal and institutional structure.

On the sidelines of the recent United Nations General Assembly, EU High Representative Federica Mogherini announced that “EU Member States will set up a legal entity to facilitate legitimate financial transactions with Iran and this will allow European companies to continue trade with Iran, in accordance with European Union law, and could be opened to other partners in the world”.

European governments have been reviewing this legal entity, known as a Special Purpose Vehicle (SPV), for months. The timing of this public announcement suggests that they have a degree of confidence that the SPV can become operational, and that Europe can use the model to showcase its ability to deliver on its commitments.

US Secretary of State Mike Pompeo immediately responded that he was “disturbed and indeed deeply disappointed” at the news. US National Security Advisor John Bolton commented: “we will be watching the development of this structure that doesn’t exist yet and has no target date to be created. We do not intend to allow our sanctions to be evaded by Europe or anybody else.”

There remains scant detail on the SPV. In her statement, Mogherini added that more information will become available “as the technical work continues in the coming days”. It may be advisable for European actors involved in the creation of the SPV to keep the details private for now. Operationalising the SPV will require a period of trial and error. Making the details of the project public in its early stages would provide the structure’s opponents with further opportunities to undermine it.

Can the SPV Model Work?

Reportedly, an internal European Commission paper describes the European Union’s efforts to “bundle and reduce cross-border payments to and from Iran”. In this way, the SPV would “avoid or severely restrict the role of commercial banks in the payment system and protect payment transactions with Iran from US sanctions”. European policymakers’ apparent consideration of this approach indicates that they want to avoid placing critical European financial institutions, such as the EIB, in the crosshairs of the Trump administration.

To operationalise the SPV, policymakers will need to quickly make progress in several technical areas. Firstly, European governments need to determine how aggressively they will push back against US sanctions; this is a consideration of the first order for the structure and operation of the SPV. Theoretically, the SPV could facilitate payments for what the US authorities consider to be sanctionable activity. Indeed, European officials have openly discussed their intention to use the SPV to support purchases of Iranian oil.

As guidelines from the US Treasury’s Office of Foreign Assets Control make clear, even barter arrangements involving petroleum or petroleum products from Iran are sanctionable – on the basis that they provide “material support” to Iran’s oil industry “regardless of whether a financial institution is involved”. However, because the envisaged SPV would bypass the US financial system and foreign branches of US banks, the American authorities would have no direct jurisdiction over it. Thus, transactions the SPV facilitated would not give rise to the same kind of civil liability that led to hefty fines on Europe’s largest banks in the previous era of sanctions.

The US authorities could, in theory, prevent entities engaged in the SPV from accessing the US market. American officials have stressed that US sanctions will target European central banks and SWIFT – an international payments messaging system headquartered in Belgium – if these institutions facilitate transactions with Iran. Furthermore, this targeting would extend beyond entities engaged in oil purchases, covering all companies that use the SPV to engage in transactions with Iran – even those in sectors that are exempt from sanctions, such food and pharmaceuticals.

European governments working on the SPV will have to find a way to counter such measures. On a technical level, they may be able to use creative structuring solutions. The SPV could be set up primarily as a payment mechanism for only small and medium-sized companies that are content to be excluded from the US market. And the mandate of the SPV could initially facilitate just payments for trade that is exempt from US sanctions.

The SPV is most likely to succeed if takes this approach, starting off small and gradually expanding. The basic structure of the vehicle is replicable. One SPV could focus on sanctionable trade related to support for Iran’s oil, automotive, or aviation sectors. Another could be limited to sanctions-exempt trade in consumer goods, food, and pharmaceuticals – allowing multinationals to use it as a convenient payment channel. With multiple SPVs available, companies could engage with Iranian entities in accordance with their appetite for risk and their business models.

Each SPV could take a different form. It could be a stand-alone, state-owned bank; a conduit for payments that European central banks ultimately facilitate; or simply a clearing house for companies that transfer money to Iran, repatriate funds from the country, or engage in barter trade with it.

