Inside Iran

The stakes are huge as President Khatami wages a bitter battle against hard-line mullahs for the soul of Iran

There's a hum these days in the cavernous lobby of Tehran's Esteghlal Grand Hotel--the sound of dealmaking. In one corner, four Japanese executives sip tea and flip through blueprints for a power plant they hope to build. In another, engineers from France's huge oil-field services company, Schlumberger, quietly discuss their growing Iranian business. And local businessmen work their cell phones, as common in Tehran as in Rome or Paris these days.

But just a mile across this sprawling city of 14 million, a different drama is playing out. On the campus of Amir Kabir University, around 2,000 protesters, many from shadowy Islamic fundamentalist groups of shock troops, howl down a moderate Muslim scholar who advocates separating mosque and state. His supporters fight back, and several people are stabbed. Others are bundled into Mercedes-Benz sedans belonging to the blandly named Information Ministry--the feared intelligence service of the Islamic Republic of Iran. "There was a lot of blood," says one eyewitness.

Daily street violence is the outward sign of a vicious, and unpredictable, power struggle unfolding in Iran. In a potentially fratricidal contest, new President Mohammed Khatami is struggling to assert his authority over Iran's conservative mullahs, who still wield enormous power. In May, the mild-mannered, relatively moderate cleric swept to office in a landslide. Riding a wave of popular discontent with the corrupt and incompetent successors of Ayatollah Khomeini, Khatami scooped up 70% of the vote.

It's a battle for the soul of Iran. If Khatami prevails, he has a fighting chance of giving Iran's government a more human face. That could mean real political parties and a relaxation of controls over the media. In turn, a democratic Iran could help ease tensions in the region--and even with the U.S. But the conservative mullahs fiercely resist any changes that threaten their autocratic powers.

The stakes are huge. Iran has one of the world's most strategic geopolitical locations. It bestrides the land bridge between the Middle East and Asia. It is the globe's second-biggest oil exporter after Saudi Arabia and has gas reserves second only to Russia's. It commands the sea arteries that pump Gulf oil to Western and Asian economies and can provide the shortest and cheapest route to bring vast new Caspian Sea energy supplies to market. "It's the vital link between the Caspian Sea and the Gulf and on to the Indian subcontinent," says Mehdi Varzi, head of energy research at Dresdner Kleinwort Benson.

The mullahs' rule has been disastrous for Iran's economy. Rigid labor and tax rules cripple manufacturing, now running at barely 30% of capacity. Effective unemployment is about 40% and inflation double the officially stated 18%. The economy is hermetically sealed by protectionist laws that control or forbid the import of most goods. "You pretty much have to restructure everything," says Mehrdad Bagheri, owner of the Tehran-based economic monthly Iran Today.

Western money and politics can play a big role. Even as its leaders are locked in dispute, Iran is stepping up its appeal for foreign investment. Billions in oil and gas revenues kept the country afloat through wars and the depressing effects of U.S. trade sanctions. New Western investment in the oil industry is needed to maintain the cash flow that funds Iran's budget and the vast public sector that accounts for 85% of its economy. Many Europeans believe that such involvement can give them a rare chance to nudge Iran toward moderation. But the U.S. remains hostile to any effort to help Iran.

FRIENDLY EUROPE. Despite U.S. sanctions and Iran's gathering political and economic chaos, the country is stumbling toward acceptance abroad. Iran is now, officially at least, preaching good neighborliness. In mid-November, European nations quietly restored normal diplomatic relations after a seven-month spat over alleged Iranian government support for overseas hit squads--and their $12 billion in annual trade is set to soar. Besides, President Khatami is showing a friendlier face to the turbulent Middle East.

On Dec. 9-11, Iran will host a 52-nation Islamic summit. American allies such as Saudi Arabia and Kuwait once regarded Tehran's mullahs as a mortal threat. But now, they are flocking back to Iran for the first time since the Islamic revolution swept the Shah from power in 1979. "The meeting shows our isolation is over," brags Hossein Nosrat, a top official of Iran's Islamic Culture & Guidance Ministry.

With Europeans and Russians signing huge oil and gas deals (table), America's hardline policy on Iran is in tatters. The eerie absence of American goods in Tehran--no Coca-Cola, no McDonald's, virtually no American cars made after 1980--mirrors America's lack of influence.

Despite Khatami's election, the U.S. Administration is unbending. "Our view is that you have to isolate and contain Iran," says Stuart E. Eizenstat, undersecretary of state for economic affairs. The stance guarantees that the U.S. will have little role in determining whether the Iran of the 21st century will be a force for moderation in the world's most incendiary region or revert to being dangerous and destabilizing.

Changing Iran is a Herculean task. Khatami, a former culture minister, has promised reform but is vague on details. His speeches invoke the need to respect law and to build what he calls "civil society"--code words for crimping the power of revolutionary courts and of mullahs who hold themselves above the law. A presidential commission is due to produce recommendations for the economy soon. Key components, say Khatami supporters, are cutting red tape and ending sudden and arbitrary changes in business rules. It is by such means that corrupt bureaucrats harvest bribes, and the bazaris, merchant class supporters of the conservative mullahs, keep their stranglehold on trade.

