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What are the big economic challenges facing the government in Iran?

Policy-makers in Iran face numerous economic challenges. The impacts of Covid-19 and the war in Ukraine – together with longer-term issues related to high unemployment, rising inflation and worsening corruption – represent a difficult puzzle for Ebrahim Raisi’s government to solve.

Ebrahim Raisi was elected as the eighth President of the Islamic Republic of Iran in August 2021. He performed well in the election – in which 48.8% of eligible voters participated – gaining 62.3% of the total valid votes (with about 18 million of 28.9 million ballots).

But within his first 18 months in power (as of February 2023), various domestic and international challenges have emerged. This is against the background of the economic sanctions, which were reactivated under the Donald Trump administration in 2018, and have remained almost unchanged under President Joe Biden.

Covid-19 intensified the destructive effects of these sanctions. Declining economic growth, increasing poverty, rising inflation rates and the devaluation of the Iranian rial have also increased the risk of internal conflict and instability.

Further, the international image of the country (and domestic legitimacy) have been damaged after the ‘woman, life, freedom’ protests following the death of Mahsa Amini in police custody in September 2022.

How have sanctions affected Iran’s economy?

President Raisi’s election followed the presidency of Hassan Rouhani, who served from 2013 to 2021. Rouhani took office during a time of significant nuclear tension and the strongest economic and energy embargoes against Iran, which were imposed in 2012.

There was significant political support both within civil society and the administration to lift these painful sanctions. As a result, Iran reached a Joint Comprehensive Plan of Action (JCPOA) on 14 July 2015 with the five permanent members of the United Nations Security Council (China, France, Germany, Russia, the UK and the United States). The JCPOA was implemented on 16 January 2016.

The agreement was designed to neutralise, and increase monitoring of, Iran’s nuclear activity, while still allowing the country to enrich uranium to generate electricity. In return, the Iranian government would gain access to more than $100 billon in assets frozen overseas, amplifying its oil exports without restriction, and reconnecting Iranian banks with global financial banks.

Following the plan’s implementation, Iranian oil exports, which had been under embargo, increased. This led to significant and immediate GDP growth, adjusted for inflation (a growth rate of 8.8% from $408 billion in 2015 to $444.2 billion in 2016). This growth in 2016 was higher than the rates in other countries, such as Egypt (4%), Turkey (3.3%), Saudi Arabia (1.67%), Pakistan (5.5%), and Nigeria (minus 1.61%) (World Bank, 2023).

This positive and hopeful period was short-lived. The election of Donald Trump as president of the United States in 2016 meant that the future of JCPOA was uncertain.

Trump was dissatisfied with the agreement, stating that it was ‘a horrible, one-sided deal, [which] failed to achieve the fundamental objective of blocking all paths to an Iranian nuclear bomb, and it threw a lifeline of cash to a murderous dictatorship that has continued to spread bloodshed, violence, and chaos’.

US policy towards Iran was one of ‘maximum economic pressure‘ under the Trump administration. The idea was to re-impose earlier sanctions with the goal of reaching a new, comprehensive and long-term agreement with Iran, which would not only include its nuclear programmes, but also other military projects such as the development of ballistic missiles.

The re-imposition of economic sanctions by the United States in 2018 resulted in a significant drop in Iran’s GDP growth rate in two consecutive years (minus 2.25% and minus 2.65% in 2018 and 2019, respectively). In contrast, the other countries mentioned earlier experienced growth during this period.

In 2018, the largest decline was experienced in the value added of industry (including mining, manufacturing, construction, electricity, water and gas) with a 9.1% decrease compared with 2017, followed by a decline of 2.4% in the value added of agriculture and an insignificant decline of 0.05% in the services sector.

Value added in the manufacturing sector also experienced a decline of 6.5% in 2018. In 2019, the value added of the industry sector declined again – by 9.7% compared with 2018 – while the agricultural sector’s value added increased by 9.2%, the services sector showed a minor decline of 0.18% and the manufacturing sector enjoyed a growth rate of 4%.

In other words, the key driver of the overall decline of GDP in 2018 and 2019 was a fall in industrial production, mainly due to re-activation of the oil embargo on Iran by the United States. The services and agricultural sectors have been more resistance against sanctions due to their limited international focus, serving mainly the domestic market.

How did Covid-10 affect Iran?

Alongside the economic challenges posed by sanctions, Iran was one of the first countries to be affected by Covid-19. Raisi assumed office at a time when the roll-out of vaccinations was still moving slowly.

In August 2021, the share of people who had been fully vaccinated in Iran was only 3%. The proportion was more than 70% in the United Arab Emirates, 50% in the European Union (EU), 32% in Turkey and 12% worldwide (Our World in Data, 2023).

As of August 2021, the cumulative confirmed death rate from Covid-19 in Iran was 1,061 per million people, compared with 541 per million across the world. By February 2023, this number had increased to 1,635 in Iran, while the global number was 860.