The process of establishing the SPV will prove instructive in testing the limits of America’s sanctions power and US willingness to use sanctions as a weapon against its putative allies. Reports indicate that the US Department of the Treasury is already starting to push back against the White House over proposals to sanction European financial institutions, particularly SWIFT, for maintaining ties with Iran.

Of course, creating the SPV will require significant technical work. For its part, Iran will need to demonstrate that its financial system is also continuing to reform in accordance with international standards on money-laundering and terrorism financing. European governments will closely watch the country’s progress in implementing the FATF action plan ahead of an important review on 14-19 October.

From a political perspective, Iran has drawn encouragement from European countries’ sustained and unanimous commitment to the nuclear agreement. Iranian President Hassan Rouhani praised Europe for taking a “big step” to maintain trade. Iran’s foreign minister, Javad Zarif, stated that while implementing the SPV will be difficult, Iran is willing to show “a little bit more patience” with Europe. The SPV is an important immediate contribution to improving conditions for trade between Europe and Iran, but both sides must view it as the start of a road map for long-term economic engagement.

Photo Credit: Depositphoto

Can Iran Weather the Oil-Sanctions Storm?

This article has been republished with permission from the European Council on Foreign Relations. 

In the coming weeks, the US administration will intensify its economic pressure on Iran through sanctions designed to curtail the country’s oil exports. Given that these exports account for a significant percentage of state revenue (despite government efforts at economic diversification), the measures will hit Iran hard. Yet the sanctions will also have an impact on energy markets far beyond Iran, and may lead to a rise in global oil prices. Moreover, they could have a negative effect on global energy security by tapping into most of the spare capacity in the market.

Since President Donald Trump withdrew the United States from the Iran nuclear deal (formally known as the Joint Comprehensive Plan of Action, or JCPOA) in May this year, US officials have stated that they aim to prevent Iran from exporting any oil whatsoever. Although the second phase of the new US sanctions only come into effect on 4 November, Iranian oil production and exports have already started to decline – partly because the US has issued conflicting statements on whether it will provide sanctions waivers to some importers, and partly because the August 2018 round of US sanctions set restrictions on payments, shipping, and insurance.

If the Trump administration truly seeks to ensure that Iran will export no oil, this is a strikingly different approach to that both the Obama administration and the European Union pursued between 2012 and 2015. These earlier measures caused Iran’s oil exports to drop by around 40 percent, to an average of 1.5 million barrels per day (mb/d). In contrast, the new sanctions are likely to reduce Iran’s oil exports to less than 1 mb/d by November. There are several reasons for this difference. One is that the Trump administration has taken a much tougher stance on importers of Iranian oil. Under the Obama administration, the US expected other countries to significantly reduce but not totally end their imports of Iranian oil. Although the Obama administration never stated a clear target for this reduction, it amounted to around 20 percent. Notably, the EU also banned imports of Iranian oil and EU member states halted almost all such imports.

Having borne the brunt of US secondary sanctions in 2012-2015, companies and countries around the world are now well aware of the consequences of non-compliance. They also have a good idea of how accurately the US tracks Iranian exports and how far its surveillance capabilities reach. The Obama administration had to engage in extensive negotiations with importers of Iranian oil to explain the consequences of non-compliance. This time around, the rules of the game are much clearer.

Another factor is that, unlike in 2012, there now is enough oil to make up the shortfall in the market. In recent weeks, traders and importers of Iran’s oil have said they can easily find substitutes for the product. Major oil producers such Saudi Arabia, the United Arab Emirates, and other OPEC members have collectively increased their supply of oil by around 1 mb/d since May, and have signed contracts with importers to provide substitutes for Iran’s oil in the future. However, this substitution of Iranian oil weakens the security of global energy markets: buyers are tapping into most of the world’s spare oil production capacity, heightening the risk of a rise in oil prices.

As oil prices are now much lower than they were between 2012 and 2015, the discount rates at which Iran hopes to export oil provide relatively little incentive for buyers to violate US sanctions. Meanwhile, by restricting financial transactions with Iran and the insurance of Iranian oil, the US sanctions that came in to force in August 2018 have created a tighter regime than that implemented under the Obama administration.

