Behind Iran's Defiant Face

Oil money flows, but business confidence and foreign investment are flagging

For Iran's president Mahmoud Ahmadinejad, it's an invigorating moment. The nation's militant client Hezbollah, in Lebanon, has been bombarding Israel with Iranian-supplied rockets. Ahmadinejad's government coffers are bulging with oil and gas revenues expected to hit $60 billion this year, making Iran's $180 million in aid to Hezbollah peanuts in comparison. Indeed, Ahmadinejad has felt emboldened to stand up to the U.S. and Europe. They are threatening U.N. sanctions if he doesn't give up enriching uranium, which they fear will lead to nuclear weapons.

Like Venezuela's Hugo Chávez, Ahmadinejad can count on his ocean of oil -- and record prices -- to keep him feeling on top of the world. Look a little closer, however, and the picture is more complex. Many Iranians, especially businesspeople, are alarmed at the government's course of action. Hezbollah's clash with Israel has heightened their concerns. "This has given the rest of the world an excuse" to beat up on us, says a prominent Iranian executive.

Business confidence in Iran has been flagging since Ahmadinejad won the presidential election a year ago. Industrialists are dismayed because politically, the President has taken Iran back to the bad old days of confrontation with the West. At the same time, his economic and fiscal policies have proved to be an incoherent hodgepodge. Ahmadinejad pours 6% of gross domestic product into subsidies for food, fuel, and other essentials, a move applauded by ordinary citizens. But a near-50% boost in the minimum wage last winter made it tougher than ever for Iranian factories to compete against Chinese imports. That forced substantial layoffs, adding to double-digit unemployment, now at 14%.


Before Ahmadinejad's election, Iranian private business was ready to ramp up investment. Now money is flowing out of the country, as evidenced by the 30% fall in the stock market over the past 18 months. Foreign business interest has also cooled. BP PLC, which wanted to be a big player in Iran, says it isn't looking for new business in the current climate. Banking giant UBS says it has stopped doing any business with Iran-based customers.

Even the oil industry has seen its share of troubles. Although Iran remains the No. 2 OPEC producer behind Saudi Arabia, it has struggled to maintain its 4 million barrel per day production. Purges of the oil bureaucracy have deepened the disarray. An award of a $2 billion gas development contract to the engineering arm of the Revolutionary Guards sparked criticism that Ahmadinejad, an ex-Guard, sought to reward his buddies for their support.

Turmoil in the Iranian oil industry will eventually take a toll on production. And with expenditures rising, the economy could be vulnerable if the government keeps stifling the private sector. Partly in response to business concerns, Supreme Leader Ayatollah Ali Khamenei recently issued a decree authorizing privatization of some 80% of the massive state sector. The move sent a ripple of optimism through the business community, which would still invest if the leadership found a way out of various political impasses.

Despite their blustering, Iran's leaders have an interest in cooling things down. Iran would be hurt if sanctions are imposed to stop the uranium enrichment program. Yet whether the Iranians can compromise with the U.S. and Europe is tough to predict. That uncertainty leaves open the possibility of a military strike by Israel or the U.S., although most analysts think it's unlikely. Such a strike could lead to a cutoff of Iran's 2.6 million barrels of daily oil exports, sending prices into the stratosphere. "I don't think things will get that far out of hand," says Manouchehr Takin, senior analyst at London's Center for Global Energy Studies. "There isn't much leeway to compensate for the lack of Iranian oil."

By Stanley Reed, with Babak Pirouz in Tehran and Neal Sandler in Jerusalem

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