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Why coronavirus could hit Iran harder than US sanctions

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Via Financial Times

For almost two years, Iranian leaders have vowed to resist the “economic war” the US is waging against their country as American sanctions have strangled the Islamic republic’s economy ever tighter. President Hassan Rouhani even suggested that the mission had been accomplished when he addressed the nation in February.

“Never in our history have we experienced an economy without oil,” Mr Rouhani said with an undisguised hint of pride. “We have come to realise we can govern without oil.” 

His message was clear: a nation with some of the planet’s largest crude and gas reserves had been forced to break its addiction to oil. And it had survived.

Three days later, Iran reported its first cases of coronavirus. The outbreak not only triggered a health crisis, but also exposed the fragility of Iran’s survival mechanisms. Some argue the outbreak is succeeding where US President Donald Trump’s sanctions failed: throttling many of the regional trading routes the republic has become more dependent on over the past two years.

In the weeks since, the number of infections has soared to 20,610 as of Saturday and the official number of those who have died has reached 1,556.

The production line in Iran Khodro Car FactoryIran Khodro Car Factory. Photo by Kaveh Kazemi
The production line in the Iran Khodro car factory. The quasi state-run company says the outbreak has had ‘no impact on the trend of production’ © Kaveh Kazemi/FT

As a result, the republic is more isolated than ever and appealing for international aid, including a $5bn loan from the IMF, while complaining that sanctions are crippling its ability to respond to the crisis. 

Many of its neighbours — including Iraq, Turkey, Pakistan, Afghanistan and Armenia — have closed their borders or imposed restrictions on crossings and trade. Only one foreign airline, Qatar Airways, still flies to Iran. 

“Coronavirus has struck a more severe blow to Iran’s economy than US sanctions over a very short period,” says Saeed Laylaz, an Iranian economist.

Iran’s survival strategy has been threefold since Mr Trump withdrew the US from the 2015 nuclear deal Tehran had signed with western powers and then imposed the “toughest ever” sanctions. It has sought to bolster domestic production, particularly in key sectors such as petrochemicals, steel, cement, agriculture and manufacturing, while attempting to boost non-oil exports, including face masks to China. It also shifted its focus to regional markets, both as a destination for Iranian goods and as transshipment hubs.

Iranian businessmen tell apocryphal tales of middlemen traversing the region with suitcases packed with hundreds of thousands of dollars; of developing a complex web of trading routes; and setting up offshore offices and front companies to keep goods and finances flowing, albeit at a higher cost and with longer delivery times.

Bar charts showing imports to and exports from Iran

The republic produces enough food for its 80m population and exports to neighbours. Iranian companies account for about 70 per cent of the country’s pharmaceutical needs, with the remainder — either finished medicines or inputs — imported. Neither sector is sanctioned, but the difficulty of conducting financial transactions, with few banks willing to touch anything connected with Iran, has led to a shortage of some specialist medicines, such as cancer drugs — and now equipment to fight coronavirus. 

Even before the outbreak, Iranian officials knew they could not disguise the damage the US sanctions have wrought, particularly on poorer Iranians, as oil exports have plunged from 2.8m barrels a day two years ago to a few hundred thousand. The IMF estimates the economy contracted by 9.5 per cent last year; the rial lost more than 50 per cent of its value in the months after Mr Trump unilaterally withdrew from the nuclear deal, inflation soared above 40 per cent and foreign companies fled the country.

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But there was a growing belief, at least among officials, that Iran was proving it could absorb the shocks. Supermarket shelves have remained full during the coronavirus outbreak, partly because in its preparations for sanctions-related shocks the republic has built up food reserves, Iranian analysts say.

Farshad Moghimi the new managing director of Iran Khodro Car Factory in his office in Tehran, Iran. Photo by Kaveh Kazemi
Farshad Moghimi the new managing director of Iran Khodro Car Factory in his office in Tehran © Kaveh Kazemi/FT

“They say, sanctions are like a knife. The more you use it, the blunter it becomes,” Mohammad Nahavandian, vice-president for economic affairs, told the Financial Times before the extent of Iran’s coronavirus crisis was clear. “There was a time that just one sentence in a statement made by an American official, president or otherwise, could send waves of worry in the Iranian economy. Not any more.”

