Iranian government’s recognition of economic grievances positive, but meaningful remedial action would increase risk to state stability

The protests have subsided, likely in response to a combination of government internet restrictions (used to mobilise protesters), lack of leadership, detention of 3,000–4,000 individuals, and high-level political commitment to addressing grievances.

Recent state actions and announcements include:

• Moderating tone on subsidy cuts: welfare minister Ali Rabiei announced on 24 January that any cuts in cash-handout subsidies would be targeted to affect the better-off;
• Additional fund disbursement: Khamenei issued a decree on 23 January, giving permission to the parliament to use USD4 billion from the National Development Fund (NDF) in the upcoming budget bill, including allocating USD2.5 billion for defence spending, USD150 million for fighting dust storms and pollution, and USD100 million for earthquake relief and reconstruction;
• U-turn on fuel price raise: The parliamentary budget committee on 23 January rejected the government’s proposal to increase fuel prices in 2018–19;
• Policy clarification on bankrupt credit institutions: Rouhani said on 22 January that the Central Bank had allocated USD3.3 billion for compensating nearly 98% of the two to three million depositors affected by bankrupt previously unregulated credit institutions;
• Commitment to social housing: Rouhani reaffirmed his commitment to completing the Mehr social housing project, initiated under former populist president Mahmoud Ahmadinejad, by the year-end (March 2018);
• Reducing the IRGC’s economic footprint: Minister of Defence Amir Hatami said on 20 January that Khamenei had ordered the armed forces, (including the powerful IRGC), to divest their “irrelevant” commercial holdings.

Supreme Leader of Iran Ayatollah Ali Khamenei visits Kermanshah on 20 November 2017, following a 7.3 magnitude earthquake that occurred on 12 November.

Anadolu Agency, Getty Images

These actions reflect an attempt by the government to present itself as responsive and capable, in response to mounting public frustration with the state’s ability to deliver its promises, and widespread popular perceptions of state corruption and mismanagement. In reality, the government’s ability to implement the needed structural reforms is far from certain, not least given the questionable political will of Khamenei and the IRGC to accept reduced and more transparent economic footprints.

For example, the environmental funds allocated from the NDF are unlikely to address Iran’s water shortages, high pollution, and frequent dust storms, which hurt farmers and have forced school and office closures in several areas, including Khuzestan province, in which there was one of the highest number of protests. These environmental problems are mainly the result of the Islamic Republic’s policies and mismanagement of resources, including its focus on food self-sufficiency, under-regulated farming and industrial activities, and excessive dam building by the previous Mahmoud Ahmadinejad administration (see Iran: 30 September 2015: Iranian dam-construction project cancellation likely to increase popular support for government, particularly among rural ethnic minorities). The state’s failures in crisis management, particularly in response to the November earthquake in Kermanshah, have fuelled public perceptions of state incompetence. Criticism over delays and the poor quality of the Mehr social housing project, a mass-appeal policy of the Ahmadinejad administration, begrudgingly continued under Rouhani, further intensified in December as footage circulated on social media showing that Mehr buildings incurred more significant damage compared with privately-built nearby buildings during the Kermanshah earthquake.

Meanwhile, the main short-term economic concessions in response to the protests, particularly the reversal of fuel price increases, indicate that the Rouhani government has few politically-acceptable options to control the budget deficit. Rouhani’s inability to audit or reduce the funds of more than USD800 million to opaque religious institutions, affiliated with the clerical establishment, further highlight his limitations in confronting entities with vested interests, reducing spending and implementing economic reforms.

Rouhani’s assertion on the allocation of funds to compensate depositors affected by bankrupting previously unregulated credit institutions, which proliferated under Ahmadinejad, marks the most significant short-term concession. He nonetheless qualified his statement with the caveat that the compensation might not prove sufficient. The pace of distribution and value of compensation, as well as the amount already transferred to depositors, remain unclear. As late as October 2017, depositors at Caspian, Samen, Arman, Alborz Angels, and Padideh credit institutions protested, demanding the release of their deposits.

IRGC’s economic influence

Khamenei’s decree for IRGC divestment marks the most politically significant recognition of the structural problem hurting Iran’s economy. Rouhani has long sought to reduce the IRGC’s economic influence, including in the construction, banking, industrial, telecommunications, and energy sectors. Existing US secondary sanctions on the IRGC for its involvement in the ballistic missile programme and sponsorship of terrorism have complicated Iran’s reconnection to international banking and slowed the inflow of foreign direct investment (FDI), badly needed by Iran to repair ageing energy infrastructure and reduce unemployment. The Rouhani administration’s publication of the decree likely reflects its efforts to sustain European political and economic support by demonstrating high-level commitment to reform. This is particularly important for Rouhani as US opposition to the Iran nuclear agreement and the threat of the reimposition of US sanctions further delay inflow of investment (see Iran: 17 January 2018: US president’s statement on Iran sanctions waivers increases risk of snapback, undermining JCPOA’s longevity).

Nevertheless, the impact of the decree on improving the economy is questionable. Khamenei and the Chief of the General Staff of the Armed Forces (IRGC Commander Mohammad Bagheri) will determine which IRGC commercial holdings would qualify as ‘irrelevant’, and therefore subject to divestment. The divestment order is unlikely, for instance, to extend to the IRGC’s engineering conglomerate, Khatam al-Anbiya, which holds a near monopoly in Iran’s large-scale infrastructure sector. The IRGC would likely acquiesce to the divestment of unprofitable or small businesses, but compliance with regards to strategic assets in the energy, telecommunications, auto and banking sectors would likely be contingent on the level of pressure from Khamenei, IRGC recognition that vast economic interests weaken its effectiveness as a military organisation, and disbursement of additional funds, as indicated in Khamenei’s 23 January decree. Meanwhile, even in the event of significant divestments, Iranian entities with purchasing power are likely to be associated with the clerical establishment, which are opaque, tax-exempt and inefficient. For his part, Khamenei is unlikely to accept restrictions to his economic network, which would threaten his political power via an independent source of revenues.

Outlook and implications

The series of financial and economic measures announced by Iran’s political establishment is intended to signal that the state is responsive to public demands, particularly those of Iran’s urban poor and working class, the Islamic Republic’s core base of support (see Iran: 3 January 2018: Iranian government risks alienating support base in suppressing disparate protests across country). The short-term concessions are likely to complicate Rouhani’s economic reform efforts, intended to reduce subsidies and control the budget deficit. Any forthcoming government progress in resolution of the pressing issues of social housing and bankrupt credit institutions would represent a positive indicator for civil unrest; however, the state’s ability to resolve these issues is problematic, even with the necessary will. In any event, IHS Markit assesses that the state lacks the capability to address longer-term issues, including substantially reducing unemployment and addressing environmental issues, underscoring elevated risk to state stability.

Labour strikes in strategic sectors of energy and auto or significant reductions in oil revenues would indicate rising risks to state stability. Nor is Rouhani likely to resolve the ongoing international banking issue, primarily driven by existing US sanctions prohibiting Iranian access to the dollar. Moreover, although the state’s recognition of structural issues, particularly the IRGC’s economic influence, is positive, IRGC divestment, in terms of scale and timing, remains problematic.

Meanwhile, potential significant pressure by Khamenei for IRGC divestment increases the likelihood of divisions within the IRGC, potentially to the point of outright defiance of Khamenei, thereby significantly increasing the risk to state stability. Provocative actions by the IRGC, particularly naval harassment of US naval forces in the Gulf, would indicate divisions among the elite, and potentially even inside the IRGC.