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The Iran deal is on life support. Can Europe revive it?
The Iran deal is on life support. Can Europe revive it?

The Iran deal is on life support. Can Europe revive it?

Originally published in euronews

The key question is whether the sum total of what Europe can offer Iran is sufficiently robust – financially and symbolically – to give those in Iran who argue for restraint and continued engagement a chance. 

President Donald Trump’s decision to exit the nuclear agreement with Iran earlier this month has set off a scramble to save the deal. But while European diplomats hope to scrape by through preserving as much of the deal’s dividends for Iran as possible, business leaders are planning for the worst. The fate of the Joint Comprehensive Plan of Action (JCPOA) may lie in the balance between these two outcomes.

The JCPOA is, at its core, a straightforward trade: Iran pledged to cap its nuclear program and allow for international inspections in return for much-needed relief from a web of international sanctions that largely froze Tehran out of the global financial system. The UN’s nuclear watchdog has repeatedly confirmed that Iran has kept its end of this bargain, and over the past two years, major international companies started to dip their toes in the Iranian market.

Trump’s disdain for the agreement resulted in an ultimatum to Europe at the start of this year: rewrite the JCPOA, or we walk away. Negotiations between the US, France, Germany and the UK nearly closed the gaps between the two sides, but for the White House this did not suffice. On 8 May, Trump announced that the U.S. was not only ending its participation in the JCPOA, but snapping back its entire arsenal of sanctions against Iran – and those who do business with it.

For Europe, keeping the deal alive, even without the US, is imperative. This is based neither on the economic dividends it has provided – trade with Iran last year was a meagre 0.6 per cent of the bloc’s total dealings – nor on the notion that somehow Iran’s domestic and regional policy is beyond reproach – it isn’t. Rather, it is predicated on a consensus that the nuclear agreement, secured after years of difficult negotiations, is serving its primary purpose and removed a major source of tension in a turbulent Middle East. “As long as the Iranians respect their commitments”, declared European Commission President Jean-Claude Juncker, “the EU will of course stick to the agreement … which is essential for preserving peace in the region and the world”.

President Hassan Rouhani is under pressure from hardliners to deliver guarantees that Iran’s continued compliance with the JCPOA yields the dividends to which it is entitled. Iranian hardliners have already declared their scepticism about Europe either having the will or the capability to withstand the US strong-arming it. For Europe, resisting Washington’s coercion means keeping the trading channels with Tehran open despite the pressure of US sanctions. This entails a combination of protections for European companies, such as a revised 1996 “Blocking Statute” to be implemented before US penalties become enforceable this summer, and inducements for Tehran, such as financing via the European Investment bank and processing Iran’s oil payments in a way that bypasses US restrictions.

While there is no foolproof way to shield Iran’s economy completely from the repercussions of a US exit or from continued uncertainty, the E3 (France, Germany and the UK) could develop a package whose political and economic value would be greater than the sum of its individual elements. The package could contain two sets of short-term and long-term elements.

The most immediate challenge is to keep Iran’s oil exports flowing into Europe.

The most immediate challenge is to keep Iran’s oil exports flowing into Europe. The EU would have to protect energy companies with a small footprint in the US to continue purchasing Iranian oil and gas, and empower pertinent European central banks to process related payments. Movement of funds could occur at the “net level”, that is, Iran’s revenues from exporting oil to Europe could be used to pay for Iran’s imports from Europe. The EU could also publish a general licence and describing an acceptable standard for due diligence and regulatory compliance for its companies to conduct legitimate business with Iran, thus providing them with a legal shield against secondary US sanctions.

The EU could replace its so-called 1996 Blocking Statute that prohibited European companies from complying with secondary US sanctions imposed on Iran with legislation that supports its companies when they press charges against US regulators at the International Court of Justice or International Chamber of Commerce. It could also establish a “clawback” clause for recovery of damages incurred for alleged sanctions violations through imposing tariffs on US exports to the EU.

