Burgess COMMENTARY

Peter Burgess

Interim nuclear deal reached after lengthy negotiations Iran and the P5+1 have agreed to a six-month interim deal under which Iran will constrain its nuclear programme in return for limited sanctions relief. The agreement is being positioned as a 'first step' to a more substantive agreement between Iran and the permanent members of the UN Security Council and Germany within a year. The degree of sanctions relief is relatively muted and unlikely to lead The Economist Intelligence Unit to revise its economic forecasts radically. But the agreement will nevertheless underpin the belief in both Iran and the West that a diplomatic solution can be workable to both sides and that a comprehensive agreement is a real prospect. The agreement refers optimistically to a 'standard principle' of the process that 'nothing is agreed until everything is agreed'. There remain significant challenges in reaching an overall understanding, but the Geneva talks have vastly reduced the chances of violent conflict and increased the possibility of improved relations between Iran and the West. The envisaged 'comprehensive solution' to the nuclear issue would be based upon Iran's rights and obligations as a signatory of the Nuclear Non-Proliferation treaty (NPT), alongside 'enhanced monitoring' and 'agreed limits' to its programme. This would lead, according to the agreement, to the lifting of all UN, US and EU sanctions. Obliging Iran Over the six-month interim period Iran will stop enrichment of uranium over 5%; will convert half of existing stocks of 20%-enriched uranium into fuel for the Tehran research reactor (mainly for medical use) while diluting the remainder to less than 5%; and will not install any more centrifuges, while leaving inoperable around half of those installed at Natanz, the main enrichment plant, and 75% of those installed at Fordow, the fortified underground enrichment plant near the city of Qom. Iran has acknowledged it must address all issues raised by the UN's International Atomic Energy Agency (IAEA) over possible past military research. Iran has also met Western concerns over the Arak heavy-water reactor, which had been a stumbling block in talks in Geneva two weeks earlier. Iran has agreed it will not produce fuel for the reactor, install additional components, operate the plant or construct a reprocessing facility (which would allow the separation of plutonium from spent fuel, and thereby open up an alternative means to a weapon). Iran has also said it will give the IAEA design information for the reactor and will agree with the agency a safeguards approach for the reactor covering future monitoring. All these curbs will be closely monitored by IAEA inspectors, who will have daily access to both Natanz and Fordow. Many aspects of the agency's enhanced role—including access to the workshops producing and assembling centrifuges —are beyond Iran's NPT obligations. In addition, the IAEA and Iran will work with a newly established commission including representatives of the P5+1 to monitor adherence to the Geneva agreement and to address any issues of concern. Setting up a joint body with the P5+1 may be a concession to Iran, as the Islamic Republic has previously felt that the IAEA has not behaved impartially, and it will now have its two diplomatic allies, Russia and China, involved in the monitoring. Sanctions relief very limited, at least for now In return, the P5+1 have agreed that the US, the EU and the UN will not impose new 'nuclear-related' sanctions for six months, as long as Iran complies with the deal. According to US government briefings, Iran will be allowed a total of US$6bn‑7bn in sanctions relief, including roughly US$4.2bn of oil revenue frozen in foreign banks. Just as important for Iran, the US and EU will not prevent buyers of Iranian crude—nearly all Asian—from continuing to buy at current import levels, and will waive existing insurance and transportation sanctions on those deliveries, which should help to maintain the attractiveness of Iranian oil. The US has also agreed to suspend some sanctions on gold and precious metals, on the automobile sector and on petrochemicals exports. It does not appear that Iran would be able to receive gold as an alternative to oil payments, but building up the stock of gold in the country would help to firm up the value of the Iranian rial. In addition, some safety-related repairs would be allowed for Iranian civilian aircraft. The US president, Barack Obama, can take these measures by executive order, making the co-operation of Congress unnecessary. But the agreement leaves in place the vast bulk of sanctions, which will be something of a salve for the House of Representatives and Senate, which had recently been baying for new sanctions that would in effect cut Iran's exports to zero. US officials have stressed that Iran would still be unable to access US$100bn in foreign exchange held abroad and would be unable to increase its oil sales from current levels of 1.1m barrels/day. Outlook for the economy only slightly less dim Ultimately, we do not believe the sanctions relief will lead to a radical change in the performance of Iran's economy. As news of the deal emerged, the rial strengthened to around IR29,000:US$1 from over IR30,000 on unofficial markets. This is still weaker than the official exchange rate of around IR25,000:US$1, but the dual exchange rates are starting to show greater convergence. As the punitive oil and financial sanctions will remain in place, Iran will have little ability to increase the volume or expand the destinations of its crude oil exports. By easing policies toward EU firms underwriting cargoes of Iranian oil, if that is indeed what is implied by the agreement, buyers of Iranian oil will find the process easier, but this is unlikely to be enough to encourage greater imports. News of the agreement led to a drop in the price of dated Brent Blend, in which markets had built a political risk premium closely linked to the sanctions imposed in 2012. One area that will benefit from the modest level of oil revenue that will be transferred into the country is Iran's fiscal account. We estimate that Iran will have recorded a fiscal deficit of around 5% of GDP in 2013/14 (March 21st-March 20th). With a much weaker exchange rate, the inflows of oil revenue will help shore up Iran's fiscal position, but any improvement in consumer spending power will remain dampened by still high inflation. Iran has conceded more The Iranian government will argue that the P5+1 has conceded a long-term demand of Iranian negotiators in committing to working towards a longer-term agreement that would 'enable Iran to fully enjoy its right to nuclear energy for peaceful purposes'. The Iranian leadership will be eager to portray the agreement as a backtrack by the P5+1 from the UN Security Council requirement that Iran freeze all uranium enrichment. The Iranian president, Hassan Rowhani, has, however, delivered little that is tangible, and Iran has offered up some substantial elements of its nuclear programme. In Geneva, the Iranian foreign minister, Mohammed Javad Zarif, said that he hoped the agreement would lead to a 'restoration' of trust between Iran and the US, and Mr Rowhani spoke on Iranian television of 'cracks in the structure of sanctions' that would become bigger over time. Although the Geneva agreement was immediately backed by Ayatollah Ali Khamenei, the supreme leader, it may well prove contentious within Iran, especially as the process develops over the coming year and as the extent of nuclear inspection becomes clear. Although the expressed intention of the two sides is to find a comprehensive agreement, what may be more likely within the time frame is another partial, time-limited deal. Nevertheless, greater optimism and brighter expectations at home and abroad may be as much benefit to the Iranian economy as the immediate easing in sanctions.