The Economic Impact of Iran Sanctions

Last spring, President Trump announced his intention to withdraw the United States from the Joint Comprehensive Plan of Action (JCPOA) and to re-impose U.S. sanctions on Iran that had been suspended under the JCPOA agreement. After an initial 90-day wind down period, the first round of sanctions went into effect. Today, the United States fully re-imposed the sanctions on Iran that had been lifted or waived under the JCPOA. The immediate impacts of sanctions on the Iranian economy are apparent–oil production and GDP growth are collapsing, Iran’s currency is weakening, and inflation is picking up. Longer-term impacts remain to be seen, including how partner countries adapt to forceful unilateral action by the United States and the role of the dollar as the world’s preeminent reserve currency. A recent CSIS commentary provides a closer look at oil market implications of the Iran sanctions snap-back.

Q1: How will sanctions impact the Iranian economy?

A1: While Iran is reportedly exploring ways to work around U.S. sanctions, (i.e. selling oil through domestic “private companies” acting as middlemen), these efforts have been insufficient to offset the economic shock from re-imposed sanctions. Many foreign companies have announced their intention to exit the Iranian market or forego new investments, unwilling to risk losing access to the U.S. market and exclusion from the dollar-based financial system. The International Monetary Fund (IMF) forecasts the Iranian economy will contract by 1.5 percent this year and another 3.6 percent in 2019, a sharp reversal from April when it forecasted 4 percent growth for both years. Iranian oil exports have fallen from a peak of 2.7 million barrels per day (b/d) in June to 1.7-1.9 million b/d in September, and is expected to decline further by year-end. Unemployment is also rising, especially among younger workers. Inflation has accelerated since April, with official figures reaching a four-year peak of 31.4 percent in September and outside estimates suggesting still higher rates of inflation. Although Iran’s central bank has intervened to support the rial, the currency has lost over two-thirds of its value in the unofficial market since January 1.

Q2: How have other countries reacted to the re-imposition of sanctions?

A2: Numerous countries requested exemptions from sanctions to continue importing oil from Iran. On Monday, the Trump administration issued temporary waivers to eight countries. Several countries, including Japan and South Korea, have reportedly already stopped importing oil from Iran, while China’s Bank of Kunlun, the key conduit for Chinese financial transactions with Iran, has said it will no longer process payments with Iran.

JCPOA signatories (China, the European Union (EU), France, Germany, Russia, and the United Kingdom, plus Iran) have voiced their strong opposition to U.S. withdrawal from the agreement and the re-imposition of sanctions. The EU has attempted to counter U.S. pressure, including with a “ Blocking Statute,” which allows EU entities to recover damages arising from the re-imposed U.S. sanctions. The Statute also “forbids EU persons from complying with those sanctions, unless exceptionally authorized to do so by the Commission in case non-compliance seriously damages their interests or the interests of the Union.” In addition, on September 25, JCPOA signatories agreed to support the development of a special purpose vehicle (SPV) to facilitate trade with Iran and avoid sanctions. Details of the SPV are unclear, but reports indicate it would serve as a “clearing house” for transactions with Iran in euros. Given the dollar’s dominant role in global finance and energy trading, these efforts are unlikely to succeed in the short-term, and experts have categorized the effort as a political statement. At minimum, the joint proposal makes clear the strong opposition to unilateral U.S. action, which in turn, has given rise to a proposal specifically designed to work around U.S. dollar centrality in the international system.

Q3: What does this mean for the dollar’s role as the world’s preeminent reserve currency?

A3: While unilateral U.S. sanctions have been successful in terms of inflicting economic pain on Iran, they have also given momentum to efforts to move away from the dollar. In a State of the Union address in September, European Commission president Jean-Claude Juncker called for a greater international role for the euro, commenting, “It is absurd that Europe pays for 80 percent of its energy import(s) … in U.S. dollars when only roughly 2 percent of our energy imports come from the United States. It is absurd that European companies buy European planes in dollars instead of euro.” In August, German foreign minister Heiko Maas and French finance minister Bruno Le Maire announced they were working on “an independent European financial tool which would allow us to avoid being the collateral victims of U.S. extraterritorial sanctions” and ensure Europe is “a sovereign continent, not a vassal.”

In addition to European-led efforts, India has explored paying for Iranian oil in rupees, and China launched the first RMB-denominated oil futures contracts in March. China’s renminbi-based Cross-Border Inter-Bank Payments System (CIPS) is a more ambitious initiative whose creation pre-dates U.S. withdrawal from the JCPOA.

None of these efforts are likely to succeed at scale in the near-term. The U.S. dollar remains the dominant currency in the international financial system, accounting for roughly two-thirds of central banks reserves, more than 40 percent of global payments, and is by far the most widely traded currency in foreign exchange markets. Dollar dominance has been preserved by a range of factors, including by the depth and liquidity of U.S. financial markets, and by sound macroeconomic policies in the United States that made dollar-denominated instruments a good store of value. It has also been maintained by a lack of viable alternatives, but that could change if the euro area were to address concerns about the monetary union’s long-term future, or if China were to implement the deep macroeconomic and financial sector reforms necessary for its currency to become truly international. Cryptocurrencies represent another potential challenger.

U.S. sanctions have been an effective foreign policy tool precisely because of dollar centrality in international finance and trade, especially when like-minded countries are willing to participate as partners in taking multilateral action. Although U.S.-Iran bilateral trade is only a small fraction of Iran’s economy, sanctions are painful because they can limit Iran’s access to international finance and penalize multinational companies that handle transactions in U.S. dollars. While other countries may not be able to reduce reliance on the dollar any time soon, unpopular unilateral U.S. actions are clearly giving some actors an incentive to seek alternatives, potentially limiting the effectiveness of future sanctions.

Stephanie Segal is deputy director of and a senior fellow with the Simon Chair in Political Economy at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Dylan Gerstel is a former research assistant with the CSIS Simon Chair in Political Economy. Matt Sullivan and Megan Waldo, CSIS Simon Chair research interns, contributed to this Critical Questions piece.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Stephanie Segal

Stephanie Segal

Former Senior Fellow, Economics Program
Dylan Gerstel

Dylan Gerstel

Former Research Associate, Economics Program