The E3 – along with other willing EU member states – could announce a joint effort by their state-owned export credit or investment agencies to cover the risks, including those related to sanctions, that their companies might face in trading with Iran. In the past few months, a number of European governments have taken significant steps to facilitate legitimate trade with Iran by sharing the risks through such a mechanism, but the E3 can spearhead a more systematic, multilateral effort. France’s Agence Française de Développement, Germany’s Kreditanstalt für Wiederaufbau and the UK’s Department for International Development could launch a joint effort to support infrastructural development projects in Iran and enter into negotiations with Tehran to select projects and extend loans as soon as possible.

Medium-term measures would require more time to negotiate and implement, but could signal the seriousness of the European commitment to the JCPOA as well as to developing a cooperative and mutually beneficial relationship with Iran. The EU could create a multilateral Euro-denominated trading bank comprising state-owned and medium-size to smaller private banks. Its aim would be to pool these institutions’ resources and share risks, process payments, and provide credit guarantees and insurance services to European private-sector firms seeking to trade with or invest in Iran, and share due diligence and compliance information.

The European Commission could move Iran from the list of potentially eligible to fully eligible countries for receiving loans from the European Investment Bank to finance large public or private sector projects, and negotiate a framework for the bank’s operations in Iran. Also, the EU and Iran could negotiate and sign a long-term energy partnership, which in return for Iranian natural gas supplies to Europe via existing or new pipelines would provide Iran with access to cutting-edge renewable energy technologies.

Finally, the EU and Iran could enhance civil nuclear cooperation, including construction of new civilian nuclear power reactors in return for an agreement to turn Iran’s enrichment plants into joint European-Iranian ventures or staff them with European nationals.

Such measures affirm a commitment that so long as the Iranians stay at the table, Europe will take the lead in salvaging the deal, even in the face of significant pressure from their transatlantic ally. Success could, in turn, eventually serve as a platform for discussing regional flashpoints, or cooperating on issues such as civil nuclear technology, banking reform or the environment.

But diplomatic will must also contend with commercial realities. Even before the US withdrawal, many multinational companies and most international banks were hesitant to conduct business with Iran. As sanctions move from potential to actual, the list of European firms announcing their intention to wind down existing operations grows by the day.

Sales of civilian airplanes to Iran by Airbus and Boeing, for example, which were among the most financially substantial and symbolically significant agreements struck with Tehran after the lifting of sanctions, will no longer receive the necessary licences from US authorities. France’s TOTAL, which struck a multi-billion Euro deal to work on Iran’s South Pars gas field, has announced that unless it is granted an exemption by Washington, it will abandon the project by early November. Polish energy firms, German banks and Danish shipping companies are among those who have made similar declarations. US Secretary of State Mike Pompeo’s speech on 21 May outlining a pressure-centric approach to “crush” Iran’s economy is likely to accelerate this exodus.

European officials acknowledge that their ability to convince the private sector is limited.

European officials acknowledge that their ability to convince the private sector is limited. As the French president, Emmanuel Macron, put it: “the French president is not the CEO of Total”. Companies are responsible to shareholders; regardless of any diplomatic side benefits, they will not do business in Iran may at the cost of losing access to the US market, or being slapped with massive fines by the long arm of US enforcement authorities.

The key question is whether the sum total of what Europe can offer Iran is sufficiently robust – financially and symbolically – to give those in Iran who argue for restraint and continued engagement a chance. Without it, Europe will have lost an opportunity to keep a renewed nuclear crisis from adding to the long list of tensions within the region that would eventually reach European shores in the form of refugees and more radicalism, and Iran will have little incentive to make new compromises with a partner who failed to deliver. Trump did not kill the deal, but how Europe’s leaders navigate between Washington’s reach and Tehran’s expectations over the coming weeks could well determine if it can survive.

A man exchanges Iranian Rials against US Dollars at an exchange shop in the Iranian capital Tehran on 8 August 2018. AFP/Atta Kenare

The Illogic of the U.S. Sanctions Snapback on Iran

The Trump administration believes that ratcheting up economic pressure on Iran will compel the Islamic Republic to curtail its disruptive Middle East policies. History suggests otherwise. Both Washington and Tehran should step off their current escalatory path.