New Obstacles to Iran’s Exports

Ambiguities over how the US will enforce its sanctions make it difficult to estimate the size and duration of the coming decline in Iran’s oil exports. While the US sanctions in place during 2012-2015 accompanied similar EU measures and had a basis in UN sanctions targeting Iran’s nuclear programme, the US is now implementing unilateral sanctions while Russia, China, and Europe continue to support the sanctions relief specified in the JCPOA.

Yet US secondary sanctions have proved to be powerful. There are indications that importers of Iranian oil such as Japan, South Korea, Sri Lanka, and most European countries will no longer buy the product after November. Although China has consistently stated that it will continue to import oil from Iran, it is also attempting to use this position as leverage against President Trump in its ongoing trade war with the US. India, which buys more Iranian oil than any country other than China, significantly reduced its imports of the product in August, but is still negotiating with US administration over sanctions waivers.

Following the introduction of US sanctions on Iran-related financial transactions and oil tanker and cargo insurance, Iran’s crude oil exports dropped from an estimated 2.3 mb/d in July 2018 to less than 2 mb/d the following month. As such, the cause of the decline is not necessarily compliance with the US ban on Iran’s oil imports but rather the new challenges of paying for, and safely transporting, the product. Judging by purchase contracts at the National Iranian Oil Company and other sources, exports of Iranian oil may drop as low as 750,000-850,000 b/d by November.

In August, amid this sharp decline in Iranian oil exports, OPEC increased oil production to 32.89 mb/d, its highest level in ten months. It appears likely that OPEC will further increase production, despite Iran’s efforts to lobby against such a move. Potentially adding to Tehran’s woes, Russia – which is not a member of OPEC – increased its oil output by around 148,000 b/d to 11.215 mb/d in July, coming close to its post-Soviet record high of 11.247 mb/d. 

As no sanctions regime is immune to shifts in the market, time could work against the US policymakers targeting Iran. Along with the increased oil supply from OPEC countries and Russia, other market conditions could have a drastic effect on Iran’s oil exports. The US administration’s ambiguous statements on the scope and duration of its sanctions could lead to non-compliance and even cause the measures to fall apart earlier than planned. For instance, if countries such as India and China continue to import discounted Iranian oil while others stop doing so, the sanctions regime may gradually become ineffective. This is especially so given that, if oil prices rise in line with market expectations, Iran’s discounts on barrels of oil and freight costs will become increasingly appealing.

Nonetheless, the new round of US sanctions will undoubtedly damage Iran’s economy. At a time when it is grappling with several domestic economic challenges, the Iranian government will have to be careful in dealing with further cuts to its revenue. Of course, having survived a series of US and EU oil embargos in the last four decades, Iranian leaders may decide to weather this latest storm through strategic patience and reliance on an “economy of resistance”. Tehran may feel it can manage these sanctions while continuing to comply with the JCPOA, allowing the measures to gradually erode.

China, Russia, and many European countries seemingly aim to support this approach, creating financial incentives that maintain Iranian compliance with the JCPOA (even if most European countries and companies are likely to comply with US sanctions). These incentives will be designed to help Iran’s economy survive the sanctions, partly by mitigating the decline in Iranian oil exports.

It is unclear whether this approach will work. The Iranian economy currently appears vulnerable to the new sanctions: the Central Back of Iran has been forced to devalue the rial much faster in recent months than it did during 2012-2015. The aftershocks of the currency devaluation and rapid inflation may exacerbate the sporadic unrest across the country that began last January – mostly due to Iranians’ economic grievances.

If American sanctions truly block the majority of Iran’s oil exports, the country may opt for an aggressive response. Iranian leaders, including President Hassan Rouhani, have suggested that Iran will disrupt oil shipments from neighbouring countries, targeting the Strait of Hormuz and/or Bab el-Mandeb. Iran could also engage in cyber sabotage or attacks in the Middle East intended to create panic among oil traders, driving up global oil prices. Such operations would create widespread chaos and perhaps lead to the formation a global political and military alliance against Iran.