From its shrunken base, growth was expected to be flat this year, the IMF predicted. And in the absence of foreign competition, some Iranian businesses were in expansion mode. 

The central bank said this month that non-oil growth expanded by 1.3 per cent in the first nine months of the financial year that ended on March 19. Adding that the agriculture, industrial and mining sectors and services grew by 7.8 per cent, 7 per cent and 1.2 per cent respectively between September and December.

“This exodus [of foreign companies] has helped Iran to stand on its feet more and produce most of the spare parts that used to be supplied by these partners,” says Farshad Moghimi, chief executive of Iran Khodro, which claims to be the Middle East’s largest carmaker.

Column chart of Annual change in gross domestic product (%) showing Iran's sharp economic contraction

Seven months ago, the quasi state-run company was a stark example of the damage US sanctions had wrought on the country’s manufacturing sector as foreign partners, including Peugeot and Renault, suspended their operations in Iran.

Fear and chaos swept across the industry, Iran’s biggest private sector employer. Thousands of jobs were lost and nearly 200,000 new cars sat unfinished as supply lines for imported parts from Europe dried up. 

The local industry appeared close to collapse. Yet, before the virus outbreak, Iran Khodro was being touted as a model of the republic’s “resistance” as it ramped up production. Mr Moghimi, previously deputy industries minister, took over the running of the company in August after his predecessor was sacked. At the time, Iran Khodro’s output had fallen to 600 vehicles a day.

This year, the company’s factories, backed by government funding, have been operating 24 hours a day, six days a week, with 2,000 cars rolling out of its plants each day, says Mr Moghimi. The plan was to increase that to 2,500 a day. In February, Iran’s defence minister, Brigadier General Amir Hatami, visited the factory, and described how the military is using its technology to develop components that the private sector cannot, such as electronic control units.

Asked how the company manages to procure imports, Mr Moghimi says: “There are many individuals and countries in the world who are opportunists.”

Since the virus outbreak Iran Khodro says 2,000 of its of 57,000 workers with underlying health issues have been sent home on paid leave, but it insists the outbreak has had “no impact on the trend of production”. 

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In this Tuesday, March 17, 2020, photo, men carry their goods through mostly closed Tehran's Grand Bazaar, Iran. The new coronavirus ravaging Iran is cutting into celebrations marking the Persian New Year, known as Nowruz. (AP Photo/Vahid Salemi)
Men carry their goods through mostly closed Tehran’s Grand Bazaar, Iran, last week. Coronavirus is curtailing the Persian New Year © Vahid Salemi/AP

Mehdi Arjomandi’s home appliances factory is among those that have continued operating through the health crisis. But the firm has cancelled overtime and it takes longer to receive parts from China because its factories are not working to full capacity, he says.

He founded Vidas, whose products include irons, vacuum cleaners and coffee machines, the last time Iran was under strict sanctions in 2014. But as he sought to grow, the nuclear deal was implemented and foreign goods flooded back in. Since Mr Trump withdrew the US from the agreement, he has been in expansion mode again, doubling production. About 80 per cent of the parts for the 25,000 items his factory churns out are now produced domestically.

“If it was not for Mr Trump . . . Iranian industry would not have had the growth it has,” Mr Arjomandi says. 

Yet, he does not attempt to sugarcoat the situation. “While many businesses grow, people’s living standards have been shrinking,” he says. “Even my workers, who are benefiting, they have concerns about health, security and rents. Will landlords increase rents? If their children are sick, will they have access to medicine?”

Column chart of Crude oil exports (millions of barrels a day) showing Iran's oil exports plummet

Iranians have more than four decades of experience of living under varying degrees of sanctions. But the Trump administration has been relentless in its targeting of entities and individuals.

China remains Iran’s main export destination, but neighbours Iraq, Turkey and Afghanistan have overtaken the likes of South Korea, India and Japan — all big buyers of the country’s crude oil before the latest sanctions — as importers of Iranian goods.

A salesman at an electrical appliance shop explains that his company brings in goods from Asia via an Iraqi middleman, with $500,000 moved in suitcases from Tehran to Baghdad. Prices have increased four times under sanctions, but Iranians “will go without food to buy their phones”, the salesman says.