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What’s new? A 40-year analysis of Iran’s economic performance and regional policy reveals little to no correlation between the two, as Tehran has continued to pursue policies it deems central to its national security no matter its degree of economic wellbeing at home.

Why does it matter? The Trump administration hopes that sanctions will force Iran to curb its regional activities. But data shows that outcome is uncertain as changes in Iran’s wealth have had little impact on the direction or capabilities of its regional policy. Sanctions risk empowering harder-line officials in the Islamic Republic and prompting them to lash out, exacerbating regional tensions.

What should be done? The U.S. optimally should leverage its sanctions to de-escalate regional tensions. That requires acknowledging Iran’s legitimate security concerns as long as Iran acknowledges those of its regional rivals. However unlikely at this time, the U.S., Iran and Gulf Arab states should take steps to build a more stable regional security architecture.

I. Overview

The intuitive presumption at the heart of the Trump administration’s policy toward Iran is that, by reducing its resources, economic sanctions on Iran will diminish its disruptive activities abroad. The sanctions that the U.S. Treasury Department will re-impose on Iran on 5 November are, in the words of Secretary of State Mike Pompeo, intended to push Iran into making a choice: “either fight to keep its economy off life support at home or keep squandering precious wealth on fights abroad. It won’t have the resources to do both”.

But historical data shows little, if any, correlation between the resources at Iran’s command and its regional behaviour. Rather, the extent to which the Islamic Republic feels threatened or senses opportunity in its neighbourhood largely defines its conduct. Measured against that standard, the Trump administration’s aggressive policy is likelier to spur Iran’s regional activism than to curb it. A better alternative exists. It would require the Trump administration not to ignore Iran’s regional interests, but to acknowledge that it has legitimate security concerns, and for Iran to acknowledge that as long as it pursues policies that its neighbours and others perceive as aggressive, tensions will persist and the risk of direct military confrontation will rise. A more stable region is possible only if the U.S. moves to provide Iran with viable security assurances, in return requiring that Tehran allow its non-state allies to integrate into their countries’ security and political systems and halt proliferation of ballistic missile technology across the region. Though currently a remote aim, both sides should work with other regional actors toward an inclusive security architecture.

Video: The Fallacy of U.S. Sanctions on Iran

II. Contrasting Eras of Iranian Regional Policy

Studying how Iran has devised its regional policies over the last four decades reveals that its choices have rarely been a function of its economic performance or resource availability.

A. “Forward Defence”

Iran’s regional defence policy was defined and shaped at a time of economic scarcity. Its “forward defence” policy – an effort to exploit weak states, such as Lebanon and post-2003 Iraq, where it can expand its influence and fight through proxies without direct harm or threat to itself – originated in the 1980s.[fn]For more background on Iran’s defence doctrine, see Crisis Group Middle East Report N°184, Iran’s Priorities in a Turbulent Middle East, 13 April 2018.Hide Footnote Then, the newly established order in Tehran, which aspired to export its revolution abroad, simultaneously felt besieged by foreign and domestic enemies seeking to undermine it and isolated in the face of invasion by Saddam Hussein’s Iraq, armed to the teeth by Arab and Western states.

At the time, Iran suffered extreme economic hardship due to revolutionary turmoil, the devastating war with Iraq and falling global oil prices. Yet as shown in Graph 1, Iran’s creation of Hizbollah in Lebanon in 1982, the bombing of the U.S. Marine barracks in Beirut the following year, and a series of targeted terrorist attacks in Europe (in which Europeans saw Iran’s hand) occurred amid falling oil revenues and economic downturn.[fn]“Outlaw Regime: A Chronicle of Iran’s Destructive Activities”, Iran Action Group, U.S. State Department, September 2018.Hide Footnote A wealthy Iran may well have acted even more aggressively insofar as it would have had more resources at its disposal. But the point is that economic deprivation did not moderate the Islamic Republic’s conduct, make it more inwardly focused or lead it to rein in its regional proxies.