The prospect of further talks between Tehran and Washington is fading as Iran’s oil production and exports continue their decline. But the ongoing negotiations between Iranian leaders and supporters of the JCPOA may produce a compromise that encourages Iran to wait patiently, in the hope that the course of events will turn in its favor and it will overcome the sanctions.

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Can Europe Defend Itself And Iran From U.S. Sanctions?

This article was originally published in LobeLog. 

In an op-ed published in the German newspaper Handelsblatt, German Foreign Minister Heiko Maas declared that the “the US and Europe have been drifting apart for years.” Nowhere is this clearer than in the disagreement between the United States and Europe over the fate of the Iran nuclear deal. When President Trump withdrew from the Joint Comprehensive Plan of Action (JCPOA) and announced his intention to reimpose secondary sanctions that would impact European businesses, he made clear that he wouldn’t treat Europe in what Maas called a “balanced partnership.” In response, Maas believes that Europe must “bring more weight to bear” in global affairs.

In order to defend the JCPOA and protect European companies active in Iran from U.S. sanctions, Maas outlined three initiatives: “establishing payment channels independent of the US, a European monetary fund, and an independent SWIFT [payments] system.” These initiatives echo ideas expressed by French economy minister Bruno Le Maire in the aftermath of Trump’s withdrawal from the JCPOA. Le Maire has called for European governments to work together to protect Europe’s economic autonomy by creating “independent, sovereign European financial institutions which would allow financing channels between French, Italian, German, Spanish and any other countries on the planet.” Le Maire has declared that “the United States should not be the planet’s economic policeman.”

It will be difficult to realize the political designs of Maas and Le Maire within the economic structures that link Europe and global markets, including Iran. As Maas concedes, “the devil is in thousands of details.” It should be no surprise, therefore, that speaking to President Hassan Rouhani’s cabinet last week, Supreme Leader Ali Khamenei declared that Iran “must not pin hope on the Europeans for issues such as the JCPOA or the economy,” noting that promises must be examined with “skepticism.”

Iran should not take for granted the hopeful vision of more resolute European leadership, especially if that leadership promises to deliver fairer political and economic outcomes for Iran. But in light of the present economic crisis, the Iranian government and Iranian people can no longer afford to take a long-term view when it comes to fundamental questions like access to the international financial system, whether or not that system continues to be dominated by the United States. As such, it is important to try and discern the specific and short-term implications of the new political vision espoused by leaders like Maas and Le Maire.

First, there has been the greatest progress in designing possible payment channels that would help sustain transactions in the face of U.S. secondary sanctions. As an initial step, the central banks of France, Germany, the United Kingdom, Austria, and Sweden have indicated their openness to establishing payment channels with the Central Bank of Iran that would be immune to sanctions since the U.S. government is unlikely to take the extreme step of sanctioning European central banks for transacting with Iranian entities. Importantly, these central banks, which would be facilitating transactions on an ad hocbasis, would not need to rely on payment systems such as SWIFT.

However, the central banks have established a pre-condition: Iran must fully implement the Financial Action Task Force (FATF) action plan. But even if Iran does successful implement the FATF reforms, and even if European central banks fulfill their promise, the creation of limited payment channels does not amount to an independent financial system. In such a scenario, the impact of U.S. sanctions on European and Iranian banks will continue to prevent trade and investment in meaningful volumes.

Second, the creation of an independent payment messaging system is essential to enabling those smaller European banks that lack a “U.S nexus” to transact with Iranian banks, thereby enabling trade and investment at higher volumes. To this end, Maas has called for the creation of “an independent SWIFT [payments] system.” Notably, Maas’ statement makes it clear that European leaders do not expect to successfully defend the independence of SWIFT in its current form. SWIFT, headquartered near Brussels, is a cooperative owned by its member financial institutions, including major American banks such as Citibank and JP Morgan. Even so, SWIFT represents a rare global financial institution in which the United States is not dominant, but dependent. Some analysts, among them former officials from the U.S. Department of Treasury, have observed that it would be harmful to U.S. economic interests to sanction SWIFT. In fact, when SWIFT disconnected Iranian banks from its system in 2012, this was only because the organization voluntarily agreed to do so in accordance with European sanctions policy at the time, not because of the realistic threat that the U.S. would sanction the entity.

