Iran

RISK ASSESSMENTS

POLITICS

Government Stability/Internal Conflict
Pressure from Many Directions
The government in Tehran continues to endure pressure from a number of different directions.  Although the pro-democracy Green Movement that took shape in the aftermath of a disputed presidential election in June 2009 has been quieted by a campaign of state repression, it has not been crushed, and government leaders are clearly worried that spreading unrest in North Africa and the Persian Gulf could embolden their domestic opponents to take another crack at toppling the theocratic regime.  In that regard, the continued evidence of disunity among top figures within the clerical establishment, and tense relations between the Parliament and the government of President Mahmoud Ahmadinejad, can hardly be reassuring.
There have been some signs of renewed vigor among the opposition, most notably in the case of a well-attended anti-government rally held on February 14, the anniversary of the revolution that resulted in the establishment of an Islamic republic in 1979.  However, the conservative regime has taken aggressive steps to marginalize key figures within the reformist fold.  Authorities have detained the main sponsors of the February 14 demonstration, Mir Hossein Musavi and Mehdi Karrubi, whose refusal to accept the official result of the 2009 election was a catalyst for the Green Movement, and the country’s chief prosecutor has indicated that they will be tried on charges of sedition.
More recently, Ayatollah Akbar Hashemi Rafsanjani, a former president who finished second to Ahmadinejad in the 2005 presidential election and voiced support for the aims of the Green Movement in 2009, failed to win re-election as chairman of the powerful Assembly of Experts, the body that will be responsible for choosing a new supreme religious leader when the aging Ayatollah Ali Khamenei steps down.  Although the new chairman, Ayatollah Mohammad Reza Mahdavi Kani, is not a hard-line conservative, the sidelining of Rafsanjani is nevertheless a victory for opponents of reform.
Holding Back the Tide of Unrest
The crackdown highlights the heightened level of anxiety among political leaders in Tehran amid a chain reaction of popular uprisings that have toppled entrenched regimes in Tunisia and Egypt, triggered civil war in Libya, and are to one degree or another threatening the status quo in Bahrain, Yemen, Jordan, Qatar, Morocco, Algeria, Oman, Syria, and Saudi Arabia.  Their concerns are understandable, given the numerous divisions—both political and structural—within the regime, the questions surrounding the legitimacy of Ahmadinejad’s claim to the presidency, and the presence of simmering discontent over economic conditions, including high inflation and unemployment.
Although several of the most important conditions that have played a role in galvanizing popular support for anti-government movements elsewhere in the region are present in Iran, the regime in Tehran enjoys various forms of protection against becoming the next Egypt, or the next Libya.  Perhaps the most important of these is the fragmentation of political power among numerous bodies.  Although the executive and the legislature are the dominant players in some policy areas, they must compete for influence with several non-elected institutions, including the Expediency Council, the Guardian Council, and the judiciary.  In Tunisia and Egypt, a highly centralized structure of government facilitated the aims of the rebellion.  In Iran, an uprising that forced the resignation of Ahmadinejad, or the replacement of Khamenei, would not necessarily threaten the survival of the regime more generally.
The potential for a second Iranian revolution is also limited by the presence of a powerful counter-revolutionary force in the form of the Iranian Revolutionary Guard Corps (IRGC), a 125,000-strong military organization that sees the protection of the system of clerical rule as a religious obligation.  The position of the former autocratic leaders of Tunisia and Egypt became untenable when military commanders in each country made clear that they had no intention of carrying out a brutal crackdown to save the regime.  Opposition leaders in Iran have no illusions that the IRGC might take a similar approach.
Members of the IRGC typically are driven by a combination of religious zealotry and a sense of fierce national pride, neither of which suggests that they might join forces (at least not in significant numbers) with a pro-democracy movement bent on toppling the theocratic regime.  Even if an uprising escalated to the point where rule by the clerics became untenable, the IRGC could be expected to assume direct control of the government, if for no other reason than to protect its extensive economic interests.
External Conflict
Extra-Territorial Risks in Flux
But for the danger that the political contagion might infect Iran, leaders in Tehran have reason to welcome the spread of unrest across the region.  Both of the regimes toppled thus far, and many of those currently facing a serious threat to their survival, were or are allies of the US, and as such no friend of Iran.  Indeed, in some cases, leaders of vulnerable governments have accused Iran of sowing discontent among their people, most notably in the cases of Bahrain (which, like Iran, is home to a Shiite Muslim majority) and Saudi Arabia (where the Shiite minority has taken the lead in organizing anti-government demonstrations).
Perhaps even more important from Iran’s perspective, the regional political crisis has distracted western powers from the dispute over Iran’s nuclear ambitions.  Tehran insists that it has a right to produce nuclear fuel, which Iranian officials insist will be used for peaceful purposes only.  However, the international community is skeptical, and has imposed sanctions with the aim of pressuring the regime to retreat on the issue.  There is ample evidence that the sanctions are biting hard, in the process feeding the socioeconomic grievances that make Iran a potential powder keg.