Graph 1: Iran's GDP growth and oil revenue (1980-1988) IMF

The ensuing decade (1988-1998) was marked by post-war reconstruction amid rising oil revenues (due in part to heightened global oil prices in the aftermath of the first Gulf War) and runaway inflation. None of this, however, appears to have produced any tangible change in Iran’s backing for Hizbollah in Lebanon or Hamas and Islamic Jihad in Palestine. Nor did the 1997 Asian financial crisis that caused oil prices to collapse and Iran’s oil revenue to fall from $16.7 billion in 1997 to $9.7 billion in 1998. In other words, the trajectory of Iranian foreign policy was essentially impervious to the fluctuations in its economic wellbeing.

B. Pragmatism and Diplomacy

Iran’s destabilising activities declined in the early 2000s when, as shown in Graph 2, both oil proceeds and gross domestic product (GDP) were on the rise. During this period Iran significantly improved its relations with its Arab neighbours, helped the U.S. in working on the post-Taliban order in Afghanistan, and briefly suspended its nuclear program in negotiations with the Europeans – though it admittedly continued to support Hizbollah and other non-state actors in the Levant.[fn]Howard Schneider, “Saudi pact with Iran is sign of growing trust”, Washington Post, 17 April 2001; James Dobbins, “Negotiating with Iran: Reflections from Personal Experience”, The Washington Quarterly (2010), pp. 149-162; Crisis Group Middle East Report N°18, Dealing with Iran’s Nuclear Program, 27 October 2003.Hide Footnote

Again, this hardly demonstrates that Tehran acts more responsibly when its economy performs better; non-economic reasons – notably the more pragmatic perspective of Iran’s reformist government at the time and concerns about a possible U.S. attack after its 2003 invasion of Iraq – can help explain Iran’s behaviour. But it underscores that realities other than the resources at its disposal determine Iran’s policy choices.

Graph 2: Iran’s GDP growth and oil revenue (1998-2003) IMF, Central Bank of Iran

Between 2003 and 2011, Iran had two key priorities. First, it worked to ensure that in the aftermath of the U.S. invasion of Iraq a central government would emerge in Baghdad that, while strong enough to keep the country together and secure its borders with Iran, was not so strong as to once again pose a threat. Second, it aimed to push U.S. forces out of its western neighbour’s territory. To achieve the former, it relied on relationships it had cultivated for decades with Iraqi leaders (particularly Shiite Islamists and Kurds); for the latter, it trained and equipped several Shiite militias that targeted U.S. forces in Iraq. This period coincided with the nuclear standoff and imposition of a panoply of unilateral, multilateral and international sanctions. But Tehran was nevertheless flush with money thanks to high oil prices. Again, this shows that its policy of backing non-state actors has remained largely consistent in good economic times as well as bad. As a senior Iranian official put it, “when you rely on a [‘forward defence’] strategy for your survival, you rely on it come hell or high water”.[fn]Crisis Group interview, Tehran, February 2018.Hide Footnote

C. Regional Escalation

As evidence that economic downturns do not necessarily curb Iranian regional activism, the most telling period is 2011-2015 (see Graph 3). A stifling web of multilateral and international sanctions inflicted maximal harm on the country’s economy, which shrank at the rate of 7.7 per cent in 2012 as oil exports declined by half, the currency fell by 200 per cent and inflation rose to almost 40 per cent. Yet this period coincided with what many consider the most significant expansion of Iran’s military intervention in the region, a product of the uprising in Syria, Tehran’s growing rivalry with Riyadh and the fight against the Islamic State.