It is not entirely clear whether Maas wants Europe to insist on SWIFT’s independence or to devise new messaging systems altogether. A new system would be technically easy to establish but would prove difficult to monitor for possible money laundering or terrorist financing, an important political consideration. Although the former approach would certainly deliver Iran a more immediate solution on banking challenges stemming from U.S. sanctions, given that Iranian banks were reconnected to the SWIFT following implementation of the nuclear deal, Europe will more likely take the latter, more time-intensive approach. German Chancellor Angela Merkel responded to Maas’ op-ed (which she called an “important contribution”) by noting that “on the question of independent payment systems, we have some problems in our dealings with Iran…on the other hand we know that on questions of terrorist financing, for example, SWIFT is very important.” Merkel’s comments suggest that political capital will most likely be spent creating a minimal, ad hoc messaging system in support of transactions with Iran rather than defending the independence of SWIFT in the face of a U.S. sanctions threat.

Finally, if payment channel and payment messaging solutions can be devised, Europe will need to ensure financing flows through these channels to Iran, in order to spur economic growth and support infrastructure and energy projects led by European companies. Here, Maas has pointed to the creation of a European Monetary Fund. Plans for the creation of such a fund have been circulating in European capitals for over a year and are based on upgrading the European Stability Mechanism (ESM), the entity that managed the bailouts of Eurozone states made necessary by the global financial crisis. Currently, ESM borrows on capital markets by issuing bonds. Such a reliance on capital markets has proven the critical barrier to the European Commission’s effort to get the European Investment Bank (EIB), which finances capital projects around the world, to invest in Iran. Like ESM, EIB raises capital by selling bonds, often to American institutional investors. Understandably, the CEO of EIB has publicly rejected calls to invest in Iran, stating that to do so “would risk the business model of the bank.”

The creation of a European Monetary Fund would be supported by financing drawn directly from European central banks and not capital markets, limiting exposure to U.S. investors, and therefore to the risk of U.S. sanctions. Such an institution would also reduce European reliance on the International Monetary Fund and World Bank, which remain politically dominated by the United States. Whereas countries such as Turkey and Egypt have readily used IMF financing to fuel growth and weather economic crisis, longstanding tensions between the United States and the Islamic Republic mean that Iran has been unable to secure IMF loans.

European governments are aware of the need to support Iran’s economic development through capital allocation. The European Commission’s recent move to allocate to Iran 18 million euros of a planned 50 million euros of development aid in order to “widen economic and sectoral relations” demonstrates the desire to fund growth. The European Commission simply lacks the right financial institutions to provide such capital to Iran at a meaningful scale.

Overall, Maas’ message contains real, practical ideas about how to not only sustain trade and investment in Iran in the face of secondary sanctions but also strengthen Europe’s economic sovereignty in lasting ways. However, Iran must recognize that there is no readymade “economic package” that Europe can deliver to save the JCPOA. There is only an “economic process” where improvements in the facilitation of trade and investment will occur over time and in sequence.

In the coming months, it will be feasible to institute a payment channel between central banks. In the coming year, it will be feasible to establish a new payment messaging system. Finally, over the course of several years, Iran could benefit from the creation of a European Monetary Fund, financing from which could truly transform prospects for Iran’s economy. For its part, Iran must remain willing to undertake its own economic process, beginning with critical FATF reforms. In this way, if Europe and Iran each grow stronger, through a renewed insistence on independence and autonomy, the prospects for political and economic cooperation will actually improve. The United States cannot be the fulcrum on which all partnerships must balance.

Photo Credit: German Federal Foreign Office

Iran's Currency Crisis is a Supply-Side Story

On Monday, the Iranian rial sank to a historic low. But those Iranians who scrambled to convert their rials into dollars found it difficult to do so—as they have for months. Since April, reports on the accelerating crisis have consistently noted a lack of hard currency available at Iran’s exchange bureaus.

