Faced with rapid inflation and growing international concern about his country's nuclear ambitions, Iranian President Mahmoud Ahmadinejad is relying on huge increases in oil and gas revenue to insulate his government from internal and external pressures.
Some of the same Western countries taking steps to compel Iran to stop uranium enrichment are also the biggest consumers of its oil and gas. The European Union said last week that it would freeze the assets of Bank Melli, Iran's largest, in keeping with U.N. sanctions. The E.U. is also the leading global consumer of Iranian oil and gas.
Oil wealth, which funds 60 percent of the national budget, has allowed Iran's government to exercise its power to cut interest rates and ignore warnings from the country's Central Bank that overspending will worsen inflation.
Iran earned $80 billion from oil and gas sales in the fiscal year that ended March 20, up from $35 billion three years ago. But the increasing oil revenue is causing a widening gap between rich and poor, as some businesspeople prosper while inflation eats away at consumers' purchasing power. These developments jeopardize Ahmadinejad's populist appeal and could hurt his campaign for reelection in 2009.
Since 2005, when Ahmadinejad came to power, the annual rate of inflation has risen from 12.1 percent to 19.2 percent, according to Central Bank figures. The rate reached 25.2 percent in May, the bank said.
Ahmadinejad has long tussled with economic officials, who say the government has lacked expertise. Indeed, Central Bank governor Tahmasb Mazaheri has straightforward advice for Iran's leaders: "They should decrease the budget deficit, limit spending money and refrain from using oil revenues."
Inflation a 'big problem'
Ahmadinejad announced last week that he would implement unspecified changes in Iran's banking, taxation and import systems and blamed their leaders for being "ineffective." He also conceded that inflation was a "big problem."
Ahmad Zeidabadi, an Iranian political analyst who writes for several anti-government media outlets, said that increased oil revenue had "given the government lots of self-confidence in many fields."
"When you have plenty of money you can solve many problems," Zeidabadi said. But he also noted the danger of intertwining the country's economic fate with the fluctuating price of oil. "If the price suddenly would drop, they will not be able to provide the country with necessary imports. The oil money is this government's lifeline."
A small coterie of developers, oil traders and businesspeople with lucrative government contracts are profiting from the oil boom. Shiny new BMWs crowd the streets of northern Tehran, where real estate prices have doubled or tripled and where luxury developments can command $2,000 per square foot.
But the majority of Iranians have suffered from the inflation that analysts say is partly the result of government spending. Asgar Eskandiary, 32, a teacher, said he thanked God for the health insurance he bought years ago because it paid for a sinus operation. Otherwise, he and his wife would have had to spend rent money on the operation and "we would have lost our apartment for sure," he said, drinking a warm Coke at a fast-food restaurant where a blackout to save energy had deterred other customers.
Every visit to the supermarket brings unpleasant surprises, he said. The price of milk powder, which the couple needs for their infant son, increased from the equivalent of $3 to about $4.30 in just over a year's time. He makes the equivalent of about $540 a month and "can barely cope," he said. "We spend all we have for our small baby."
The teacher said he saw only one solution. "I want to write a letter to Supreme Leader Ayatollah Ali Khamenei. He needs to bring back the experts, people who know about economy. The government doesn't know what they are doing."
During an interview conducted by one of his close aides on state television, Ahmadinejad acknowledged last Monday that mostly the rich were benefiting from the subsidies that Iran provides for gas, water, energy, wheat and rice. He announced the establishment of national bank accounts in which the poor would receive their subsidies directly.
But analysts feared that the move would lead to more economic problems. "Yet another direct injection of money into the society will create more inflation," Zeidabadi said.
The private sector, which makes up only 15 percent of the Iranian economy, could help with providing jobs. But businesspeople say they have been particularly hurt by sanctions that target international banking.
"We simply can't transfer money, which means that we can't buy spare parts for our factories," said Bodagh Khanbodagi, honorary president of the private Iranian-German business chamber. German export credits backing trade with Iran totaled about $730 million last year, about half the value of German export credits in 2006 and one-fifth that in 2004, according to a report by the Congressional Research Service released this month.
"Nobody's coming over, and I don't see any minister visiting here in the near future," he said, sipping tea in an office decorated with pictures of himself with German and Iranian dignitaries.
Even if European companies want to deal with Iran, the financial obstacles imposed by Western countries have made payment nearly impossible, he said. "When an Iranian entrepreneur wants to purchase an engine part in Germany, he will find himself in a situation where he simply can't pay through a bank, since almost all big international banks have stopped working with Iran. What should this person do? Fly to Frankfurt carrying a briefcase holding 5 million euros? He will be arrested at the airport," Khanbodagi said.
"We are now looking towards the East," he said. "Almost everything we need we can get there. It just takes longer and some of the quality is less."
Ties to non-Western countries
The Iranian government has been increasing ties with non-Western countries, mainly China, but relations with several South American and certain African nations have also expanded.
"Because money doesn't matter, the government has started buying many products from abroad. But this has been hurting production inside Iran and has basically made us more dependent on foreign states," said Zeidabadi, who has been imprisoned several times for his writings.
"If oil prices would have been lower, the government would have had to change its internal and foreign policies," Zeidabadi said. "Ahmadinejad now fully depends on a high oil price. They got used to the high income. But they are depending on something that they cannot control. That is a dangerous game."
Mazaheri, the Central Bank governor, is regarded as the last remaining technocrat to hold a powerful position in the Iranian executive branch, which is now mostly run by partisan supporters of Ahmadinejad. "We ask all of the policymakers, including the government, to adhere to the economic principles and not to compromise them," he said in a recent interview.
Ahmadinejad recently overruled the governor's opposition to further decreasing interest rates, which have been cut from 24 percent in 2005 to the current rate of 10 percent. "The government believes that by decreasing the interest rate they can lower the inflation rate," Mazaheri said.
If the government doesn't change its policies, he said, "inflation will increase, just as we faced higher inflation rates last year."
Mazaheri, who sports the three-day stubble that Iranian civil servants wear to honor Islam, said that when he goes shopping for groceries with his wife, she complains about the high prices.
"My wife and many Iranian people are suffering from the inflation," he said. "The rich benefit from it -- their assets increase in price and, in the absence of a fair tax and efficient tax system, their income will be more. But the majority of the people in the middle and lower class suffer."