Iran: At the End of the Tether?

By John T. Haldane

Iran's present military advantage in the almost six-year-long Iraq-Iran war, gained by the seizure of the Iraqi port of Faw and areas near the Kuwaiti border, may soon be undermined by pressing economic problems. Since the drop in oil prices from about $28 to $18 and lower per barrel, victory could be determined by which belligerent can keep its economy from collapsing. Without the advantage of large contributions from rich neighbors, Iran is facing increasing financial pressures alone.

Up to now, Iran's religious leaders have been able to demand severe economic sacrifices without significant dissent from a population more than three times that of Iraq. However, religious fervor does not produce modern military equipment or desperately needed spare parts for the deterioriating industrial sector.

Crude oil exports traditionally account for more than 95 percent of Iranian foreign currency earnings. During the 1985-86 fiscal year, oil brought in about $15 billion. This year, however, Iran will earn only half that amount. Some $3 billion of this is needed for food imports. As one Western commercial attache in Tehran noted recently: "That doesn't leave much for the other economic sectors and the war."

Iranian Minister of Heavy Industry Bezad Nabavi has warned that the industries dependent on imported materials would soon be forced to shut down. He noted that his budget for the coming year had been halved from two years ago.

In January, 1986, the Organization of European Cooperation and Development (OECD) estimated Iran's total foreign reserves at $5 billion, with about $3.5 billion of that in cash. This barely covers Iran's foreign military purchases for one year. Military and military-related items consume about a third of the current $45.7 billion national budget. These huge military expenditures and severe restrictions on consumer goods have distorted the economy, fueled inflation, and led to a burgeoning black market. While Iranian officials claim an inflation rate of 10.5 percent, the OECD estimates the rate at 30 to 35 percent. Iran gets some imports through oil barter arrangements, but the bulk of its food, industrial raw materials, machinery, spare parts and weapons must be paid for in Western currency.

Iranian Economy Faces Long-Term Problems

The impact of foreign currency shortages on Iranian factories has been devastating. Some 8,000 plants are operating at 25 to 40 percent of capacity. Industrial production dropped 17 percent during the second quarter of 1985 as compared to the same period in 1984.

The financial pinch comes on top of serious management problems. An estimated 10,000 managers and senior technicians were fired after the 1979 revolution. Training a new generation of managers is proving difficult. Meanwhile, unemployment is estimated at 20 percent and would be even higher if so many young men were not serving in the armed forces.

On top of the loss to the Iranian treasury from the drop in oil prices, Iraq's continuing air strikes against Iranian oil installations and tankers are reducing Iran's oil shipments out of the Gulf. The Iranians have set up a shuttle system, using 10 to 12 chartered tankers, to move oil from Kharg Island to another offshore terminal on Sirri Island, 500 miles southeast down the coast, This permits international tankers to avoid venturing into the Gulf war zone to pick up oil shipments.

While this permits movement of Iranian oil to the West, another serious problem arose in May when Iraqi warplanes raided a large 200,000 b/d oil refinery in Tehran, raising havoc with a vital supply of refined products needed for the local economy. Internal consumption of oil products is estimated at about 600,000 b/d.

Since Iran's total refining capacity before the air raid was estimated at only 700,000 b/d, the manufacture of oil products for the Iranian home front was badly hurt. Repairs to such a bomb-damaged facility could take up to six months before normal production resumes.

Iran's only friends in the Arab world have been Libya and Syria. The latter, several years ago, shut down pipelines which formerly transported Iraqi oil across Syria for shipment to Europe. The quid pro quo was sale of Iranian oil to Syria for its own domestic needs. Now, in the wake of reports that Saudi subsidies to Syria have been reduced and that Syria was behind in payments to Iran for Iranian oil, President Assad of Syria seems to be flirting with his Iraqi former arch-enemies, with Jordan's King Hussein acting as a latter-day John Alden. While any real friendship between Assad and Saddam Hussein seems unlikely, it could be that Assad has decided to realign Syria's position in the Iraq-Iran war, or perhaps even play a role in seeking to bring to an end a war that is financially draining not only Iraq and Iran, but most of their Arab neighbors as well.

Despite the unfavorable population odds, Iraq has had two advantages in its struggle with Iran. It has been able to raise its oil income through the opening of new pipelines through Turkey and Saudi Arabia. And it has enjoyed continuous donations from Saudi Arabia, Kuwait, and other Arab states of the Gulf. In the first years of the war, both Kuwait and Saudi Arabia contributed an estimated $20 billion to Iraq. More recently, as dropping oil prices have cut their incomes, they have contributed 300,000 b/d of oil from the so-called "neutral zone" between Saudi Arabia, Kuwait and Iraq. There are indications that Saudi Arabia has agreed to increase its financial help to Iraq since the Iranian invasion of Faw. Certainly all of the Arab Gulf states are worried about militant Iranians near their borders.

The Iranians cannot defeat the Iraqis militarily without replenishing their military equipment and spare parts. All branches of the Iranian military use American equipment purchased during the days of the Shah. Since the United States forbids the export to Iran of military vehicles, equipment to manufacture military vehicles, and all related supplies, Iran has been forced to turn to costly "unofficial" sources of supply. One of these channels was exposed recently when U.S. authorities in New York charged 17 suspects, including a retired Israeli general, with plotting to sell to Iran $2.5 billion in American-made weapons, some of which had originally been provided to the Israeli Defense Forces. Included were fighter planes, tanks, helicopters, missiles and other sophisticated armaments.

The International Institute of Strategic Studies in London recently listed China as a primary supplier to Iran, providing interceptor jets, tanks, artillery and surface-to-air missiles. The Institute reported that Iran also is receiving arms, ammunition and spare parts from Israel, North Korea, Eastern Europe, Argentina and Switzerland.

Can Iran Afford to Keep Waging War?

If Iran manages to keep its military forces at some semblance of efficiency, can it afford to keep spending the huge amounts of foreign currency needed to continue the struggle with Iraq? The Petroleum Economist, an esteemed British publication, reports that at present Iranian oil revenues are not even keeping up with the cost of damage incurred by Iran's oil industry as a result of the war. Eighteen months ago, war damage was estimated at more than $100 billion, taking into account lost output and rebuilding costs. Iran's own estimate is that the war is costing $6.5 billion a year, roughly 20 percent of total GNP. Last year the Petroleum Economist estimated that Iran would need 18 years to bring itself back to the economic situation it would have held without the war. Since then there has been a major escalation in the damage rate, with a concomitant fall in oil prices.

Given Iran's steadily deteriorating finances, the precipitous drop in world oil prices and the absence of effective external support, it does not appear possible for the Ayatollah to defeat his enemy, Saddam Hussein, by purely military means. The longer it drags on, meanwhile, the poorer Iran becomes. While Khomeini still has popular support, in the absence of a decisive warending military breakthrough it may become increasingly difficult for him to maintain some semblance of a decent standard of living for his people. A mutually face-saving political formula to end this debilitating slaughter may therefore evolve not from military but rather from economic necessity.

John T. Haldane is a specialist in Middle East affairs who has served as a foreign service officer in Baghdad, Beirut and Cairo, and as an international economist in the Departments of Commerce and Treasury.