This important detail of the current crisis has gone largely unexamined in foreign reportage. While the determinants for demand for foreign exchange—widespread anxiety about the state of the economy and the return of sanctions—are well understood, the second determinant of market prices—foreign exchange supply—remains subject to mere passing mention. This is a mistake. Iran’s currency crisis is a supply-side story.

In the absence of data, it is hard to show quantitatively that the currency crisis is primarily a supply-side phenomenon, but there are numerous factors that make this likely. Iran has been prevented from repatriating its foreign exchange reserves held in Europe. Its regional neighbors have vowed to cease using the US dollar to conduct bilateral trade. Illicit networks that have long funneled US currency to the black market have been interrupted. Most tellingly, the Trump administration is being urged by its close advisors to “quickly exacerbate the regime’s currency crisis” by interfering with Iran’s foreign exchange supply.

While the government has no doubt failed to inspire confidence in its economic leadership, contributing to the ouster of both the central bank governor and economy minister, it is unlikely that expectations of rising inflation and economic recession alone would create so dramatic a rush to the safe-haven of the dollar.

In an interview with Euronews, economist Saeed Laylaz, offers more detail on how the historic exchange rate principally reflects a shortage phenomenon. “You might imagine that the dollar price of 12,000 or 13,000 toman accounts for 100 percent of the currency market, when in actuality we have various companies completing imports with a dollar at a price less than 8,000 toman in the secondary market,” Laylaz explains. In his assessment, while the 8,000 toman rate accounts for 80 percent of transactions on the secondary market, “the dollar bill is 12,000 toman.” Greenbacks are physically scarce and this accounts for the historic prices making headlines worldwide. 

For companies with access to dollars at 8,000 toman and especially for those enterprises with access to dollars at the government rate of 4,200 toman, the price of the physical dollar bill offers an immense opportunity for arbitrage. The temptation for companies to divert a portion of their foreign exchange into the most lucrative and speculative parts of the free market has proven hard to ignore. One example can be seen in the petrochemical sector, where major companies, including state-owned enterprises, have been slow to make their foreign exchange available for sale on the secondary market through NIMA, the country’s centralized marketplace, despite instructions from the central bank and oil ministry.

Economist Hossein Raghfar described these companies as “accountable to no one” when it became apparent that they may have sought to sell their currency at the free market rate, rather than at the lower official exchange rate, despite the government instruction. Nonetheless, in the assessment of Masoud Nili, the government's chief economic advisor, this kind of arbitrage activity is a symptom of the rising premium and not its root cause. Nili comes close to acknowledging that the government's focus on profiteering in the early months of the crisis was an attempt to deflect from more consequential interruptions in foreign exchange supply. 

It is likely that the primary cause of the currency crisis is a severe shortage in foreign exchange. This places the Rouhani administration in an especially difficult bind. It might seem straightforward that increasing the foreign exchange supply would help stabilize the rial and prevent the speculation enabled by the extreme scarcity of the dollar and euro. Mohammad Reza Farzanegan looks at some of these issues in his study of illegal trade in Iran from 1970 to 2002. He confirms that easing the ability of actors to “acquire more subsidized exchange” will lead to some part of the currency to be “sold in the black market of foreign exchange.” The actions of the petrochemical companies offer a perfect case study. 

This is especially important at a time when the incentives for illegal import activity are increasing. Farzanegan writes that “whenever state intervention drives a wedge between international and domestic prices… there is an incentive for underground activities.” In subsequent research he has shown convincingly that the “wedge between international and domestic prices” can be applied externally—sanctions spur “underground activities.” In this way, making foreign exchange more readily available may stabilize the exchange rate, but it can serve to accelerate rent-seeking and smuggling, the agents of which have historically used their trading networks to take their profits offshore.

The specter of capital flight looms large over the administration. In a recent address, newly appointed central bank governor Ehsan Hemmati announced that the country would not use oil revenues in order to prop-up the currency. In a likely related move, Iran has decided not to seek to transfer EUR 300 million in cash from its funds in Germany to Iran to increase foreign exchange supply. A report in Shargh, a leading newspaper, suggests that the government had decided not to intervene to support the rial in order to prevent capital flight by allowing the dollar to become a scarce and expensive "luxury item." 

