There has been speculation in the media about the possibility of the US re-joining the Joint Comprehensive Plan of Action (JCPOA), the nuclear deal it and several other countries signed with Iran in 2015. The Trump administration withdrew from it in 2018 and Iran has subsequently breached commitments under the deal. This note explores the impact of sanctions on Iran’s economic performance over the past decade, and uses Fathom’s Financial Vulnerability Indicator (FVI) to identify the extent of Iran’s vulnerabilities. The FVI models the probability of a crisis, either currency, banking, or sovereign, occurring within a particular quarter.
There has been significant volatility in Iranian growth over the previous decade amid the impacts of sanctions. Growth was very weak over the 2012–15 period, before surging in 2016–17 after the JCPOA was signed. The economy then contracted by 6% in 2018 and by almost 7% in 2019 as sanctions were tightened. This weakness was driven by lower oil production, with value added falling by 19% and 39% in 2018 and 2019, amid sharp falls in exports. Non-oil GDP was more robust, contracting 2.4% in 2018 but then expanding 0.9% in 2019.
The impact of sanctions and the importance of oil are evident in the trade data. The value of exports rose sharply over 2016 and 2017 but fell markedly in 2019 and 2020. Production of crude oil averaged close to 5 million barrels per day through 2016-18, the highest since the ‘70s, but fell to 3.5 million barrels in 2020. Import growth has also fallen sharply, and while such a contraction is clearly not desirable, it has helped to ensure the current account has remained close to balance, which in the FVI is reducing the probability of a currency crisis.
As well as a very weak economy, the sharp depreciation of the Iranian rial contributed to the contraction in imports. Currently there is a 500% difference between the official exchange rate to the US dollar and the parallel rate traded on unofficial markets. The gap has widened since the last currency crisis in 2013 when the wedge was 185%, placing increasing pressure on the currency. The FVI considers the official rate, not the wedge, which may result in it understating the risks of a currency crisis.
Sanctions and the sharp depreciation of the currency have exacerbated Iran’s inflation problems. After averaging close to 10% over 2015-17, inflation has since been north of 30% on an annual basis and is likely to remain high. Loose monetary policy is also an important contributor with M1 and M2 growing by 80% and 36% year on year, respectively, on the latest available data. Central bank policy is typically being driven by the liquidity needs of banks rather than trying to control inflation. High inflation is actually pulling down on the risks of currency crisis according to the FVI, because crises tend not to hit when inflation is building, but when the bubble created by imbalances bursts, demand drops, and inflation subsequently falls.
In terms of fiscal policy, the government deficit was modest at less than 2% of GDP between 2010-18 but has surged to 5.1% in 2019 and the IMF forecasts a deficit of 8.4% in 2020 amid sanctions and COVID-19. The key driver has been a decline in government revenues from an average of 15.5% of GDP over 2010-2018 to around 10% in 2019 and 2020.
Amid the deteriorating fiscal backdrop, the World Bank notes that the government has been relying on debt issuance, sales of state-owned assets on the stock market and drawdowns of strategic reserves, which they argue could increase financial contagion risks in the stock market and put additional stress on the undercapitalised banking sector. While there have been widely highlighted problems with the Iranian banking system, Fathom’s FVI suggests that the probability of a banking crisis is low in absolute terms, but a combination of plausible domestic and international scenarios could push up the risks.
In conclusion, sanctions have clearly contributed to significant difficulties for the Iranian economy over the past decade, which have been exacerbated by the pandemic. The significant reduction in international exposure of the economy and the lack of financial linkages reduces the risk of a typical emerging market-style crisis driven by foreign investors fleeing, although the exchange rate channel could clearly be a trigger for further significant domestic difficulties such as soaring inflation. According to Fathom’s FVI, the probability of a currency crisis is low, with the GDP improvement in 2020 and a current account balance close to zero pulling down on this metric.
With very loose monetary policy and rising global commodity prices, clearly there is a significant risk of a much more pernicious rise in inflation and the damaging economic and political fallout that would ensue. Serious attempts to rein it in by the central bank, could have large negative ramifications for the economy and banking system, and for asset markets that have seen large gains such as equities and housing. From the perspective of Fathom’s FVI, a banking crisis is more likely than a sovereign crisis over the medium term. Of course, in terms of upside risks, a new nuclear agreement and sanctions relief would be a significant positive.
 Mazarei, A. (2019), Iran Has a Slow Motion Banking Crisis, Peterson Institute for international Economics.
 World Bank Group (2020), Iran Economic Update, October 2020; World Bank Group (2021), Iran Economic Update, April 2021.
 Mazarei, A (2019), Iran Has a Slow Motion Banking Crisis, Peterson Institute for International Economics.
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