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Republican Reference - Area (sq.km) 1.648 million - Population 77,891,220 - Capital Teheran - Currency Iranian rials - President Mahmud Ahmadinejad

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Key Economic Data 
 
  2012 2009 2008 Ranking(2012)
GDP
Millions of US $ 548,900 331,015   21
         
GNI per capita
 US $ 4,520 4,530 110
Ranking is given out of 213 nations - (data from the World Bank)

Update No: 141 - (26/11/13)

Summary: The negotiations over Iranís nuclear programme proceed, but substantial differences between the west and the Iranians remain. The optimism that welcomed the November Geneva talks might therefore have been premature. But Teheran seems genuinely keen on a deal, as its sounding out of western oil companies for investment in Iran seems to suggest.

Like a rainbow
The negotiations for an interim agreement on Iranís nuclear programme look like a rainbow Ė the closer one seems to get, the farther away it looks. The latest round of talks in Geneva seemed at one point to be close to a deal, where Iran would see some of the sanctions against its economy withdrawn, in exchange for slowing its nuclear enrichment programme and allowing more inspections. But then the Iranian position seemed to be hardening on the third day of the talks.

A negotiating tactic, aimed at extracting as many concessions as possible from the west? An attempt to damp down criticism from the conservatives on the Iranian home front?

Difficult to say at this stage, but the hawks in the American Congress have been emboldened and now want to push through a new wave of additional sanctions. The two remaining contentious points concern.

1. the heavy-water reactor at Arak, which the Iranians say they will not load fuel into during the six-month interim period, while western governments want to construction of the site to be suspended;

2. the Iranian demand that the US recognise that in any case Iran will maintain the right to enrich uranium, at the end of negotiation.

The Iranians are under pressure even from the Chinese to not allow this opportunity of resolving the matter go. The talks have also created great expectations inside Iran, and if the Iranian government failed to achieve a breakthrough it could face a major domestic backlash. The Teheran stock exchange rose by 25% in the first 100 days of Rowhaniís presidency. For now the rial is stable against the dollar, even if the government is running a 30% budget deficit.

Thinking beyond
In fact the Iranian government itself seems to be preparing for an end to the sanctions. In recent weeks Teheran has contacted major oil companies about investing again in Iran and some of the officials appointed at the head of Iranís state oil company are already known to the west as pragmatists. The government is seeking to develop a plan to attract investors, replacing the old and unpopular buyback schemes with new schemes more tailored to what oil majors want. The oil ministry reportedly wants to attract US$100 billion in investment, to invert a trend of declining productivity in the Iranians fields. Currently Iran uses 20% of its natural gas production to boost oil output, a wasteful and backward technology.

In the meanwhile the national gas company has been forced to declare bankruptcy, crushed under a $4 billion debt. The sanctions have blocked LNG exports, forcing Iran to rely exclusively on pipeline exports, which account for just a fraction of natural gas sales. In addition, foreign investors have pulled out of key natural gas projects like South Pars, blocking their development. The government will probably have to intervene and rescue the company, but the most significant thing is perhaps that the news was widely reported and discussed in the media, an indicator of the new climate, that reminds of the early years of Glasnost in Russia.

The government has revealed that Iran has 3.5 million unemployed and that unemployment is expected to rise by another 5 million if the economy is not turned around. Unemployment is particularly high among graduates (40%), while overall youth unemployment is 26%. Considering that for the moment being the economy is still on a diving path, the challenge appears huge. Not surprisingly perhaps Rowhani seems to think that loosening up the political repression might be a little premature. So far Rowhaniís government has only released a dozen political prisoners, out of some 800.


Forecast 2013
Although the Iranian regime is much more solid than either Mubarakís was in Egypt or Assadís in Syria, it seems to be have been doing its best to bring about a Ďperfect stormí against itself. The policy choices of recent years are all converging towards putting pressure on Iranís strained resources. Ahmadinejadís low cost house building projects have been endangered by inflation, because the home buyers who paid an advance are finding out that the agreed prices no longer apply. They will have to pay much more to finalise the purchase. The government has advanced the money to the builders and if its buyers will not/cannot pay the higher prices, the costs of that will all be added to the governmentís debt. In addition, Ahmadinejadís cash handouts to the population, were more expensive than the price subsidies which he had cut, which means even more government debt, unless energy prices rise further.

Infighting among factions of the establishment within the Islamic Republic of Iran has been intensifying in recent months. Feeling under siege, President Ahmadinejad had been fighting back violently, repeatedly accusing the judiciary of being politically manipulative and hinting that the prisons of the Islamic Republic mistreat and torture their prisoners (among whom are now some of Ahmadinejadís associates). He and parliamentary speaker Larijani were sparring all the time, forcing Supreme Leader Khamenei to intervene and scold both of them for their undisciplined behaviour, which threatened to discredit the Islamic Republic. Their respective supporters were even beginning to clash in the streets. Larijani accepted the need to apologise to Khamenei for his behaviour, but not so Ahmadinejad. Even worse, Ahmadinejad had also issued a veiled threat of banning the forthcoming presidential elections should his candidate Esfandiar Rahim Meshai be disallowed by the Guardian Council as a legitimate candidate, which they did Ėand he didnít.

If he really had done that, he would have unleashed the deepest institutional crisis ever faced by the Islamic Republic. But it was not to be! Ahmadinejad was also hinting for the first time in public that it was not him who is pushing for the nuclear programme to continue at all costs, but Supreme Leader Khamenei; Ahmadinejad now says, that he would be ready to have direct talks with Washington to reach an agreement quickly. Such a statement also offers a glimpse into the impact of the sanctions regime, which was a matter of discussion among presidential contenders. Even a former intelligence minister and current member of the Assembly of Experts like Ali Fallahian, who had recently announced his (disallowed) candidacy at the presidential elections, has stated that he would stop the nuclear programme and sign a deal straight away.

In the meanwhile Khamenei shows no intention of letting the nuclear programme lapse, in fact new centrifuges were installed in Natanz recently. Official figures (not fully trustworthy) put the inflation rate at the end of 2012 at 27.4%, that is rising strongly from 26.1% just a month earlier. A survey done for the Iranian parliament (itself not neutral at all, as it predominantly opposed Ahmadinejad) has shown that production levels are falling, people are losing jobs and the production costs are rising due to the fall of the rial and the rising cost of imported components. Whether accurate or not, the survey shows how the sanctions-driven crisis is now a matter of public debate, after having been long dismissed by the Iranian government.

The Oil Minister recently admitted that oil exports are down 40% and oil revenue is down 45%, the first open admission that the sanctions are biting hard on the oil industry. After reaching a low of under 900,000 bpd in the summer, Iranís oil exports rebounded somewhat, to 1.3 million bpd in October, which is well below the over 2 million bpd Iran was exporting before the sanctions. In December exports were estimated at around 1 million bpd, despite major imports from China, which purchased almost 600,000 bpd, an increase of 39% on November. It is no surprise that Iranís imports are falling. In the current financial year, they are expected to fall by US$4-5 billion from the usual US$55-60 billion of recent years, but next year the gap is expected to rise to US$7 billion.

In a display of nervousness, the Supreme Audit Court (controlled by the parliament) dismissed the Central Bank governor over allegations of mis-managing the rial in the face of economic sanctions. The fall of the rial appears once again to be the factor which Iranís political elite had not expected, when it decided to charge on, in the face of international sanctions. The rial lost about 70% of its value, while overdue loans now account for 104% of the deposits of Iranian banks and keep rising fast.

Yet another indicator of rising friction within the Iranian elite, following the impact of sanctions, was the dismissal in January of the health minister, Vahid; she had complained that her colleagues in the cabinet were not allocating sufficient resources for the purchase of necessary medicines. Shortages of medicines are a major source of discontent in Iran at the moment. There is of course plenty of evidence that the sanctions bite the Iranian economy hard, even without looking at the politicians sparring. Internal recession has allowed the Iranians to increase their power exports to neighbours by 29% over the last 11 months. December, the last month for which data was available at the time of writing, was actually not a bad one for Iranian oil exports, with just above 1.4 million bpd, the highest level in several months even if still well below the pre-sanctions 2.2 million bpd. As even tighter sanctions will come into force soon, however, this level is not expected to be sustainable. Oil output was estimated at 2.65 million bpd in January, down from the 3.7 million in late 2011. South Korea is expected to further reduce imports from Iran, although the Chinese seem inclined to keep their imports at high levels because of the strong incentives offered by Iran: China is allowed to barter consumer goods (often low quality ones) for oil. That might be the only way, as the number of banks willing to process payments to Iran is shrinking all the time.

The Indians were happy when the Iranians agreed to accept Rupees in payment for oil, but they cannot find banks to transfer the money to Iran. Even the Indians therefore are planning to reduce imports of oil from Iran by over 10% from the coming spring. Oil exports were estimated at 1.08 billion bpd in April, up from 0.81 million bpd in March, but well below the 1.5 million bpd estimated to be required for funding its budget. It could become worse, as pressure on importers of Iranian oil grows relentlessly. Turkey is still refusing to cut Iranian oil imports, despite intensifying US pressure. Turkish imports reached a 8 month high in April, at 140,000 barrels. The shortage of cash resulted in falling imports of even essential goods. Medicine imports, for example, fell by 54%. Official unemployment figures are believed to be unreliable, but official data show that even highly qualified professional categories are affected. There are for example almost 20,000 doctors who are either unemployed, or not employed as doctors.

An Indian company has volunteered to provide insurance for tankers carrying Iranian oil, allowing at least temporarily a resumption of imports. The Indian government is refusing to cap oil imports from Iran, but technical issues like insurance have been curtailing imports. Taiwan was also resuming crude imports from Iran in April. Although China remains the most dependable customer for Iranian oil, commercial considerations represent a growing obstacle. Recently a major Chinese ship insurer announced that it will halt indemnity cover for tankers carrying Iranian oil, making it more difficult for importers to buy Iranian oil. Oil buyers want steady supplies first and foremost, and even Iranís special offers are not wholly reassuring to most of them. So the trend even among Iranís most faithful customers is to look elsewhere for the bulk of supplies.

India in particular is struggling to deal with the range of issues created by the financial sanctions against Iran. Some Indian refineries are contacting alternative OPEC suppliers, including Iraq, Saudi Arabia and Kuwait, as a replacement. The Japanese and the Koreans also seem set to further reduce their imports from Iran from April. The latest Iranian budget foresees oil exports of between 0.9 and 1.06 million bpd for the current year, compared to 1.3 million bpd last month. The Iranians therefore expect a further drop in exports, even if they say there are on-going discussions between them and the Indian government on how to resolve the insurance issues which is pushing Indian refiners away from Iranian oil. This would leave only the Chinese as steady buyers of Iranian oil. The Chinese have the added benefit of bartering their products for Iranian oil; the Iranians however are trying to renegotiate the terms of the bartering agreement, reducing the importance of consumer goods, which are flooding the Iranian market at the expense sometimes of local products. Instead the Iranians would like the Chinese to deliver large infrastructural projects; one might already being in the process of being finalised, involving the high speed rail network.

The fact is, however, that the Chinese have been reducing dramatically their investments in Iran, from US$3 billion in 2011 to US$400 million in 2012. Still, the few foreign visitors to Teheran these days report that the economy seems still far from collapsing: shops and restaurants are full. Government finance has absorbed the worst of the pressure, something Iran can do because it does not have debts: the state deficit is rising to 3.9% of GDP this year, but gross debt is barely 9% of GDP, so this is still very bearable. The government is making some money by selling dollars to the private sector at inflated exchange rates. Assessments of how the Iranian economy is doing vary widely.

The Iranian government implausibly is claiming that the GDP has grown by 5.2% in 2012, while the IMF talks of a 0.9% decline. The Iranian parliament has openly challenged the governmentís statistics and published an estimate according to which the economy has grown by just 0.36% in 2012. The Iranian government, admitting implicitly a worsening economic situation, has prepared a plan to distribute subsidised food to the poorest part of the population, using in fact a rationing system. According to official figure in February the inflation rate reached close to 30% and forecasts are that it could reach 31.5% by the end of March. Government sources say that even this figure is considered an achievement as experts had forecast a 40% inflation rate; the counter-measures adopted by Teheran according to them, had some effect and contained inflation.

By October the IMF was forecasting that Iran's GDP will grow 1.3% in 2014, against a 1.5% decline in the current year. The new cabinet plans to carry out four major reforms: the foreign currency market, the cash subsidy payment, the privatization process, and the banking system. For now, however, Rowhani has little to show and could easily become a target of the conservatives if he stepped too far out of the line. The conservative dominated parliament has already reminded him of its power by rejecting three of his nominees to ministerial posts, all reformers. Industrial production has fallen 27% from its peak two years ago, while inflation runs at a yearly rate of 36% now, slightly down on the 39% rate of one month earlier. Yet studies commissioned by Rowhani put the inflation rate at 45%. However there is no question that the Teheran stock exchange has soared 37% since Rowhaniís victory, showing what the business class thought of his predecessor. The other good news so far is that the rial has recovered some ground against the dollar from its low of 36,000 to a dollar of four months ago; it now stands at 30,000 to the dollar. Common Iranians have been buying dollars to hedge against the depreciation of the rial and it is now estimated that Iranian households have stored 18 billion dollars so far. Those who did not have means to protect themselves against the wild inflation have suffered. It is now estimated that the percentage of the population below the poverty line has increased from 22% to 40%. According to a study commissioned by an adviser to Rowhani, the overall level of employment in Iran has gone up by just 140,000 over the last eight years, against claims made by Ahmadinejad of 7 million jobs having been created.

The May 2013 decision of the Iranian government to stop providing dollars at subsidised rates for the import of most basic goods is likely to stimulate inflation considerable in the coming months. The rial trades now at around 35,000 to a dollar, while the government was providing dollars at the rate of 12,260 rials. Now the subsidised rate will only be made available for the import of wheat, barley, corn and soybean. The standard rate for importers is 24,500 rials, still subsidised but not as much. The decision seems motivated by the desire to preserve foreign currency stocks, but prices are already rising on the decision. The inflation rate had already reached 31.5% in March, but in April it was reported to have fallen back to 29.8%. While the economy is in trouble, Iranís commitments abroad are rising. In Syria, Teheran is reportedly forming a militia with the help of Hizbollah in order to shore up the Assad regime, or to maintain an influence once Assad is gone. This seems to have reached tens of thousands of men and is still growing, implying a significant financial disbursement.

Objectively in a sense, the resilience of the Iranian elite is admirable, if perhaps ill-advised. Despite rising economic difficulties, there is no unambiguous indication yet that the Iranians are ready for a nuclear deal anytime soon. Relations between Teheran and the IAEA remain tense as the two cannot agree on a new inspections regime; some observers believe that Teheran is leaving the door open to a deal on enrichment, but there seem to be little hurry to reach that.

In the meantime, Obama has signed a new layer of sanctions against Iran, further tightening the grip on its trading activities. Having embarked on a round of international policy brinkmanship not seen since the 1930s, the Iranian elite is risking everything for unclear and uncertain rewards. Increasingly isolated, the Iranian regime is at risk of losing its two main international allies (Assad of Syria and Maliki of Iraq) pretty soon, and cannot do much about it. Iran in the middle of major financial difficulties now has even to help Assad, whose resources are modest not least because of the sanctions against his regime. Recently Teheran agreed to open a line of credit for US$1 billion to Syria for imports from Iran; it is far from certain that this money will ever be recovered. Even the gains made in recent years by Iranís regional diplomacy have been compromised by the hardline attitudes of Teheran and its support for the even more isolated Assad. The Egyptian government has been the target of Iranian blandishments, but the results have been meagre so far, despite the Islamist-leaning tendencies of the new Egyptian government, now of course removed by the military.

Ultimately both Washington and Teheran would like to reach a deal on Iranís nuclear programme, but the terms which they are ready to accept do not coincide yet (and might never coincide). The Iranians want a complete normalisation of relations with Washington, but in their effort to put pressure on Washington (having concluded years ago that blandishments would not work) they are making Obamaís task even more difficult: the more Ďrogueí Iran looks, the more difficult for Obama to hammer together a deal which American public opinion (influenced by the relentless Israel lobby), would accept.

The time is ripe for the moderate new Iranian president to take over and order a u-turn in policies, going back to where President Khatami was before Ahmadinejad.

The Iranian elections of 13 June ended up with a surprise result, at least as far as external observers were concerned. Rowhani, a moderate conservative, won at the first round. He was decisively helped by the withdrawal of the only reformist candidate, Adel, who was advised to do so by leading reformist figures. The exclusion from the race of former president Rafsanjani also helped Rowhani to win: the two men are close and it is likely the Rowhaniís candidacy might have been conceived as a ĎPlan Bí in case Rafsanjani was banned from running by the Guardian Council, as in fact happened. By contrast, the conservatives remained well divided: the five conservative candidates split the vote, although in the end it did not make much difference as Rowhani got more than 50%. In addition, even the majority of the conservative candidates campaigned on moderate platforms, even adopting some reformist ideas, a fact which suggests that the Iranian elite has accepted that there exists a crisis in the relationship with the electorate and that the gap has to be bridged somehow. The detailed results were:

1. Hassan Rowhani: 50.7%

2. Mohammad Baqer Qalibaf: 16.6%

3. Saeed Jalili: 11.4%

4. Mohsen Rezaie: 10.6%

5. Ali Akbar Velayati: 6.2%

6. Mohammad Gharazi: 1.2%

The vote was reportedly not affected by allegations of fraud, as had been the case in the previous elections. Perhaps this result is what Supreme Leader Khamenei really wanted? Rowhani was appointed by Khamenei to several jobs in the past, a fact which suggest a positive relationship between the two. Rowhani could help Iran cast a more moderate image, while at the same time not having the same weight as Rafsanjani and presumably not being able to eventually challenge Khamenei in the event of disagreements. In this way, Khamenei could change course in Iranís foreign policy without losing face.

The election of Rowhani in any case was welcomed in Iran and did not create much controversy. He hinted that although he would not surrender to western powers, he would adopt a more pragmatic and flexible foreign policy, including on matters such as the nuclear programme and Syria. The Islamic Republicís detractors, including American hawks and of course most Israelis, believe that Rowhani is just a diversion intended to gain some time for the Iranian regime, while the nuclear programme goes ahead. Rowhani adopted however a rather constructive approach when he was nuclear negotiator for Iran in 2003-5 and is believed to be able to maintain close relations with Iranís various internal power centres, which is necessary if the Iranian regime has to find a consensus over a nuclear deal. The Russians say that Rowhani is ready to announce a suspension in the production of enriched (20%) uranium and that western powers should react to such an offer with substantial reductions to the sanctions regime. In the west opinion is divided, with some arguing that this is an opportunity to be seized and others arguing that Rowhaniís election is a demonstration that the sanctions work (presumably with the silent co-operation of 50.7% of the voting electorate) and that pressure should continue unabated until Teheran fully Ďcapitulatesí.

Newly elected President Rowhani presented his 18 cabinet members to the parliament in August, but faced strong verbal criticism from the dominant conservatives. Three of his candidates were in fact voted down (sports, science and education) Ė they were all linked to the reformists and had been educated in the west, which did not help them with the MPs. Then there were reports that Supreme Leader Khamenei himself vetoed several of the Presidentís choices as being too close to the reformists. In particularly, he strongly opposed the nominations of Ali Yunisi to intelligence minister and Ahmad Masjed Jameiíi as minister of culture; they both had served under president Khatami. Rouhani obliged and replaced them on his list. Mahmud Alavi will be minister of intelligence, he was MP under Rafsanjani and Khatami and seems to be relatively liberal. Ali Janati will be minister of culture and is a moderate.

Of those ministerial candidates who made it, most noteworthy was foreign minister Javad Zarif, formerly ambassador to the UN, a technocrat who played an important role in brokering the Bonn Agreement on Afghanistan with the Americans. He was approved by the parliament despite having been educated in the US. It is now believed that he might take a lead role in future new negotiations with western powers over Iranís nuclear programme. Indeed Velayati, a key adviser to Supreme Leader Khamenei and former foreign minister, has already been sending signals to the west that the new presidency represents a major opportunity for resuming and concluding negotiations. While it is clear that the final word on a nuclear deal would be with Khamenei and not with Rouhani or with Zarif, Velayati is probably delivering a message from the supreme leader. In fact the very election of Rouhani might have been engineered by Khamenei in order to allow a change in foreign policy.

The cabinet is in fact full of experienced cadres, quite a few of whom have served under previous presidents. Former oil minister Bijan Namdar Zanganeh got back his job. He presented a plan of re-launching oil production and has even been talking of the adoption of new technologies to boost production in old fields, but it is not clear what Iran could do with more oil, given that exporting it is more and more difficult!

Hossein Dehghan, the Defence Minister, is a former commander of the Revolutionary Guards, but worked as deputy Defence Minister under reformist President Mohammad Khatami. Abdolreza Rahmani Fazli, the Interior Minister, is probably the least likely of being suspected of being a reformer, among the top ministers. The only woman appointed to the top levels of government by Rouhani was Elham Aminzadeh, a conservative who has been named vice president for legal affairs.

Rouhani inherits a complicated economic landscape. With the change in government, there is little incentive for now to underestimate the extent of the trouble. The new government recognized that the current budget, approved under former president Ahmadinejad, faces a funding shortfall of about one third, due to reduced revenue levels. The government would like to revise the budget rather than to print currency to face the shortfall, in order to avoid stoking inflation further. The July inflation data show that it has already reached a yearly rate of 37.5%. It was 25.4% in March. Interestingly, one of Rouhaniís first measures was to revive the Management and Planning Organization, which Ahmadinejad had shut down. He seems to agree with those who believe that the abolition of the MPO disrupted the governmentís budgeting and human resources administration.

Rowhaniís presidency is fully in its honeymoon phase and everybody in Iran is positive about him. In fact some observers believe that the Rowhani effect is such that even the Iranian economy is benefiting from it. Following a EU court decision to remove sanctions against some Iranian shipping lines, prices of food commodities declined slightly. In reality the EU decision has nothing to do with any goodwill towards Rowhani, but was perceived anyway, as good news in Iran. The rial currency gained about 25% against the dollar and was trading at about 30,000 to a dollar on 20 September. Rowhani however is coming under pressure to quickly enact economic reforms, such as giving back to the central bank its independence and maybe even privatising the gas and oil sector. There are indeed signs that the new administration is trying to increase the transparency surrounding the economic role of powerful foundations linked to the Revolutionary Guards, in order to ease the de facto monopolies and oligopolies that these foundations enjoy, as a result stimulating the economy. Accepting the argument that the current runaway inflation rate (it has now reached 44%) is in part at least, the result of Ahmadinejadís housing projects, funded by oil money, the new government has announced that it will wind up the projects.

The new administration no longer has an incentive to massage economic statistics, at least for now. So the real economic legacy of Ahmadinejad is beginning to emerge. The GDP shrank by 5.4% last year, much more than admitted previously, or even estimated by the IMF and other international organisations. About 44% of Iranís oil earnings cannot reach the country because of economic sanctions, compounding the effects of a 58% drop in oil exports. Many state projects are being left incomplete because of the lack of liquidity. 70% of municipalities are bankrupt. Employment fell by 330,000 to 20.51 million. The economy is 80% controlled by the state or by entities connected to it.

The main driver of such optimism as exists is that Rowhani will deliver a more responsible foreign policy, end the sanctions regime and more or less reinsert Iran into the international community. Some observers however point out that while the strong technocratic presence in Rowhaniís cabinet (10 ministers) has been a common trend for the Islamic republic since its foundation, the strong presence of ministers with a background in the Ministry of Intelligence (4) is something new. At the same time there is a strong drop in the number of Revolutionary Guards compared to Ahmadinejadís tenure, with only three such ministers left. Is Rowhani trying to contain the power of the Revolutionary Guards and counter-balance it by co-opting other institutions of the Republic? Will he succeed?

Abroad, many seem willing to give Rowhani some credit and give him a chance, even if everybody is aware that Supreme Leader Khamenei is still in place, and is the ultimate holder of power. Khamenei allowed and even helped Rowhani in getting elected; now the question is: for what purpose?

To gain some more time, or to enable a genuine change in foreign policy? Even if Khamenei is only bluffing and worst case, he manages to fool his western counterparts into somehow allowing him to produce a handful of atomic bombs, the sanctions would not go away.

There seems to be some awareness among the Iranian political elite that the current sanctions regime is not sustainable and that the political base of the Islamic republic is eroding. So perhaps the desire for a change is real, but Teheran is not going to simply surrender its nuclear programme. What will Rowhani ask in exchange for that?

In October there was optimism that some breakthrough might be achieved soon, mainly because of an Iranian hint that it may freeze its uranium enrichment. The Obama administration is keen to send Teheran a signal that any concession would be reciprocated and there are efforts to delay the approval of new sanctions against Iranís oil exports. There already have been intense meetings between the Americans and the Iranians and although the Americans came out of them convinced that the mood has changed, a breakthrough does not seem to be round the corner. The Iranians also say that they have detected a change in the approach of their counterparts. There is still a lot of suspicion towards the Iranians and powerful pro-Israeli / conservative lobbies in Washington pushing against any relenting of the pressure. What the Iranians want (and always wanted) is the abolition of all sanctions against Iran in exchange for de facto giving up their nuclear programme, or placing it under strict scrutiny. What has changed is the way to achieve that Ė soft diplomacy rather than aggressiveness. Some cynics see a long term strategy of Khamenei in this Ė since Khatami was not appreciated in 1997-2005, he let the West taste eight years of Ahmadinejad before serving up another moderate and see what kind of welcome he gets. It is worth noting that Rowhaniís candidate to the place of foreign minister, Zarif, despite not being loved by the conservatives obtained a strong approval in the parliament Ė an indication of Khameneiís support for the new policy line?