Despite significant human loss during the pandemic, especially in 2020, and the lack of vaccines, the economic impact of Covid-19 was less significant in Iran than in other countries. The annual percentage growth rates of GDP in Iran (adjusted for inflation) in 2020 and 2021 were 3.3% and 4.7%, respectively.

This weaker negative economic reaction in Iran was mainly due to ‘less stringent COVID-19 restrictions, lower dependency on highly affected sectors such as tourism, oil recovery in the second half of 2020/21, and a relatively lower economic base after two consecutive years of economic contraction following the reimposition of US sanctions’.

What are the latest challenges for the Raisi administration?

Iran’s GDP growth rate, which suffered under the Trump sanctions, recovered to some extent in 2021, mirroring an increase in global economic growth after the initial year of the pandemic.

This was due to increased oil exports as the world started to ease Covid-19 restrictions in 2021. For comparison, the GDP growth rate of China was 8% in 2021, while it was 5.4% in the OECD (after a fall of 4.2% in 2020) and 5.8% globally (following a fall of 3% in 2020).

Higher demand for crude oil, and higher prices (from $42 per barrel in 2020 to $71 in 2021), led to an increase in petroleum export revenues for Iran. Petroleum export revenues grew by 220%, from the historically low record of $7.9 billion in 2020 to $25.3 billion in 2021. The latter figure is comparable to Iran’s oil revenues in 2015, the year before implementation of JCPOA.

Despite this slight recovery in 2021, supply chain disruptions caused by the pandemic and Russia’s invasion of Ukraine in February 2022 have led to high levels of inflation in Iran.

The annual change in the consumer price index, which was single digit (a rare observation in Iran) in the years of the JCPOA (7.2% in 2016 and 9.6% in 2017), increased to 43% in 2021, and remained high in 2022 (at 42.4%). In 2019, the year before the pandemic, Iran’s inflation rate of 41% was the sixth highest in the world (see Figure 1).

Figure 1: Iranian Inflation – consumer price index (CPI), 2010-2021

Source: World Bank

In 2022, the inflation rate of 42.4% put Iran tenth in the world in terms of rising prices. Iran’s inflation rate is interconnected with the country’s oil revenues.

Both positive and negative shocks to oil rents result in higher levels of inflation. In the case of a positive shock, the sudden increase in income can have a harmful inflationary impact on the country (a phenomenon known by economists as ‘Dutch disease’).

In the case of negative shocks (such as those caused by oil sanctions or the pandemic), the government’s budget deficit and borrowing from the central bank to deal with the deficit result in a higher money supply, pushing up prices. Negative price shocks also result in higher pressure to reduce subsidies and increase taxes, which then translate into a higher inflation rate (Farzanegan and Markwardt, 2009).

What about the Iranian currency?

One of the drivers of high inflation is the depreciation of Iran’s currency (the rial) since the imposition of sanctions in 2012. Faced with a significant decline in oil export revenues under sanctions and a shortage of hard currencies – as well as higher demand for the rial in the domestic market – the government decided to implement a currency rationing system (Farzanegan, 2013).

The subsidised exchange rate on the official market was reserved for the import of essential goods, such as basic foods and pharmaceutical products including selected medical devices, and for other imports, higher exchange rates in the free market were applied.

The black market premium (the gap between the official and free exchange rates) grew during the sanctions period: from less than 1% in the years between 2002 and 2009 to 112% in 2012. This increased the incentive for ‘mis-invoicing’ foreign trade documents as well as illicit trade (Farzanegan, 2009; Zamani et al, 2021).

The devaluation of the rial also raised import prices and production costs where products relied on imported raw and intermediary materials, fuelling inflation.

Food costs have also risen substantially in Iran. While the food inflation rate was ‘only’ 6.5% in 2016 (the year of implementation of the JCPOA), ranking 39th in the world, it reached 58.6% in 2022, putting Iran seventh globally. In 2019, the food inflation rate in sanctioned Iran was 55.7%, the fifth highest in the world after Venezuela, Zimbabwe, Sudan and Argentina.

What about unemployment in Iran?

Growth in Iran’s oil export revenues in 2021 did not significantly reduce the unemployment rate, which has been more or less stable over the last few years. While the unemployment rate was 10.7% in 2019, it increased by just over one percentage point (to 12%) in 2020 (the first year of the pandemic plus sanctions) and remained similarly high (at 11.4%) in 2021.

The oil sector provides few job opportunities and only has a small effect up and down the supply chain (known as forward and backward linkages) within the rest of the economy. The unemployment rate in Iran is higher than in other comparable countries, such as Egypt (9%), Saudi Arabia (7%), Pakistan (4%) and Nigeria (9.7%).

The depth of the labour market problem is more visible among the country’s young people (those aged 15-24), who made up 13% of the population in 2021. The development of a ‘youth bulge’ – a theory that identifies a link between ‘too many young men’ and violence – has been said to be an important driver of political instability (Farzanegan and Witthuhn, 2017).

Equally, the unemployment rate among young women (those aged 15-24) was around 42% in 2021. This is much higher than the (already high) proportion young unemployed men (at 24%).