Since their election debacle, conservatives have dug in for a long night of political attrition. The increasingly unpopular Ayatollah Sayed Ali Khamenei, Supreme Spiritual Leader, Iran's highest office, controls foreign policy, the armed forces, and public broadcasting. Khatami's predecessor, the wily Ali Akbar Rafsanjani, heads a powerful group called the Expediency Council, which oversees government policy. Khatami is a council member, but he must answer to Rafsanjani. "The problem is that Khatami's opponents haven't lost anything except the elections," says Ibrahim Yazdi, a former foreign minister who is now in opposition.

Nothing symbolizes the revolutionary mullahs' grip on power better than the heavily guarded 17-story headquarters in central Tehran of the Bonyad Mustazafan ve Janbazan Foundation of the Oppressed and the Disabled. Created to take over assets of the former Shah, the Foundation is a conglomerate, and then some. It owns a domestic airline, Bon Air, as well as shipping companies, real estate and industrial concerns. It accounts for about 25% of the Iranian economy. Chairman Mohsen Rafikdoost, Ayatollah Khomeni's former driver, answers only to Khameni.

Khatami faced a stacked deck even during the short election campaign. The 54-year old cleric received little airtime on state television, and his campaign headquarters were shut down by police on the eve of polling. In a country where intelligence agents are everywhere, women are veiled by law, and alcohol is banned, "there was a feeling right after the election that anything was possible, that you could go out dancing," recalls a Tehran TV director.

RAMPANT CORRUPTION. Khatami, indeed, was hailed as Iran's Gorbachev. Like the Russian leader at the outset, Khatami wants to make the system function better, not overthrow it (table, page 17). But unlike Mikhail Gorbachev, Khatami doesn't have effective control of Iran's power structure. He has, though, made some important personnel changes. Ali Fellahian, head of intelligence, was replaced by a budget expert from Iran's parliament. Fellahian was indicted by a German court last April for involvement in assassinating opponents in Berlin. In September, Khatami fired Mohsen Rezai as head of the Revolutionary Guards who act as a counterweight to the armed forces. Khatami appointed Ataollah Mohajerani, once attacked for advocating dialogue with the U.S.

People like Mohajerani are genuine reformers. But many doubt the new President's willingness to challenge Iran's theocracy. Khatami's power base is a fundamentalist behind-the-scenes group, the League of Combative Clergy. Its 24 members include radicals such as Mussavi Khoeiniha, who led hostage-takers at the U.S. Embassy in 1979, and Ayatollah Khalkhali, a judge who sent thousands to their deaths in the 1980s. Whatever differences Khatami has with political opponents, says League head Ayatollah Karroubi, "all accept the fundamentals of the Islamic regime."

That's why many analysts interpret the increasingly frequent and violent street clashes between rival political groups as a power struggle rather than a rift over religious ideology. It's not pretty: In mid-November, dozens of Ansar-e-Hizbollah, a radical group supported by Khamenei, ransacked the Tehran offices of an opposition newspaper and beat up the editor-in-chief, who had to be hospitalized. Gholamhossein Karbaschi, Tehran's popular mayor and a key Khatami supporter, is being drawn into a widening corruption investigation that many suspect is politically motivated.

The economy, already flailing, is falling victim to the political infighting. Although Iran has a wealthy and well-educated middle class numbering 7.5 million--around 12% of the population, according to Standard & Poor's DRI--it isn't being given any chance to flourish and invest. Local business people, for example, are scared by a new government campaign against "quick profits." Recently, two major Tehran real estate developers received long sentences--and had all their property confiscated--on vague fraud charges.

At the same time, Tehranis complain that corruption is rampant, from low-level bureaucrats seeking to augment their meager monthly paychecks of less than $100 right up to senior government members. Tales abound of hefty commissions paid into Swiss accounts of leading mullahs. Recently, eyebrows were raised when one of Rafsanjani's sons, Mohsen, became head of the Tehran Subway Co. A daughter, Faeze, already managed a publicly funded women's sports league, a huge font of patronage. "In the Shah's day, people stole, but the money trickled down," complains an Iranian businessman. "But nowadays, the mullahs keep putting it in their pockets, and no one sees it."

Iran's oil and gas industry still works relatively well. Suspicion of foreign oil companies is waning. September's $2 billion deal with France's Total, Russia's Gazprom, and Malaysia's Petronas to exploit and develop the huge offshore South Pars gasfield is a precursor of others, say officials.

Talks with companies such as Royal Dutch/Shell and British Petroleum Co. to participate in onshore exploration and production are at an advanced stage, Iranian sources say. If completed, they would be the first such deals since the mid-1970s. "There's a much more flexible attitude now to foreign participation," says Fereydoun Barkeshli, an adviser to the Iranian Oil Minister.

The South Pars deal, Iranian officials are quick to note, shows that tough U.S. sanctions aren't working. Still, many openly complain the total absence of American companies means Iran has less choice when it comes to tapping technologies and know-how. "There may be no specific equipment or process that is solely developed and manufactured in the U.S.," says Mohammed Reza Nematzadeh, chief executive of Iran's state-owned National Petrochemical Co. "[But] if U.S. companies could enter our tenders, we would have more choice."

After 18 years, Iran's revolutionary fervor is wearing thin. It seems as faded as the "Death to America" signs still to be seen around Tehran. Khatami's election has opened a new chapter in Iran's troubled history. But as the rising tumult in Iran indicates, pushing through real reforms will be much harder than winning an election.

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