A recent report by Iran’s Parliamentary Research Center estimated that capital flight in the year leading up to March 20 amounted to USD 13 billion dollars. By comparison, during the Ahmadinejad administration, that figure was possibly ten times higher, with reports suggesting that between USD 100-200 billion was taken out of the economy as sanctions tightened. Between 2005-2012 Iran generated USD 639 billion in oil revenues, with falling exports offset to a degree by historic oil prices. Yet Ahmadinejad left office with Iran’s foreign exchange reserves at only around USD 50 billion higher than when he entered.

To prevent capital flight on that order, the Rouhani administration can prioritize rate convergence and stabilization over interventions that would significantly lower the price of the dollar. The Central Bank of Iran has sought to "bridge" the two sides of the market that Laylaz describes, announcing that "authorized exchanges can sell foreign currency bought from exporters and other sources registered through the SANA system, in the form of banknotes in the open market." The banknotes would be purchasable upon request from the central bank. In this way, any increase in the supply of banknotes at the upper end of the market will be associated with reduced supply at the lower end, helping push the rate to convergence, even if the rate remains historically high. A high exchange rate may be a necessary evil in order to protect fragile economic growth.

In a study of the Iran’s economy from 1981-2012, Hoda Zobeiri, Narges Roshan and Milad Shahrazi of the University of Mazandaran identify a strong negative relationship between capital flight and economic growth in Iran. By trapping capital at home, even devaluing rials, the Rouhani administration might hope that wealth is committed domestically towards investments and capital formation that can sustain growth. Some evidence that this may be taking place can be seen in the fact that the Tehran Stock Exchange is on a historic bull run.

Laylaz and others have criticized the administration for “adding fuel to the fire of the market” by failing to curb the demand for foreign currency. But by focusing on demand, critics will miss important supply-side phenomena, such as how the currency shortage may slow the capital flight that has historically preceded the reimposition of sanctions. Whether or not this is an intentional outcome of the Rouhani administration’s policy, that the inability or unwillingness to increase foreign exchange supply may be consistent with attempts to limit illicit trade and capital flight is a surprising outcome and one that deserves to be formalized as part of wider efforts to manage and minimize rent-seeking in Iran.

Photo Credit: Depositphotos

FATF Faces Test of Fairness on Iran at Plenary Meeting

Next week, Iran is facing the end of a four month extension given by the Financial Action Task Force (FATF), a global standard-setting body, for the reform of the country’s AML/CFT regulations. Beginning in June 2016, Iran gave its political commitment to the action plan, accepting technical assistance in order to effectively implement the action plan. This political commitment saw Iran removed from the so called “black list,” the informal name given to the list of Non-Cooperative Countries and Territories (NCCT). The common practice in recent years has been to apply "countermeasures" against non-cooperative countries. With countermeasures suspended, Iran was moved to a list of “high-risk” countries subject to “enhanced due diligence.”

As per the FATF procedure, Iran can only be returned to the countermeasure list if it proves to be non-cooperative. It should be noted that no country has been added to countermeasure list merely because of less-than-perfect compliance; if that was the case, in this world which is full of corruption and terrorism, the list of countries against which countermeasures should apply would be far more extensive. No country has managed to achieve perfect compliance with all forty recommendations that form the basis of FATF’s guidelines.

Iran will be hoping for a further extension of suspension of countermeasures at next week's plenary of the FATF, as it is in the process of amending its national laws. Some FATF members have sought to characterize such extensions as exceptional. However, a quick glance at the list of countries currently in the gray list or those which managed to get delisted, points to the fact that extensions are a common procedure.

Countries such as Iraq, Syria, Vanuatu, and Yemen have remained on the gray list for many years.  Countries such as Bosnia and Herzegovina, Uganda, Afghanistan, and Myanmar were all eventually delisted in recognition of progress in enacting the recommended reforms, but were given between two and six years in order to proceed with their action plans. Iran has been under much more significant pressure, opening FATF to charges of unfair treatment.