Graph 3: Iran’s GDP growth and oil revenue (2011-2015) IMF, Central Bank of Iran

According to the Stockholm International Peace Research Institute, Iran’s arm transfers to allies in Syria and Iraq peaked in this period.[fn]SIPRI Arms Transfers Database, available at https://www.sipri.org/databases/armstransfers.Hide Footnote Resource scarcity at home neither prevented Iran from extending a multibillion line of credit to Damascus nor from mobilising Shiite militias from Afghanistan, Pakistan and Iraq to fight in Syria. Iran also stepped up its support for Yemen’s Huthi rebels, training and equipping them.

D. Post-Nuclear Deal Boon?

Critics of the 2015 Joint Comprehensive Plan of Action (JCPOA) contend that Iran grew more belligerent in the aftermath of the nuclear accord, which provided it with billions of dollars in unfrozen assets. Yet it is hard to point to anything Iran did after the deal – from supporting Yemen’s Huthi rebels to propping up the Syrian regime – that it was not undertaking prior to the agreement.

There was one notable change: a nearly 30 per cent increase in the country’s military budget.[fn]Clare Foran and Nicole Gaouette, “Trump repeats misleading claim on Iran's military budget”, CNN, 13 May 2018.Hide Footnote Even that should be assessed in the right context. As shown in Graph 4, the 2016 bump brought spending back to 2009 levels – not to a new high. More importantly, Iran was broadening its regional involvement at a time when it was spending less on its military (2011-2015), suggesting that this expansion is a product of opportunity or perceived necessity, not economics, and that the increase in defence spending does not necessarily have a discernible impact on the ground.

Graph 4: Iran’s Military Expenditure per GDP Percentage (2007-2017) World Bank

Besides, Tehran’s military expenditure likely is not in and of itself a main U.S. concern. In 2017, Iran’s annual defence spending of $16 billion paled in comparison to Saudi Arabia’s $76.7 billion.[fn]SIPRI Military Expenditure Database, available at https://www.sipri.org/databases/milex.Hide Footnote Iran spent less than 3 per cent of its GDP on defence (where sectoral spending ranks fourth in per capita terms after social insurance, education and health), not excessive for a country of its size.[fn]راستی‌آزمایی: بودجه نهادهای نظامی در ایران چقدر است؟” [“Fact checking: What is the budget of Iran’s military institutions”], BBC Persian, 13 August 2017; Mark Perry, “Putting America’s enormous $19.4 trillion economy into perspective by comparing US state GDPs to entire countries”, American Enterprise Institute, 8 May 2018.Hide Footnote

Iran’s activities in the region are inherently – and deliberately – inexpensive and thus largely impervious to economic fluctuations. The Trump administration contends that Iran has spent $16 billion to project power in the region since 2012. If accurate – though the figure is likely inflated – that makes for an average of $2.6 billion per year. This is not an onerous expense for a country that, even under sanctions, will reap more than $25 billion in oil revenues in 2019 and holds more than $100 billion in foreign reserves.

III. The Perils of a Sanctions Backlash

Iran may well choose to tactically retreat or halt certain activities, as it has in the past. It is likewise logical that when it has additional resources it can continue expanding its regional footprint. But nothing in the history of the Islamic Republic suggests that sanctions will prompt a substantive shift in its foreign policy. To believe otherwise is to misunderstand the sources of Tehran’s conduct, predicated on the notion that strategic depth, achieved through backing allies, partners and proxies, is vital for its national security. Israel’s invasion of Lebanon in 1982, the U.S. invasion of Iraq in 2003 and the Saudi-led war in Yemen since 2015 allowed Iran to exploit chaos and deepen its clout. In all these cases, it took advantage of its adversaries’ mistakes and filled security vacuums created by failing states.

