Despite the Iranian regime’s defiant bravado, the Islamic Republic is under extraordinary pressure. Supreme Leader Ali Khamenei faces unprecedented discord within his own circles, multiple challenges to Iran’s strategic regional influence, the threat of attack and the noose of draconian sanctions. But the story has another side: threats and sanctions have had benefits as well as costs for the regime and are exacerbating strategic problems for the West. The change of tone emanating from both Washington and Tehran indicates both sides see advantages to meaningful negotiations.

Tough times for the Islamic Republic

On the economic front, Western sanctions are exacerbating the combined effects of unbridled corruption and President Mahmoud Ahmadinejad’s economic mismanagement. These forced many private businesses into bankruptcy and drove up inflation even before the worst of the sanctions started to bite last year. Soaring unemployment, lethal air pollution levels and severe shortages of essential medicines are exerting unprecedented pressures on the public. Sanctions have suppressed oil exports by 40%, with the remainder sold or bartered at a discount. Income is further reduced by the costs of repatriating profits. Iran’s foreign currency reserves are estimated to have declined by 1/3.

Regional influence threatened

Meanwhile, Iran’s intricately woven webs of influence in the region are under severe attack. The Syrian conflagration is decimating a pivotal ally. Worse, it threatens Iran’s principle access route to its strategic Hezbollah allies in Lebanon, leaving the latter vulnerable as well. Iran’s pressure on Hamas to back Assad contributed to divisions within that movement, helping drive Hamas leader Khaled Meshaal into the arms of the Qataris. Iran’s relations with Hamas rival Islamic Jihad have improved accordingly, but even the latter is cautious about treating this as a positive turn of events.

Differences over Syria have rekindled tensions with Turkey, a crucial neighbouring trade partner as sanctions continue to bite. To date, the Turks are benefitting too much from Iran’s desperate trade needs to cut off imports and exports. But their policies together with those of the Saudis have effectively created a two-pronged challenge to the cornerstone of Iran’s foreign policy: Iraq. While the Saudis fuel the resurgence of Sunni mass protests and jihadist attacks in Iraq, the Turks are ramping up tensions between Irbil and Baghdad over Kurdish oil and gas sales directly to Turkey. Maliki himself prepared the ground for Saudi intervention amongst Iraq’s Sunni minority with sheer political incompetence and heavy-handed repression, which had already put his government on the defensive.

Meanwhile, a deal to deliver 5,000 barrels of oil a day via tankers was struck following the collapse of a compromise agreement to export through the official state pipeline. The tanker deliveries are meant to be an interim measure pending completion next year of a new Kurdish pipeline into Turkey capable of exporting up to 1m barrels a day. Baghdad hotly disputes the Kurdish regional government’s right to agree export deals independent of the national government. The last thing either Syria’s Assad or Iran’s Supreme Leader Ali Khamenei can afford is disruption to Iran’s supply lines into Syria or diversion of Iran’s military and political attentions to yet another struggling ally.

Faced with the threat of resurgent Sunni jihadism along its western border as well as against its allies in Syria and Lebanon, Iran has rediscovered the importance of Islamic solidarity across the Shia/Sunni sectarian divide. Hints by senior Iranian officials that negotiations are preferable to escalating regional conflict have been dismissed out of hand by the Saudis. Calls for Islamic solidarity ring hollow given Iran’s own history in such matters, not to mention its own endemic discrimination against Iran’s Sunni minority.

President Ahmadinejad’s trip to Egypt early last month and his offer of financial assistance to the new government, in spite of sanctions, should be understood in this context. While little love is lost between Iran’s Shiite leaders and the Sunni Muslim Brotherhood, improved ties with Egypt could partially offset the loss of Syria. In the competition for regional influence, however, Egypt is unlikely to provide Iran with major advantages.

Internal political challenges

Meanwhile, unprecedented levels of infighting within the regime’s own ranks present an even greater challenge.  June’s presidential election will be the principal public nexus of dispute.  Disputes over who will represent Khamenei’s faction, and who will be allowed to challenge the Supreme Leader’s candidate, started last autumn and have escalated since.  The election thus has become a convenient shield behind which enormous battles over interpretations of Islam and, above all, conflicting interests are being waged.   The very public ceremony of the election may force some kind of resolution of these key disputes.  Until then, little progress is likely in negotiations with the 5+1.