Summary of 2012
While originally the Iranian regime saw the Arab Spring as a largely positive development, which might reduce Iranís isolation in the Middle East, this attitude has been changing as a result of the not-very-friendly attitude towards Iran of the new regimes and coalition taking over in a number of Arab countries, as well as of the crisis of the Asad regime in Syria, one of Iranís main allies in the Arab world (the other being Iraq). The fall of Asad in Syria would also cut the supply line connecting Iran and Hezbollah in the Lebanon.

As of February indications started emerging that the oil sanctions against Iran were beginning to have an impact even before they actually came into place. The EU purchases 600,000 bpd of Iranian oil and Iran started shutting off deliveries in retaliation, even before the Europeans implemented their ban. Iranís situation is compounded by the fact that Chinese purchases of its oil were running low, due to price disputes; it is estimated that in this quarter, China will end up buying only half the amount of Iranian oil it bought a year ago. In all likelihood, Chinese imports will recover once the terms of the contracts are sorted out - the Chinese seem to be exploiting Iranís diplomatic weakness to extract better conditions. However, one of Chinaís two main importers has said that it expects to reduce imports from Iran somewhat this year. The cost of Iranian oil has been going up because of the sanctions, the Chinese say, so they want the Iranians to make up for the Chinese losses somehow. Such costs will increase further in the future, as the (banking) Society for Worldwide International Financial Telecommunication (Swift) bans the sanctioned Iranian banks from using its facilities. It seems unlikely that at this stage that even the Iranian Central Bank will be affected, as in this case Iran would be nearly cut off from international banking, but the costs of banking are going to go up significantly anyway.

The Indians on the other hand have reached an agreement to pay for the oil they buy in Iran in rupees; this decision covers purchases for US$10 billion of oil and has been resented in Washington, as it is a major blow to the sanctions strategy. The Chinese probably expect a reward of similar value for their readiness to keep trading with Iran. A number of other Asian purchasers seem to be shifting some of their supplies away from Iran to hedge bets, in case the situation in the Straits of Hormuz deteriorates: so more purchases from Russia and Africa and less from Iran. Taiwan for example cut its imports by half last year in anticipation of sanctions.

It appears that China and some European countries might stop insuring Iranian crude, adding a further incentive not to import from Iran. By the end of March it was estimated that Iranís oil production had already declined by 250,000 bpd, to 3.3 million, and it is believed that it might collapse by another 500-700,000 bpd by the summer. That of course would wreak havoc on the Iranian state finances. Every week some new country announces measures to cut Iranian imports. On the other hand, the world needs Iranís oil and despite all efforts to replace its production, the sanctions are pushing prices well above the $100/barrel mark and are likely to continue pushing them even further. President Ahmadinejad claims that Iran can do without selling crude abroad; this obvious hyperbole has an element of truth, in that Iran has been selling many more petrochemical products in recent years, bringing its non-oil exports to US$45 billion in 2011. However, nothing eventually would prevent sanctions to be imposed on petrochemicals too. Prices continue to rise fast because of the sanctions.

Iran was using the Labuan port in Malaysia to store oil and free its own oil tankers to carry oil to Asian buyers. For a while Iran had been storing oil in its tankers, but after accumulating an estimated 33 million barrels of oil it started running out of tankers to move the oil. This is only the latest in a long series of tricks the Iranian leadership has been adopting to circumvent sanctions, but in July Iranís oil earning were about a third as those of Iraq.

Iran is estimated to have pumped 2.75-2.85 million bpd of oil in August, compared to 3.1-3.2 million in July. Exports actually bounced up a little in August, to 1.1 million bpd from less than 1 million, due to the resumption of exports to some Asian countries. Exports should rebound further in September and October as South Korea, Turkey and Japan have all announced a resumption of oil imports from Iran either in September or shortly afterwards.

Despite reports that the Iranian oil industry is moving towards a standstill and that excess oil which is not being exported is running out of storage space, the government reports investing in boosting oil production, as for example in the Nargesi field, where US$33 million are to be spent injecting gas in order to obtain an additional 120 million barrels. Perhaps part of the same attempt to project an image of normalcy in the midst of a worsening crisis, the government continues to highlight ambitious infrastructural development plans. The privatisation of power generation industries is said by the government to be almost complete and the government now plan to expand electricity generation capacity by 5 GW to over 70GW this year. In order to keep the economy moving somewhat, the government is now pumping funds for US$3 billion from the National Development Fund (originally meant as long term national savings) into the economy to finance industrial, mining, water and agricultural projects.

In reality, evidence is mounting that the Iranian economy is beginning to suffer heavily under the sanctions. Sources in Iran report that due to the difficulty to import components, car production has fallen by 37.5% in the last four months, from a production plan of 2 million vehicles. Production of cooking oil may be falling by almost half because of the difficulty to import grains. The rial trades at well over 20,000 for a dollar, more than twice as much compared to a year ago. Although the IMF estimates that Iranís GDP will grow by 0.4% in 2012, some observers are much more pessimistic, on the basis of anecdotal reports from Iran which talk of massive layoffs and of factories closing down. Some members of the Iranian parliament estimate that 500,000 to 800,000 Iranians may have lost their jobs in the past year alone. Even the much criticized official inflation rate showed an acceleration to 23.5% in August, from 22.9% in July.

As evidence of sanctions having a significant impact on Iranís economy grows, and the price of oil rises, the two diplomatic sides have been exchanging signals that they are ready to talk. The Obama administration has indicated (through the Turkish government) that Washington would be satisfied if the Iranians could demonstrate that their nuclear programme is civilian only in nature. The move coincides with a renewed Iranian willingness to negotiate, although so far it proved difficult to even to agree on the location where negotiations would take place. Teheran is locked in a confrontation with Ankara over Syria, where the two countries support opposite sides, and proposed Baghdad as a host, as opposed to Istanbul as proposed by the westerners. In fact the Iranians even treated harshly the visiting Turks, as Ahmadinejad avoided meeting Turkish Prime minister Erdogan, who also had to fly on to Qom to meet Supreme Leader Khamenei. Upon returning to Ankara, Erdogan decided to join the US-sponsored sanctions and to cut purchases of Iranian oil by 20%.

Banking sanctions against Iran are becoming more and more effective because of the determination of the Americans to make them respected. Some major banks are already being investigated for having violated the sanctions and having kept trading with Iran Ė even Deutsche Bank is among the list of the suspects. Several banks have already received fines. Dubai banks are now coming under scrutiny: for them trading with Iran is a major business and it is difficult to let it go. Just two countries seem to be able to ignore the sanctions altogether: Turkey and Iraq. The Iraqi attitude is not a surprise, given the links between Baghdad and Teheran, but why is Turkey doing this favour to Teheran in the face of the major disagreement on Syria and Iraq? Ankara seems to be trying to position itself as an independent actor in regional politics and knows that following US policies will not earn it any credit in the Middle East. Plus, maintaining some links with Teheran gives it some leverage to be used in the future. Iran is also trying to circumvent sanctions with tricks like using other countriesí flags for its ships: (the Tanzanian government found in August that 36 Iranian tankers were sailing under the Tanzanian flagÖ)

The flow of capital from Iran is mainly directed towards Dubai, where Iranians are investing in the property sector. On the positive side, the impact of the current oil sanctions is stabilising. Some countries which had suspended purchases of Iranian oil are now planning to resume it, like South Korea, which hopes to be able to get its deliveries on Iranian tankers, without having to face the problem of how to insure them. The Iranians have also offered South Korea the same deal they offered to India and China: bypass banking sanctions though a bartering agreement. The Japanese are also resuming oil imports after resolving the insurance problem. Iranian oil exports are now stable at 1.1 million bpd, with an estimated daily loss of revenue of US$133 million. Production in July was down to 2.9 million bpd, the lowest level since the war with Iraq. The Iranians are hoping to recover market share by striking deals for the sale of oil to new clients, like Egypt and Russia, but so far have not been successful in reaching agreements. Moreover, the Americans are about to enforce new sanctions against Iranís oil trade and this could curb export further during the next few months.

Eventually the Iranians agreed to see the talks hosted in Istanbul, perhaps an indication that the Iranians do not see it fit to keep postponing. Moreover, although the relations between Ankara and Teheran are far from at their peak, Turkey is still well positioned, compared to western powers, to talk to Teheran. How long that will be the case is another matter, particularly if the Iranians retaliate for the cut in oil purchases. The Iranian negotiator in Istanbul in any case took Iranís unquestioned UN right to a civilian nuclear programme, as his line of defence. Now most commentators worry whether this is just another ruse to gain time, or something more serious, although this is the official Ayatollah-endorsed purpose of the whole nuclear programme and the crux of the way in which decisions will fall.

Like Istanbul and Baghdad before, the Moscow meeting over the Iranian nuclear programme crisis in June ended with no significant progress. What is worse, negotiations became close to collapse in Moscow, as the only agreement was for a further meeting of technical experts to look into a possible future deal. There is no agreement for further political meetings. Observers believe that the Iranians might see no point in negotiating before the forthcoming US elections, as they would not be able to extract the concessions they want from the west: a reduction of the sanctions in particular, would be very embarrassing for President Obama during an electoral campaign. The Iranians may also have calculated that the risk of an Israeli attack is no longer so high given the deep divisions that have emerged in Israel over the issue and clear US signals against.

The European Union tightened its sanctions against Iran in October, hitting more than 30 firms and institutions for asset freezes in the EU, mostly belonging to the oil industry. Previous sanctions are hitting harder and harder already, causing inflation inside Iran to rise fast. Recently Iranís largest car maker Khodro has announced a 20% rise in the price of its cars. Car production was down 66% by the summer, because of shortage of imported parts; soon factories may have to lay off workers. There are also major shortages of medicines, because the government had decided to prioritise imports of food items, as a shortage of the latter would be more likely to lead to riots and protests. Riots have already started over the fall of the currency, with a major one in Teheranís bazaar in October. Although Teheran has managed to maintain exports of oil to some key Asian clients going, its tanker fleet is struggling to keep the pace and deliveries to China have been delayed. Despite all of Teheranís efforts to circumvent sanctions, exports are falling. Some sources now say that Iranís oil exports were down to 860,000 bpd in September, compared to 2.2 million in late 2011. Even Chinaís imports are running about 16-20% lower than a year ago. Clearly this situation is not sustainable in the long and even medium-term.

The unsustainability of the situation probably explains why the wall of silence on the impact of sanctions on Iran was beginning to break down in October. The Iranian government said in October that it would cut imports of Ďnon-essential goodsí. Foreign made cars and cell phones are being particularly targeted. Among the conservatives in the parliament, criticism is beginning to emerge that the governmentís line, to deny the impact of sanctions, has been counter-productive because it prevented the government from adopting essential measures to mitigate their impact. They are not yet saying that a deal should be made as soon as possible. In part the willingness to criticise the government derives from the fact that candidates and factions are positioning themselves for next yearís presidential elections. Most recently Parliamentary speaker Ali Larjani, has been chosen by the Ďprincipalistí conservative faction as the future presidential candidate. The conservatives look for Supreme Leader Khamenei for endorsement, yet for now Khamenei sticks to his plans concerning the countryís nuclear programme (whatever these plans may be). Western observers believe that Iran will run out of foreign currency reserves by next spring; there are also those who believe however that Iran might have enriched enough uranium by then to produce a few atomic bombs. Moreover, it is not clear how much Iran actually owns in terms of foreign currency reserves: estimates vary widely between US$30 and $110 billion. The indisputable fact is that the Iranian currency, the rial, continues to fall and was down to 43,000 to the dollar in October.

At the same time, some observers believe that the Iranians are showing greater willingness to achieve a deal on their nuclear programme. Iran has started converting 20% enriched uranium to U308 for the purpose of using it in civilian reactors; this reduces the stockpile available for conversion to military purposes and would delay by several months the production of a nuclear weapon, if Teheran is indeed aiming for that. Iranian diplomats however suggest that Teheran would expect a complete lifting of sanctions in exchange, probably even the old ones decided by Washington in 1980s following the hostage crisis then. In the intelligence community there had been rumours circulating that Iranian Supreme Leader Khamenei and President Obama are already close to a deal to be announced before the American elections, featuring the lifting of most sanctions in exchange for a temporary halt to enrichment, but this didnít happen.

A positive note for Iran was the fact that China resumed large scale imports of oil. In May it imported 524,000 bpd, compared to 390,000 bpd in April, although that level is still slightly less than it imported in May 2011 (537,000 bpd). The resumption is due to Iran and China resolving a payment dispute that badly affected oil sales in the first quarter of this year. Observers believe that China may obtain a significant discount on the price of its purchases. The Indians too have finally approved a scheme to pay for Iranian crude in rupees; in practice the rupees will only be used by Iran to purchase Indian goods which is an added bonus for India. However, with the new sanctions the Indians have to face the problem of how to insure the tankers carrying the crude; the Iranians are talking of providing insurance themselves. The Koreans are stopping imports exactly for this reason. Only Japan is maintaining imports of Iranian oil after the parliament approved a bill to insure tankers carrying Iranian crude. Iranian oil exports are forecast to fall to 1.5 million bpd by end June, 1 million bpd lower than the pre-sanctions level and up to 100,000 bpd lower than in May. It will fall further in July. With almost all storage capacity already being utilised, Iran may have soon to shut down its production. Iran has allied with Iraq to try and push oil prices higher, but rising Iraqi production, Libyan recovery, a sluggish world economy and Saudi overproduction have all conspired to push oil prices actually down in recent months.

In the meanwhile Teheran suffers from the crisis of its currency, the rial, affected by a strong black market demand for the dollar as well as by the fear of a military escalation around Iran, with the Israelis making more and more threatening noises. Teheran was forced to devalue the rial by 8% in February, while at the same time cracking down on illegal currency exchanges. The new rate is fixed at 12,260 rials to the dollar, but the black market rate was 20,000 before the devaluation and the crackdown, although it has since fallen to 17-18,000. Another measure that the government was forced to take despite strong initial resistance by President Ahmadinejad has been the raising of interest rates; rates paid by banks are now at 21%. Another problem that has been re-emerging recently is inflation: after a long decline, in recent months inflation has been accelerating again and is now at 21%, up from 20.6% in December.

Teheran is also accelerating its subsidy reforms, despite the unpopularity of the matter. It wants to cut off cash handouts in compensation for higher energy and food prices for about 3 million of the 72.5 millions of Iranians (out of a total 75 million) who receive them. Last year the cut in electricity subsidies alone saved the government US$11 billion and reduced consumption by 2%, allowing Iran to export more power. Until 2010, power consumption was rising 8% a year. The Iranian government is also intervening in the cereals market, buying millions of tonnes abroad to fulfil internal demand, because private Iranian importers are prevented from buying by the financial sanctions. Iran will need to import even more in the near future as this yearís harvest is forecast to be lower than last yearís, due to poor rainfall.

In the meanwhile western diplomats are trying to use such new leverage as is gained with the progress of oil sanctions, to force the Iranians to the negotiating table. On offer might be the concession of allowing Iran to continue enriching uranium at a level lower than the 20% required for nuclear weapons. IAEA inspectors went back into Iran as scheduled, in late February.

Not for the first time Iran seemed to signal, via the EU's Lady Ashton, that it could be ready for talks, but there is nothing concrete to report yet

Reportedly President Ahmadinejad has stated in public that the conservative factions opposed to him, including Supreme Leader Khamenei, has been pushing the nuclear confrontation that Ahmadinejad himself contributed to start, well beyond the point where he had planned to stop. The purpose would be, in Ahmadinejadís view, the desire to discredit him and help defeat his political faction in the forthcoming parliamentary elections (see above). Ahmadinejad claims that the assault on the British Embassy in Tehran in November, the failed assassination plot against the Saudi Arabian US ambassador, the continuing support for President Bashar al-Assadís regime in Syria, the threats concerning the Strait of Hormuz and efforts to sabotage the relationship with Turkey, are all the work of Khameneiís group.

Ahmadinejad seems to have argued that it is time to slow the pace of the confrontation with the west, despite his on-going fiery rhetoric, in part because of signs that the existing sanctions are weakening the Iranian currency, the rial, seriously: it has lost 20% of its value in a single month. The Central Bank has introduced a cap on the exchange rate, but many rials are being exchanged on the black markets against dollars; the Iraqi authorities have noted a massive outflow of dollars towards Iran (as well as Syria). While the Bank wanted to increase the base rate to 21% to contain the fall of the currency, Ahmadinejad refused to countersign the order.

By the summer President Ahmadinejad, widely seen as a lame duck now that he has little influence left in the parliament, was being eclipsed in media reports by Supreme Leader Khamenei. Ahmadinejad was mainly notable during this period because of having been snubbed by Brazilian president Roussef while on an official visit to Brazil.

The debate concerning the 2013 presidential elections and the lead candidates who will be allowed to run.

Recently former president Rafsanjani has been seen re-emerging and taking part in public events, sometimes alongside Supreme Leader Khamenei, leading to speculation that Rafsanjani might be trying to enter the good graces of Khamenei and be accepted as his official candidate. Rafsanjani could then present himself as the candidate who would bring about a thaw in relations with the west, as well as some internal pacification with the reformists, with whom Rafsanjani has decent relations.

The IMF forecast is that GDP will slow down further to 0.4% this year, from 2% last year. This means that Iran is going to miss most of the gains deriving from the renewed phase of high oil prices. Inflation is projected to rise to 22% in 2012. President Ahmadinejad had presented a daring draft state budget, which assumed very unrealistically a 20% increase in revenue. Now the government has been forced to revise the budget on the basis of more realistic assumptions. The new US$462 billion budget represents a drop on last yearís, but is still deemed by many as unrealistic, as it assumes steady oil sales. The budget assumes however an oil price of US$85 a barrel, which is significantly lower than current prices. The cuts in the budget could have deflationary implications, further reducing growth.

Teheran has to struggle against increasingly effective oil sanctions. President Ahmadinejad himself admitted that the new European Union sanctions implemented in July are the strongest yet against Iran. Oil production continues to fall and it is now estimated at 2.9 million bpd. The official inflation rate has accelerated to 24% in June and the government had to abandon plans to further cut energy and food subsidies in order not to stimulate inflation or to add to the pressure faced by the population. One bit of economic reform that is set to go ahead is the privatisation of the energy sector. The government has already privatised 17 of its 45 power plants in 2008-12 and now plans to privatise 28 more, hoping to reap US$11.4 billion before the end of this fiscal year. This is part of a wider programme to privatise, to sell to the private sector most of Iranís state-controlled industries, which were 70% of the total in 2007. Since 2005, assets worth US$63 billion have been sold.

The rial has suffered a new crisis after the implementation of the European sanctions and reached close to 20,000 for a dollar. This of course is going to have a major impact on the inflation rate in the coming months; even some representatives of the regime admit that in the coming 6 months the inflation rate could accelerate by 50 to 70%. The price of some imported goods has already trebled since the beginning of the currency crisis. The sanctions have prompted international organisations to revise economic growth estimates downwards: the World Bank foresees a 1% drop in the GDP this year and another 0.7% drop next year.

In order to sell its crude to Europe, the Iranian government has abolished its previous tight requirement that all oil be sold through the national oil company and it allows now private companies to trade it. European firms report being offered Iranian crude at discounted prices, often even with fake documentation showing a different country of origin, or mixing Iranian and other crude. Even these tricks, however, will not be enough to offset the inability to sell on official markets, the more so as banks, which are tightly controlled, refused to channel payments for Iranian oil. Iran is not being helped by the fact that oil prices are relatively low, a combination of the impact of economic recession, of rising internal production in the US and of growing Libyan and Iraqi production.

In this context it is easy to understand why the Iranians are so keen on completing a gas pipeline project with neighbouring Pakistan? While the project is being considered seriously by the energy hungry Pakistanis, it will in any case take a relatively long time before the pipeline is completed.

At the same time the judiciary, controlled by Ahmadinejadís enemies, continues its campaign against close associates of the President: In January Ahmadinejadís aide Javanfekr was sentenced for having offended the Supreme Leader, although it was never clear what he might have said or done. It does not help his cause that Ahmadinejad had decided to confront openly his conservative rivals in the parliamentary elections, fielding his own slate of candidates.

The parliamentary elections of early March were in many ways a foregone conclusion: Ahmadinejadís supporters knew they would be targeted by the clerical conservatives, who control the vetting bodies in charge of determining who is qualified to run for election, so they did not try very hard to compete. Only the Monotheism and Justice Party compete, a relatively minor group. Hit hard by the vetting, it secured a modest 6.6% of seats (15 of those elected in the first round). It was the two main clerical-conservative factions, which took the bulk of the seats, the United Principalists Front, which wrapped up 76 seats in the first round, and the Front of Islamic Revolution Stability, a more hardline group which took 37 seats. Peopleís Voice, a group of moderate conservatives, took 13 seats. The reformists, despite being also heavily targeted in the vetting process, managed to elect 55 members of parliament in the first round, not a bad outcome given the situation and the fact that many reformists advocated a boycott. Moderate reformists got four seats. Supreme Leader Khamenei has consolidated his influence within the parliament, but the obviously heavy handed manipulation of the vetting process has further discredited the way the Islamic Republic selects its leadership, and weakened even more its legitimacy. Because of the dubious character of the victory, Khameneiís supporters stress the importance of the high participation rate, reported as 65%, although doubts have been cast on the genuine character of the voter turnout figures.

With the announcement of the results of the second round of Iranís parliamentary elections in May, the early indications of Ahmadinejadís defeat were confirmed. The reformists improved their position and obtained about 35% of the votes, gaining 24 seats to reach a total of 75. Among the conservatives, the pro-Ahmadinejad groups only got 17 seats, with anti-Ahmadinejad conservatives dominating the scene. This does not reflect the real extent of popular support to Ahmadinejad, however, as his candidates were mostly banned from running. Now with Supreme Leader Khamenei almost in full control, theories of who between him and Ahmadinajad is really pushing for a confrontation with the west, are soon going to be tested.

If he wanted, Khamenei might now proceed to eliminate the figure of president, elected by popular vote, and replace that with a prime minister selected by the parliament. This would avoid future clashes between the Supreme Leader and a president, whose popular election implies a strong element of unpredictability. This, however, will again upset many and damage what is left of the credibility of the Islamic Republic. Like the heavy handed manipulation of the elections, it seems to reflect Khameneiís own anxieties about his lack of religious legitimacy as supreme leader.

President Ahmadinejad shows in any case no sign of seeing himself as terminally weakened. Shortly after the elections, he established a Supervisory Committee for the constitution, a clear challenge to the role of the Guardian Council, which plays a similar supervisory role. Paradoxically, such a Committee had already been established by reformist president Khatami years ago and Ahmadinejad had abolished it when he became president, claiming that it was unnecessary. Now Ahmadinejad says that he has changed his mind, but the Guardian Council has made clear that it is against the new body.

Needless to say, Ahmadinejad and Khamenei continue their private war at the top of the Iranian state. April saw the investigation of Said Mortazavi, a prosecutor close to Ahmadinejad, for alleged mistreatment and torture of demonstrators in 2009. Khamenei would therefore seem to be starting to court the reformers, in an effort to further isolate Ahmadinejad and cast him as the scapegoat for all that does not work in the Islamic Republic.


Forecast and summary 2011
Iran entered 2011 with Ahmadinejad seemingly still in a solid position, despite his growing political isolation. How many Iranians see themselves as primarily linked to a political faction? It is hard to say, but the absence of firmly established political parties means that political sympathies are quite fluid. Ahmadinejad clearly has a base of support in the rural areas and among the poorer sectors of the population. Will it be enough to keep him going? Much depends on how far he is ready to push his confrontation with Washington. This game of brinkmanship might end in a resounding success, with Teheran becoming a nuclear power and forcing the western powers to come to terms with it, or in a disastrous failure, with Iran becoming the epicentre of a new regional war. After all, in less than two yearsí time the US might have a new Republican president, just in time to intervene before Iranís nuclear weapons approach readiness!

The pressure exercised on Iran through the sanctions will not per se crush Ahmadinejad, or force him to bow to it, but it certainly has been creating trouble for him. His judgment is now questioned even by a majority of his fellow conservatives; in 2011 Ahmadinejad will very likely continue his efforts to build up a new conservatism in Iran, less clerical and more nationalist (which the Ayatollahs have spotted and voiced their disapproval). Apart from being a better fit for him, it would also make him increasingly autonomous from the wider conservative tendency.

The success of popular demonstrations in Tunis and Egypt injected a new lease of life in the Iranian Green Movement, which had completely petered out several months ago. Hundreds of thousands then hit the streets again, forcing the regime to clamp down on external media, targeting satellite dishes and the internet, as well as to issue threats of violence and even of executing the leaders of the movement. This reaction suggests that the Islamic Republic is not entirely confident that the Egyptian contagion will not hit Iran as decisively as it has been hitting the Arab world. It is hard to believe, however, that the regime will be betrayed by its own armed forces, which are more ideological than the Egyptian or Tunisian ones, particularly the Revolutionary Guards, and have a lot to lose from a change of regime. There are some rumours that some high rank officials of the Guards are increasingly critical of the regime, but this is impossible to confirm for now. Some observers believe that the regime has been shocked by the size of the demonstrations, at a time when it seemed that the opposition had been definitely defeated. Some also believe that the Iranian working class, hit hard by the recent cut in subsidies, might join the Green Movement this time, adding a whole new thrust to it. Ahmadinejad had presented himself as the paladin of Iranís lower classes in his early years, but the subsidy cuts respond more to a logic of economic nationalism.

