The Iran oil embargo carries an uncertain cargo to Tehran

The EU's sanctions are likely to further damage a struggling economy but the political consequences are more unpredictable
Iran's president, Mahmoud Ahmadinejad
The Iranian president, Mahmoud Ahmadinejad, has attacked western sanctions as 'the heaviest economic onslaught on a nation in history'. Photograph: Raheb Homavandi/REUTERS

It took time for the EU to agree to ban Iranian oil imports. But the decision is one of the toughest steps yet taken internationally to apply pressure over Tehran's nuclear programme and it is likely to have a damaging impact on an already deeply troubled economy.

The embargo matters because of the scale of the relationship, with 20% of Iran's daily oil production, 2.6m barrels, going to the EU, Iran's second-largest oil customer after China.

Barack Obama, leading the campaign, claimed last week that Iran's economy was in a "shambles" because of existing punitive measures, including financial restrictions. Iranian officials have admitted that they are having a serious effect. President Mahmoud Ahmadinejad has attacked them as "the heaviest economic onslaught on a nation in history". EU action to freeze assets of Iran's central bank is expected to affect the government's financial position and hamper procurement for nuclear activities.

Iran is the world's fifth-biggest oil exporter but its economy is suffering badly from rising unemployment and inflation, with the riyal falling sharply against the dollar. When Obama announced the latest US measures on New Year's Day, Tehran tried to shore up the value of the riyal by imposing a lower rate in banks and currency exchange bureaux and banning transactions outside of those outlets. Black-market dealers are reported to have gone underground.

Housing prices are said to have risen 20% in the past few weeks alone and food prices by 40%. Meat has become impossibly pricey for many families. Private companies and importers are also in deep trouble, according to independent media. The price of imported luxury goods changes almost by the hour.

Domestic economic mismanagement is a big part of the problem, with particular criticism of government cuts in fuel and food subsidies despite public and parliamentary opposition. Rising utility prices have forced many factories to shut.

Yet the economic effects of new sanctions may be clearer than their political impact, given the nationalist response to concerted foreign pressure. "An EU oil embargo would greatly strengthen the Ahmadinejad regime at a time when it is under considerable pressure, especially with parliamentary elections looming in March," argued Paul Stevens in a recent Chatham House paper.

March's elections will be the first since the disputed presidential vote in June 2009 led to a second term for Ahmadinejad and eight months of street protests. Those demonstrations were crushed by force, but the Arab spring uprisings of the past year have shown the vulnerability of autocratic states in the Middle East to anger fuelled by economic hardship.

"Unemployment remains very high, as does inflation," commented Stevens. "The latter has been greatly aggravated by the removal of many price subsidies in the last 12 months. Moreover, in the last few weeks the value of the Iranian rial against the dollar has fallen dramatically (at one point reaching a devaluation of over 30% before recovering somewhat). This has damaged the credibility of the government and will fairly quickly aggravate the problem of inflation. Given the crucial role of oil in Iran's deepest political DNA, an EU embargo would put the population solidly behind the current regime."

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