Supreme Leader Khamenei remains dominant but commands only a fraction of the authority his predecessor Ayatollah Khomeini once wielded. Despite the high costs of imposing Ahmadinejad as president four years ago, Khamenei soon found himself challenged by the president and his key aides. Last November, Khamenei publicly warned Ahmadinejad that his tendency to publicize internal differences was tantamount to “treason”. Several of the President’s closest allies have been imprisoned and nine of his ministers impeached, but his powerful faction within the Revolutionary Guard and state apparatus is unlikely to disappear quietly. Nor have the reformists’ supporters in the Guard gone away. A senior commander came under attack several months ago for publishing an article in which he asked whether, if the Shah had listened to his people, respected their opinions, and allowed them to speak their mind, the Revolution would have happened. The implicit comparison between the Islamic Republic and the Shah’s regime caused an uproar. The sizable reformist camp has been prevented from convening a conference, let alone nominating a candidate for the June elections, and its leaders remain incommunicado under house arrest. Khamenei and his conservative allies have even pushed aside former President Akbar Hashemi Rafsanjani, the pro-business pragmatist whose influence is as infamous as the wealth he has accumulated over the past 34 years.

While overt resistance from the democratic opposition has largely been quashed, potential for explosive protest simmers just below the surface. Despite heavy surveillance and repression, some banned independent trade unions came out on strike in support of the 2009 post-election protests. Today, their strikes and protests are called to demand unpaid wages or job security. In January, for example, Safa Rolling Pipe factory workers in the city of Saveh staged an indefinite strike to secure 6 months of unpaid wages that, at the last report, had brought the factory to a halt for 8 days. Teachers’ unions, the Iran Free Workers’ Union (IFWU), the Tehran bus workers’ and Dezful sugar cane workers’ unions, are among the largest and most active independent trade unions in Iran.

The discrimination, neglect and lack of rights suffered by Iran’s Kurdish, Arab, Azeri Turk, Balouch and Turkoman minorities have long made their regions ripe for opposition. Long established, legitimate groups, such as the Kurdistan Democratic Party (KDP), the Democratic Party of Iranian Kurdistan (KDPI), and Komala, remain strong and active. Predictably, the US and Israel have been taking advantage of discontent and unemployment amongst ethnic minorities to nurture murkier separatist-inspired terrorist groups. Seymour Hersh revealed the equipment, training, and intelligence provided to Arab separatist groups and the Balouchi Jundallah, in particular. The city of Ahvaz and the Pakistani border are areas where terrorist activities by these groups have been particularly deadly.

But Israel and America’s most important Iranian partners are the Mojahedeen-e Khalgh (MEK). Years of assiduous lobbying, lubricated by generous payments, have produced a long list of US, UK and other EU politicians and journalists who advocate the MEK as “champions of human rights and democracy” and “the principal Iranian opposition movement”. The list reads like a Who’s Who of neo-con luminaries and right-wing conservatism, including John Bolton and the Daily Telegraph amongst its ranks. But in 2005, Human Rights Watch published a scathing report condemning the MEK for human rights violations against its own members in their Camp Ashraf base in Iraq. These included prolonged solitary confinement, psychological abuse, coerced confessions, threats of execution, and torture. Members who managed to escape or defect have published shocking accounts of how the leadership forced members into a cult-like mindset in which absolute obedience was paramount.

Why do they matter? Powerful factions within the US establishment have been grooming the MEK as a military force, and using them to carry out terrorist and espionage assignments inside Iran. “The M.E.K. was a total joke,” a senior Pentagon consultant told Seymour Hersh, “and now it’s a real network inside Iran. How did the M.E.K. get so much more efficient?” he asked rhetorically. “Part of it is the training in Nevada. Part of it is logistical support in Kurdistan, and part of it is inside Iran. M.E.K. now has a capacity for efficient operations than it never had before.”

Silver linings

Iran’s leadership has used these threats and sanctions to demonstrate once again its knack for finding silver linings in the darkest of clouds. The crisis atmosphere they provoke has become essential for maintaining control as the regime’s internal power base contracts. Khamenei is doing all he can to avoid a repeat of the explosive aftermath of the 2009 elections. Internet sites report a continual stream of arrests, torture, deaths in custody and executions of civil society activists and others who fall foul of the regime’s most reactionary elements. The Committee to Protect Journalists reports that in 2012 Iran imprisoned 45 journalists, second only to Turkey with 49. In the past month, 17 more have been detained, and even the renowned independent film guild, the House of Cinema, has been closed down. Independent trade unionists around the country face severe harassment and imprisonment.

Similarly, the regime has reinstituted a multi-tiered exchange rate and other measures which effectively focus the effect of sanctions on the middle class. It is no coincidence that this sector also formed the backbone of the Green Movement which exploded in opposition to the announced election results in 2009.

Threat of attack has also escalated development of Iran’s strategic defence capabilities. Experts question just how significant a development Iran’s much trumpeted new fighter jet actually is. But Iran’s advances in extending its capabilities into space should be giving serious pause for thought.