For the time being the renewal of the Green Movement has not reunified the different conservative factions. At the beginning of February the parliament voted to impeach Transport Minister Hamid Behbahani, following yet another air crash. President Ahmadinejad resisting the move, accused the parliament of political interference and has reappointed Behbahani as caretaker. Just a few days earlier the same parliament had approved Ali Akbar Salehi as foreign minister, replacing his predecessor who had been sacked by the President without warning last year; Salehi is seen as a close ally of Ahmadinejad and his approval had seemed to signal better relations with the parliament: clearly a premature conclusion. The parliament feels that Ahmadinejad does not respect its prerogatives and wants to play a bigger role, despite Supreme Leader Khameneiís warnings that executive and legislative branches of the state have to cooperate; perhaps more importantly Parliamentary Speaker Larijani, who has been harbouring presidential ambitions for some time, is keen to discredit Ahmadinejad as much as possible. There have been also reports that US intelligence sources have identified divisions within the Iranian leadership, between those who fear sanctions could weaken popular support for the regime and stimulate popular protest.

The most important development in the first three months of 2011 was the ousting of Hashemi Rafsanjani from the leadership of the Assembly of Experts. The candidacy of arch-conservative Mahdavi-Kani received majority support from the 86 members of the Assembly (about 50 reportedly expressed support for the cleric) and Rafsanjani opted to withdraw his candidature to re-election. Rafsanjani however continues to lead the Expediency Council, another important organ of the Islamic Republic. Ahmadinejadís relations with other conservatives remains however edgy; in March he narrowly avoided (by one vote) another one of his ministers being impeached, energy minister Majid Namjou.

Tension between Ahmadinejad and the Iranian clerical establishment reached a new height in April, when the President sacked intelligence minister Heidar Moslehi against the advice of Supreme Leader Khamenei. The Supreme Leader then ordered Ahmadinejad to reinstate the minister, but Ahmadinejad resisted. A large majority of members of parliament came out in support of the Supreme Leader, affirming that Ahmadinejad had to obey his order. The dispute goes beyond the minister himself: he clashed with Ahmadinejad over his sacking of his deputy Abdollahi, who is close to one of the key advisers to Ahmadinejad, Chief of Staff Esfandiar Rahim Mashaei. The latter represents the revolutionary/nationalist line of thinking within the Iranian regime, arguing that the ideology of the regime and Iranian national identity takes precedence over Islam and therefore intellectuals matter more than clerics; Mashaei has been accused by other conservatives of wanting to challenge the authority of the Supreme Leader. Eventually Ahmadinejad had to give up on Moslehi, and even demote Mashaei by dropping him as Chief of Staff (Mashaei maintains other less important functions within the government). Previously Khamenei had already intervened to prevent Ahmadinejad from choosing Mashaei as his vice-president after his re-election.

After the clash with Supreme Leader Ahmadinejad last month over the sacking of Intelligence Minister Moslehi, Ahmadinejad even refused to attend cabinet meetings for two weeks and refused to acknowledge the reinstatement of Moslehi. Ahmadinejadís ally Mashaei, is now being targeted by the Supreme leader and is being accused of sedition; some of his supporters, who propose a line of Iranian nationalism and relative anticlericalism within the Iranian regime, have recently been arrested under the accusation of exorcism; among other things Mashaei says that the return of the hidden Imam is imminent, a messianic point of view that the clergy reject. Mahsaei is believe to harbour presidential ambitions and might be trying to manoeuvre to attract support from the reformist opposition; his anti-clerical message might have some appeal in the absence of a genuine reformist candidate. This month the row continued when Ahmadinejad sacked three senior ministers, believed to be opposed to Mashaei: oil, welfare and industries and mines. A day earlier Ahmadinejad seemed to have accepted mediation over the issue of merging eight ministries, including the ones of the three sacked ministers. Then he struck with the sackings. He also appointed himself caretaker Oil Minister, which might have taken him to preside over the next OPEC summit. On the whole, the rising confrontation with Khamenei seems to be taking the profile of a serious political crisis.

As a result of Ahmadinejad's unresponsiveness to the Parliament, a majority of members of Parliament filed a compliant to the judiciary against him, accusing him of illegally delaying the appointment of ministers. The Parliament is definitely on the war path against Ahmadinejad. In May a close associate of the President, Vice-president Mohammad Baghaei, was banned for four years from any state job, under the accusation of Ďmisusing state assetsí. Then in June deputy foreign minister Mohammad Sharif Malekzadeh was dismissed because the Parliament opposed his nomination. The Minister of Foreign Affairs, Ali-Akbar Salehi, tried to insist on his appointment, but himself risked impeachment by the Parliament. Although there are allegations of corruption and misconduct against Malekzadeh, most observers have no doubt that his dismissal is part of the power struggle within the regime. Supreme Leader Khamenei appears to be using the parliament to send messages to Ahmadinejad, that his prerogatives as Supreme Leader should not be touched. Foreign affairs is one of the ministries considered to 'belong' to the Supreme Leader and Ahmadinejad has claimed it for himself.

Many believe that the parliament is ready to impeach Ahmadinejad; what is preventing this from happening is the fact that Supreme Leader Khamenei has not made up his mind yet in this regard. Khamenei is no longer supporting Ahmadinejad unconditionally, as he did in the past, but seems to believe that impeachment could be a trauma that the Islamic republic cannot afford. He appears to be trying to force Ahmadinejad to play by the rules. Former President Rafsanjani advocates Ahmadinejad's removal as a way to recreate national unity and ultimately save the regime, but his influence has been in decline for quite some time. The reformists are now lying low, hoping that the conservative split will deepen and lead to a collapse of the ruling coalition. Then the reformists would stand a chance of re-emerging as a strong force. It is not clear however when Khamenei's patience will run out, or even whether Ahmadinjad can be restrained or not.

Former President and leading reformist Khatami recently hinted in a speech to the war veterans that given certain conditions the Reformists would be ready to go back to politics and take part in the next parliamentary election. Another reformist, Ali Mazru'i, even spoke of a reconciliation between the Green Movement and certain factions of the 'Principalist' conservatives. The thinking is clearly that with the growing gap between Ahmadinejad and Khamenei there might be a chance for the reformists to drive a wedge in between and be admitted back into the political game. More radical reformists are however incensed by what the moderates are saying and even accuse them of betraying the democratic movement. Khatami had to backtrack in public, but the message was launched.

Khamenei, apparently out of distrust towards Ahmadinejad and his cronies, has transferred much of the nuclear programme from the Defence Ministry to the control of the Revolutionary Guards. Ahmadinejad too is trying to bring the Revolutionary Guard into government and therefore increase their power. After ventilating the idea of appointing his former aide Mohammad Aliabadi as Minister of Oil and receiving warning signals from Parliament that it would be war, Ahmadinejad seems now to be going to appoint in that position Rostam Ghassemi, a member of Iran's Revolutionary Guards Corps and commander of the IRGC Construction Camp. Ghassemi at least is technically a more credible candidate than Aliabadi.

The emergence of a major bank scandal in Iran is turning into a tool of political infighting. A branch of the Saderat Bank has been caught in a US$3 billion fraud, which has involved another seven banks as well. This is reportedly the largest case of embezzlement in Iranian history. Investigations have been going on for several months and the contours of the case are not clear. What is clear is that some political commentators and conservative politicians are using the case to hit out at Ahmadinejad, accusing the government of involvement in the scandal, and in particular Ahmadinejadís ally Mashai, a pet hate of the so-called 'principalist conservatives' because of his unorthodox views. Although Ahmadinejad has sided with Mashai and defended him from the allegations, the President has clearly been weakened by the campaign. The fact that the scandal only started being discussed in public recently, despite having been long ongoing, and the unusual step of washing the Islamic Republicís dirty laundry in public, all suggest that the conservatives have deliberately chosen to attack Ahmadinejad on this front. The President after all had campaigned against the economic interests of some of the conservative groups, and their corrupt practices. Transparency International however does show a dramatic worsening of corruption in Iran under Ahmadinejad, with the countryís ranking falling from place 58 to place 180.

Despite these deep divisions among the conservatives, the reformist opposition lacks leaders and a strategy and is being very ineffective; not even the impulse of the Arab Spring has managed to kick-start the rise of the opposition. That allows the regime to claim immunity from the wave of turmoil which is investing the region and cast itself as a regime of a different breed from the waning Arab dictators. In September the Iranian regime appears to have given up hope that its key ally Syria could emerge unscathed from the crisis that started months ago; high level Iranian officials have been issuing statements concerning the need for reform in Syria and the need for President Assad to listen to the people. Clearly the Iranians are worried about their deteriorating image in the Arab world. Opinion polls, for what they are worth, show a decline of the popularity of Iran, to the advantage of Turkey, within the public opinions of the Middle East.
These developments do not seem to imply that Iran is about to adopt a more moderate foreign policy, even if among the Iranian conservatives many believed that Ahmadinejad has in mind some deal with the Americans. In September the Iranians have announced the transfer of its uranium enrichment activities in a new location in Fordo, where they would be better protected against an external attack.

The Israelis believe (2011), that following some technical problem with the nuclear programme, an Iranian atomic bomb might still be 3 years away. 2014 curiously enough was the CIA predicted date during the Bush/Cheney administration and viceĖpresident Cheney, building up with the Israelis the imminence of an Iranian bid to take over the world (read the Iraq playbook), went ape at US Intelligence shooting his fox. At the time, some observers like us, thought that given the chaotic Iraq invasion discovering no WMDs being blamed on faulty intelligence, the CIA pre-emptively got the word out about Iran as they did. Indeed one wonders if the same phenomenon might be in play in Israel. The prediction that Iran was three years away from a nuclear weapon came from the retiring chief of Mossad. No doubt they too were embarrassed when no WMDs were found in IRAQ. Israelis are not all hawks, even if that is how they are often portrayed.

The Americans now believe that Iran has achieved the ability to produce highly enriched uranium, as required for the production of weapons. Now the focus of the effort to slow if not halt the programme is shifting towards preventing Iran from having access to other, important components such as centrifuges. It is believed that many of Iranís first generation of centrifuges have been retired and that the model being used (of Pakistani design) has proved unreliable. If Iran could be prevented from developing a new, more advanced generation of centrifuges, the whole programme could be slowed considerably. Carbon fibre in particular is one centrifuge component that the Americans have been targeting for some time, trying to prevent it from reaching Iran. Another school of thought insists that clever Israeli geeks, or US hackers employed by the Pentagon for cyber-warfare, or both, had sabotaged the programs of Iranian centrifuges and that this is the cause of the delay. If that is true than it would be logical to expect reprisals from clever Iranian hackers!

However, at the current rate of progress, even by then negotiations over a civilianisation of the nuclear programme might not have made much progress. The last Istanbul talk with the Western powers in January did not achieve anything. Iran insisted that it wants to enrich uranium and instead wanted (embarrassingly), to use the occasion to discuss Israeli nuclear weapons, which automatically puts the Americans on the back foot, since there is probably nothing they can say.

Meanwhile, Western powers are discussing additional sanctions to be developed outside the UN framework, where Russian and Chinese opposition would make it difficult to achieve an intensification of the sanctions. The talk is of more financial sanctions and also sanctions affecting the oil and gas sectors. Incidentally the latest economic data shows that in January inflation continued to rise, reaching an annual rate of 10.8%, compared to 10.1% for the year to December; this was largely expected because of the massive subsidy cuts. For the time being the net around Iran is not tight enough to prevent Teheran from scoring a few goals. Most recently an agreement was signed with neighbouring (FSU) Armenia, with whom they share a short frontier, to build a pipeline and supply oil to the trans-caucasian country. Ahmadinejad reacts to the internal trouble by re-launching his strategy of provoking international condemnation and using that to mobilise Iranian national sentiments behind himself. Most recently it was announced that he was to send a couple of warships through Suez into the Mediterranean, superficially to visit Syria. Obviously it attracted Israeli protests, but as we pointed out in our March Overview, Israel had done exactly the same thing not long ago, sending two warships in the opposite direction through the canal into the Red Sea, and on another occasion an Israeli submarine made a return trip.

Perhaps the recent reluctance of the US to get involved in Libya is encouraging the Iranians to think that they in Iran can make it. Recently Iran has started replacing its old and primitive centrifuges with more advanced ones, which will allow for faster productions of enriched uranium. Some intelligence agencies now believe that President Ahmadinejad is pushing to break open with an announcement that Iran is going for nuclear weapons. The intelligence community, however, is still divided on the issue and many believe that Ahmadinejad is in fact relatively moderate on the nuclear issue, compared to Supreme Leader Khamenei. Yet others still however believe that Khamenei himself is very worried about the implications and consequences of Iran going nuclear. The Iranians continue sending signals that are open to interpretation that the nuclear programme is effectively an effort to force Washington to talk to them. According to a recent statement of Iran's Foreign Minister Ali Akbar Salehi, what the Iranians want is Washington agreeing to negotiations among equals and without preconditions.

If Ahmadinejad can contain his own enemies at home, he also faces the welcome prospect of a friendlier Middle East in the foreseeable future; if the promise of free elections in Tunisia and Egypt are kept, governments influenced by Islamist parties are likely and Iranís stance on Israel and hostility towards the US might be more appreciated. Another benefit for Ahmadinejad is that he can now easily point to Western double standards in dealing with Arab revolutions: intervention in Libya against a dictator, silence on the repression unleashed by the Yemeni and Bahraini dictators. Bahrain, with its Shiite majority being at the centre of social mobilisation and with Saudi troops deployed to prop up the regime, now handing out Life sentences to protestors is perfect for Ahmadinejadís propaganda. Iran will probably try to stir up trouble in Bahrain, if it can, and it is openly encouraging the opposition to resist the bloody crackdown. Of course there is a high degree of hypocrisy in Iranís condemning the brutal treatment of street protestors in Bahrain when Iran itself is probably the worldís worst culprit at this time, in the violent repression of street protest and the torture and killing of those that it arrests.

Until now, pro-Iranian sentiment among the Bahraini Shiites has been minoritarian, but a radicalisation of opposition might occur now. At the same time the task of Iranís internal opposition gets more complicated. Ahmadinejad in any case took no chances and cracked down on the Greens leadership even before the Saudis deployed to Bahrain, turning house arrest for Kharrubi and Moussavi into full detention.

Forecasting the Iranian economy is particularly difficult because of issues with the reliability of the data. The IMF forecast for the final 2010 GDP growth data is 1.6%, which is expected to rise to 3.1% in 2011. This will be mainly due to rising oil prices; the Iranian government continues to announce discoveries of new oil and gas fields, but its data about recoverable oil and gas are a bit suspect given the lack of foreign investorsí involvement. It is not clear whether Iran and its few remaining foreign friends have the capacity to exploit the new fields. The end of the fuel subsidies regime in Iran turned to be smoother than expected, without major disorders. The savings made by the Iranian government might not be the originally planned US$70 billion, due to the decision to use Iranian petrochemical plants to produce gasoline, but they are nonetheless substantial. What seemed to be an impossible task might therefore have been achieved. The immediate rationale is to defeat the sanctions regime, but the gains would go much beyond that if it is sustainable, freeing massive resources for investment. Following the subsidies cut, consumption reportedly fell from 61 million litres a day to 52-53 million litres, reducing the impact of sanctions on Iran considerably. In fact the Iranian government claims that it no longer needs to import any fuel due to the combined impact of reduced consumption and increased internal production. Teheran has also been using a series of tricks to remind the west of its potential for bringing disruption to its vulnerable neighbours. It blockaded fuel supplies to Afghanistan in January, creating a crisis in its eastern neighbour; it despatched Muqtada As-Sadr back to Iraq to campaign against the US for a couple of weeks, before he returned to Iran. Ahmadinejadís determination to greatly reduce the almost US$100 billion which Iran spends on subsidies of various kinds has been such that even the chief of the IMF, Strauss-Kahn, had to praise the Iranian government for its achievements, according to Iranian government sources [if we were plot-sniffers what could we make of that?] As of April 2011, the Iranian government had already cut subsidies by US$20 billion, with another US$5 billion to be cut in the next financial year. Ahmadinejad was given two years to implement the US$20 billion cut, but he implemented the cuts straight away in the first year. His original plan was to cut at last twice as much in two years, but the parliament forced him to slow down. In reality Ahmadinejad has kept going much faster than agreed. However, in his tug-of-war with the Iranian parliament, Ahmadinejad recently suffered a major defeat when the latter voted to extend welfare payments (meant as replacement of the subsidies) to virtually the whole population, whereas Ahmadinejad had meant to limit them to the poorest strata of the population. This means that monthly welfare payments are now estimated at US$2.9 billion/month, exceeding the value of the cuts made so far. The government is therefore expected to reduce entitlements soon, cutting off the middle classes from the benefits.

Imports of refined fuel are down 95% and Iranís dependency on fuel imports is down from 40% before the slashing of the subsidies to 5% today. Because Western sanctions against Iran were focused on fuel imports, identified originally as a major Iranian weak spot, this success of the Iranian regime in reducing imports and ramping up internal refining has reduced much of the impact that the sanctions might have had. Although there are now twice as many vehicles in circulation as in 2006, daily consumption of gasoline is down from 76 million litres to 60 million.

The IMF continues to issue endorsements of the economic policies of the Ahmadinejad government. The latest forecast sees inflation coming down to 12.5% next year after having risen rapidly this year. By the end of 2011 inflation is expected to reach 22.5% and then come down. Once the subsidies system has been stabilised, inflation could be coming down further to reach 7% in 2013, according to the IMF. GDP growth in 2011 is forecast at 2.5%, not too bad considering the international economic environment, while GDP could reach 3.4% in 2012.

For what they are worth, Iranian official statistics do not suggest a country on its knees because of economic sanctions. The Teheran stock exchange index rose 86% over the last year, while trade with Asian countries burgeoned, with imports up 15% and now accounting for 61% of all Iranian imports, against 34% for Europe. Teheran also claims to have increased its exports of petrochemical products from US$6.5 billion to US$8.6 billion last year, a 30% increase. The Iranian government tries to project an image of self-confidence and optimism by continuing to announce the discovery of new oil fields all the time. The most recent announcements in May concerned the discovery of five fields, for a total value of 5 trillion cubic feet of gas and 500 million barrels of oil. However, no detail whatsoever over the new discoveries was distributed, reinforcing the feeling that there might be some manipulation involved. What the government is less keen to discuss is the mess that the replacement of the subsidies system with a welfare system is turning into; or the state of the banking system. The Iranian banking system struggles with under-capitalisation and is afflicted by a mountain of bad loans, estimated at 20% of their capital. From this point of view there is little difference between state and private banks, which in any case have been taken over by the foundations linked to the regime. The exception is represented by a few new private banks, which have emerged recently.

The Iranian government acknowledges that it needs to invest US$48 billion in the oil and gas sector. The South Pars gas field alone is said to need US$16 billion and Iran will prioritise it in terms of investment, because it is shared with Qatar and any delay in extracting gas from there means that Qatar will extract more at Iranís expense. The government wants to increase oil production to 5.2 million bpd from the current 3.92 million and has recently announced that its estimated reserves stand at 158 billion barrels, up from the 150.3 billion estimate of a year ago. The government also plans to more than double the gas output, to reach 1.2 billion cubic meters annually at a cost of US$38 billion by 2014-15. The problem is that Iran continues to struggle in reaching agreements with even the most friendly of foreign investors. It recently cancelled a deal with Russian Gazprom over the Azar oil field, which is shared with Iraq. The reason appears to be that Gazprom was delaying negotiations in order to obtain better conditions, but Iran knows that delays in developing oil field shared with its neighbours cost output. Similarly for the North Pars gas field, a contract with Chinese CNPC was suspended in retaliation for the same companyís slow progress in South Pars, shared with Qatar.

The petrochemical sector continues doing badly, because the government prioritises internal consumption over exports and therefore does not feed enough gas and oil into the petrochemical industry, whose capacity is 30% under-utilised. The main problem with the petrochemical industry is however bad management. President Ahmadinejad replaced Mohammad-Reza Nematzadeh as its manager, despite his outstanding record, and replaced him with his own associates, none of them showing much success in developing the industry. One of the latest ideas is to start producing jet fuel, which should start within a few months.

It is not only the oil and gas sector which suffers from the sanctions. The steel industry is the object of an ambitious government plan to expand production to 50 million tons of steel by 2015, so that the country could export a substantial amount. Instead, at the moment because of the sanctions making it difficult to replace spare parts and buy new machinery, production is just 11.9 million tons, not even enough to meet internal demand (18 million tons).

In July inflation reached 16.3%, up from 15.4% a month earlier. The continuing rise of inflation is a worrying aspect of Iran's economic predicament, but quite a few external observers believe that all in all the Iranian regime has managed its plan to reduce subsidies quite successfully. Inflation rose by 6 percentage points overall after the scrapping of the subsidies, which is less than what most economists had predicted. At the same time, thanks mainly to the increased oil revenue, GDP growth has accelerated to 3.2% in the last Iranian financial year, a good result compared to the 0.6% growth recorded in 2008-9. The main benefits of cutting subsidies worth 15% of GDP should be seen in the future, in terms of improved economic efficiency. The abolition of the subsidies should lead this year to flat GDP growth, but the rewards would come in 2010 with a forecast 3% growth. The IMF forecast is that inflation will continue to accelerate and reach 22.5% this year, before falling back to 12% in 2012. Among the first effects of economic reform, some observers see a revitalisation of small towns thanks to the new welfare system, benefiting the lower classes.

Iranís oil exports seem safe for now. China has renewed its oil import agreement with Iran, maintaining import levels at 460,000 bpd. Banking sanctions are making it difficult for European buyers to have access to Iranian oil, but some companies, like Italyís ENI receive Iranian crude because of their investments in Iran. Also some Russian and Chinese banks trade with Iran and allow Iranian exports of oil. In total, Europe receives only about a quarter of Iranís exports; almost another quarter goes to China and the rest to a range of Asian refineries. India, second only to China among buyers, is still locked in a payment row with Iran and it is not clear whether it will renew its deal; Indian refinery sources say that supplies of Iranian oil have not been disrupted and that the intention is to continue buying Iranian oil, probably using banks not concerned by the sanctions regime. South Korean and Japanese buyers reduced purchases last year but it is believed that they will not further reduce it this year. The Chinese however do not have the advanced technology that Iran needs to keep its oil fields efficient; official sources acknowledged recently that oil production dropped by 25,000 bpd in the last year, while external observers believe that the drop might have reached 400-500,000 bpd over the last six years.

Ahmadinejad knows that he is soon going to benefit from rising oil prices: oil revenue for the current year is expected at US$80 billion. Certainly Ahmadinejad would be able to fix a few at least of the economic problems affecting Iran, with that new cash. Ahmadinejad presented his budget for the coming Iranian year to the parliament in March. He proposes a massive increase in expenditure, particularly investments to reduce Iranís dependency on oil revenue. From US$368 billion in the previous year, the budget should rise to US$539 billion, including state-affiliated companies. Ahmadinejad claimed that under his leadership Iranís non-oil exports have already increased from US17.7 billion in 2008-9 to an expected US$30 billion this year.

Iran's aggressive tactics within OPEC (in alliance with Venezuela), derailed the June meeting of the organisation. The Saudis, who were demanding a rise in production, saw their proposal rejected and derailed the meeting as a reaction. With no quotas agreed, the Saudis are actually free to increase production as they see fit. If Saudi proposals for adding 1.5 million bpd to production had been accepted, the extra production would have been distributed among all OPEC members. This way, they will almost all come from Saudi Arabia itself. Therefore, the Iranian victory might be a very temporary one. Iran's aggressive tactics are however not as foolish as they might seem. The Iranians oppose higher production levels also because they are already producing all they can, in contrast to the Saudis who can add over 1 million bpd. President Ahmadinejad certainly has plans for the country's oil industry; in June he appointed a close loyalist as caretaker Minister of Oil, despite that fact that he had been rejected by the Parliament as Minister of Transport and that he has no experience in the oil industry.

Although the sanctions are being felt, Iran is trying hard to maintain clients for its oil and gas exports. The friction with India over its failure to pay for its oil is being resolved after the Indians found a new way to route payments to Iran, through Turkey. The two countries have even discussed the possibility of India paying for its purchases with gold. The Pakistanis seem to have determined that the easiest route to cheap energy is Iran and are now trying to mobilise the resources necessary to building a gas pipeline with the western neighbour. More in general the Pakistanis seem intent on improving their ties to Iran, probably as a reaction to worsening relations with Washington. The Indonesian government now says that it is ready to import liquified gas from Iran. Indonesia is already importing oil and gas from Iran and its imports have more than doubled in value over the last two years. Trade with the UAE has also been expanding dramatically in the wake of the sanctions, with much of the US$15 billion worth of trade between China and Iran now going through the UAE. The sanctions have favoured the expansion of the black market, rather than reducing the volume of trade. Iran has also announced that the Kish International Commodity Exchange, Iran's oil and gas bourse, has concluded its first contract after having opened in July. The shipment of 500,000 barrels of crude follows three previous failed attempts to sell crude in Kish. The main characteristic of the bourse is that it does not trade in dollars, but primarily in Euros, Rials and some other non-US$ currencies.