In the first year of the pandemic (2020), youth unemployment among both men and women increased: from 22.5% in 2019 to 25.5% in 2020 for men; and from 38% in 2019 to 42.5% in 2020 for women.

What about poverty and income inequality?

These factors combine to hit the poorest in society hard. Rising inflation and the devaluation of the rial, while the country is under economic sanctions, have meant that poverty ratios have increased in Iran since the sanctions of 2012. This was a trend previously in decline since the end of the war with Iraq in 1988.

The share of the population living in extreme poverty (defined as existing on less than $2.15 per day), which was 8.4% in 1990, reached its lowest record in 2013 (at 0.27%). But since then it has increased, reaching 1% in 2019. The share of the population living on less than $10 per day, which was stable (at around 40%) between 2005 and 2013, has increased to almost 50% in 2019.

This indicates a decrease in the size of the middle class and an increase in the share of the vulnerable population. It should be noted that these figures do not reflect the effect of the pandemic and the war in Ukraine (Our World in Data, 2023).

Income inequality – as measured by the Gini index – stood at a high level of 0.44 in 2005-06 (under this measure, zero indicates complete equality and one means complete inequality). But it decreased to 0.37 in 2013 after the implementation of subsidy reform and direct cash transfers by the Ahmadinejad government (in other words, society became more equal).

It then increased during the lifting of sanctions in 2016-17, reaching 0.41. So, it seems that income inequality is positively related to the flow of oil, perhaps due to the intensification of wealth accumulation (through rent-seeking) as well as increased corruption during oil booms (Farzanegan and Krieger, 2019).

What other issues does Iran face?

Iran’s challenges are not limited to its economy. According to World Governance Indicators, the control of corruption – which measures the perception of the misuse of public power for private benefit and ranges from approximately minus 2.5 (highest corruption) to plus 2.5 (least corruption) – has been negative in Iran since 2002.

But in the years after 2018, it fell below minus 1 for the first time, showing worsening corruption levels. In 2021, it reached its worst ever level of minus 1.1. Corruption feeds into wider socio-economic issues – indeed, research shows that increasing corruption is one of the key drivers of internal conflict in Iran (Farzanegan and Zamani, 2022).

Political stability, as well as levels of violence and terrorism, are also the worst they have been since 2002. Government effectiveness – which captures perceptions of the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s commitment to such policies – has also dropped to historic lows in recent years.

Corruption, together with low levels of government effectiveness, are critical reasons for the slower progress of vaccination projects in Iran and elsewhere (Farzanegan and Hofmann, 2021). This led to weaker public trust in the Iranian state, especially at the height of the Covid-19 crisis (Farzanegan and Hofmann, 2022).

The way forward

The Raisi government is facing several challenges that won’t be easy to solve. The country experienced one of the largest post-revolution protests at the end of 2022, which has made the situation even more complicated.

Tensions with the West are growing due to issues related to the nuclear programme, human rights and the Iranian government’s stance on the Russia-Ukraine war. It is also worth noting that Raisi came to power in an election that saw the lowest turnout for a presidential election in the history of the Islamic Republic, with just 48.8% of eligible voters participating. In Tehran, the capital city, only 26% of registered voters participated in 2021 presidential election.

Initially, it was believed that Raisi’s administration would be able to coordinate policies easily and quickly. But the marginalisation of experts and delays in concluding negotiations with the West on saving the JCPOA have highlighted the inefficiencies of the new administration.

The Middle East cannot afford an unstable Iran. There is an urgent need to rebuild trust in the country’s formal institutions, which is only feasible through political and social reforms. These include control of corruption, improved social and political freedoms and economic welfare (such as addressing inflation and youth unemployment).

The global community should also provide significant economic incentives in exchange for real and sustainable domestic reforms in Iran. Increased economic isolation at the international level, and closing diplomatic and dialogue channels, will only serve to make it ‘less costly’ for the Iranian government to increase repression at home. Higher security risks for the Iranian government could amplify the country’s militarisation projects (at the costs of non-military sectors), further damaging the quality of democratic institutions (Dizaji and Farzanegan, 2021). Deterioration of democratic institution, in return, feeds military spending (Dizaji, Farzanegan and Naghavi, 2016). Working with, and not against, Iran is therefore vital – for the economic wellbeing and security of international community and Iran itself.

Where can I find out more?

Who are experts on this question?

  • Sajjad Dizaji, Lecturer, Coventry University, UK and Tarbiat Modares University, Tehran
  • Hassan Gholipour, Associate Professor, Western Sydney University, Australia
  • Hassan Hakimian, Professor and Director of Middle Eastern Studies Department at Hamad Bin Khalifa University, Doha
  • Massoud Karshenas, Professor, SOAS, University of London
  • Ida Mirzaei, Senior Lecturer, Ohio State University
  • Hashem Pesaran, John Elliott Distinguished Chair in Economics, University of Southern California
  • Djavad Salehi Isfahani, Professor, Virginia Tech University
Author: Mohammad Reza Farzanegan
Picture by Domicile Media on iStock
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