For the purposes of a closer comparison, we can look to the case of one country delisted from the so-called gray list in 2017. Based on FATF’s latest evaluation, this country is non-compliant with numerous recommendations outlined in Iran’s action plan. First, the country is non-compliant in terms of “criminalizing terrorist financing.” Second, the country is non-compliant in terms of “Targeted financial sanctions related to terrorism and terrorist financing (identifying and freezing terrorist assets in line with the relevant United Nations Security Council resolutions).” Third, the country is only partially compliant with measures for “customer due diligence.” Fourth, the country is only partially compliant with establishing an effective “Financial Intelligence Unit.” Fifth, the country is non-compliant with wire transfer controls. Finally, the country is only partially compliant with recommendations on criminalizing anti-money laundering.

It is clear that this particular country has deficiencies equal-to or greater-than those of Iran as measured by Iran’s action plan. Yet the country was never included in the FATF blacklist and even managed to be delisted from the gray list as well. This raises the question—is FATF applying double standards against Iran?

FATF emphasizes that it is a technical and not a political body and that all countries are treated equally. Impartiality is important for a global standard-setting body, which seeks to ensure that countries cannot seek to politically undermine one another. 

Iran has attended FATF’s face-to-face meetings and answered extensive questions. Moreover, the FATF recommendations call for the enacting of six laws: criminalizing money laundering (i.e. the AML law), criminalizing financing of terrorism (i.e. the CFT law) and four other laws regarding joining four UN conventions. Of these four laws, two had already been approved by the parliament—Iran has joined the UN Anti-Corruption and Vienna conventions. The remaining laws are being deliberated. These legislative measures are among the most difficult recommendations to enact, as they require the coordination of government agencies, parliamentarians, and other supervisory bodies and therefore it seems that the action plan of Iran has been a difficult one with a rather short deadline provided.

Passing a single law may require 18 months of work, as it needs to be reviewed by the committees of the government and the cabinet, parliamentary commissions and then the parliament itself, and finally the powerful Guardian Council. Iran has achieved a degree of compliance with some aspects of the action plan, a fact acknowledged by FATF itself. Therefore, it would be illogical for the country to be considered non-cooperative.

The authority of FATF derives from the number of countries that have trusted it as a technical body. Therefore, this is not only a sensitive juncture for Iran, but also for the legitimacy of FATF, which must strive to preserve its reputation as an impartial technical body that treats all countries equally.

Photo Credit: FATF Twitter

Governor of Sweden’s Central Bank Visits Iran for Technical Dialogue

The governor of the Riksbank, Sweden’s central bank, will visit Iran on April 5-6 at the invitation of Iran’s central bank governor Valiollah Seif.

Stefan Ingves, the governor of the Riksbank will be leading a day of technical exchanges including a working dinner hosted by Sweden’s ambassador in Tehran, Helena Sångeland. The visit, which comes as political uncertainty around the nuclear deal reaches a fever pitch, underscores the long-standing commercial and economic relationship between Sweden and Iran. In February of 2017, Swedish Prime Minister Stefan Löfven visited Iran with an itinerary that included a visit to the Scania truck factory in Qazvin. 

For the Central Bank of Iran, the visit by one of Europe’s most seasoned central bankers is a valuable opportunity to draw on the Riksbank’s experience in central banking, financial stability, and monetary policy. Ingves has held the position of Riksbank governor since 2006 and navigated the country through the 2009 global financial crisis. He is also the chairman of the Basel Committee on Banking Supervision, which sets global standards for prudential regulation of banks. Iranian banks have been undertaking extensive reforms in order to better conform to so-called “Basel” standards.

A spokesperson for the Riksbank confirmed to Bourse & Bazaar that Ingves will give a presentation entitled “Central Banking and Financial Crisis: Lessons Learned.” The topic is of particular relevance as Iran seeks to manage systemic risk in its banking sector stemming from non-performing loans, a key driver of the 2009 crisis. Sweden was one of the fastest recovering countries in the aftermath of the last major global recession, earning praise as a “rockstar of the recovery” for its combination of intelligent fiscal and monetary measures. 

No doubt, Iran’s central bankers will listen to Ignves’ presentation attentively.

Photo Credit: Riksbank