The Iranian Rial is fluctuating rather wildly against the dollar; just in 2011 it has moved between 10,700 and 12,500 to a dollar. The fluctuations are the result of the market being increasingly undersupplied with foreign currency. An indicator of the economic difficulties of the regime can be found in some recent initiatives of Supreme Leader Khamenei. He has been urging the press to report positively about the economy and avoid discouraging news. He also published a plan to fight unemployment. The plan is nothing radical, rather a series of prescriptions on how unemployment could be contained with a series of technical improvements. It is unlikely that such improvements would be enough and more importantly their implementation would imply that the ineffective Iranian bureaucracy is turned around and becomes much more capable. NaÔve thinking perhaps.

 

Background:
Known as Persia until 1935, Iran became an Islamic republic in 1979 after the ruling shah was forced into exile. Conservative clerical forces subsequently crushed the westernising liberal element. During 1980-88, Iran fought a bloody, indecisive war with Iraq over disputed territory, which caused large-scale damage to its economy. The key current issue is how rapidly the country should open up to the modernising influences of the outside world, with a conservative faction in control of some key institutions, such as the Council of Guardians, and a reformist faction centred on elected President Khatami. 

Summary for 2002 

US and Iran 

Despite the apparent improvement in the relations between the US and Iran, which had followed the 11 September terrorist attacks, by January 2002 the tension between the two countries had reached new peaks. President Bush accused Iran of being part of an "axis of evil" together with Iraq and North Korea and asked Iran to stop meddling in the internal affairs of Afghanistan and developing weapons of mass destruction. While the Iranian leadership had good reason to be worried about the intensification of American hostility, the Bush administration was clearly not planning any direct action yet. By July, however, with his call for "reform from below", President Bush appeared increasingly interested in fomenting a revolt against the Islamist regime. There are clear signs that the ruling elite felt seriously threatened and feared at least a tightening of the embargo. It seems that at least part of the several billion US$ that returned to the country during 2002 was made up of the gold reserves of the government, previously held by European central banks. By mid-May even the reformist President Khatami felt that he had to take a strong stance and warned the US administration against "threatening, insulting and humiliating" Iran. As a reaction to growing American pressure, Teheran strengthened its efforts to improve its relations with its Muslim neighbours, such as the Central Asian countries, Azerbaijan and even Saudi Arabia. The reformist government of Iran remained in reality keen on improving relations with the US. During 2002 it gave out plenty of signals pointing in this direction. Among them, not only it stated that it was ready to accept a new, tougher resolution on Iraq and collaborated to enforce a stricter embargo, but also took the unprecedented step of declaring that a two-states solution is acceptable for Palestine, so long as the Palestinians accept it. Even the conservatives, who dominate a number of key institutions, first and foremost the Council of Guardians, and count among their members the Supreme Spiritual Leader, Ayatollah Khamenei, were not uniformly hostile to improving Iran's relations with the US, at least not at all times. Some of them argued that such an improvement would make it easier to maintain the status quo internally. Supporting a US war against Iraq could be a suitable way to buy American acquiescence for the lack of internal reforms. The majority of the conservatives, in any case, maintained at least on the surface a strong opposition to reconciliation with the US. Even if the reformists were willing to acquiesce to US war plans in neighbouring Iraq, they feared that in the event of a war its economy would suffer severely, not least because of a likely massive influx of refugees. The possibility of Kurdish nationalism being strengthened by a war in Iraq was also seen with apprehension in Teheran. On the whole, the Bush administration did not openly respond to hints coming from conservatives that a deal might be possible, but the press suggested that it might actually be considering to enlist some help from Iran. For sure, as the international attention turned to Iraq, from October Iran was spared the war of words that had afflicted it during the previous months. In any case, as the end of 2002 approached, the Bush administration maintained that it would welcome an internal overthrow of the Iranian regime. Iran and the rest of the world. The main tool in the hand of the US administration for exerting pressure on Iran is increasing its isolation from the rest of the world, in particular Iran's neighbours and trading partners. During 2002, it appeared clear that the largest economies were the least likely to bow to the pressure. The European Union in particular decided to actually expand its ties to Iran. After some initial anxiety, the EU announced in July its readiness to develop closer commercial ties with Teheran, although conditionally on Iranian willingness to discuss such issues as nuclear proliferation, terrorism and human rights. There have been delays in the negotiation of deals with Russia and Japan in the oil, nuclear and defence industries, but in the end both countries looked intent on continuing their flourishing trade with Iran. The main danger to Iran could have been that Russia could soon be lured towards a more pro-American stance in exchange for economic concessions, which might include forgiving Russia's Soviet era debt in exchange for the termination of nuclear cooperation with Iran. The fact that Russia and Iran developed diverging ideas about how to deal with the resources of the Caspian Sea might have contributed to push Russia away from Iran. President Putin, however, opted instead to strike a delicate balance between continuing Russia's lucrative trade with Iran, while at the same time doing his best to appease American fears of Iranian interest in weapons of mass destruction. By December, Iran responded by showing some more willingness to tackle the issue of the Caspian Sea resources.

Economic performance
Apart from the international tensions, the economic and political situation of Iran remained highly uncertain throughout 2002. The development of oil extraction in Iran was negatively affected by project delays and by some flaws in the buy-back deals negotiated with the international investors and it increasingly looked doubtful whether Iran could succeed in increasing its production to the levels planned. A failure would have very negative consequences for the economic stability of the country, due to the rapid growth of internal consumption of oil, which was expected by some analysts to match the volume of exports as early as in 2002 itself. Petrol is sold within Iran at heavily subsidised prices, with a litre costing to the Iranian motorist just $0.063, which encourages therefore high consumption levels and waste, only makes the matter more urgent. The non-oil sector of the economy showed little sign of development in 2002. After having expanded rapidly in the early 1990s, following the adoption of an export-led growth strategy by the government, Iranian non-oil exports have stabilised at around US$5 billion. The economy, dominated by an inefficient public sector and by the notorious foundations, simply demonstrated that it lacked the dynamism to exploit the opportunities offered by the new policy. The free trade zones, set up in the past, have so far failed to generate productive economic activities and are mostly being utilised for import/export activities.

Economics and demographics of a latent crisis 
If the debate about the chances of success of Iran's plan to expand its oil production was still undecided at the end of 2002, there has never been any doubt that the Islamic Republic cannot afford a failure. Although the birth rate has been brought down to manageable levels in recent years, the baby boom generation is beginning to join the workforce, causing a terrible headache to the government. With 5.5 million high school certificate holders expected to join the job market in 2002-2005, the government needs to create more than 1,300,000 new jobs every year to prevent an increase in the unemployment rate and keep the population happy, but in 2000/2001 it succeeded in creating just 400,000. To generate the required amount of jobs, Iran's economy should grow at the yearly rate of 12%. Economic growth reached 4.5% in 2000/2001, short of the 6% target but still not a bad achievement when judged by the standards of Iran's performance over the last decade. In 2001/2002, which according to the Iranian calendar ended on 21 March, low oil prices and a cut in production ensured that growth was lower, around 3.5%. In 2002-2003 very favourable circumstances, including most of all an increase in oil prices, contributed decisively to strengthen economic growth, now expected to reach 6.4%. Many Iranian businessmen, faced with poor performances in the American and European markets, moved their assets back to Iran, which on the other hand has reduced taxes and has approved a more friendly foreign investment law. It is estimated that private funds account for a large part of at least US$7 billion which have gone back to Iran in 2002, underpinning among other things a very good performance of the Teheran stock exchange, which became one of the world's best performing, up by 30%. However, even such as performance will not be enough to cure Iran's economic ills. Moreover, during the early months of 2002 the negotiations with potential investors in Iran's oil and gas industry took a negative turn, although there were signs of improvement towards the end of the summer. In 2002 a wave of financial scandals hit executives of some Iranian oil companies involved in partnerships with foreign investors and Iranian officials showed a marked tendency to delay negotiations, fearful of attracting the attention of a judiciary which is closely aligned with the conservative faction. International investors, on the other hand, became increasingly wary of investing in the Iranian market, in particular as they began to feel that it might be possible to extract better conditions. Only state-owned companies, such as Norwegian Statoil, continued to sign contracts with the Iranian government. Starting from May there were indeed some signs of a growing willingness to offer more appealing conditions to foreign investors, as the chairman of the parliamentary energy committee, Hossein Aferideh, proposed to lengthen the buy-back contracts which represent Iran's approach to reaching agreements with international investors. At present, buy-back contracts last five to seven years, which is considered too short by many players in the oil industry. In 2002, the situation of the oil industry was compounded by an extensive program of well maintenance and by a series of strikes in the industry, which resulted in an estimated 8-9% decline in exports of crude Iranian oil. It is significant, however, that one of Iran's newest gas clients, Turkey, successfully bargained for lower prices after being offered a substantial discount by Russia. Russia's increasingly aggressive marketing practices might cause more problems to Iran in the future, as it continues its efforts to penetrate the European market.

Foreign investments and internal politics 
Investment in the oil industry is less controversial, because it tends to be easier to isolate from the mainstream of society and because the rewards are so obvious. But that will likely not be enough to inject enough dynamism in the Iranian economy. The opportunity to attract funds towards other sectors certainly exists. An important sign was the successful launch in July of the new euro bonds, the first denominated in a foreign currency since the Islamic revolution. Soon the government was planning new issues of euro bonds, while the Iranian parliament was asked to examine a proposal to receive oil payments in euros. The attempts to reform the Iranian economy and political system were slowed by the opposition of the conservative faction. The Council of Guardians blocked the introduction of several laws, including the new foreign investment law, despite its approval by the parliament, forcing its amendment. Other such laws were still blocked by the Council of Guardians at the end of 2002, including a project to end the unaccountability of the foundations, which control a large part of the Iranian economy, a large-scale privatisation program, a new labour code and several others. There are however some signs that during 2002 a split began to emerge within the conservative camp, with some taking a more moderate stance. On the other hand, there were divisions within the ranks of the reformists too. At the beginning of 2002, the main item of contention among the reformists was the liberalisation of the economy, with some groups favourable to the liberalisation of the economy and others, such as the Islamic left, who were cold towards it. By the end of the year, however, the picture had been redrawn and the main fault line was now running between moderates, willing to accept Khatami's slow pace, and more radical reformers, who were clamouring for a final confrontation with the conservatives and were beginning to voice criticism of Khatami himself. The renewed pressure of the units of the "moral" police on an increasingly impatient youth, together with the ongoing repression against the reformist press, only contributes to the radicalisation of a part of the opposition. The death sentence against a reformist intellectual, Hashem Aghajari, guilty of having attacked the power of the conservative clerics during a lecture, unleashed in November a new wave of student unrest across the country, the largest after that of 1999. The resurgent student movement took most observers by surprise, as many had diagnosed its demise. On the internal political front, the main development in February was the apparent confirmation that the reformist front is slowly disintegrating. Three separate reformist lists will contest the 28 February municipal elections in Teheran, ranging from the pragmatic right to radicals who criticise Khatami for his lack of action. The electorate appears rather disillusioned and apathetic and in 2,000 municipalities there will be no elections at all because of the lack of candidates. Occasional arrests of dissidents continued in February, although the reformist front could claim at least a partial victory when a re-trial was ordered of outspoken reformist Aghajari, who had been sentenced to death because of his public statements against the regime. However, Aghajari will be re-tried by the same court which had sentenced him to death earlier and it might well be too early to say that his case is closed. Even the 2002-2003 Iranian budget, approved during the spring, reflected the political constraints under which Khatami and his government had to operate. Spending went up massively on the previous year, with tax cuts and massive pay rises to civil servants, whose real income would increase by 17% in real terms. The government expected to pay for a large part of such increases in expenditures through the privatisation program, which however had been stagnating for a while and might well continue to do so in the near future. Most observers therefore believe that Teheran will soon be running a massive deficit, the more so since the 2003/2004 draft budget, presented to the parliament in December, shows a 21% increase in spending on the previous year. While promising to public employees salary increases to match inflation, the draft budget counts on privatisation to reduce spending and getting some extra revenue. Reflecting the compromise character of the budget, military expenditures are also going to increase. Observers estimate that the fiscal surplus of 2001/2002 will turn to a 2.1% budget deficit this year and might still double in 2003/2004. It should be considered, however, that Iran's government debt is comparatively low, at just 19% of GDP. By the end of 2002, on the other hand, there were signs the Iran's financial situation might be improving, with a buoyant stock exchange, growing interest among international investors for the domestic car industry and a more general consolidation of Iran's image on the financial markets. Fearful of losing his own base of support, during September President Khatami finally decided for an all-out assault on the main conservative stronghold, the Council of Guardians. During September the reformist government presented a draft law, which would greatly reduce the powers of the Council, especially as far as its ability to disqualify election candidates is concerned. The government also presented other constitutional and administrative reforms, including greater powers for the president. President Khatami warned that he might resign if his projects were not approved, leaving the country in a state of chaos. By the end of the year there was talk of a conservative coup d'ťtat against the reformists, while the security forces were stepping up indoctrination and "ideological training" of the rank and file, possibly preparing for taking part in a violent repression. Some conservative circles were increasingly promoting former President Rafsanjani as the right man to lead a coalition of moderates, aimed at addressing the economic difficulties of the country, without touching the institutional framework. 

Summary for 2003

Impact of war in Iraq
Neither the reformers nor the conservatives were unanimous about the war in neighbouring Iraq. Hard-liners are too hostile to the US to consider anything but complete opposition to whatever the Americans might do. Khamenei, a relatively moderate conservative, appeared to be ready to cooperate with the US, but only in exchange for substantial concessions, such as Iran's removal from the "axis of evil" and for the recognition of Iran's interests in Iraq. Former President Rafsanjani, a more pragmatic conservative, seemed to be ready to content himself with much less, such as a promise that the US will not attack Iran next. The reformist government, on the other hand, continued to focus on an alternative foreign policy, aimed at reminding the Americans and the world how friendly Islamic Iran can be instead. In the end, the real issue turned out to be Iran's attitude after the toppling of Saddam Hussein's regime, when Iraq faced chaos and anarchy. Privately, US diplomats were ready to admit that Iran had been behaving rather well up to mid-May. Nonetheless, the Bush administration kept up the pressure and Rumsfeld warned explicitly Iran not to interfere in Iraq. At the beginning of May Iran was once again being branded the most-active state sponsor of terrorism by the Americans. Secretary of State Powell stated explicitly at the beginning of May that the policy of the Bush administration is to isolate Iran as much as possible, but without closing all channels of communication. It is in fact known that the US and Iran are holding talks about Iraq and Afghanistan. However, there is a strong faction at the Pentagon which is in favour of a strike against Iran's nuclear facilities, if Iran does not accept to stop its nuclear program. 

Iran's nuclear program
The Iranians are divided on how to react to American pressure. There is a general agreement that Iran should maintain its nuclear program. The majority of Iranians, including leading reformists, reacted negatively to former president Rafsanjani's proposal to reopen a dialogue with the US, claiming that such a public statement would just be interpreted as an admission of weakness. Russia's decision not to abandon its ties (and profitable trade) with Iran appeared in all its importance in January, when the Bush administration dropped its objection to the building of a nuclear power station in Iran, with the clear aim of softening Russia's opposition to the war against Iraq. However, by March the tension was up again, as US claims were for the first time substantiated at least in part by inspectors of the International Atomic Energy Agency (IAEA). If US fears about the nuclear reactor being completed in Bushehr continue to appear unjustified, the uranium processing plant in Isfahan, which is about to start operations, and the enrichment plant construction site found in Natanz look definitely more suitable for the development of nuclear weapons. In February President Khatami had admitted for the first time that Iran is mining uranium. Some sources now estimate on the basis of the new discoveries that Iran might be just a couple of years away from producing an atomic bomb. It is possible that the climax of admissions and discoveries of the last two months is part of a plan to trade Iran's stricter adherence of the non-proliferation treaty against the lifting of the sanctions imposed by the US. In fact, Iranian officials have clearly hinted at the possibility of such a deal. In the meanwhile, the Iranians have been quite successful in forcing their interlocutors to drop their political demands. In September the Japanese dropped the attempt to link progress towards an agreement and Iran's good behaviour on the nuclear issue. The three leading European powers (Germany, France, UK) also appear to have offered a bargain in August, against the advice of the Bush administration, offering to share technology in exchange for the end of the controversial fuel enrichment program. The Russians too, despite being increasingly puzzled by Iran's attitude, are trying to salvage the program, for obvious economic reasons, since they build Iran's nuclear stations. As the end of October approached, the Iranian government finally showed a greater willingness to cooperate with IAEA. The pressure was such that Iran had to do something, although nobody wants Iran to lose its face or the nuclear enrichment program to be completely halted. The Iranians look set to use their influence among Iraq's Shiites as a bargaining chip in their secret negotiations with the US, which have been going on for some time, although with several interruptions.
The release of the IAEA draft report in early November appeared as a major victory for Iran, as the Agency accepted that Iran, despite some violations of the Non-proliferation Treaty, could not be proved to be developing nuclear weapons. However, the Bush administration engaged in a major lobbying effort to turn the situation around and to convince the Europeans to adopt a harsher language in the IAEA resolution, condemning Iran's behavior. This, despite the Iranian government's efforts to appease the Bush administration by providing some cooperation in Iraq. Apart from its apparent role in restraining the Iraqi Shiite population since the fall of Saddam Hussein, Iran recognized the Iraqi Governing Council in November and declared its readiness to arrange swap oil deals with Iraq, which would facilitate the recovery of the oil industry in that country. Few observers doubted that Iran was actually seeking to develop the potential for producing nuclear weapons and that the signing of the protocol would not be the end of the story, but it also appeared likely that such program could be traded off against some substantial concessions from the Bush Administration.
By year's end, in any case, there was enough uncertainty concerning Iran and its nuclear program to discourage some of the more cautious investors. BP, for example, decided to drop out of the bidding for the Bangestan field, for which it had been shortlisted together with Total.

Human rights
While the hard bargaining with the EU on the issue of human rights will continue for a some time, the Iranian government could in January show at least an initial success in this regard, with the abolition of death penalty by stoning. By the summer, however, the negotiations for a trade agreement were getting stuck because the conservatives within the Iranian establishment refuse to concede enough on the human rights front. The harsh repression of the demonstrations in June was a further blow to those in favour of engaging Iran. As the end of the summer approached, the relations with Europe and other Western countries were strained further by the cases of Iranian-Canadian journalist, Zahra Kazemi, beaten to death in custody, and of former ambassador Soleimanpur, arrested in Great Britain (and denied bail) for complicity in the bombing of a Jewish centre in Argentine. Finally, on 22 November the General Assembly of the UN expressed "serious concern" about the violation of human rights in Iran. In January important trade agreements were signed with India and Afghanistan, which are likely to greatly increase Iran's influence in the East. On the other hand, Teheran's position in the Caucasus and central Asia is likely to remain weak, as shown in March by the failure of the visit of Turkmen President Niyazov to Teheran to produce the expected consolidation of the alliance between the two countries. 

Decline of the reformist coalition
Even when a war is over, an Iraq occupied by the Americans will inevitably affect Iranian internal politics. The more radical reformers and the extra-parliamentary opposition are likely to become emboldened, as shown already by the street protests of June 2003, while it is much more difficult to predict how the conservatives might react. The trend which emerged during 2002, of a split between moderate and hard-line conservatives, might well strengthen in 2003, and there are signs that something like that might be taking place within the ranks of the reformists too. In March the defeat of the reformists in the administrative elections, especially in Teheran, highlighted the growing rift between the Islamic left factions and the right-wing reformists of the Executives of the Reconstruction group, which all support Khatami in the national parliament. Division exists also within the Islamic left between clerics, who tend to be more moderate and more supportive of Khatami, and secular members, who are increasingly becoming radicalised. Then, the two moderate factions might ally and form a centrist government, which would try to reform the economy and certain institutions, without challenging however the clerical nature of the Iranian state. Towards the end of 2002, Supreme Leader Khamenei's intervention against the judiciary, which had passed the death sentence against Hashem Aghajari, appeared a sign that Khamenei himself could be willing to support the leadership of the moderate conservatives. However, the leadership of the moderate conservative camp is increasingly being taken by former President Rafsanjani, who in April took a bold step and proposed a referendum on Iran's relations with the USA. Among the leading reformers there seem to be little appetite for a compromise, mainly because their support base opposes it. As the end of 2003 was in sight, there appears to be left little room for a compromise anyway, as the conservatives appeared to be aiming for an all-out victory. During August there were however signs that despite tensions at least two of the three reformist factions will maintain their unity until the future elections. The pragmatist party close to Rafsanjani will likely abandon the alliance, given the projects of its mentor to form a new coalition, but the Society of the Combatant Clergy and the lay reformist parties appear to be trying to maintain their unity. Between May and June 2003 the Guardian Council rejected both reform bills, which would have given president Mohammad Khatami greater authority over a judiciary dominated by the conservatives and limited their ability to screen candidates in parliamentary elections. At this point, political developments within Iran might take three different turns. By mid-June some talks seemed to be going on between Khatami and Supreme Leader Khamenei to find a behind-the-scene solution to the deadlock, such as modifying the bills to some extent and re-presenting them. This is the first option. Should the talks fail, the reformist camp is divided among those advocating a referendum on the issue, those arguing that the MPs should resign in protest and those favourable to accepting a compromise brokered by the Expediency Council. Only about 20 MPs are reported to be serious about resigning, with another 30 or so also considering it, while the other two options obtaining much greater support. The conservatives might still refuse to concede any ground and, if faced with an increasingly militant opposition in the streets, stage a coup d'ťtat. Some prominent conservative leaders, such as Khamenei himself and former president Rafsanjani, threatened openly the recourse to force already during the course of 2002. The conservatives, in the meanwhile, are also getting ready for the next elections by hinting at a social agenda that they might include in their electoral "manifesto". In reaction, the government is increasingly devoting its attention to initiatives in favour of the poorer social strata. At the beginning of 2003 it also appeared possible that the conservatives might succeed in attracting moderate reformers such as Khatami towards a compromise which would still increase his powers, although without weakening the capability of the conservatives to resist the reforms as much as most reformists desire. By the summer, however, the most likely outcome appeared to be a new government headed by moderate conservatives and right-wing reformers, maybe strengthened through recourse to rigged elections. In September Khatami took the unusually bold step to refuse a compromise with the conservatives on the reform bills that he introduced last year and that were blocked by the Council of Guardians. The head of the Council, Mohammed Ali Abtahi, offered to let through the bill which enhances the powers of the President, if Khatami accepted to withdraw the other bill, which reduces the Council's power to pre-select election candidates. At present, there are only scant signs that the politically active minority of the radical opposition is succeeding in establishing links with other sectors of the population. In some factories there have been walkouts in support of the democratic movement, while teachers have been on strike and even in the bazaars, normally a stronghold of the conservatives, there have been shutdowns in support of the demonstrations. So far only the intelligentsia and a part of the clergy show clear signs of drifting towards a more radical opposition, but the potential for a larger movement is there. The Nobel Peace Prize to Shirin Ebadi offered the radical reformers the opportunity to relaunch their campaign, although moderate reformers like Khatami were only embarrassed by the news. The conservatives, however, are not waiting hand in hand and look increasingly set to steal part of the reformist agenda. They promise some social reforms in favour of the poorer strata of the population, while claiming that they too are reformists, although of a different type. It is worth noting the key role played by moderate conservatives like Ayatollah Janati and Hojatoleslam Rowhani in engineering the deal with IAEA at the end of October, a confirmation that this group is trying to emerge as a protagonist of Iran's relations with the rest of the world. Their profile was raised, but at the price of deepening the split between them and the hardliners.

