The war has cost the U.S. $120 billion thus far. How many years will it take for such a huge expenditure to be returned through selling Iraqi oil?

After the conflict in Iraq, Iran’s economic officials and diplomats were trying to come up with a comprehensive analysis of the forthcoming conditions in the aftermath. Nobody seemed to be certain of what would happen next and everybody was waiting for the last act of the conflict, so they could present their views with the fewest possible mistakes. Now that the fog of war has settled to some extent, it is clear that the U.S. has emerged as Iran’s new neighbor, and has extended the frontiers of its geographic security to the Middle East as well as the western and southwestern borders of Iran. It is naïve to deny that the U.S. is now a member of OPEC, even if the Iraqi representative bears an Arab name and is sent to Vienna by an Iraqi government. Although some state officials talk about mechanisms for minimizing the effects of war on the Iranian economy and try to show themselves as ready, these are merely pretensions. The new governing circumstances necessitate new plans –in both diplomacy and the economy– to protect the country’s national interests.

Dr. Masoud Nili, a senior Iranian economist, and Mohammad Javad Zarif, Iran’s ambassador to the United Nations, have made the following comments on the economic and diplomatic effects of having the U.S. as a next-door neighbor.

Regional developments following the war on Iraq will have profound repercussions for the region, especially the big countries like Iran and Saudi Arabia. To say that the only goal of the war on Iraq was domination over that country’s oil resources is over-simplistic. Estimates show that the war has cost the U.S. $120 billion thus far. How many years will it take for such a huge expenditure to be returned through selling Iraqi oil? So, the U.S. must have something more important in mind.

We must consider this as a preplanned move with long-term prospects. Therefore, its consequences must be analyzed both in the medium and long terms. The war will have profound long-term implications for the economy of Iraq. But the war will also have immediate consequences for the Iranian economy in 2003. Economic concerns in this regard are due to the economic vulnerabilities of Iran combined with other regional developments, which exacerbate these concerns.

In the short time following the collapse of Saddam’s regime, oil prices have slumped by about $10. At the same time, OPEC members are producing surplus oil. On the other hand, Iraqi oil will enter the market soon. To make matters worse, we are approaching the second season of the year during which consumption and demand usually falls and leads to further surplus oil production in the market. Therefore, the most likely outcome of this scenario is oil prices dropping to a level lower than that projected by Iran’s annual budget bill. On the other hand, we are already facing an alarming budget deficit for the current year and an oil price slump will only worsen this deficit. If this happens, Iran will be facing serious problems for compensating this deficit, which would be followed by a burgeoning liquidity.

The third factor is that the volume of liquidity has had a remarkable increase during the past three years. In some years it has grown by 28% and in others by 30%. Meanwhile, the inflation rate has been lower than liquidity. However, this difference should not and cannot be so profound and is not the real difference and thus cannot persist. It seems that the Iranian economy is prone to an increase in the rate of inflation as well. This can add to the effects of a rise in the volume of liquidity as a result of a budget deficit.

The fourth factor is that during the past three years, the forex rate has been stable, while the domestic inflation rate has been very distant from the inflation rate in the countries with which we trade. Basically, whether maintaining a constant forex rate is correct or incorrect, there is a discussion in macro economy about what conditions must be brought about for the forex rate to remain at a specific level. If the forex rate is kept stable in the absence of those conditions, the rate will try to adapt to its real rate. As a result, any (political or economic) development will cause a sudden spurt in a forex rate, which has been kept down by applying certain pressures. As a result, it may even jump to a higher level than it should really be. Theoretically, one variable that can explain the existence of a forex rate crisis is a fraction whose numerator is the volume of liquidity and its denominator is the volume of central bank reserves.

However, all the solutions to these problems cannot be summarized in terms of the economy and economic performance alone. Only diplomacy combined with correct economic performance can solve the country’s problems. This case will be stronger in the future. It should have been so in the past, but in the future this combination will be stronger and more efficacious. Diplomacy will be a very important part of our future economic performance. For example, under the current circumstances and due to the control the U.S. will exert over Iraq we must take it as a given that from now on, the United States will be a member of OPEC. The answer to the questions such as what will be the future policy of OPEC; what will be Iran’s policy in OPEC; and whether the new composition of OPEC will make it more vulnerable or stouter; will all depend on Iran’s diplomacy.

Another point is that financial irregularities with regards to expenditures, revenues and budget deficit must first be put in order; especially since the situation of the current year’s budget will be worse than the previous year’s. Therefore, the financial trend of the country must inevitably change. For example, decisions must be made considering energy prices. If no structural change is made we will inevitably become more vulnerable.