Turkey, which imports Iranian gas, has become a favoured destination for Iranian businessmen to set up offices or locate representatives to continue trading. Iranians established more than 2,000 companies in Turkey in just two years up to 2019. Some are buying $250,000 properties to secure Turkish passports, which can make it easier to do business.

“I know lots of people doing that, I want to do it,” says a food trader. “Food, livestock, pharmaceuticals are not sanctioned, but when you cannot use bank transfers, it’s like sanctions.”

He, like others, uses a third person to help with financial transfers, but it can come with risks — the trader says he lost $200,000 when a middleman simply disappeared with his money.

Even if Iranian businessmen find a reliable partner, they face the challenge of financing deals. US sanctions have severed the republic’s links to the global financial system and a shortage of foreign currency at home has exacerbated the situation. Before the outbreak, Tehran had already restricted the allocation of dollars to priority sectors, such as pharmaceuticals and food, and put curbs on the imports of 1,400 goods.

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A businessman who used to import $20m worth of Chinese water pumps annually is now working on a joint venture with his supplier to start producing them at home as a result of the dollar restrictions.

“We provide the land and infrastructure, they provide the parts. We will open the factory in six months,” the businessman says. “A Chinese guy living in Dubai signs for this [JV]. Who he is working with I don’t know.”

Line chart of Current account balance (% of GDP) showing Iran's current account deficit expected to deepen this year

Brian Hook, the US special representative for Iran, said in a speech in December that the country had about $100bn in foreign reserves, but added that only about 10 per cent of that was “immediately accessible” because of sanctions. He calculated that Iran had lost about $50bn since May 2018 in oil revenue.

Iranian analysts and officials say the government has offset some of the losses by increasing other exports, notably petrochemicals, steel and cement. Iran’s Revolutionary Guards, which oversees a sprawling, opaque business empire, has stepped up its activities in some of these areas. 

Oil and gas exports accounted for 31 per cent of government revenue and 61 per cent of foreign currency earnings in 2017, but that dipped to 23.5 per cent and 30 per cent respectively last year, Mr Nahavandian says. 

An industry executive says Iran exported petrochemicals worth $15bn, including polymers, urea and methanol, and steels products worth $6bn and $8bn in the first 10 months of the financial year. Often the goods are sold at a discount, the executive says, with liquefied petroleum gas more than 10 per cent below the market benchmark.

TOPSHOT - Medical staff in protective gears distribute information sheets to Iraqi passengers returning from Iran at Najaf International Airport on March 5, 2020. - Iraqi health authorities announced the country's first two deaths from the new coronavirus, one in the capital Baghdad and the other in the autonomous Kurdish region. (Photo by Haidar HAMDANI / AFP) (Photo by HAIDAR HAMDANI/AFP via Getty Images)
Medical staff distribute information to Iraqi passengers returning from Iran at Najaf International Airport, Iraq, on March 5 © Haidar Hamdani/AFP

He adds that Iran’s crude exports are easy for the US to track. But with petrochemicals, which can be stacked into shipping containers, it is much harder.

“America cannot control all the sea, 10m containers leave [Iran’s] Bandar Abbas [port] every year, how can they check what’s inside every container?” the executive asks.

He adds that the country’s annual petrochemicals production has risen from 55m tonnes five years ago to 66m. Output continues to expand as the shortlived easing of some western sanctions after the nuclear deal provided a window for the republic to procure specialist parts required to complete refineries and chemical plants. That has also helped it produce enough petrol to prevent domestic shortages and export other oil products in the region.

However, the US sanctioned Chinese companies, a South African group and five entities based in the United Arab Emirates last week as it sought to strangle trade in Iranian petrochemicals.

It is a precarious existence for the government as Tehran manages diminishing resources amid simmering social pressures. At least 300 people were killed in a brutal crackdown after a massive rise in fuel prices triggered mass protests in November.

“Nobody is predicting what will happen, it’s very difficult,” the petrochemicals executive says. “Maybe we will be able to survive but what is the cost for the people? For the country?”

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Additional reporting by Laura Pitel in Ankara

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