A mixed economic picture
The government remains committed to market reforms, as showed in may 2003 by the appointment of a pro-reform new head of central bank, who was welcomed by analysts. The government also appears to be becoming increasingly conscious of the damage that inflationary pressures could cause to the economy. There is also a growing awareness in government circles that the government does not spend its money in a balanced way. On the one hand there are a lot of subsidies, on the other Iran spends little in crucial sectors like health, where its expenditure reaches just 5.7% of GDP and lags behind that of other oil states. The announcement at the beginning of May of a US$21 billion 4-year plan to greatly expand the telephone and cellphone networks also represents an answer to the recognised need for increased investment in infrastructures. 
Unfortunately, from the point of view of the man in the street, the government has little to show. At the beginning of May president Khatami had to acknowledge that his plan to create 765,000 jobs a year is lagging well behind, with just over 530,000 created on average in the last three years. Whether the reforms accelerate or not, political and social tensions are not going to die down in 2003. Faster reforms will in any case mean more hardship for some sectors of the population. The latest estimate of the inflation rate in 2002/2003 was 15.3%, up four percentage points on the previous year due at least in part to the abolition of privileged currency exchange rates for some Iranian institutions, which was one of the reforms of the Khatami government. By some estimates, inflation could exceed 20% in 2003/2004, due to the growing budget deficit and price hikes in a number of commodities. 
Despite the improved economic performance of 2002/2003, it appears obvious that it will be difficult to achieve significantly higher growth rates without attracting massive foreign investment. The forecast of the Economist Intelligence Unit for 2003/2004 is 5.3%, lower than in the previous year, although still comparatively good. Even in this regard, a successful compromise among moderates could play an important role in reducing the opposition among conservatives against foreigners playing a much larger role in Iran's economy. The Iranian government is quite optimistic, as shown by its 2003/2004 budget. The assumption that oil revenues will maintain the level reached in 2002/2003 (around US$15 billion), when the Iraqi and the Venezuelan crises combined to push oil prices upwards, appears doubtful indeed. By April, the Iranian state oil company itself was expecting oil prices to fall soon to US$18/19 a barrel. The government, however, has the option of drawing resources from its stabilisation fund, which is expected to stand at US$7 billion by the end of the current fiscal year (20 March) and which is meant to compensate the fluctuations of oil prices. 
The government confidently predicts GDP growth at 6% next year, which would confirm the performance of 2002/2003. The Economy and Finance Minister Mahazeri also predicts that Iran will finally be able to attract significant foreign direct investment next year, in the range of US$4 or 5 billion, as opposed to the less than US$500 million invested in 2002/2003. Iran also plans to expand its oil production to 5 million barrels a day by 2004, up from the 3.6 million of 2002. The government is making natural gas available to most of the urban areas, in order to reduce internal consumption of oil and have more available for export. Moreover, the Khatami administration is going to borrow money to fund its many projects. It is authorising the issuing of bonds over the 2003/2004 financial year for a value of 5,400 billion rials (US$676 million), a 125% increase over the current year. The good news for the economic prospects of Iran is that the government also authorised the private sector to issue its own bonds as a way of making up for the inability of the banking sector to provide adequate funding. The level of foreign debt is at a relatively modest US$23.4 billion and the country's hard currency reserves are higher than ever. During 2003 there was a growing optimism among international observers, concerning the future prospects of the Iranian economy. In December Fitch Ratings upgraded its outlook on Iran's currency ratings from Stable to Positive, on the basis of positive forecasts for the economy and in particular for foreign earnings. The agricultural sector, which has long been a source of headaches for Teheran, was also sending positive signals. In December the government claimed that Iran is finally self-sufficient in wheat, following the end of a drought that lasted from 1999 to 2001. 
During March the first signs emerged that the Khatami administration is trying to tackle the issue of the excessive subsidies to consumption, that are undermining the Iranian economy. After an official of the oil industry admitted that Iran will have to import 5.8 billion litres of gasoline this year to meet internal demand, up 2 billion on 2002/2003, the government increased in April the price of gasoline by 30%, from US$0.06 to US$0.08 per litre. While the latter would still be a very low price by any standard, there is opposition even among reformist parliamentarians, who fear a backlash among the population and an upsurge in inflation. On the other hand, the uncontrollable increase in internal gasoline consumption represents a growing burden for Iran's economy and contributes to erode the country's oil exports, which fell by 7.6% in 2002, to just over 2 million barrels a day. Efforts to put some order in Iran's chaotic economic system continued in September. The government announced at the end of August that there are plans to introduce value added tax, which is widely seen as a positive step since it will be easier to implement than any overhaul of the direct-taxation system. The Teheran stock exchange was reformed in September, to bring its regulations more in line with those of developed countries and to introduce control mechanisms that limit the danger of a crash.
Foreign businesses express a strong interest in the Iranian internal market, which at present is underdeveloped, due to restrictions to imports, which the government tries to maintain at around $15 billion, and to the inability of the domestic industries to meet demand. After achieving the first modest successes in attracting foreign investments in 2002, the Khatami administration hopes that 2003 will finally see the beginning of a massive inflow of foreign investment into Iran's industry and services. This might be rather optimistic, but there were some signs of growing interest in January and February. After FIAT and Peugeot had showed up in earlier months, in February it was the turn of DaimlerChrysler and Chinese manufacturer Chery to announce their plans for the Iranian car industry, whose annual sales of 300,000 are estimated to cover only half of potential demand. It is expected that in the foreseeable future most investments in the non-oil sector will come from Arab countries, but already some European companies are beginning to invest small sums. The government expects its privatisation program to finally take off in 2003. Before the end of the current fiscal year (20 March), several state companies are expected to be floated on the stock exchange, as a prelude to privatisation. Banks in particular figure prominently in the list of state firms to be privatised. At present, there is just a single genuinely private bank in Iran and its network of branches is still very limited. There are, however, a number of obstacles towards a successful privatisation campaign. State banks are largely overstaffed, often have been operating at a loss for some time and are burdened by bad debts granted to state firms, the foundations and privileged individuals. The overall approach to economic reform remains cautious. This caution is sometimes dictated by genuine political concerns, as in the case for example of the planned reduction of tariffs on imports. At the beginning of February the deputy minister of commerce stated that the elimination of tariffs on imported goods would be eliminated gradually, in order to safeguard the interests of consumers and producers. However, in other cases this "caution" is the consequence of divisions within the government and the state administration. The complex web of interests which grew over the Iranian economy over the past quarter of a century makes reforms objectively difficult. The laws and regulations of the Central Bank of Iran, for example, encourage investment in unproductive activities, such as import businesses, which benefit from tax holidays, while production goods are subjected to high tariffs and taxes. 
The economic impact of 'regime change' in Iraq was on the whole modest. The US might veto a participation of Iranian firms in the reconstruction and in the medium/long term the opening of the Iraqi oil market might draw away potential investors in Iran's oil fields, especially if, as it is likely, conditions offered were better. In this case, Iran could at least count on US determination to favour US companies, which cannot invest in Iran anyway due to the embargo. But Iraq's more economical oil fields are shared with Iran, so that improved production there would affect Iran's production negatively in any case. Oil minister Zanganeh showed his awareness of the situation when he called for Iran to act quickly to attract foreign capital to develop its oil fields. Indeed, the national Iranian oil company claimed in May to be planning to sign contracts worth between US$5 and US$7 billion during the current year, with the aim to expand production by one million barrels. However, in the past the optimism of Iranian officials with regard to signing contracts with foreign investors has often proved unjustified. There is on the other hand capital looking for some employment in Iran, especially after at least US$7 billion returned to Iran mainly from the US, to which a growing tide of Saudi investments have to be added. The Teheran stock exchange has been growing so quickly this year that in August the government had to intervene and impose a two-week block on stock prices, fearing an imminent crash and the subsequent repercussions on the wider economy. Investors will however likely continue to prefer the stock market, given the lack of transparent investment opportunities in industry and the low returns of the agricultural sector. The government appears intent to capitalise on the trend towards the return of capital from abroad and a bill is being discussed in the parliament, which will reinstate the nationality of those Iranians who have left the country. The law that requires the sale of property belonging to people stripped of Iranian nationality is also being abolished. 
Some signs have been emerging in recent months that Iran might be willing to offer better terms to foreign investors in its oil industry. These developments continued in September, as a deputy minister hinted that new types of contract are under consideration to attract investors to the Caspian Sea, possibly including production sharing agreements.
The IMF reported that non-oil GDP has been growing at the average rate of 7.9% in 2000-2003, that is faster than GDP as a whole, confirming that the economic reforms are stimulating the economy to some extent. However the IMF pointed out that price subsidies and controls and limitations to free enterprise remain a major problem. For example, the very low price of gasoline is leading to a boom in consumption, which increased by over 26% in the March-August 2003 period alone. Production of gasoline, on the other hand, increased by just 2%, forcing Iran to import massive quantities of it, a paradox for such a big producer of oil. Fuel subsidies are a major problem for Iran and cost each year 10% of GDP. In November the oil ministry came out in public for the first time with plans to ration the distribution of gasoline, which the country imports at the rate of 13 million litres per day. 
Another source of worries is the fiscal balance, which is now negative, with a deficit of 2.3% of GDP. The government is aware of the problem and is considering measures to contain the fiscal deficit, hoping to contain the inflation rate at no more than 18%. The government is also aware of the increasing social tensions and is carrying out a number of schemes aimed at reducing unemployment. One of them foresees the replacement of "foreign workers" with Iranian ones and according to the minister of labor and social affairs it will be enforced firmly. The government is also spending money on job creation schemes and it claimed in September that the official unemployment rate fell by two percentage points over the last 12 months, to 11.2%. It is not clear, however, how sustainable these job creation efforts are in the medium and long term, while replacing foreign workers will only create unskilled and low-pay jobs, which will make few Iranians happy. Besides, official unemployment figures are not considered very reliable by economists and the actual impact of these schemes is uncertain.
Towards the end of the year, the government renewed its efforts to convey the idea to the public, that the program of privatization is still on track. It announced at the beginning of December that Khuzestan Cement Company will be privatized at 96%, the largest proportion of shares ever sold by the state in Iran since the revolution. 

Oil industry
Iran also needs to unblock the development of the oil industry. Iran will need to invest $30 billion over the next 8-9 years to maintain its share of world oil exports. The ageing Iranian fields have lost production capacity at the rate of 250,000 barrels per day, 6.4% of annual production. At least $1 billion are needed every year to maintain production at the current levels. To maintain the level of exports in the face of rising internal consumption and to increase them to satisfy the needs of a growing population, much more than that amount will be needed. However, the Iranian oil industry continues to be starved out of investments and progress has been recorded recently only in the development of the manufacturing of liquid natural gas. Several large Western multinationals, such as Royal Dutch/Shell and Total, are reported to have lost faith and to be already scaling back their presence in Iran. Japanese companies like Japex and Inpex maintain some optimism, although the Azadegan project too, for which the two have bidden, had not yet been signed by its stated deadline of end June and appears likely to be delayed further. As always, the source of the delays is the political sensitivity of foreign investments in Iranian oil industry. A Deutsche Bank study estimated that the profit margin in Iran is about 15%, compared to a world average for the oil industry of 20%. Moreover, the deals tend to last only about half of what they last elsewhere. This difference would not be enough to discourage investors, but the long queues imply extra costs and uncertainty. The awareness that the availability on the market of the Iraqi oil fields over the next few years could represent a major blow for Iran's chances to impose its own terms has not succeeded in accelerating the pace of the oil ministry. Some industry experts say that unless Iran speeds up investments in the oil fields, its production could fall to 3 million barrels per day over the next few days, from the current 3.6 million. At this rate, the goal of attracting US$16 billion in foreign investment in the oil and gas industries by 2010 does not seem to have many chances to succeed. 
In the strategy of the Khatami government, gas is supposed to make up for the shortcomings of the oil industry. Since Iran has huge reserves of gas, which at present are largely under-exploited, it would make good sense to move the focus of the investments in that direction. After the blow of the re-negotiation of the deal with Turkey, which could have cost Iran as much as 20% in discounts on the previously agreed price, Iran will be looking east, having identified China and most of all India as potential major markets of the future. 
Nonetheless, in the second half of 2003 it began to emerge that the recent discovery of three new oil fields in July was having an impact on Iran's development strategies. After having focused on its gas sector until the summer, the Iranians began now to show a renewed interest in oil, for example by trying to accelerate the signing of some oil deals, like the Bangestan and Azadegan fields. In November the National Iranian oil Company invited bids for 16 new exploratory oil blocks, with a new and more attractive type of contract, which covers both exploration, description and development of the fields. Iran's wariness of OPEC cutting oil production can also be seen as a sign of a renewed desire to attract more investment and expand its production. Investors too seemed to be finding some new optimism about doing business in Iran. Total and Petronas, for example, seem set to finally make a profit this year in Iran, a fact that might encourage others to sign, despite the strict conditions. It is known that Petrobras, never previously active in Iran, is considering to enter this market. Despite US pressures, which apparently played a role in keeping Italy's ENI and Royal Dutch/Shell from accepting the invitation to bid, the negotiations on the Azadegan oil fields seemed finally to have reached an advanced stage, in which French company Total appeared to be in a favourable position to win. 

Summary 2004

Internal policy
The parliamentary elections of 20 February 2004 were undoubtedly a major defeat for the reformists, not only because the Parliament will now have a conservative majority, but also because the participation rate was not as low as originally predicted, although it was still much lower than in the previous elections. The inability of the reformers to campaign as a single block and to present to the voters with a single proposal likely confused them and damaged the prospects of a successful boycott of the elections. The reformist front approached the parliamentary elections in a state of disarray and could not but lose. While the defeat of the reformists is not debatable, the victory of the conservatives is not so clear-cut, however. The largest group among them is the pragmatic Developers of Islamic Iran, whose positions differ little from those of the most moderate component of the reformist coalition, the Executive of the Reconstruction. Both groups are sponsored and encouraged by former president Rafsanjani, whose efforts to re-enter the political scene have received a major boost. Interestingly, Rafsanjani criticized the exclusion of many reformists from the electoral lists. The Developers, who won all the seats in Teheran, are quite tolerant of the new social attitudes which emerged in recent years and attract the wrath of the stricter conservatives. They focus on economic and development issues and their main promise during the electoral campaign was to end unemployment and cut inflation. They will open the country to foreign investment, but will not allow political dissent. They already control the Teheran city council and are applying a similar strategy there, where they launched a large scale program of public works aimed at reducing unemployment and improving the quality of life in the city. One of the first acts of the new parliament was the election of a new speaker, who happens to be the first one in the history of the Islamic Republic not to be a cleric. Another signal was the scrapping by the judiciary of the death sentence against dissident Hashem Aghajari. Under the reformist government, the judiciary had stubbornly continued to maintain that the death sentence was appropriate. President Khatami appears likely to accept to work with them and has already been offered the olive branch by leading conservatives. President Khatami started already during April to replace the ministers deemed to be least compatible with the new parliament. The ministers of road and transport and education and training were the first targets, but soon the minister of the interior too was added to the list of the undesirable ones. He actually resigned on 8 April. They seem ready to work with what is left of the reformists on a number of issues and many among them long to isolate the radical conservatives who want to push a conservative agenda which has no support in society. In 2005, when presidential elections are due, he is likely to be replaced by a conservative as a President. Former president Rafsanjani might well be a candidate. At least 16 small moderate reformist parties offered their support to him, but other moderate reformists expressed doubts about his candidature, mainly because having already been president once he would only be able to complete a single term if successful. Mustafa Moin, the leading reformist candidate-to-be, was first reported to have agreed to be a candidate for the two main reformist groups and then to be wavering about the prospect. Most reformists remain keen on Moin, not least because his candidature is believed to be likely to be approved by the Guardians Council, which has vetting power on all candidatures. Some reformists put forwards the name of Asqar Musavi-Khoeniha, a moderate reformist who is one of the leaders of a third group of reformers, the Militant Clerics Association, who however does not appear too keen, while others suggested Hassan Khomeini, the grandson of the Ayatollah. One of the main "selling points" of the latter is that he could attract conservative voters too. 
On the conservative front, by the end of 2004 there were already two official candidates, Ahmad Tavakoli, a member of parliament from Teheran, and Ali Akbar Velayati, a former foreign minister. The numbers might grow, as the mayor of Teheran, Mahmud Ahmadinejad, is being pushed to run by the new generation of conservatives which controls the parliament, while there are also rumours that Mohamad Baqer Qalibaf, a general of the Revolutionary Guards, is also considering to run.
After having kept a low profile during the first several months of the new parliament, the conservatives began taking a tougher stand during October. A major development was the vote of no confidence for the Minister of Transport Khorram, a reformist close to President Khatami, who had to be replaced, but the parliament started increasing the pressure on reformist members of the parliament across the board, to the extent that vice-president Mohammad Ali Abtahi, another key reformist figure, decided to quit the cabinet. The parliament also succeeded in reversing some of the reforms of the previous reformist majority, rejecting proposals to expand the inheritance rights of women and calling for placing more restrictions on women's social freedoms. At the same time, the crackdown on the press and on the internet also continued. In part, the recent move by the parliamentary conservative group can be read as an attempt to form an alliance which would include hard-line grass-roots conservatives, weakly represented in parliament, possibly helping to pave the way for a joint conservative candidate to the post of President of the Islamic Republic. Some pragmatic moves, like the allocation of US$800 million to the Imam Rescue Committee, a conservative social welfare organisation which had been in the hit list of the reformists, and the decision to place the Ministry of Intelligence under the control of the (conservative) judiciary clearly point in that direction. The same could be said of the parliament's opposition to foreign investment, especially in areas where organisations linked to the conservative lobby also operate. 

Foreign policy
Even if Iran's foreign policy will still reflect a substantial degree of factional infighting within the regime, in the longer term a parliament dominated by the conservatives will at least offer the advantage of Iran speaking with a single voice in matters of international relations and might make reaching some sort of settlement easier. The first signs were that Iranian foreign policy might take a more assertive turn under a conservative majority. The short detention of eight British servicemen in July was clearly a way to remind once again the "West" that Iran is a regional power to be taken into account, but with means quite different from those which the reformist government had been using in recent years. The seizure was likely an effect of the rising influence and power of the Revolutionary Guards, many of whose associates were elected to the parliament in the recent elections. The attempt to find an accommodation with the US in its own terms will also continue, as reformists and conservatives mainly differ on what precise type of settlement they want, rather than on the idea itself of dealing with the "Great Satan". On 30 January a breakthrough in US-Iranian relations seemed to be about to happen, as it was announced in the US that a 10 member congressional delegation trip to Teheran had been agreed. Interestingly, it was the Iranians who dashed any hope, denying that such a deal existed. The electoral climate in Iran certainly contributed to prevent the delegation's trip. What could be the last attempt of the reformists to establish a benchmark in foreign policy for a while took place in April, when an Iranian mission sponsored by the reformists travelled to Iraq to start a mediation between the US and the Shiite insurgents. The international position of Iran appeared compromised again in February by substantiated allegations that it is not complying with the UN resolution which demands that it fully declare its nuclear program. First there were revelations that Teheran failed to declare to having acquired drawings for an advanced uranium-enrichment centrifuge, then such a centrifuge was found in a base of the Iranian air force. It is now believed that Iran is continuing to assemble centrifuges, despite the agreement. Following this development, a senior official of the state department stated that the US government might even consider the use of force to prevent Iran from developing nuclear weapons. In September President Khatami declared that Iran would start enriching uranium, disregarding whatever the international community might think about it. The IAEA report issued in early September, that absolved Teheran from the accusation of having started to enrich uranium for an atomic bomb, might well have encouraged Teheran to take such a new step. Iran has the legal right to enrich uranium, according to the Non-Proliferation Treaty, but the Americans in particular are distrustful of the ability of the IAEA to effectively monitor how the enriched uranium is going to be utilized. Already at the beginning of September the EU had threatened that if Iran developed weapons-grade uranium its relations with Europe would be at stake. As the end of the month approached, the Bush administration claimed that a draft resolution on Iran's nuclear program had been agreed with the Europeans, although this has not been confirmed by European sources yet.
In Afghanistan Teheran's foreign policy faced a new situation in September, with the removal of Iran's main ally in Western Afghanistan, the governor of Herat Ismail Khan. Although Teheran gave its consent to the move, opting to improve relations with the central government in Kabul, some factions within the regime might not have been as happy. The Afghan government was keen to offer improved relations between the two countries in exchange and on 26 August an agreement on economic cooperation was signed. Iran will contribute to the training of Afghan technicians and provide books and software, as well as building a road in Western Afghanistan. In Iraq too Iran is facing rapid and constant changes in the political situation.
US hostility is definitely harming Iran's economy. During 2004 the Bush administration expressed its opposition to a plan to build an oil pipeline from Kazakhstan to Iran, which would allow the Central Asian country to export its oil through Iran. The Japanese consortium which was awarded the right to exploit the huge South Azadegan oil field is falling apart under US pressure. One of the companies within the consortium, Tomen Corp., has already pulled out, while another one, Japex, is considering to do the same. Inpex Corp., which appears inclined to stay on, has tried to attract Royal Dutch/Shell into the consortium, without success, and is now trying to convince a number of other oil companies, such as Total, Statoil and others.
As the US presidential elections approached, the debate on Iran intensified in Washington. Democratic presidential candidate Kerry stated that he would offer to provide Iran with the enriched uranium it needs for civilian use and then collect it back for reprocessing, in exchange for the renunciation to develop its own capacity to process uranium. Although the Iranian government welcomed such proposals, most observers were sceptical of the possibility of such a plan ever being implemented. The Bush administration, on the other hand, continued to be divided between hawks, who remain keen to subvert the Iranian regime from within (after the US elections), and moderates who speak in favour of some form of engagement. This is reflected in the fact that over the summer the administration was speaking relatively positively of Iran's role in Iraq, where it abstained from trying to encourage opposition to the government, but maintains an aggressive rhetoric on the issue of Iran's nuclear program. Teheran's announcement in July that it will restart building nuclear centrifuges added fuel to the fire and there are signs that the Bush administration has been seeking British support for referring Iran to the Security Council of the UN, despite IAEA's opposition. During August the rhetorical campaign of the Bush administration against the Iranian establishment continued to accelerate, with bellicose statements coming from Condoleeza Rice and John Bolton, under-secretary of state for arms control. The Bush administration, in short, was implying with increasing strength that covert action and air attacks are not ruled out as a way to prevent Iran from developing nuclear weapons. The attempt to weaken Teheran's potential proxies in Iraq and Afghanistan, which took place during the summer, appear however to suggest that the Bush Administration is getting ready for an escalation after the US presidential elections. The Iranians, on the other hand, might be divided about the final purpose of their nuclear program, but agree that they are not going to stop without receiving some benefit in return. At least, if the US were to launch an air campaign to destroy nuclear installations in Iran, the regime would benefit from a growth in anti-American sentiment among the population. In the meanwhile, Iran's nuclear program carries on. Russia completed in October the construction of the Bushehr civil atomic plant, while the conservative-dominated parliament started debating a bill which would force the government to resume enriching uranium no matter what. The position of the government is more moderate, but it appears clear that even under pressure from the friendlier Europeans, Teheran will not concede more than a temporary suspension of the uranium enrichment program. Washington's stand however suffered a blow in August when the IAEA established that at least some of the samples of enriched uranium found in Iran were indeed of foreign (Pakistani) origins, as claimed by Teheran. Despite its failure to attract the international community towards its positions, the Bush Administration was still asking at the end of 2004 that sanctions be automatically implemented if Iran resumes work on the part of its nuclear program which is susceptible to lead to the production of an atomic bomb. Moreover, the US does not like the idea that the production of plutonium is not covered by the current deal. The Iranian, on the other hand, are likely mostly intent on buying time and declare it unacceptable that the text of the agreement include the possibility of an automatic referral to the Security Council of the UN. Whatever the final outcome of the debate on the Iranian nuclear program, US pressure is likely to increase anyway. The new Secretary of State, Condoleeza Rice, appears keen to raise a number of issues in the near future and even before taking charge was allegedly organising a major campaign on the violation of human rights in Iran. The Bush Administration might well increase its support for the Iranian illegal opposition. The Iranians likely fear this more than any campaign against their nuclear program. In fact, during December they repeatedly added fuel to the fire of the nuclear debate, stressing that the suspension of the uranium enrichment program was only temporary and even asking to be allowed to keep running 24 centrifuges for "research purposes". 
Although the origin of the large majority of the samples has not been tracked down, the announcement lent some credibility to the claim that Iran was never involved in enriching uranium. 
Regardless the US role, Teheran's moves are not always wise and sometimes harm relations even with friendly countries. Its attempts to intensify economic relations with its former Soviet neighbours might lead to a deterioration of the relations with Russia. The signature in May of a deal with Armenia for the construction of a gas pipeline is irritating Moscow, which fears an extension of the pipeline to Georgia, Ukraine and eventually Europe, a development which would weaken Russia's position in this market. Also, the plans to involve India in Iran's oil sector, which have a political as well an economic rationale, have been hampered by Iran's failure to offer suitable oil fields to India, despite the promises made. US hostility on the other hand meant that Iran's application to join the WTO was rejected in December. 
Although the relations of Iran with the surrounding countries are in general expected to continue to improve, it is difficult to forecast what type of relationship will be established with the new Iraq. There is little doubt that the Iranian regime will try to develop a stake in the future governments and given the difficulties experienced by the occupation forces led by the US it might well succeed in obtaining a settlement quite favourable to its own interests, at least in the short-medium term. Therefore, the rapid deterioration of its relations with the new Iraqi government in July and August represented a worrying development from Teheran's point of view. 
Iran scored some positive developments in its international relations during January. Egypt and Iran finally announced that they will soon re-establish diplomatic relations. A remarkable development in August was the declaration of Saudi Crown Prince Abdullah that Iran is a "brotherly and friendly" country. The new friendship with Saudi Arabia, once a sworn enemy of Iran, is likely the outcome of the pressure which both Teheran and Riyad are under from the US government. 