For now, banking on the remaining signatories to the JCPOA’s effort to provide it with an economic lifeline in the face of unilateral U.S. sanctions, Tehran appears to be pursuing a relatively cautious path in the region.[fn]In May, Crisis Group published a list of recommendations aimed at preserving a certain degree of trade between Europe and Iran as means of preserving the JCPOA. Some of those suggestions, including the development of “specially purposed vehicle” to conduct financial transactions, are close to materialising. Crisis Group Middle East Report N°185, How Europe Can Save the Iran Nuclear Deal, 2 May 2018; “EU mechanism for Iran trade to be symbolically ready on Nov. 4: Diplomats”, Reuters, 24 October 2018.Hide Footnote It has largely refrained from responding militarily to more than 200 Israeli strikes on its assets in Syria and engaging in skirmishes with the U.S. Navy in the Strait of Hormuz.[fn]“Israel says struck Iranian targets in Syria 200 times in last two years”, Reuters, 4 September 2018; “Iranian boats mysteriously stop harassing U.S. Navy”, Daily Beast, 8 October 2018.Hide Footnote

Paradoxically, however, Tehran could become less risk-averse if Washington were to succeed in crippling its economy. As a senior Iranian official put it, “if the economy spirals out of control, the leadership in Tehran will welcome a crisis that could change the subject domestically and rally the population round the flag”.[fn]Crisis Group interview, New York, September 2018.Hide Footnote Given the high level of friction between Iran, the U.S. and their respective allies in the region, such a clash could easily spiral into a disastrous conflict.[fn]These flashpoints can be monitored on Crisis Group’s Iran-U.S. Trigger List.Hide Footnote

If its goal is to constrain Iran’s regional reach, the Trump administration would be wiser to address the political drivers of conflict.

Indeed, there are early signs that the U.S. approach might be backfiring. The Trump administration has accused Iran of targeting U.S. diplomatic facilities in Baghdad and Basra through its allied Shiite paramilitary groups. If true, these attacks would constitute an escalation unseen in Iraq since 2011 and indicate that tightening the noose of sanctions has made Iran more, not less, aggressive. Equally risky is a scenario in which Iran’s economy stays afloat and U.S. sanctions fail to curb Iran’s regional policy. This could prompt U.S. allies in the region to provoke a confrontation between Washington and Tehran that would significantly weaken their regional foe on their behalf. As an Israeli official put it, “my distinct impression is that [Prime Minister Benjamin] Netanyahu is pushing toward actual use of force by the U.S. against Iran. Unclear of what scope – a single attack, a broader move?”[fn]Crisis Group interview, Tel Aviv, October 2018.Hide Footnote

If past is prelude, the Islamic Revolutionary Guard Corps, which is primarily responsible for implementing Iran’s regional policies, will again benefit – both politically and economically – from sanctions. Its influence expanded markedly amid the nuclear standoff and mounting pressure of sanctions (from 2006 to 2013). It controls the smuggling networks and embezzles billions in public funds through complex shell games purportedly aimed at skirting U.S. sanctions. At the same time, the middle class, which tends to drive social protests and exerts a countervailing pressure on the state, will shrink and suffer from critical shortages of food and medicine.

If its goal is to constrain Iran’s regional reach, the Trump administration would be wiser to address the political drivers of conflict, which are informed by local factors. To leverage the pressure it has managed to accumulate against Iran to produce a shift in Tehran’s policy, it would need to acknowledge Iran’s legitimate security concerns, namely its comparatively inferior conventional military capabilities. Tehran is unlikely to agree to compromise its national security assets for economic incentives. The U.S. optimally would signal its willingness to address these concerns and provide viable security assurances to Iran’s leaders. In parallel, it would work with other regional actors toward a broader security architecture that includes Iran. That said, such a policy shift is hard to envision given the administration’s current posture toward Tehran.

For its part, and regardless of what Washington does, Tehran should take steps to address its neighbours’ concerns – most importantly to recognise that the more its security doctrine promotes expeditionary warfighting, the more it will provoke aggressive pushback by its adversaries. In the same vein, Iran should encourage the integration of its non-state allies into their countries’ security bodies under the direct and effective control of their central governments, and it should stop proliferating ballistic missile technology around the region.

The alternative to both sides taking a step back from their escalatory path is a sanctions regime that penalises Iran and the Iranian people, but does not enhance peace and security in the region and could well lead to war.

Washington/Brussels, 2 November 2018