Sanctions are driving Iran and Venezuela into each other’s arms

Bourse and Bazaar | Esfandyar Batmanghelidj and Francisco Rodríguez: Over the past few years, Venezuelans have seen thousands of shops shuttered, with business after business failing under the weight of a massive economic depression and crippling economic sanctions. So it was somewhat of an event when a huge new supermarket opened in eastern Caracas in July. Yet what was even more unusual was that shoppers who flocked to the store had a hard time understanding what they were buying: many of the products’ labels were in Farsi, not Spanish.

The supermarket opening was only the latest episode in the warming of the relationship between Venezuela and Iran—two countries subject to stringent U.S. economic sanctions. U.S. policymakers were quick to denounce the event, with acting Assistant Secretary of State Michael Kozak describing the store as an example of “an alliance of pariah states.” Over the past five months, Iran has sent gasoline tankers, parts, and experts to fix an ailing refinery, and a ship full of food to help the crisis-ridden South American nation.

Foreign-policy experts often classify Venezuela and Iran similarly—as pariah countries under pressure from U.S. secondary sanctions, which deter other countries from trading with them for fear of being punished by Washington.

Sanctions on Venezuela and Iran have been effective in cutting export revenues, contributing to one of the largest economic contractions in recorded Latin American history, and to a loss of more than two-thirds of the Iranian rial’s value and high fiscal deficits in Iran—but it is also driving the two countries into each other’s arms.

Iran is not doing as badly as Venezuela, but its deep recession and accelerating inflation have fed concerns that Iran is on the verge of a Venezuela-style economic collapse, where hyperinflation stokes unrest and the delegitimization of the government.

Yet the simple fact that Iran, which has faced a broad campaign of sanctions for more than a decade, has recently come to aid of Venezuela, which has been under concerted sanctions pressure for only a few years, suggests a remarkable degree of economic resilience. When comparing the two economies, the most salient question is not whether Iran will become like Venezuela, but rather whether Venezuela will become more like Iran.

Since the international community first levied broad economic sanctions against Iran in the mid-2000s, Iranian policymakers, particularly those with a conservative outlook, have repeatedly asserted that the country would respond by adopting a “resistance economy” which would aim to reduce dependency on imports and Western investment. These statements gave rise to the belief that Iran would embrace economic isolation as well. But as Parvin Alizadeh and Hassan Hakimian argued in 2013, characterizations of Iran’s “attitude and posture towards the global economy as wholly distrustful, apprehensive, or critical would be a simplistic stance.” While it may be anti-imperialist, it isn’t isolated.

In the year leading up to March 2020, Iran generated $41.3 billion of export revenue from nonoil goods. Around half of this total was from manufactured goods. In the same period, Iran’s oil exports totaled just $9 billion, marking a historic moment in its modern economic history where the country’s industrial sector, which employs around one-third of the labor force, earned double the export revenue generated by the country’s oil sector.

Remarkably, Iran managed to grow nonoil exports during a period in which it was subject to U.S. secondary sanctions for all but two years. One of the major consequences of sanctions pressure, the steep devaluation of the rial, actually served to make Iranian exports more competitive abroad.

The development of the Iranian private sector in the first decade of the millennium—encompassing improvements in the quality and efficiency of manufacturing as well as the capture of local market share—led to a larger number of manufacturing firms eyeing export potential. From March 2019 to March 2020, China was the top destination for nonoil exports, with Iraq, the United Arab Emirates, Turkey, and Afghanistan rounding out the top five destinations.

Iran still faces significant economic challenges because of U.S. President Donald Trump’s “maximum pressure” campaign. The knock-on effects of expensive and unreliable imports on Iran’s manufacturing sector not only short-circuit the push for nonoil exports, but also act as a driver for inflation. This vulnerability can be seen in the recent depreciation of the rial, where pandemic-related disruptions to trade pushed the rial lower.

But Iranian policymakers are already indicating that their response will be to double down on what Alizadeh and Hakimian have described as a long-standing feature of Iranian economic policy under pressure: the “search [for] beneficial opportunities for engagement with the international economy.” Iran’s recent outreach to Venezuela, with the new spectacle of Iranian exports for sale on supermarket shelves in Caracas, is the latest example of this opportunistic approach to international engagement.

Venezuela’s economy has been hit hard by U.S. financial and economic sanctions imposed over the past several years—a blow that followed the damage done by the administrations of former President Hugo Chávez and President Nicolás Maduro, which both mismanaged one of the largest resource booms experienced by any country in the region.

Yet, sanctions on Venezuela have been ineffective in generating the regime change U.S. officials want. Twenty months after the decision by the United States and a large number of European and Latin American nations to recognize Juan Guaidó as interim president of Venezuela, Maduro is, if anything, even more deeply entrenched in power.