Economy
Inevitably, the economic performance of Iran will depend in 2004, as in the past, from the trend of oil and gas prices. The growing awareness of the need to attract more foreign investment might finally begin to translate into the signature of more contracts, but not necessarily, especially if the factional conflict remains obviously undecided. The buyback system, deeply disliked by the oil multinationals, remains in place, although now investors can now tender for up to 25 years, compared to 7-8 years previously. Moreover, investors will not need to re-bid after exploration work has been carried out. Despite Iranian claims that even US companies have expressed interest in the tenders, however, most potential investors are disappointed, also because the major oilfields have been excluded from the new buyback deals. Still, a major Iranian success was the signature on 18 February, after protracted delays of the Azadegan oil deal with the Japanese, worth US$2 billion. By 2020 the government would like to raise production of oil to 7 million bpd, up from the current 4 million bpd. Iran is also trying to expand its gas production. The plans are ambitious, as gas exports should rise to 20 billion cubic metres by 2010 and 60-80 billion by 2020, up from just 3.5 billion last year. Exports to Turkey are planned to increase to 10 billion cubic metres by 2007, while negotiations are being held with Kuwait for a further 4 billion cubic metres. Despite the attempt to make buyback deals more attractive to foreign companies, most of these still do not find this type of contract attractive enough. The attitude of NIOC, which sometimes adds extra clauses to the contract, does not help either. For example, in the case of the Ahwaz Bangestan oil field, NIOC is asking that the bidder agrees to buy 5 million tonnes LNG from Iran's state company, which will surely contribute to delay the reaching of a deal. 
In any case, the benefits of new oil contracts did not directly affect the economy during 2004. On the whole the impact of the efforts to develop the non-oil sectors of the economy remained limited, except for some specific sectors, like communications. Significant benefits might derive from a partial return of capital from abroad, which already began in 2003, but there are few signs at the moment that this capital is going to be invested in productive activities. Creating employment for the mass of young Iranians who every year join the job market will remain a daunting task. The economic liberalization will continue. In March, for example, new rules were approved which will allow foreigners in invest in Iran's stock exchange. They will have to keep their money in Iran for at least three years and their share of the total value of the market will have to be no more than 10%. 
The 2004/2005 draft budget features a 10.5% increase on the previous year, to reach US$127 billion. The budget aims at achieving a 7.3% economic growth, based on the assumption of an average price of oil at US$19.5 a barrel. The Guardian Council however rejected the new state budget, on the ground that it conflicts with the constitution and with Sharia law on several points. The new budget once again confirms Iran's proclivity to spend to stimulate the economy. Even during the current year, the government admits that it will have to draw US$500 million from its Oil Stabilisation Fund, despite oil earnings US$6 billion higher than expected. The Fund will therefore drop to US$7.7 billion, a negative development in a year of oil revenue windfall like 2003/2004 has been. The conservatives supported a better balanced budget and are closer to the positions of the government, although they might just want to save the money, which will come from the reserve fund, for their own projects once they are in power. 
The figures for 2003/2004 see the oil and gas sector grow by 8.4%, up from a growth of 5.1% last year, whereas growth in the non-oil sectors is declining to 6.5% from 7.8% last year. The government is not worried by this trend, because the slow down is limited to the agricultural sector, which could never have repeated the excellent performance of the previous year, when weather was excellent. In the industrial sector, which was the main contributor to a 28% increase in the increase in fiscal revenue for the central government in 2003, growth was mostly considered satisfying. The most dynamic industries are petrochemicals, iron and steel, cement and car manufacturing. On the other hand, the relaxation of import regulations led to a rapid decline in the current account surplus, while at the same time hurting local producers. Inflation stabilized at 15.6%, very close therefore to the 15.8% recorded in the previous year. The government also claims that unemployment has been reduced from 16% to 11.6% during 2003/2004, but several observers cast doubts on the credibility of these claims. 
Despite its ongoing struggle to sort out its internal economy, Teheran is not renouncing grandiose plans to radically alter its position in the world economy. In June a plan to design a new oil trading market was launched, with the aim to compete with the London International Petroleum Exchange, which some oil producers suspect of manipulating oil prices against their interests. The new oil bourse should open in 2005, but many observers doubt that it will succeed in establishing itself as a serious alternative to London and New York. In July it was also announced that the government plans to privatise Iran's tourist industry, mainly with the aim to attract foreign investment. The fact that such an announcement comes despite the conservative majority in the parliament, shows how pragmatism is likely to dominate the economic debate. Iran will need up to US$5 billion a year to bring the sector up to international standards and hopes to expand its share of world tourists from the current 0.1% to 1.5% by 2024, who should bring to Iran revenues of around US$25 billion a year. 
Despite the new aggressiveness shown by the conservatives after the summer, including in matters which affect the economy, in many regards the economic reforms continued. The Expediency Council, dominated by moderate conservatives, authorised the plans to privatise several sectors of the economy, including banking, insurance, foreign trade, telecommunications, airlines, railways, shipping, power generation, petrochemicals, distribution and postal services. Such plans had been blocked by the Guardians' Council, where the presence of hardline conservatives is stronger, and will now move forward. The plan to expand Iran's power production by relying on private investment has already been approved by the parliament. The suspicion of foreign involvement does not extend to every sector of the economy either. Negotiations concerning foreign investment in the car industry have been completed and Renault and Volkswagen will start production between 2005 and 2006, not least because internal demand is so strong that the 10-year ban on car imports had to be abandoned in July. Imports are still limited to just 10,000 cars a year, but if the industry does not catch up further concessions might become necessary. The current plan is to export half of the Renaults manufactured under license. Worryingly, however, the vice chairman of the parliamentary commission on industries and mines stated in August that the plans to assemble Renault cars on a large scale jeopardises Iran's independence and should be scrapped. 

Summary 2005

International politics
The main unknown factor in Iranian politics in 2005 was whether the confrontation with the US would degenerate in to open conflict or not. The re-election of the Bush Administration was not a good omen for the Iranian regime and the appointment of Condoleeza Rice as Secretary of State made it even worse. On the Iranian side, some actors in Iran's foreign policy institutions seemed to think that practicing some brinkmanship is the only way to improve Iran's standings in the world. The Iranian regime moved consistently to develop a stake in both the Iraqi and Afghan future governments, exploiting the difficulties experienced by the occupation forces led by the US. Nonetheless, the risk of a US intervention in Iran declined throughout 2005, as the US remained trapped in the Iraqi quagmire and faced reconstruction problems at home. The main possibility of a change in Iranian foreign policy rested on the chance of Hashemi Rafsanjani winning the presidential elections, as he was the only one to possess the skills and authority to impose a change of tack and avoid an American aggression. 
Throughout the year there was a succession of propaganda scores on both sides, with periodic revelations about the lack of transparency of the Iranian nuclear programme, some of which however turned unjustified, as for example in the case of the accusations against Iran of having imported large quantities of substances suitable for producing atomic bombs. An European effort aimed at offering Iran benefits in exchange for dropping parts of its nuclear program which are susceptible of leading to the production of military equipment run into difficulties as the US only agreed to support it if the European stance toughened and no benefit big enough was offered to entice the Iranians. In the end the Bush Administration aligned its position with that of the European countries, declaring its readiness to offer incentives to Teheran in exchange for the abandonment of the nuclear program. Clearly Washington was not ready to go it alone (without even the support of the UK) against Iran and is now hoping that a failure of the European initiative will convince the Europeans to endorse sanctions against Iran. In other terms, Washington is giving a chance to the Europeans, hoping that in exchange they will agree to impose sanctions once the ongoing attempt will have failed. The US are convinced that the Iranians would soon get caught cheating on their deal with the Europeans.
Repeatedly during 2005 the Iranians appeared to be renouncing their push for restarting uranium enrichment, but as they seemed to feel that they were not succeeding in extracting the desired concessions from the Europeans, the Iranians would resort once again to their brinkmanship tactics, announcing that they would restart enriching uranium. Russia made an attempt offering to take charge of the enrichment of Iranian uranium, while Iran would be allowed to resume the production of uranium hexafluoride. It was not reasonable in any case to expect an Iranian decision before the mid-year presidential elections. As Ahmadinejad emerged as the winner in the elections, the Iranian position became tougher, is not always clearer. Iran looked clearly disinclined to give up the right to enrich uranium, if only for "research purposes", short of major concessions, such as the abolition of the US embargo. The Iranian elite appeared to be convinced that even UN sanctions would in the end amount to little more than a token and do no serious harm and therefore did not feel under serious pressure. 
What initially appeared as the inept behaviour of President Ahmadinejad, who in November by delivering one of his usual anti-Zionist speeches offered the opportunity to the European press to unleash a wave of criticism, emerged later as part of a strategy to deligitimise the still ongoing attempts by the likes of Rafsanjani to negotiate with the US with the approval of Supreme Leader Khamenei. By creating an atmosphere of nationalist agitation, Ahmadinejadundermined Rafsanjani's attempt and weakened his role of shadow statesman. In this optic Ahmadinejad's decision to purge the Iranian diplomatic corps of moderates and appoint new faces does not necessarily look as lunatic as some commentators have said. The ambassadors to France, Germany and the United Kingdom, the three European countries involved in negotiations with Teheran, were all replaced, as well as the ambassador in Geneva, who was also involved in the nuclear discussions. The Iranian team to the UN has also been completely changed. Some serious damage might derive by sending a team of inexperienced diplomats to such important negotiations and the reappointment of Javid Zarif as permanent representative to the UN (he had resigned a month earlier) might be a sign that the regime is worried about not pushing the purges too far. However, in terms of factional competition within the conservative front the move might prove advantageous. Unsurprisingly, the main criticism of Ahmadinejad's move came from Hashemi Rafsanjani, who is once again trying to take the lead in the negotiations with the Americans. On the other hand, Supreme Leader Khamenei is trying to position himself between the two conservative factions, radical and pragmatic, sometimes apparently favouring Rafsanjani, some other times coming out in support of Ahmadinejad. 
During September for a while it even looked as if a referral to the UN Security Council might not be approved within the board of the IAEA itself, due to the opposition to a referral of countries like Brazil and Pakistan and the hesitation of Russia, China, India and South Africa. In the case of India the Bush administration threatened not to renew the US-India Nuclear cooperation program. Contrary to the expectations of many, Iran suffered a defeat at the October IAEA meeting, which decided to refer it to the Security Council over alleged violations of the non-proliferation treaty. Iran was certainly disappointed at the abstention of Russia and China, whose contrary vote it expected, but was especially angry at India for having voted in favour of Iran's referral. The only country which voted against was in the end Venezuela. Iran's foreign affairs spokesman hinted that Iran might reconsider its flourishing economic relations with India because of that vote. In fact, India's stance was a major development for that country, the first instance in which it moved away from its traditional policy of non-alignment. It is disputable whether this was dictated by any genuine apprehension over Iran's nuclear programme, or by the desire to get closer to the United States, a country known to be reconsidering its long-term partnerships in South Asia, probably at the expense of Pakistan. The Iranian leadership was seriously taken aback by the development. 
After the IAEA decision last month, which put Iran just one step away from referral, Teheran has been engaged in damage limitation. On 20 October Iran handed over to IAEA the requested documents and allowed its inspectors to question one of the key officials involved in the nuclear programme. Interestingly, US officials called this an important concession. At the same time, Iran had been putting pressure on IAEA members not to vote in favour of a referral on 25 November, when the next session at IAEA took place. The South Koreans have been the most heavily targeted, with a ban on some of their exports, even if it is clear that South Korea's vote in October was motivated by its concerns with North Korea and not by a particular willingness to align with the US. Other tools are being used with some countries. For example, in the case of India, Iran despatched its officials to convince the left wing parties in the government coalition to maintain pressure on the Indian Prime Minister not to vote for a referral. 
In the event, the IAEA have postponed a referral to the UN Security Council following an inconclusive debate. Both the US and the troika of European powers involved in negotiations, Britain, France and Germany, sensed some signs of a shift in the Iranian position and decided to allow more time for further negotiations. Russia was given time to negotiate with Iran on behalf of the IAEA, despite some reservations among EU representatives. After another few days, it appeared that Iran was not too keen to negotiate with the Russians either, having set conditions which will be difficult to meet for the other side. EU diplomats were becoming increasingly nervous about Iran's attitude and even El-Baradei, the chief of the IAEA, began to criticize Iran's position openly.
The Bush administration, in any case, continued not to miss any opportunity to irritate the Iranians, possibly hoping to push them towards some inconsiderate action. The main pillar of US strategy will be economic pressure. Some successes were achieved in January 2005, with German giant ThyssenKrupp announcing that due to US pressure it was forced to drop the representative of the Ministry of Economic Affairs from its board (Iran owns a 4.5% share in ThyssenKrupp). The growing US pressure continued to achieve results in February, when General Electrics, another US company which was doing business with Iran despite the embargo, announced its decision not to accept any more orders. The Europeans kept holding against US pressure, but are beginning to feel the need to demand concessions on Teheran's part, as shown by the insistence of Germany's Foreign Minister that Iran gives verifiable guarantees of the non-military character of its nuclear program. On the positive side the victory of the Shiite religious alliance in Iraq offered some relief to Iran, although the margin of the victory was probably lower than expected.
On the whole US sanctions made little impact on Asian countries during 2005. In January the Indian government signed a deal with Iran's national oil company to import at least 5 million tonnes natural gas a year over a 25-year period. The contract is worth US$40 billion and gives India the right to develop two Iranian oil fields and a gas field. Iran's economic attractions are such that not many will be discouraged. India itself does not seem to have any intention of renouncing its plans concerning the pipeline and there are also other plans for joint ventures between small and medium-size companies of the two countries. Shell will be commissioning two new offshore fields for Iran over the next few years and is planning new investments. Even a country as close to the US as Kuwait just signed an agreement with Iran for importing gas starting from 2007, despite the long-standing dispute between the two countries over the Arash gas field. The only neighbour of Iran in whose case friendly relations have been sorely tested in recent months is Turkey. The recent case of Turkcell mobile company, whose agreement with Iran was subjected to revision due to a decision of the parliament, is only the latest one. In a surprise move, at the end of January the Iranian parliament announced its decision to cut Turkish company Turkcell's 70% stake in affiliate Irancell to 49%. The Turkish company now threatens to quit, although South African rival MTN appears ready to step in and replace Turkcell. Turkey is still trying to renegotiate the price of its gas imports from Iran. During the unusually harsh winter Iran had even interrupted gas exports to Turkey, further complicating the issue as some sources claimed that the interruption was due to divergences between the two countries. By the end of the year US attitude towards Iran seemed to be changing and for the first time the Bush administration offered to the Iranians to hold bilateral public negotiations concerning Iraq. Even Israeli officials were reported by some sources as saying that their country might have to live with a nuclear Iran and are looking for ways to increase their own deterrent capacity. 

Economy
Even in 2005 the growing awareness of the need to attract more foreign investment struggled to translate into the signature of more contracts. The buyback system, deeply disliked by the oil multinationals, remained in place, although investors could now tender for up to 25 years, compared to 7-8 years previously. Moreover, investors did not need to re-bid after exploration work has been carried out. However, the major oilfields were excluded from the new buyback deals, which limits the attractiveness of the changes. Within the Iranian oil industry different positions continued to surface concerning the future role of buyback deals. Some industry officials admitted that as they were, the buyback deals were not good enough to attract foreign investors, who would like to participate in the sales phase too. On the other hand, the new ten year development plan, which rest on attracting US$100 billion worth of investments, did not foresee any change in the buyback contracts. According to UNCTAD, Iran received foreign investment worth almost US$5 billion in 2004, a big increase over the previous year's US$1.5 billion. On the other hand, UNCTAD was rather negative about Iran's innovation capability, where it ranked it 75th of 117 countries, and about its human capital, where it ranked 81st. The increase in foreign investment, however modest in terms of the needs, is nonetheless remarkable given the constraints that still existed in Iran. Foreign investors, for example, could only buy up to 10% of the value of any company listed on the stock exchange. This might have contributed to the negative performance of the Teheran stock exchange since May 2005, although the main reasons were others. Concerns over Iran's foreign policy and the apparently negative attitude of President Ahmadinejad towards the stock exchange conspired to create a climate of uncertainty around it. Since 80% of the market value of the stock exchange was owned by state institutions and only about 200 companies trade regularly, manipulation of stock prices was relatively easy, another factor which might be deterring investors. 
The Iranian government continued to announce new deals in April, this time with Iranian companies. The failure of the tenders for the development of Bangestan and South Pars resulted in the decision to award the projects to Iranian firms on the basis of buyback contracts. Interest in bidding for future projects remains strong among multinationals, as expressed in April by Total (France) and ENI (Italy). In July the government announced that production of oil has started in three new fields (Darkhovein, Soroush, Nouruz), for a total of 190,000 bpd. During August, outgoing Oil Minister Zanganeh revealed that Iran's oil production has recently increased to 4.2 million bpd, as a result of the investment of US$50 billion over the 1998-2004 period. This contradicted the expectations of oil industry analysts in the West, who had predicted a decrease in Iran's oil production due to the exhaustion of existing fields. Zanganeh admitted that capacity is falling at the rate of 300-350,000 bpd, but also said that investment was sufficient to more then offset those losses. In November, however, the director of the National Iranian Oil Company admitted that some decline in production might occur soon, due to "technical problems". 
New president Ahmadinejad's early comments on the oil industry were clearly not designed to downplay any fear in the industry. He said that he will favour domestic firms in the oil sector. He however accused his defeated presidential rival Rafsanjani of having been in control of the oil ministry and promised to clean up the industry. Within the oil ministry there are fears that a purge will soon start and that experts will be replaced by unskilled cronies of the new president. Among oil companies reactions were mixed, but predominantly rather negative. BP, for example, declared that it will maintain its long-term interests in Iran, while Sasol, on the other hand, is reconsidering its plans to develop gas-to-liquids plants in Iran and will probably wait to see how US-Iranian relations develop. In general, his statement in favour of domestic companies and of a clean up within the oil ministry were not welcome and contributed to push oil prices slightly higher. Given the importance of oil and gas for Iran's economy, Ahmadinejad's attempts to appoint political cronies to the post of Oil Minister badly backfired when the first three of his candidates were rejected by the parliament. 
The 2004/2005 draft budget featured a 10.5% increase on the previous year, to reach US$127 billion. The budget aims at achieving a 7.3% economic growth, based on the assumption of an average price of oil at US$19.5 a barrel. The Guardian Council however rejected the new state budget, on the ground that it conflicts with the constitution and with Sharia law on several points. The new budget once again confirmed Iran's proclivity to spend to stimulate the economy. Even during 2005, the government admitted that it would have to draw US$500 million from its Oil Stabilisation Fund, despite oil earnings US$6 billion higher than expected. The Fund will therefore drop to US$7.7 billion, a negative development after years of oil revenue windfall like 2003/2004 and 2004/2005 have been. 
Despite their earlier statements in favour of continuing the economic reforms, the conservatives continued to oppose foreign investments, especially in strategic sectors such as communications. Another example of contradictory Iranian attitudes towards foreign involvement in the national economy was the diatribe concerning the Soroush and Nouruz oil fields, which Royal Dutch/Shell failed to develop within the agreed time schedule. Delays are common among "buy-back" deals in the Iranian oil industry, where they occur in 20-30% of the cases. The fact that the National Iranian Oil Company insisted that Royal Dutch/Shell pays a fine for its failure to deliver according to schedule would, if implemented, further discourage foreign investment in the Iranian oil industry. 
The last reformist government had put forward some plans in February, proposing that refineries be privatised and that the share of Iranian contractors in the oil industry be increased from 3% to 6% over the next 10 years, in order to increase their ability to compete against foreign firms, which according to the Oil Ministry benefit from easier access to credit. Plans to privatise the tourist industry and the railways were also announced. The rail infrastructure will remain under state control, while services and wagons will come under the control of private companies. Although the participation of private companies was already allowed in the railways, fares are so low that none ever tried to invest in the sector. It is likely, therefore, that in order to make the privatisation feasible fares will have to be substantially increased. In practice, however, little progress is being made on the privatisation front, despite the fact that 41% of the largest public enterprises are in the red. Out of a net worth of US$110 billion, only US$570 million worth of shares have been put for sale and of this only US$17 million effectively sold. Even these have been bought by other public companies. On the other hand, some signs of a renewed interest in foreign investment could be seen in November, when vice president Davoudi invited foreign companies to explore opportunities in the mining sector. In the meanwhile the stock exchange continues to lose ground, not least because of Ahmadinejad's lack of concern about the prospect of economic sanctions.
Final figures showed that Iran's GDP grew by 6.7% in 2004/2005. Growth was stronger in the agriculture, mining and industry sectors and weaker in the services. Although this was higher than previous estimates, it still fell short of what Iran needs to absorb an expanding workforce. The macroeconomic conditions of Iran remained stable, according to the information provided by the Central Bank in May. On the other hand, Teheran's stock exchange, which made significant gains in the run up to the election, betting on Rafsanjani, was badly shocked by Ahmadinejad's surprise performance. Ahmadinejad, the son of a carpenter, was seen as the candidate of Iran's pious poor and the business community fears that he would roll back the market reforms of recent years.
An ongoing debate of 2005 concerned import tariffs. According to the chief of Iran's police force, Baqer Qalibaf, high tariffs give an incentive to smugglers. Apart from narcotics, the value of goods smuggled into Iran is estimated at US$5.5-6 billion. As a result, rather than stimulating domestic production, high tariffs undermine and the state does not even earn any custom revenue from smuggled goods. Attempts to prevent the smuggling are being frustrated by widespread corruption, including within the police force. 
The fate of the oil stabilization fund was also a matter of discussion. The last reformist cabinet proposed to spend US$1.3 billion from the Fund (worth a total of US$8 billion now, but likely to rise significantly due to high international oil prices) to pay for the cost of importing petrol, which Iran cannot manufacture in quantities large enough. The conservative majority in the parliament, however, cut the figure to US$825 million and insisted to spend the rest on its own constituencies in the countryside and in the Islamic Foundations. 

Internal politics
After much debate, both the conservatives and the reformists went divided to the presidential polls. There were two official reformist candidates, Mehdi Kharrubi, who was supported by the clerical wing of the reformist front, and Mustafa Moin, who had the support of the more secular components of the front. However, many younger reformists also favoured the candidacy of former president Hashemi Rafsanjani, despite the fact that originally he was considered a more likely candidate of the moderate conservatives. Rafsanjani's advantage would have been that his chances of winning were much higher and that he will not be disqualified from running by the Guardians Council. Indeed the relationship between Rafsanjani and the conservatives seemed to be worsening, as they appeared to be trying to push him towards renouncing the idea of a candidacy in favour of somebody more ideologically committed to their cause. Even influential individuals from within President Khatami's inner circle were beginning to endorse him. The fact that troublesome times seemed to lie ahead for Iran, with US pressure growing stronger and stronger, was playing in his favour. The need was increasingly felt for a strong and experienced leader who could handle the situation and Rafsanjani, who had already been president once, portrayed himself as the right man for the job.
On the conservative fronts the leading candidates were Qalibaf, a law-and-order man who enjoyed some popularity for having improved the efficiency of Iranian police during his tenure as chief of national police, Mahmud Ahmadinejad, the eventual winner and Teheran's mayor, who attracted the sympathy of the new generation of conservatives, who currently dominate the parliament and Ali Larjani, who was doing well in the early opinion polls. The conservatives appeared likely to end up more divided than the reformists in the actual elections. Conservative candidates were under pressure to withdraw their candidacy in favour of Larjani, who was endorsed by the main conservative association, or Qalibaf, who was favoured by Khamenei, but only two, Tavakoli and Velayati, did so. Several of the minor conservative candidates showed no intention of retiring in favour of the main ones, as in the case of Mohsen Rezai, who stated that if he was not selected as a joint candidate, he would run anyway on his own. Larijani seemed to have taken a clear lead before the elections. He was trying to repeat the formula which led to the success of the conservatives in the last parliamentary elections. Despite his impeccable conservative curriculum, he claimed that the expertise of the academics is needed to lead the country. He criticised the excessive state involvement in the economy and tried to appeal to youth. Interestingly, the wave of social repression which had characterised the first several months of conservative majority in the parliament had ended by spring and now a new climate of tolerance of "unislamic" behaviour among the youth has emerged, suggesting that the law enforcement agencies, dominated by the conservatives, were trying to undermine the appeal of the reformist candidates. 
Hashemi Rafsanjani's positions are not very different from those of Larijani, except in foreign policy, where he advocated a dialogue with the Western countries, which Larijani opposed. In the end, contrary to all forecasts, the Iranian presidential elections were won by one of the most conservative candidates, Teheran Mayor Ahmadinejad. The first round of the Iranian presidential elections ended as foreseen with Hashemi-Rafsanjani in the lead, although his score (21%) was not as high as many had imagined. What was unexpected was however his challenger, Ahmadinejad, the mayor of Teheran, who came very close with 19.5%. The surprise was two-fold: not only it was not a reformist candidate to make it to the second round, but it was not Qalibaf who had emerged as the favourite conservative in the June opinion polls. Qalibaf ended fourth with 13.9%. Another surprise was the fact that Mehdi Kharrubi emerged as the strongest reformist candidate, with 17.3%. He ranked third in the race. Erstwhile favourite Moin, rather to the left of Kharrubi, took only 13.9% and arrived fifth. With around 36% of the votes, split among three candidates, the reformists as a whole did rather badly. The conservative candidates gathered among themselves 43%. It appears obvious that the campaign run by the Bush administration against Iran's nuclear program ended up favouring the conservatives. 
During the short campaign leading to the second round, Ahmadinejad was able to deliver his message more effectively to the mass of the electorate, as the attention was now focused on him and Rafsanjani. Despite most of the political establishment, including moderate conservatives, rushing to support Rafsanjani, Ahmadinejad won by a large margin, with 62% of the votes. In fact, he took votes away from Rafsanjani and the reformist candidates who did not make it to the second round. This suggests that much reformist vote was anti-establishment and expressed frustration for the slow improvement in living standards after the end of the war against Iraq. Rafsanjani, very much an establishment candidate, was snubbed by many who had voted for the reformists just a few days earlier. Ahmadinejad appears to have won not so much because of his conservative message, but because of his targeting of the poorest strata of the population, whereas the reformists had focused on the middle class. The economic reforms about which both Rafsanjani and the reformists agree leave the rural population and the urban poor cool at best, as in the short term they would suffer from their implementation. Moreover, radical reformers boycotted the election in large numbers, causing a division in the reformist ranks which was a key reason for their defeat, together with having fielded as many as three candidates. 
Despite his claims that he wanted to be the president of 70 million Iranians and that he would use all skills and competencies available in his government, Ahmadnejad filled his cabinet with hardliners, among whom quite a few have a background in the Revolutionary Guards. Not a single reformer was appointed. A lonely centrist was Mohammad Rahmati, who stayed on as Transport Minister from the previous Khatami government. Among the key players Manouchehr Mottaki was the Foreign Minister, who has in past issued statements in favour of a tougher position in the negotiations on Iran's nuclear programme. Not only no reformer figure in the new cabinet, but many even within the ranks of the right wing faction in the parliament were disappointed. The appointees were largely from the "new right" tendency, which left the traditional right with little power. In the Teheran Council, a formal split between the two tendencies rapidly occurred and 15 conservative councillors have decided to form their own group. Ahmadinejad made a number of statements with regard to his future policies even before taking charge. He said that his domestic policies would be moderate and that he would accept criticism. The new chief of police appointed by Supreme Leader Khamenei echoed Ahmadinejad and promised moderation especially in dealing with youth about breaches of the moral code. At the same time Ahmadinejad's statements concerning freedom and human rights were at best ambiguous. The reaction of the Teheran stock exchange was also negative and prompted accusations from Ahmadinejad's team that "certain investors" were undermining market confidence.
By the end of August new president elect Ahmadinejad had managed to get most of his cabinet through the hurdle of parliamentary approval, but not without losses. Four of the ministers he had proposed were rejected. The most noticeable rejection was that of Oil Minister Saidloo, but the candidate ministers for cooperation, education and welfare were also rejected. The candidate Interior Minister was also criticised for his past in the intelligence service, but managed to get through. During the parliamentary debate, the main reasons stated for the rejection were the lack of professional competence of the candidates. Five of his ministers have a background in the revolutionary Guards and one of Ahmadinejad's first acts is likely to be the granting of police powers to the Basij paramilitary force, which is affiliated with the Revolutionary Guards. According to sources close to Ahmadinejad, their role would be the enforcement of the laws against "decadent behaviour". It took until December for Ahmadinejad to identify a suitable candidate to the Oil Ministry, after three failures. Kazem Vaziri-Hamaneh was finally confirmed by parliament. He too has a background in the ministry and is seen by some as being close to the interest groups nicknamed the "oil mafia", but is considered to be politically closer to the conservatives. He is known to have criticized Iran's oil buy back schemes, but it is not clear what he proposes to do in this regard.
The new president moved quickly to exploit the disarray of the reformist groups, with the announcement of his own plan to woo the youth away from them. A US$1.3 billion "love fund" will be created to help low-income couples to marry. 
Following the presidential elections, the ranks of the reformers, on the other hand, were increasingly in disarray. Former president Khatami took up the leadership of the clerical reformist party, Militant Clerics Association, but the former leader of the party Karrubi has announced that he will form yet another reformist party. Moderate reformers close to former president Rafsanjani are on the other hand discussing the formation of a Moderation Front, while the old Executives of Construction Party, the first pro-Rafsanjani group to be created, appears to be in crisis and is expelling some of its members.
At the beginning of October, Supreme Guide Khamenei surprised many by extending the powers of the Expediency Council, headed by Akbar Hashemi Rafsanjani, the defeated presidential candidate. This body will now supervise the implementation by the government and the parliament of a 20 year development plan drafted by the Council itself. It would appear that Khamenei, worried at the assertiveness of the new right now in control of both parliament and presidency, was trying to counter-balance its power by extending that of other institutional bodies. Within the parliament too, more rumbles were being heard, especially about the Interior Minister, who was rapidly becoming unpopular because of his failure to consult parliament over the appointment of governors.
The new government definitely had a security-focused agenda, as the reported expansion of the Basij voluntary force shows, but its agenda also did seem to include a genuine intention of making the regime more efficient. The Minister of Interior Purmohammadi hinted in October that more powers might be devolved to the provinces and municipalities. He also raised the issue of improving Iran's economic productivity, which remains low even by the standards of the developing world. President Ahmadinejad himself complained about the inefficiency of the banking sector, but in typical fashion continued to express hostility towards private banks and identified the solution in "better supervision." Indeed, at the beginning of November Ahmadinejad also replaced the managing directors of the state-owned banks. The President, after all, had promised to bring new faces into government, although some argue that Ahmadinejad might just want to be surrounded by people with little personal power base in order to be able to dictate policies more easily. Even some fundamentalist groups, like Ansar Hezbollah, criticised the President's penchant for choosing cronies, although what they demand is the appointment of religiously committed individuals. 