Sanctions help the government to deflect blame for its fiscal incompetence and provide a cover for further consolidation of economic as well as political & social control in the hands of Khamenei loyalists. Powerful interests at the heart of the Islamic Republic have grown used to enormous profiteering on the back of sanctions. It is debatable whether the sanctions help the Islamic Revolutionary Guard Corps (IRGC), who control much of the Iranian black market, more than they hurt them.

Fighting back

While it can be argued that threats of attack and draconian sanctions have encouraged Iran’s return to the negotiating table, it is patently clear that they haven’t succeeded in their stated goal of forcing Iran to abandon its nuclear programme. On the contrary, Iran is defiantly installing a new generation of advanced centrifuges with the potential to significantly accelerate production of enriched uranium. While Iran is careful to keep enriched stock levels below Israel’s ‘red line’, carefully raising the stakes puts the US on notice that Iran has no intention of letting sanctions slow development of its strategic technological goals.

Similarly, although Iran’s influence in Syria and Lebanon is seriously under threat, it continues working ceaselessly to extend and develop political and economic ties with non-Western countries elsewhere. Along its eastern border, Iran is using its energy wealth and technological prowess to significantly deepen strategic ties with Pakistan and Afghanistan. Further afield, the BRICS have become core trade partners while relations with Nigeria, Malaysia, Thailand, Venezuela and North Korea have deepened.

Far from bowing to sanctions, Iran has spun them into a global game of cat and mouse. With its ability cut off to accept payment through the usual channels, Iran has agreed to payments in kind of rice, medicines, engineering materials and steel from India. To overcome sanctions on marine shipping, Japan has been persuaded to insure shipments of oil imports from Iran itself. Creative evasions have similarly continued trade at significant levels with Russia, China, Turkey and others.

West faces its own challenges

While sanctions and threats of attack take a high toll on Iran, it is important to recognise their costs to the West, too. The sanctions, in particular, have proven to be more of a double-edged sword than the US may have expected. How long can the West bear the costs of sustaining them?

The looming US budget deficit has become the overriding issue in American politics. Maintaining a credible threat of attack against Iran requires keeping a huge military presence in the Persian Gulf. Furious Congressional infighting over how to contain the monstrous US debt has led to a fiscal crisis in which the military budget and aid to Israel are being hit with harsh cuts. Under these circumstances, credible threats of a military strike against Iran are difficult to sustain. And if the reduced military budget is to be spent on war with Iran, what happens to the administration’s stated priority of making a strategic shift to East Asia?

Reaching the limits of sanctions?

Meanwhile, soaring petrol costs together with closure of an important export market, are contributing significantly to Europe’s economic woes. Further significant reductions of Iranian oil exports are too destabilising to contemplate. Iran’s oil exports are expected to remain at 1.1-1.2 million bpd in 2013. Conservative estimates put average Iranian crude sales in 2012 at 1.1 million barrels a day, resulting in oil revenues of about $45 billion USD. Al-Monitor puts this in perspective, estimating the figure to be roughly double Iran’s income from oil at the beginning of this millennium under Mohammad Khatami’s presidency. Despite the sanctions, Iran’s GDP was ranked 18th in the world in 2012.

Just how long can sanctions at this level be maintained? The first major cracks in the legal framework have come from successful legal challenges to EU sanctions against individual Iranian banks and other entities in the European Union’s Court of Justice. Delisting several important players may encourage reinvigoration of black market trade, providing some limited relief even as the US Congress threatens to impose yet more sanctions. And some analysts suggest that secondary sanctions, the bedrock of the sanctions regime, are open to challenge under the WTO.

Weakening the USD

But the loudest alarm bells should be ringing over a topic no government is willing to discuss openly: the threat to the strategic strength of the USD. Pressure to adhere to sanctions has encouraged China & India to develop international trade through their own currencies, eroding the long term global supremacy of the USD and bringing forward its inevitable gradual decline as the world’s reserve currency and sole denomination in which oil and other commodities are valued and traded. Decline of the dollar will have to be carefully managed as many countries have enormous USD denominated holdings. Already these efforts are clearly visible; China has financed $1 trillion dollars of U.S. debt, significantly limiting American leverage over China’s trade with Iran, especially considering U.S. dependence on cheap Chinese manufacturing.

Softening on both sides

With the US elections over and Hilary Clinton on her way out of the State Department, the Obama administration lost little time in signalling a change in its approach to Iran. Despite Khamenei’s tough positioning, it is clear that while there is “no talk of surrender”, many of his closest allies also are keen to negotiate a settlement. Vice President Joe Biden’s signal that the US was ready for bilateral talks was met with a nuanced reply from Iran: yes in principle, but not with ‘a gun to our heads.’