Calling on Venezuelans to think of sanctions as the necessary pain that must be undergone to get rid of the Maduro regime is a message that plays a lot better in Florida than it does in Caracas. A recent unpublished survey by Venezuelan pollster Datanálisis found that 65.2 percent of Venezuelans are against oil sanctions. That may be one of the reasons why over the past 18 months opposition leader Guaidó’s approval rating has fallen from 61 to 28 percent, according to the same survey. Meanwhile, the dearth in foreign exchange revenue has forced the Maduro government to correct course in some areas.

For example, in September 2018, one year after the United States imposed financial sanctions and after a drop of around 800,000 barrels per day in oil production, the country overhauled its foreign exchange system, allowing the currency to become fully convertible for the first time in 15 years.

At first, these currency reforms were met with skepticism; it wasn’t the first time that Maduro had tinkered with exchange rate flexibility. Yet over time it became clear that the new system implied a stunning reversal in one of the key policy levers used by the Venezuelan regime. One of the standard measures of economic distortions in highly regulated economies is the black market premium, which is defined as the difference between the price at which dollars are sold on the black market and their legal price.

In Venezuela, this premium captures the size of the profits that would accrue to persons sufficiently well connected to gain access to scarce dollars sold by the government at the lower official exchange rate. The measure, which had reached a surreal 350,000 percent average in the 12 months before the reforms, averaged just 4 percent last month according to calculations based on foreign exchange and central bank data, and it is not unusual these days for it to be negative.

Just as with the partial liberalization in Iran, the end of the system of exchange controls in Venezuela had major macroeconomic implications. First, it implied the end of substantial rents that accrued to those who were able to gain access to preferential dollars. It also ended a huge implicit tax on foreign companies, including joint venture partners in the oil sector, who had been previously been forced to sell dollars at the overvalued official rate. Additionally, it put an end to the government’s attempts to enforce strict price controls on retailers, who previously were required to value their imported inputs at the official rate.

The rigid system of government-set prices in almost all sectors which had been in place since 2011 was replaced in 2018 by a system of “accorded prices” set in bilateral negotiations with the private sector. According to the liberal Venezuelan think tank Cedice, the government carried out only about 1,000 government audits of privately owned stores in the first seven months of 2019, in contrast to an average of 7,700 per year between 2017 and 2018. By 2020, accorded prices were denominated in foreign currency and were largely in line with private-sector requests.

The Maduro government in fact went further by not only tolerating but outright embracing the use of U.S. dollars for domestic transactions. When opposition candidate Henri Falcón promised to dollarize the Venezuelan economy if he won the May 2018 presidential election, Maduro reacted by accusing his adversary of wanting “to sell Venezuela out to imperialism.” But by November 2019, Maduro had completely changed tack, saying that he saw “nothing wrong with it.”

In an echo of Iran’s November 2019 move to reduce long-standing fuel subsidies, Maduro put an end to the decades-old practice of selling gasoline at a near-zero price. In a new scheme unveiled in May, the government will now ration access to subsidized gasoline yet allow buyers to purchase as much gasoline as they want at international prices. The retail sale of nonsubsidized gasoline will be carried out by privately owned stations. Notably, Maduro explained that the need to sell gasoline at market prices had to do with the fact that the country had to pay in cash for the gasoline it was purchasing from Iran.

It will be long before Venezuela can think of private-sector investment as leading a role in the economy’s recovery. But there is another way in which Venezuela has adjusted to the collapse of its oil industry which also makes it much more resilient. Over the past five years, more than 5 million Venezuelans—or around one-sixth of the population—are estimated to have left the country. Remittances have now become one of the main sources of foreign currency. Despite the COVID-19 pandemic, income from remittances has continued to flow into the country, allowing Venezuela to forgo further import substitution. Imports actually rose 3 percent year-on-year in the first four months of the year based on data from 31 trading partners, despite a complete collapse in oil exports.

Venezuela’s economic collapse has many causes, and it is hard to disentangle how much of it is caused by mismanagement and how much by sanctions. But what is clear is that both the government and the economy more generally have developed their own coping mechanisms to deal with a much more restrictive external environment—evidence that steps toward economic development can take place in periods of severe economic contraction. For Venezuelan policymakers, Iran’s push to grow nonoil export revenue, along with its increased reliance on the private sector, is a model to emulate.

Esfandyar Batmanghelidj is the founder of Bourse & Bazaar.

Francisco Rodríguez is a visiting fellow at the University of Notre Dame’s Kellogg Institute for International Studies and a former head of the Venezuelan Congressional Budget Office.