Summary 2006
The coming year should tell us whether the shift in Iranian politics, away from conservative clerics towards right-wing lay politicians, will continue or not. Although Ahmadinejad and his circle are certainly pious people, the fact that they are not clerics tends to push them towards legitimizing their role by playing the nationalist card and using an implicit criticism towards the privileges and corruption of that establishment. This has allowed them to defeat the clerical elite in the presidential elections, surprising all the main players. Some observers think that Ahmadinejad has been pushing too hard and is alienating the old-style conservatives, who are influential in the parliament and control the Experts and the Guardian councils and are therefore well positioned to trap the President as they did with his reformist predecessor, Khatami. The next appointment will be the forthcoming elections to the Council of Experts, which holds a lot of power in Iran, including the ability to elect the Supreme Leader. President Ahmadinejad and his supporters appear to be working to get their Ayatollah of choice, Ayatollah Mohammad Taqi Mesbah-Yazdi, as Supreme Leader, but it is likely that the results of the election will show continuity with the past and favour more traditional conservative characters. 

Ahmadinejad's uncompromising stance on Iraq and the nuclear programme reflect his need to mark his distance from the old-conservative establishment. His announcement that women will be allowed to attend matches at the stadium also clearly appears to have been thought to strengthen his neo-conservative credentials, while at the same time upsetting the conservative clergy. His supporters also did not seem too averse to allowing non-clerical individuals, who have expertise in certain fields, to be candidates in the elections to the Council of Experts, as this might have had the effect of weakening the hold of the old-conservatives on the Council, for example allowing military personnel to be elected. In the end  the December elections to the Council of Experts were in part pre-determined by the vetting of the Guardian Council, which ruled out many reformists and supporters of President Ahmadinejad. The victory of moderate conservatives is therefore not very surprising. Former President Rafsanjani topped by far the list of the elected representatives, but this too is not so surprising considering that he was the best known of the candidates and that he had received millions of votes as a Presidential candidate earlier. The local elections which took place at the same time are somewhat more indicative of the mood of the population. It would appear that the electorate opted to issue a strong warning to the President and the government. Although the group sponsored by Ahmadinejad was not wiped out, its ambitions to expand its influence in the representative bodies were frustrated and it may even have suffered substantial losses. Undoubtedly, Qalibaf's moderate conservatives did well, while the reformers regained some ground. In Teheran, Ahmadinejad's group appeared poised to get less than a third of the seats, according to partial results, while Qalibaf's group seemed to be securing a majority. Qalibaf had enjoyed the support of Supreme Leader Khamenei in the 2005 Presidential elections, but had failed to make it to the second round. He is now Teheran's mayor and the voters seem to have rewarded his dynamic style of administration. Qalibaf will now be emboldened in using the mayorship as a launch platform for the next Presidential campaign, just as Ahmadinejad did. In general the reformists' attempt to stage a comeback, strengthening relations with the clergy and trying to pay greater respect to traditional values, while at the same time exploiting worries among the public that Ahmadinejad may be pushing the confrontation with the US too far, appears to have been mildly successful. 

In terms of foreign policy, Ahmadinejad's tough approach appears to be paying off. Whether by design or by accident, he appears to have succeeded in convincing the Bush Administration and its allies that Iran could not be intimidated and that the regime could easily withstand an air campaign against it, lest oil infrastructure is attacked, which given the current high prices of oil is unrealistic. The peak of tension between the Iranians and the Americans is therefore probably past, although Ahmadinejad's unpredictability raises a few question marks here. There are also dangerous issues involving the State of Israel, the Palestinian peace process and Ahmadinejad's involvement underwriting the religious party, Hamas, regarded by the US and the EU as a terrorist organisation. Over the next year the Bush Administration will have to work out how to trade Iran's cooperation in stabilizing Iraq with concessions on the nuclear front, at the same time not making their own defeat too obvious to US internal and world opinion. As it often happens in US foreign policy, short term objectives, often dictated by the electoral schedule, might end up having pre-eminence over longer-term ones. 

The Bush administration is desperate to get out of Iraq and now accepts that it may even in some way have to enlist Iranian help for that, maybe even accepting longer-term risks which in a different situation would have been deemed as unacceptable. During January (2006) US officials once again voiced the possibility of the use of force against Iran, although at the same time the same officials were blandishing the Russians by describing their proposal of cooperation with Iran as a good plan. However, even if the Bush Administration might succeed in driving a wedge between the Russians and the Iranians, this might not have got far enough to convince the Russians to accept a referral, even if they were clearly irritated by Iran's cold reception of their plan. Russia's Foreign Minister Lavrov maintains that sanctions are neither the best nor the only way to put pressure on Iran. In any case, even if Iran was referred to the Security Council, there seems to be little scope for sanctions. Iran would only be seriously hurt if sanctions affected its oil exports, which is unthinkable in the current predicament; besides, US ally Japan, Iran's largest customer, would be the hardest hit. Oil sector analysts argue that the loss of Iran's oil could only be partially offset by increased production in the few countries which have unused production capacity, chiefly Saudi Arabia. As a result, oil prices would shoot up further, hurting mainly Asian countries and among them China, a country whose support is essential if sanctions have to be approved. 

By February both the US and the Europeans were openly stating their support for referring Iran to the Security Council. The Israelis, who believe an embargo on Iranian oil is feasible, were actively lobbying the Russians, who however are still opposing the referral of Iran to the Security Council, even if starting from mid-January their position has been coming closer to that of the US and Europeans. Many analysts in reality agreed that even if an embargo was imposed, preventing smuggling would be problematic and would entail the risk of an armed confrontation. Although US and Israeli threats of military action, including by Rumsfeld himself, were widely seen as attempts to force the Security Council to take action, rather than genuine forewarning of action, quite a few military analysts believe that an air campaign against Iran will indeed take place, but not before 2007, by which date diplomatic sources could well said to have been exhausted and the no-return threshold in the Iranian nuclear programme have been approached. However, the opinion of the analysts is divided with regard to whether such air strikes would be effective in seriously disrupting Iran's nuclear programme. News that Iran was moving its foreign exchange reserves out of Europe seemed to confirm in late January that the country's leadership was getting ready for a sanction regime, even if it was later clarified that the withdrawals only affected Italian banks and were motivated by a court case which had led to the freeze of an account controlled by the Iranian government.

At the beginning of October Iran once again tried to break the European-US front by proposing that France lead a consortium to enrich uranium in Iran. This attempt is unlikely to succeed and in fact a couple of weeks later the European Union announced that it supports gradual sanctions against Iran. Nonetheless, Teheran can still count of the diplomatic support of Russia and China to avoid the imposition of sanctions from the Security Council. The Bush administration and the Israelis are actively lobbying Moscow, but it is not clear whether the US are ready to offer anything substantial to Moscow, such as clearance for its demand to accede to the WTO. Even if the Russians were to be convinced of some form of sanctions, it is likely that these will concern military sales and technologies rather than commercial sanctions, at least initially. Condoleeza Rice herself has ruled out sanctions on Iran's import of refined fuel, widely seen as Iran's most vulnerable spot. As a result, the impact on the economic conditions or Iran and on the regime would be minimal. In any case the government is hedging its bets and announced in October that it will start rationing fuel distribution in March, following the adoption of a new smart card which is just reaching the final stage of development.

By late January Supreme Leader Khamenei appeared to be growing so worried by Ahmadinejad's brinkmanship policies that he agreed to a suggestion by former president Rafsanjani to create a new body in charge of nuclear policies. Even some top leaders of the Revolutionary Guards, supposedly Ahmadinejad's main base of support, appear to be in favour of such a move, possibly because they think that Iran is not ready yet to withstand successfully international sanctions. In particular, many think that as long as Iran imports 40% of its consumption of gasoline it will be very vulnerable to sanctions. 

The plan to convert to liquefied gas is still in a very early stage. As a result of Rafsanjani's found-again influence, in early February it looked as if Iran was inclined to major concessions, including the end of enrichment in Iran, which were being negotiated between Iranian and Russian diplomats. However, in mid-February Ahmadinejad intervened to pre-empt Rafsanjani's move and froze talks with the Russians "indefinitely", moved to unseal the research sites and to start uranium enrichment, while at the same time warning that it would not allow snap UN inspections. On 11 February President Ahmadinejad even threatened publicly to withdraw from the non-proliferation treaty if pressure from the West continued, although his foreign ministry reaffirmed Iran's commitment to the NPT a day later. At the same time, a state of emergency has been declared at the country's nuclear sites, presumably reflecting the fear that an Israeli/US air strike could take place at any time. As the end of March approached, Iran found itself increasingly isolated in its confrontation with the US over the Iranian nuclear programme. Iran definitely abandoned negotiations with the Russians over having them in charge of uranium enrichment, after the Russians bowed to US and European pressure to drop their earlier proposal to let the Iranians continue some "nuclear research". By the end of the year, the situation had been overturned. With the Bush Administration in a weakened position and enduring Russian and Chinese support within the UN Security Council, the Iranian government felt confident enough to leak information that it was actually accelerating its nuclear programme, with a second cascade of centrifuges being activated in October. In December Russia and China responded with caution to US and European calls for a quick UN Security Council vote on the draft resolution imposing sanctions on Iran. Russia in particular objected to certain aspects of the draft, such as the travel ban and the freezing of assets belonging to a list of Iranian citizens, despite intensive lobbying by Condoleeza Rice. Many within the Iranian political elite seemed convinced that 'mild' sanctions will be imposed at some point, but they do not seem unduly worried about it, or at least say so in public. The expectation is that sanctions will be symbolic and aimed mainly at saving face for the Bush Administration. The Iranians seem also convinced that a number of states, including European ones, will be enforcing any sanctions only loosely.

For all his seemingly extremist positions in foreign policy, Ahmadinejad appears to be succeeding in dictating the terms to the Iranian leadership, including supreme leader Khamenei, who had to dismiss the danger of sanctions, recalling that in the past they actually helped to generate self-reliance among Iranians, and Ahmadinejad's main rival, Hashemi Rafsanjani, who in January hinted in a speech delivered in Teheran that the "enemy" wants to prevent Iran from developing nuclear know-how in order to keep it weak. Support for nuclear fuel production seems to be widespread among Iran's legislators too. On the other hand, Khamenei appeared to be using Ahmadinejad to demonstrate to the world that Iran cannot be ignored and that the US were wrong not to make a deal when that was possible (i.e. under Rafsanjani and Khatami). On 16 March Iran seemed to be trying to capitalise on its brinkmanship game when it announced their acceptance of the offer of the Bush Administration, made several months earlier, to hold talks about Iraq. 

During June and July Supreme leader Khamenei sent once again clear message that he will not allow President Ahmadinejad to unilaterally run the show. He first established a new body to supervise Iran's foreign policy, the Strategic Committee for Foreign Policy, and most interestingly appointed to lead it Kamal Kharrazi, a reformist who has served as foreign minister under former President Mohammad Khatami. Although the body has no executive functions, it is clearly an attempt to bring experienced professionals into the policy making process, following accusations that Ahmadinejad was relying excessively on zealots to staff his diplomacy. In fact, Ahmadinejad's purge of the diplomatic corps continued in July, with the appointment of new Ambassadors to London and Paris. 
Then Khamenei took the initiative to decree the privatisation of Iran's state-controlled companies, except for the upstream oil industry and the largest state banks. Airlines and shipping companies are also included in the privatisation plan. Up to 80% of the shares of each company will be sold and foreign investors will be allowed to buy, although they will still need a specific authorisation from the Economy Ministry. This will be Iran's second attempt to sell government assets (the previous one (2004-2005) was not very successful, with just 30% of the US$2.5 billion worth of shares finding a buyer). In the past, a lack of transparency and the overvaluation of state assets were blamed for this failure. This time, there seems to be little more transparency, while at the same time the economic climate is clouded by international tensions. Therefore, the plan might again not be very successful, but its political importance derives from Khamenei's attempt to stem Iran's economic policies away from Ahmadinejad's state-friendly inclinations. 

The government seems to be losing popularity rapidly, haunted by charges that many ministers are not up to the task. Two new minister were approved by the parliament in November, Cooperatives Minister Mohammad Abbasi and Welfare and Social Security Minister Abdul Reza Mesri. Mesri's predecessor had been heavily criticised for his lack of skills and experience and for hiring incompetent people, as well for his inability to exercise control over the Social Security Organisation. Other Ministers appear to be in a shaky position, either because they are politically suspect or because they failed to deliver to Ahmadinejad. The list includes the Minister of Roads and Transport and the Minister of Commerce. Many changes have also occurred in the middle ranks of the administration, particularly in the management and Planning Organisation, in the Ministry of Economy and Finance, the Oil Ministry, the Commerce Ministry and the Central Bank. The Parliament, moreover, is not happy about the performance of the Ministers of Interior, Agriculture, Education and Energy and might take action soon. The declining popularity of his cabinet does not seem to be deterring Ahmadinejad from launching controversial initiatives. After sacking 40 university professors in June because of their secular and liberal views, he is now calling for a wider purge of the academic establishment, in order to free it from the vestiges of 'colonial' influence. 

Press leaks indicated in early April that preparations for a military offensive against Iran are already going on and that the likely date is sometime in 2007. Although US officials denied the content of the leaks, most international analysts upgraded the chance of a US military campaign against Iran. The Bush Administration, appeared to be divided between hardliners and extreme hardliners. Following the Iranian announcement in April, that it had succeeded in mastering uranium enrichment technology and had developed advanced centrifuges to speed up the process, the Americans were busy trying to convince Chinese President Hu Jintao to soften their opposition to sanctions against Iran, but at the same time the Russians were hardening their own position against the sanctions, arguing that they would only be acceptable if it was possible to demonstrate that Iran was indeed developing atomic weapons. The Iranians, on the other hand, seem convinced that they still have cards to play. In April Supreme Leader Khamenei made explicit his endorsement of direct talks with the US over Iraq, in part probably to counter-balance Ahmadinejad's radicalism, but also to remind the Americans of the choice that the Iranian leadership is presenting to them, i.e. that what Iran really wants is US recognition and an end to the embargo. If that happened, Khamenei seems to imply, the Ahmadinejad problem could be sorted out. After all, was not the previous president Khatami marginalised by the establishment? 

Ahmadinejad, however, still appears to have a few aces up his sleeve. In March the news that Iran's establishment had accepted to hold talks with the US over Iraq had caused some excitement, as it appeared to have some potential to break the deadlock. However, quite typically the President intervened to deny that there was any need to hold talks on Iraq, now that a new government was being established. Ahmadinejad also won the headlines with his statement that the latest European proposal, to offer Iran a nuclear reactor in exchange for giving up nuclear enrichment, was "laughable". The Europeans had been convinced of the need to offer something more substantial to the Iranians by the refusal of the Russians to agree to a referral to the Security Council. The latest version of the package, agreed with the US, offered precisely that: nuclear assistance, but most importantly trade and economic incentives, in exchange for abandoning the military component of Iran's nuclear program. The trade incentives include among others an end to the US ban on the sale of aircraft and aircraft parts, which are badly needed given the Iranian ageing aircraft fleet, but even more noteworthy because it is the first important step in the direction of what Iran has always been asking, i.e. the abolition of the trade embargo. Also, the Bush Administration has for the first time hinted that it might consider allowing Iran to continue its own uranium enrichment program, on certain conditions. The alternative would be UN sanctions against Iran. By June there were signs that part at least of the Iranian leadership was tempted to accept the package or at least not to flatly reject it, possibly also because of pressure coming from Russia and China, which want to safeguard their trade relations with the West while building a political-military bloc of their own, the Shanghai Cooperation Organization (SCO). 

Iran's President Ahmadinejad has been invited to attend the forthcoming meeting of the SCO, a sign that Russia and China might be considering to invite Iran to join as a permanent member. In the meanwhile, Iran was sending signals that the bargaining process would continue for a while. In mid-June it once again reiterated that it is no longer interested in talks with the US on Iraq, despite US hints that the talks might have addressed other issues too, of greater interest to the Iranians. As the 31 August deadline for answering the European nuclear offer came and went, as most observers expected, Iran gave a non-committal answer apparently playing for time, and gave no undertaking to abandon its uranium enrichment program. Teheran refused to suspend uranium enrichment, but at the same time it declared its readiness for further 'serious' talks. Clearly, the Iranian leadership feels that it is not in a position of weakness after the 'lessons' of Lebanon and given the worsening violence in Iraq and Afghanistan. The message to Washington is clear: after Lebanon, more lessons could be taught elsewhere if Teheran was too drastically challenged. What seemed to be implicit in Iran's actions in Iraq is now explicit, as vice-president Saidlou and Ahmadinejad's loyalists stated in September that it is about time for the Americans to leave Iraq. On the face of it, Teheran's diplomatic gamble once again seems bound to be successful. After the initial round of negative reactions to Iran's failure to comply with European and American demands, the French government in a matter of days stated its readiness to restart dialogue with Iran. As mid-September approached even Condoleeza Rice was not excluding the possibility of new negotiations with Iran, despite President Bush's late August statement that 'Iran must face consequences'. Predictably, Teheran's response to the uncertain and confused reaction of its interlocutors was to announce its willingness to suspend enrichment for two months, too little to appease the Americans, but possibly enough to divide the Europeans, some of whom, in Iran's view, are ready to a compromise in favourable terms to the Iranians in order to avoid disruption to oil supplies and a major crisis. Finally, by 20 September it appeared clear that neither Russia, China nor France would support sanctions against Iran, forcing the US to approve a new round of negotiations between EU foreign policy chief Solana and the Iranians. IAEA reports suggest that in reality Iran's progress in enriching uranium has so far been limited and that some of its claims of making progress are inflated, a strategy which recalls somewhat the one adopted by Iraqi President Saddam Hussein in the 1990s.

US efforts at hurting Iran's economy continued unabated. Contradicting earlier statements by President Bush himself, the Pakistani government was asked in April by the US Ambassador to abandon the Iran-Pakistan-India pipeline project and choose another option. In March the Bush Administration had even asked the Japanese to at least temporarily halt work at the Azadegan oil field, in order to put pressure on the Iranians concerning the nuclear dispute, although Tokyo refused to bow. Despite the modest results, the Bush administration seems to be seeking new ways to put pressure on Iran. It has announced that it will step up the use of Security Council Resolution 1540, which allows to target financial institutions which cooperated with countries in breach of the non-proliferation treaty. The resolution was used with some success against North Korea and will now be used against Iran, at least in the intentions of the Bush Administration. Some US companies, such as General Electric and Aon, have already decided to revise their attitude towards Iran. There are also plans to force the revision of the risk appraisal for doing business with Teheran, which would lead to higher costs of loans and guarantees. These are seen as de facto sanctions which could replace UN-approved sanctions if Russia's and China's opposition to any resolution sanctioning armed intervention and Germany's opposition to a tight sanction regime were not overcome. Germany, which is Iran's main trading partner, has signalled to the US that it would not go for serious sanctions. 

However, financial institutions appeared to be more sensitive to US pressure. In May the OECD downgraded Iran as a credit risk, consequently raising insurance premiums on Iranian export credits. UBS and Credit Suisse had already halted operations in Iran in January, worried about the ongoing political developments, but now several other European banks, including ABN AMRO and HSBC, were downscaling their involvement in Iran, not least because some European governments had also been cautioning banks about the rising risks. This will lead to higher trading costs particularly for small Iranian businesses, which need letters of credit in order to import machinery and components from abroad. However, in September Japanese firm Inpex appeared to have agreed to a contract to exploit part of the south Azadegan field. The contract has long been delayed due to disagreements between the Iranians and the oil firms involved and was originally supposed to start in March 2005. Some observers believe that some of the trouble being incurred by the Iranian economy is due to the psychological pressure deriving from the feeling of isolation and incumbent disaster: the 20% fall in the Teheran stock exchange last year, the decline in investment and construction activities, the outflow of cash or its conversion into gold. Others, however, believe that as long as the price of oil will be this high, in order to hurt the Iranian economy, sanctions should target imports of gasoline, for which Iran is 40% dependent from its neighbours. The debate about just how vulnerable Iran is to sanctions divides Iranians, even if the government assembles experts to claim that the impact would be minimal. 

US and European analysts are less convinced of Iran's impermeability to sanctions and identify the huge imports of fuel as the main weak spot. Teheran in reality seems to be aware of this weakness, but its recent effort to limit consumption through rationing faltered in August, when the government decided to allocate additional funds and backtrack from its earlier decision to slash the amount spent on fuel subsidies. Any plan to reduce consumption has been postponed till the next financial year, with the government trying to save face alleging problems in printing ration cards as the reason for postponement. The government now claims to be working to improve public transport in order to prepare the ground for future measures. Iranian efforts to reduce the consumption of fuel, which started earlier this year with ambitious rationing plans, have now boiled down to creating incentives for drivers to replace old, fuel-inefficient cars with newer vehicles running on natural gas. This is clearly a long term strategy and also one of doubtful impact. 