Since then, a variety of other US officials have gone out on a limb to be diplomatic, respectful and even conciliatory in their remarks about Iran. Secretary of State John Kerry caused a ruckus during a visit to France late last month when he described Iran as "a country with a government that was elected”. Implying that the results of Iran’s much disputed 2009 presidential election were legitimate could not have been a slip of the tongue. Fellow cabinet member Chuck Hagel had been forced to ‘correct’ a very similar statement during his own confirmation hearings just a few weeks earlier.

Addressing Iranians through the BBC’s Persian service, the State Department’s Farsi language spokesperson, Alan Eyre, went much further: “If Iran abides by its agreement to have a strictly peaceful, non-military nuclear programme, the sanctions will be lifted. Iran can have a nuclear programme, but it must manage that nuclear programme within the framework of the NPT.” Emphasising that the US enters the negotiations with seriousness, good will and mutual respect for Iran, he continued, “We aren’t after Iran’s surrender… Through diplomacy and negotiations, this problem can be resolved. …Both Iran’s leader and our president [Obama] have stated that it is not acceptable for Iran to have an atomic weapon. [Thus] there is scope for negotiations.”

Though most details of the talks in Almaty remain secret, enough was revealed to show that the offer made by the 5+1 was a significant improvement on ones tabled in earlier, unsuccessful rounds. Enhanced, though unspecified, sanctions relief was part of the package, but the real change was in what was absent. Gone were demands to terminate all enrichment programmes and to close and dismantle the underground Fordow enrichment centre. For the first time it seems that the US is ready to agree Iran’s right to enrichment within the guidelines of the NPT.

Iran took the offer away to consider, but left on a positive note. Iran’s delegation head, Saeed Jalili, described the meeting as a “turning point” and talked of “reciprocal steps”. Another round was agreed for 5 April, again in Almaty, with technical experts from both sides due to work on the details on 18 March in Istanbul.

A good deal of patience is likely to be needed between now and the Iranian elections. Just as the world had to await the outcome of the US elections before a serious proposal to Iran could be agreed by the 5+1, so too the infighting and factionalism dividing Iran’s elite must be resolved in order to provide a definitive response. Iran has had its fingers burnt several times in the past, and scepticism remains high. Even Mir Hossein Mousavi, under house arrest since he challenged Ahmadinejad in the 2009 elections, issued a statement before the talks began warning against entering into a humiliating deal for short-term gains that ultimately harm the country’s "independence, sovereignty and national interests". If both sides are serious, they will find ways of propelling this momentum until June. The question is whether America’s powerful neo-cons, in league with the formidable Zionist lobby, will succeed in scuppering the process.

Playing chicken

Ultimately, the US and its allies must decide whether they can afford their threatened alternative: a war in Iran. Israel’s AIPAC lobbying machine is pushing hard to kill any chance of progress in negotiations with Iran. Neo-con obfuscations, such as the discredited demands for IAEA access to the Parchin military site in Iran, continue to muddy the waters. But Khamenei is betting that the Obama government will finally find a way to stand up to the Israeli lobby and avoid a further war. The US faces stark strategic realities that mitigate against transforming political bluster into outright military attack. The volatility of the entire region, and the knock-on effects any major conflict will have on the global economy, makes the Persian Gulf region an extremely high stakes theatre of conflict. With jihadi extremists taking advantage of instability in Syria, Afghanistan, Yemen, north Africa and beyond, does it make sense to turn yet another country into a failed state?

The Iranian regime has hinted that it will press for a grand bargain that not only settles nuclear questions but also reduces threats to the regime’s existence. This gets to the nub of the problem: if the US and its allies were serious about countering the alleged ‘existential threat’ to Israel of Iran’s much hyped but never verified nuclear weapons programme, they could have taken Iran up on several earlier offers to limit it. The broad basis for a deal has been clear since negotiations began years ago; the Arms Control Association published yet another paper laying out the position and rationale for this just last month.

If the West’s real aim was to contain what they have dubbed a ‘nuclear threat’ from Iran, it could have been done years ago. To date, US policy has been dominated by those who insist on nothing less than destroying the Islamic Republic. The fact is that neither side can win this game outright without destroying itself in the process.

The stakes have never been higher in the Islamic Republic’s play for regional dominance. Threats of attack and sanctions have proven to be a double-edged sword, inflicting real damage on both the regime and its democratic opposition. Crucially, they are a growing problem for the West, too, with real costs for the fragile European economy in particular, even as they weaken the dollar’s dominance of the global economy and hence America’s strategic power. Whether the sanctions regime can be maintained long enough to exhaust Iran’s reserves remains an open question. It’s a bet neither side can afford to lose. This time around both sides need negotiations to produce results.