That consideration might explain why Iran has been surprisingly quiet about the recent initiation of a bombing campaign in Libya by US and European military forces.  The effective declaration of war against the Libyan regime headed by Muammar al-Qaddafi meshes comfortably with the Iranian government’s narrative of imperialist and anti-Muslim designs on the part of the western powers, and officials in Tehran will attempt to use that fact to promote a sense of defensive unity among the Iranian people.  Whether the Iranian people will buy what they are selling is at this point a subject of debate.
In any case, the initiation of hostilities by the US, the UK, and France is likely to add heat to the already simmering tensions in the Arab world, where vulnerable (or potentially vulnerable) regimes will face an increased threat of rebellion from two sides.  On the one hand, western intervention in Libya might embolden political liberals to turn up the pressure on their own autocratic regimes.  On the other hand, religious conservatives could rise up against governments they see as abetting a western assault on yet another Muslim nation.
None of which is to say that Iran can just sit back and watch the drama unfold.  A decade ago, the six-member Gulf Cooperation Council (GCC) concluded a mutual defense pact.  Although framed as a means of protecting members from any external threat, the main impetus for the agreement was the fear of aggression on the part of Iran.
Saudi Arabia recently deployed security forces to Bahrain, a move justified (unconvincingly) as fulfillment of its GCC obligations.  Iran has loudly protested the presence of Saudi troops in Bahrain on sovereignty grounds, and the government of Bahrain has responded by accusing Iran of interfering in its internal affairs and expelling the Iranian ambassador.  In all likelihood, Iran is simply attempting to curry favor with the Shiite majority in Bahrain.  But given the current state of affairs in the island kingdom, it could be argued that Iran is inciting rebellion.  Based on recent statements from officials in Manama, including a claim that security forces had foiled a “foreign plot” against the monarchy, that is precisely how the government of Bahrain views the matter.
For more than two years, Iran has faced the possibility that Israel might launch air attacks to take out its nuclear facilities.  Over the same period, the US has concluded massive weapons deals aimed at bolstering the GCC’s defenses.  It is widely assumed that the only thing preventing Israel from sending bombers to Iran is the strong opposition of the US to the move, which could weaken if regional instability increases.  Likewise, the new military hardware purchased by Saudi Arabia, Oman, and the United Arab Emirates could be used for offensive purposes if the Gulf monarchs reach the same conclusion as Israel, namely, that Iran poses an existential threat.
Sanctions Tightened
In combination, the barriers created by sanctions, the threat of an eruption of domestic unrest, and the danger that Iran might become embroiled in an international armed conflict create significant risks for foreign investors and exporters who are conducting business in Iran or considering expansion into the Iranian market.
In December 2010, the US introduced a new set of targeted financial sanctions aimed at weakening the economic power of the IRGC.  Under the rules, American companies are prohibited from conducting any business with Ansar Bank or Mehr Bank, both of which provide services for members of the IRGC, or with the Bonyad Taayon Sepah foundation, which manages the IRGC’s business and financial interests.  Sanctions were also applied to the Iranian company that provides maritime insurance for the Islamic Republic of Iran Shipping Lines (IRISL), which is a key player in Iran’s oil industry, and is accused of facilitating the transport of weapons and other military equipment to and from Iran.
In addition to creating headaches for foreign investors, the sanctions have squeezed state finances, forcing the government to take the politically dangerous step of slashing subsidies for key consumer goods.  On the evening of December 18, President Ahmadinejad delivered a televised address in which he informed the Iranian population that the first phase of five-year plan to completely eliminate subsidies would take effect at midnight, resulting in a tripling of prices for electricity and water, a five-fold increase in the cost of cooking oil, and a quadrupling of prices for rationed gasoline.
In a bid to soften the blow of the price increases, the government used part of the savings to finance the distribution of cash payments totaling $80 for each member of a household.  Ahmadinejad pledged that a portion of future savings realized as subsidies were cut further would be used to finance socially beneficial projects, such as housing and infrastructure.
Just in case those sweeteners were not sufficient to prevent a backlash over the price increases, the government imposed a ban on any negative reporting on the fiscal reforms in the media, and warned that strikes or protest demonstrations would not be tolerated, a message it reinforced by beefing up the presence of security forces.  The precautionary measures worked as planned, and the price increases took effect with little disruption to domestic calm.
ECONOMY
Inflation Will Dampen Spending
However, the sharp rise in prices for essential items will stoke inflation, which is forecast to average 18.7% in 2011, and reduce disposable income, weakening the contribution of household consumption to the overall growth of the economy in 2011.  Oil prices have risen rapidly amid growing concern that instability in North Africa and the Middle East could adversely affect global supplies, and as long as they remain near $100, the performance of the energy sector will be sufficient to produce overall real GDP growth of 2.5% this year.
High oil prices will point to another sizeable current account surplus in 2011, but stagnant oil production and the negative effect of sanctions on non-oil exports will limit the growth of exports, while the depreciation of the rial and higher prices for imported staples will increase the imports bill.  On balance, the current account surplus is forecast to narrow to $12.7 billion, or somewhat less than 3% of GDP, in 2011.