Teheran received unwelcome news in July, when the Japanese government declared that it is ready to support sanctions against Iran and to freeze Iranian bank accounts in Japan, should the international community opt for such a move. In the past, many observers had expressed doubts about Japan's readiness to go that far, since the country is heavily dependent on oil imports from Iran. 

On the other hand, the Russians appear to be seriously interested in a strategic partnership with Iran and are trying to lure Teheran, currently holding observer status, into the Shanghai Cooperation Organisation. Russia and China are making it clear that they remain hostile to any idea of imposing sanctions on Teheran and Putin even stated that it would be wrong to push Teheran to deliver a quick answer to the plan presented by the Europeans for resolving the issue of Iran's nuclear program. Increasingly Russian commentators speak of a 'gas alliance' between the two countries, which would allow the two of them to exercise a dominating influence on the price of gas. The Iranians might seriously consider reciprocating, as shown by the fact that in June they offered Gazprom participation in the building of a gas pipeline from Iran reaching as far as China. However, some commentators point out that the two countries remain potential competitors on the European market (as indeed in China), so reaching a deal might not be easy. Moreover, Iran's own gas plans are unclear, following a new focus on oil as the main source of hard currency.
Ahmadinejad's decision in October to redistribute much of the power of the planning agency to provincial governors caused a lot of turmoil, including a wave of resignations, starting from that of the chief of the agency. The resigning officials fear that the autonomy of the agency will be compromised under the new system, to the advantage of Ahmadinejad (who appoints the governors). In line with his populist ideas, the president seems to have the intention of re-directing economic planning to benefit the poorer strata of the population.

The prospects of a US success vis-ŗ-vis Iran never looked so weak after President Bush lost control of both houses of congress in the November elections. The credibility of the Bush Administration's gung-ho approach reached its nadir and Bush himself was forced to make concessions to the Russians, in a last ditch attempt to win a UN endorsement of his request for sanctions against Iran. In mid-November Bush proposed to exclude the oil and gas sector from sanctions against Iran, a move which would greatly weaken the impact of the sanctions. It was indeed expected that eventually any sanctions would not affect the hydrocarbon sector, but not that this would become the American negotiating position. While initially the Russians and the Chinese might have been genuinely worried about some American trick, which would impose sanctions but leave the door open to a UN-legitimised military campaign, their enduring hostility to any sanctions against Iran appeared now rather determined by the prospect of a complete defeat of the US. 
The Iranian leadership also seemed to share the same feelings that American efforts in the region were doomed and raised its flag even higher in November, when it responded to accusations of supporting terrorist organisations by announcing an increase of its support to Hamas in Palestine from US$50 million to US$120 million. Clearly there was little sign that Teheran is being intimidated. Quite the contrary, in Iran analysts and observers were now becoming worried of an excessively fast decline of American presence in the region, in particular concerning Iraq. Teheran's strategy of letting the American do the dirty job of crushing the Sunni insurgency was beginning to appear outdated as Washington was forced to seek a way out and chaos is spreading throughout Iraq, including parts of the south. If the US indeed was going to leave, Teheran would inherit the mess.

Economy
Since oil prices do not appear bound to fall drastically any time soon, the Iranian economy is expected to keep doing well next year. The Oil Minister announced that 2005/06 was a record year in terms of Iranian oil revenue, which reached US$45 billion. However, it is doubtful whether the current administration in Teheran will be able to spend this windfall for the best of the country. Populist measures such as the decision, taken in March by the government, to raise the minimum wage by 25% are already backfiring, as shown by a wave of job cuts which occurred in May, as many companies opted to lay off workers rather then afford the sudden pay rise. In other cases, wages have not been paid due to cash flow problems in a number of companies. It is estimated that just in the textile industry 10,000 workers have already been sacked since March. 

Iran is cooperating with other OPEC countries in an effort to maintain oil prices at high levels and cut its production levels slightly this summer. It is estimated that Iran, Kuwait and UAE altogether reduced production by 200,000 bpd, while Saudi Arabia cut production by another 200,000, Nigeria by at least 120,000 and Venezuela by 50,000. However, this has had little effect on oil prices, due to slowing US demand. Nonetheless, the longer-term prospects of the oil industry remain fuzzy. Although information on the productivity of Iran's oil fields is limited, it seems that the output of existing fields is accelerating its decline. Onshore fields are reported to be losing production at a 8% rate this year, up from 7%, while offshore fields are losing production at a rate of 13% a year. This means that Iran's production loses 350,000 bpd of capacity and some analysts believe that this figure could soon grow to 500,000 bpd. Iran will have to work harder to develop new fields if it does not want to see production actually decline. Moreover, by 2020 the government would like to raise production of oil to 7 million bpd, up from the current 4 million bpd. Iran is also trying to expand its gas production. Iran itself is planning to invest US$100 billion in its oil industry over the next five years, of which US$12 billion will go towards downstream oil industry projects, hoping to turn around stagnant production levels. This is badly needed, as imports of gasoline continue spinning out of control, to the extent that in February it was even proposed to ration petrol. The plans are very ambitious, as natural gas exports should rise to 20 billion cubic metres by 2010 and 60-80 billion by 2020, up from just 3.5 billion last year. Exports to Turkey are planned to increase to 10 billion cubic metres by 2007, while negotiations are being held with Kuwait for a further 4 billion cubic metres. In the short term, the target is represented by neighbouring countries like UAE and Oman, in which case projects can be implemented in a couple of years, but a number of European countries including Bulgaria, Romania, Slovenia and Austria completed feasibility studies in June and the technical lead time for them starting to receive gas is five years from the signature of the contract. However, while the Khatami presidency had developed grandiose plans to develop gas exports throughout the world, the Ahmadinejad presidency appears to be siding with a faction within the Oil Ministry which argues that Iran's best option is to use gas mainly for internal consumption. In part, this line of thought maintains that given the declining productivity of Iran's oil fields, massive injections of gas are needed to maintain and improve the recovery rate. Some also argue that it would make better economic sense to use gas to replace oil for internal consumption rather than build a huge export infrastructure in order to export gas. However, in October some declarations from Oil Ministry officials seemed to confirm that a massive increase in gas exports remains planned. While 70 million cubic meters were exported in 2005, 200 million are expected to be exported in 2006 and up to 250 million in 2007. The increase should continue in the following years at the rate of 50 million per year. In November came the news that Iran and Austria are negotiating a deal for the delivery of gas. This would be a further confirmation that the original plans to limit exports of gas and utilise it for internal consumption might have been shelved already. According to Iranian commentators, Austria would only be the first European country (apart from Turkey) to become a client for Iran's gas. At the same time even negotiations with India for the building of a gas pipeline seemed to be approaching the final phase, after Iran responded with a new price offer to India's complaints that Iranian price demands were too high.

While there continues to be interest among all factions in exporting gas to India and China, the plans to increase exports to Europe might be sacrificed if the attempt of the Ahmadinejad circle to seize full control of the oil ministry succeeded. It is important to point out that in the plans of Rafsanjani, the man who has been indirectly controlling the oil ministry for many years, exports of gas were also seen as a way to increase Iran's geopolitical influence, an aim which is not shared by Ahmadinejad. The new Oil Minister Vaziri-Hamaneh confirmed for the first time in public that new plans have been developed for the oil industry. 

The plan is now to increase production from the current 4 million plus bpd to over 5 million by 2010, in part through the modernization of installation and pipelines, but also using gas injection and other technologies. In any case, if Iran's oil production has to increase, it does not seem likely at present that this will be thanks to foreign investment. Until the end of February it appeared that at least the oil-hungry Asian countries would not alter their relations with Iran, with the Japanese promising to help Iran avoid international isolation. It was a real surprise, therefore, when in March Nippon Oil, Japan's largest refiner, announced its intention of cutting purchases from Iran by 15% this year, in order to reduce the risk coming from the possibility of an interruption of supplies. This is not the first sign that the nuclear dispute is harming Iran's prospects of attracting foreign investment. Some oil and gas companies had already shelved their Iranian plans in wait of better times, as in the case of British Gas and Sasol (South Africa), both of which had been talking to Iran about gas liquefaction projects. This however must not have been seen as a major blow by the Iranians, given their intention to scale down gas export plans. Although it is expected that other countries will step in to replace Nippon Oil, the latter's move is a more serious signal and sources within the international oil industry confirm that many buyers are beginning to see Iran as an unreliable supplier. As a result of Nippon Oil's decision, Iran's share in Japan's imports will fall by 4 percentage points. 

The only recent development in the oil and gas industry was the agreement with Turkey in August. While uncertainty continues to surround Iran's plans concerning gas exports, Teheran has decided that since a pipeline to Turkey is already in place, it makes sense to use its residual capacity of 5 billion cubic meters to export gas to Europe.
If the efforts of the Bush Administration to isolate Iran economically had limited effects, the Ahmadinejad government gave a hand with its own nationalistic approach to foreign investment. Ahmadinejad's hostility to private and foreign investment has already forced the more pragmatic Supreme Leader Khamanei to intervene. Certainly, the business sector continues to show little love for Ahmadinejad's policies. After having lost 25% of its value last year, the Teheran stock exchange index is down 12% so far this year. 
In April his government announced that in the future Iran will allow foreign companies to participate in oil development projects only in oil fields jointly owned by Iran and neighbouring countries. All other oil fields will be reserved exclusively to domestic companies, although the latter may still use foreign companies as subcontractors. At the same time it was announced that the long criticised buy back contracts for investors in Iran's oil fields will be replaced by a new type of contract called 'investment sharing', although the Iranian authorities did not elaborate on the exact shape of these contracts, which are under development. Only in the case of the South Pars project, where the Iranians are falling behind the Qataris and fear being left with too small a share of the oil, future bidding will still take place according to the old buy back contracts. 

Because of lack of transparency, it is not clear whether the government's claims to have been able to more than offset the declining trend in oil production just with its own resources are completely true or not. In any case, even the government expects to need foreign investment in the future, which is somewhat at odds with Ahmadinejad's careless foreign policy. It is likely that some move might being prepared concerning buyback deals more attractive to foreign companies, if not replace them altogether, but a consensus on what to do does not appear to have emerged yet. 

Because Iran wastes so much of its resources subsidising consumption of fuel internally and in several other ways, there has been little money in recent years to be invested in infrastructural projects. A good example is that of power generation. Prices are too low and the state company in charge of power generation and distribution cannot invest. In fact, it is heavily in debt. It is thought that Iran might face serious blackouts this year. 
The National Bank forecasts that this year GDP growth will reach 5%, while inflation will stand at 15%, in line with the performance of recent years. GDP growth is, of course, too slow to absorb the rapidly growing workforce, and this is recognised by officials within the Bank and elsewhere, but they do not seem to be able to offer any short- or medium term fix. The IMF forecasts solid GDP growth at 6% for the current year (ending March 2006), which is not surprising given the high oil prices. 
For Iran's investment prospects, year 2006 began badly, as one of the consequences of the worsening international climate is that Iran's prospects to attract international investment are suffering a severe setback. Even internal investors appear increasingly depressed and the Teheran stock exchange has been badly hit. The property sector is also reported to be markedly slowing down, but a crisis of liquidity is reported across the board, while capital outflow has been increasing, especially towards Dubai and the United Arab Emirates. According to UNCTAD, foreign investment in Iran is increasing in 2006, with US$7 billion expected to be invested, up from US$5.5 billion last year. However, foreign direct investment not only remains negligible but is probably even declining. Last year it fell to just US$30 million, from US$100 million in 2004 and US$482 million in 2003. Most foreign investment remains concentrated in the oil industry, where it normally takes the shape of buy-back contracts, which do not allow the foreign investor to establish any degree of control over the business, contrary to direct investment. The UAE remain the main investors in the country, as they were last year. 

President Ahmadinejad's populist politics compound Iran's problems. This year his most controversial decisions yet have been an increase in foodstuff subsidies, the increase in minimum wages and forcing banks to lower interest rates by two percentage points. Some economists estimate now that as many as 100,000 jobs were lost after the increase in wages. The increase of import tariffs by 5.2% has also attracted much criticism among economists. His attack on Iran's main private bank, Parsian, drove the bank's shares down to one eighth of their previous value. He accused private banks of profiteering rather then investing in the productive economy and therefore of contributing to widen the gap between rich and poor. Ahmadinejad and others within the establishment might have been thinking that the bank had grown too big and influential and might therefore represent a threat to their monopoly of power. Earlier this year the government pushed banks to lower their interest rates, in line with Ahmadinejad's view that banks should not lend to the rich, but to the poor, so that these can lift themselves out of poverty. Ahmadinejad also opposes interest rates on Islamic grounds and most banks now offer interest-free accounts, as well as small interest-free loans in order to please the government. But Ahmadinejad wants to go further. The President is now trying to sack the chief executive officer of the Parsian bank, Abdollah Talebi, for having privileged big borrowers over small ones, but the case is being reviewed by the judiciary. If the judges reversed Ahmadinejad's decision, it would be a significant blow to his administration.
In June it was reported that the inflation rate seems to be coming down, being estimated at 10.5% in May on the previous year, compared to 11.1% in April and 12.1% in March. However, uncertainty about the economic plans of the government was contributing to discourage investment. According to sources within the state customs authority, the government plans to raise import duties on many goods, ranging from electrical appliances to mobile phones, to textiles and foodstuff. In some cases, such as silk, the plan is to increase duties tenfold. The purpose seems clearly to support national manufacturers, in line with the nationalist leanings of President Ahmadinejad, but many traders and businessmen are unhappy, not least because such plans are at odds with Iran's stated ambition to join the WTO. 

The government cut this year its funds for gasoline imports from US$4 to US$2.5 billion annually in its budget: it wants to cut consumption of car fuel, concerned that dependency on huge imports of fuel is a key vulnerability of Iran to possible international sanctions. The favourite option is to start rationing fuel distribution, beginning from September, while an increase in the price of fuel has been ruled out for fear of social unrest. Many in government and in the parliament fear that rationing too will be a very unpopular move, a fact which has delayed taking a decision on the issue. Some observers still think that the government might not dare introduce rationing and eventually ask the parliament to approve the budgeting of additional US$ billions to import the missing gasoline. The government is also looking for ways to incentive the use of vehicles fuelled by natural gas and for improvements to the public transport system, but these are long-term measures. The plans to expand the capacity of existing refineries and build new ones are getting bogged down because of the difficulty to find the necessary funds. According to government figures, every year 1.8 billion litres of refined oil products are smuggled out of the country. 

Summary 2008

The Ahmadinejad era seems to have entered its final phase, as the Iranian President has been increasingly losing support among Iran's conservatives. Although a full recovery of the reformists does not seem to be in the cards, it is the conservatives that appear to be manoeuvring to isolate him. In January Khamenei signaled once again that his current alliance with Ahmadinejad might not last forever, a s he hinted that he would support a deal with the Americans if that was in the interest of the country. This can be seen as a confirmation that Khamenei uses Ahmadinejad to get the Americans to view him as a comparatively moderate figure with whom negotiations can be held. It is not clear what alignments will emerge after the 2008 parliamentary elections, but it seems quite likely that the next president will be a relatively moderate figure. However, although the western press is keen to portray the Iranian president as a lame duck, increasingly isolated and in decline, Ahmadinejad still appears to have a solid base of support in the provinces, where he has been focusing his efforts, travelling and spending money. About 1.5 million Iranians, for example, have received loans at favourable rates from the state to build homes, while 1 million more are scheduled to receive them in the future. At the same time Ahmadinejad is moving to weaken or intimidate his clerical critics, by unleashing accusations of corruption against them, which might well be true given the record of the clerical regime in the 1980s and 1990s. 

Sources of criticism towards Ahmadinejad are multiplying. Economy and Finance Minister Daoud Danesh Jaafari is reportedly about to step down due to strong tensions with the President over economic management. In particular, Jaafari criticises Ahmadinejad's free loans to poor Iranians as a major factor in driving money supply growth and inflation. A debate is also raging within the cabinet, among supporters of cheap loans and those like the president of the Central Bank who want them to at least match inflation. The loan spree is considered by many economists as a major factor in inflation growth. Even among the clergy, criticism over Ahmadinejad's economic policies is mounting. In an unusual step, two traditionalist clerics, Ayatollahs Mohammad Reza Mahdavikani (former prime minister) and Grand Ayatollah Nasser Makarem Shirazi, and a moderate Grand Ayatollah, Abdolkarim Mossavi Ardebili (formerly head of the judiciary), echoed popular discontent over prices and the cost of housing. A reflection of the increasingly defensive attitude of Ahmadinejad's circle is the increasingly interventionist mood of the military into politics, and the open attacks by Hassan Khomeini, the grandson of the Ayatollah, who is close to the reformists.
An Ahmadinejad already increasingly weakened by the deteriorating economic situation suffered a further blow when one of his close associates, Minister of Interior Ali Kordan, was sacked by the Parliament over his submission of a fake degree in Oxford as an educational credential. The majority of the conservative lawmakers voted against him. Perhaps even more significantly, when Ahmadinejad replaced Kordan with another of his close associates, Sadeq Mahs ouli, he only narrowly won parliamentary approval: 138 voted for him, 112 against and 20 abstained.

The campaign to bring former President Khatami to contest the forthcoming presidential elections gained speed towards the end of 2008 and reached the status of a mass movement. Negotiations are going on between the reformists and the supporters of moderate conservative Rafsanjani, another former president. Rafsanjani reportedly stated his readiness to support Khatami. He seems to enjoy much stronger support than incumbent Ahmadinejad, at least in the cities. Moreover, if he runs, the Council Of Guardian could not possibly veto the candidacy of a former president, a threat which could deter most other reformist candidates from running. Finally, his candidacy would force the conservative (but anti-Ahmadinejad) camp to face a dilemma: present their own candidate and thus split the conservative vote, probably allowing Khatami to win, or throw their support behind the despised Ahmadinejad as a lesser evil?

The latest official figures show inflation at 25.4%, up one more percentage point on the previous month. The plan to lend cheaply to businesses has produced little economic growth, as the inability of the government to supervise the deals, resulted in many abuses and non-productive use of the cash. The inflationary trend which is quite widespread in the world due to high oil prices, is therefore being accelerated by the policies of the government. Some unofficial estimates place inflation well over 30%. A plan to strengthen the rial against the dollar was for example reported recently, as a tool to fight inflation, but the plan was denied by central bank officials. In fact, with presidential elections scheduled for 2009, inflationary pressure might even grow as Ahmadinejad plans a 17% increase in spending in order to boost his popularity by fulfilling the many promises which he made during his trip to the provinces. The budget plan is much less detailed and transparent than in the past, which could allow much discretionary spending and patronage. 

Although Iran's economy is not near its collapse, it is increasingly feels the pain of the sanctions. Increasingly foreign banks refused to open credit to Iranian businesses, pushing up the p rice o f transactions. For example, South Korean paper costs now 25% more because of this. According to Bank Sedarat, Iran's most active bank in international transactions, says that a third of the 600 banks which used to deal with it are now refusing to do so; the number of correspondent banks declined from 29 to 8. Although Middle Eastern banks have been resilient against US pressure, some of them are stopping their deals with Iran too. One recent example is Ahli United Bank in Bahrain, despite the fact that the bank has strong interests in Iran. Others, however, are not likely to do, particularly in Dubai where 400,000 Iranian expatriates live and 9,000 Iranian firms operate. Most import deals have now to be done through Dubai, except for deals with Russian and Chinese companies, which however are not always able to fill the gap. Some observers in the West believe (or hope) that the situation will ultimately lead Iranian businessmen to put such pressure on the regime that it will have to modify its positions - the point after all of sanctions, although others believe that the regime will not be responsive.

Ahmadinejad's policies are not just about populism, however. One of his strongest programs is a massive investment in the petrochemical industry. Apart from US$13.3 billion to be invested by the state oil company during the current five year plan, joint ventures worth another US$4.5 billion have been signed with Venezuelan, Indonesian, Indian and Omani firms for implementation in the period up to 2010. Iran's dependence on petrochemical imports might be over soon, therefore. Iran's gasoline policy continued to evolve in March, with the decision to allow consumers to buy gasoline over the rationing quota, but at a much higher price (45 cents a litre as opposed to 42 cents a gallon). The decision was timed to coincide with the New Year (which starts 21 March), but might continue indefinitely if the government finds it a suitable way to surreptitiously increase prices without causing protests. The longer term prospects for Ahmadinejad are however somewhat critical. For a populist based politician as he is, the tough decisions required to re-launch Iran's economy are not easy to take. The attempt to curb the consumption of fuel is now acknowledged to have fallen short of expectation and the government is now planning to request an additional US$7 billion to buy gasoline abroad. Efforts to further reduce consumption continue, as owners of luxury vehicles are now requested to buy fuel at market prices. The government now says that it plans to end all subsidies on fuel by 2011, but it remains to be seen whether it will have the stomach to go through with the cuts. For the time being there is no mention of cutting subsidies on gas and electricity. Overall Iran spends US$85 billion each year on energy subsidies. 

The Iranians are investing significant resources in the expansion of their still modest gas sector. They are said to own the worlds second largest gas reserves but account for only a 1% share of the world gas export market, although they plan to expand that to 10%. They have already been expanding their capabilities in the manufacturing of heavy compressors and turbines; internal distribution of gas has greatly been expanded too and now 76% of the households have domestic supplies of gas. Teheran also plans to expand its role in the world petrochemicals market, where its market share has always been very low. Production, at least according to government sources, now stands at 22 millions tones, behind only Saudi Arabia, but exports are low even if they have been increasing. In order to boost them, Iran opened in February its first oil exchange in the island of Kish, a free economic zone. Iran plans to sell crude too there, pricing it in euros in order to attract European customers and to reduce its reserves in the American currency. The Iranians are confident that the move will be successful given the tight conditions of the market and the savings that it promises to euro zone customers.

Despite the obvious impact of the sanctions among multinationals, many of them are still keen on not burning the bridges with Iran. French company Total, for example, stressed recently that it has no plan to abandon its existing projects in the country, which include a major oil field in Kharog Island, and is just postponing investment because of the excessive risk involved as the situation stands. Indeed, several observers believe that the worst might soon be over for Iran, as the Bush Administration enters its last few months and the international 'correlation of forces' is at least temporarily shifting in Washington's disfavour. After the row over Georgia , there seems to be no chance whatsoever of Russia agreeing to new sanctions against Iran. The Chinese are happy to let the Russians play the more assertive role, but are not far behind. Indeed negotiations over a fourth sanctions package have so far led nowhere. The Iranians are exploiting the situation by raising the stakes and reducing their cooperation with the International Atomic Energy Agency. They recently complained about the lack of Iranian cooperation on its investigation on the Iranian nuclear program, on top of the fact that Iran refuses to halt its enrichment program as requested by the United Nations. The IAEA has also recently released information concerning some evidence that the Iranians are working at adapting one of their missiles for carrying nuclear warheads.

Beyond the next few months, the expectation is that a new American president might open a new page on Iran. Not only Senator Obama has publicly taken the stand that he would open talks to Ahmadinejad if he was elected, but such a mood seems to be predominant in Washington and not just among Democrats. In mid-September five former U.S. secretaries of state (Henry Kissinger, Warren Christopher, Madeleine Albright, Colin Powell, James Baker) all stated in public that they favour opening talks to Teheran as the best strategy to prevent the development of an Iranian atomic bomb, even if they have different visions of what the content of the talks should be. Senator McCain however seems to be of a different view.

Not all that happens in Iran's economy is bad, however. Some observers do believe that within 3-4 years Iran will produce enough gasoline (as opposed to oil), to meet not only internal demand but also to export it. The controversial measures taken to reduce the consumption (or waste) of gasoline are reported to have more than halved imports, from 223,000 bpd to 94,000 bpd. Similarly, oil production is growing, although not very fast. In April it reached 4.21 million bpd, the highest level since the Revolution.

In August the Iranian government announced that in 2007-8 GDP growth reached 6.9%. This is a modest increase compared to 2006-7, but a rather disappointing one given the oil boom. Moreover, at the same time inflation kept getting out of control: the official figure for June was 27%. President Ahmadinejad's vulnerability on this issue is leading one of his mai n rivals, former president Rafsanjani, to attack him increasingly openly. Rafsanjani declared in August that Ahmadinejad is turning the economy into a fully state-dominated one, instead of pursuing a policy of privatisation. 

Ahmadinejad is keen on a major plan involving in particular the banking, customs, and tax systems. The idea seems to be to lowering taxes on low income families and increasing redistribution, as well as improving the targeting of the benefit programs. To fight inflation, a new chain of stores cutting out intermediaries is planned, while the country's currency , the Rial, will be adjusted at a new rate against the dollar, making imported goods cheaper. This, however, might hurt Iranian industries, which are not very competitive and will struggle to keep the pace with imports.

By the end of 2008 it was becoming apparent that the economic crisis was beginning to have a social impact. Iranian official figures place the number of jobs lost just in the first half of the current Iranian year, whereas some independent local analysts are inclined to double that number. More layoffs are expected in the coming year. There have been recent street protests in a number of Iranian cities, among factory workers. Business circles complain about the low custom rates, which allow cheap imports into the country, damaging local industries, which are not very competitive internationally. Moreover, the building industry is grinding to a halt and ready to lay off tens of thousands more. Many economists also doubt that the current government's privatisation plan can be implemented in the current circumstances of economic and political isolation and therefore do not expect that to significantly soothe the growing economic pains. The latest figures show inflation accelerating further to 31%, a development which also impacts heavily on the lower social strata and hurts Ahmadinejad's old supporters.

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