The capture of Kabul: What the Taliban takeover will mean for Iran’s economy

Over the last year, Iranian leaders have kept lines of communication open with the Taliban, anticipating the eventual US withdrawal. They now appear to be seeking some kind of accommodation with the Taliban, and are concerned by the prospect of rising instability in Afghanistan. For the moment, the outlines of any political agreement between the two remain wholly unclear, although Tehran is likely to focus on preventing new refugee flows and weapons and drug smuggling.

What is certain is that the economic consequences of the Taliban takeover will be significant for Iran. The two countries are more economically interconnected than is widely appreciated. The strengthening of these ties has come about in a largely unplanned way, caused by Iran’s search for economic opportunities in its own region as US sanctions cut it off from the global economy. In particular, the role that Afghanistan plays in Iranian currency markets, and the status of Afghanistan as a primary destination for Iranian non-oil exports, suggest that Iran is set to pay an economic price for the Taliban’s success.

The first major issue facing Tehran in this respect is that recent international moves to limit the Taliban’s access to hard currency will impact on exchange rates in Iran. In recent years, Afghanistan has been an important source of hard currency for Iran, whose foreign reserves remain frozen due to American sanctions. Reports suggest that the two countries’ trade in hard currency amounted to as much as $5m transferred to Iran each day from Afghanistan. The outflows were so significant that the Afghan central bank expressed concerns that this was having a material impact on the exchange rate of the afghani. But last week the US Treasury halted dollar deliveries to Afghanistan in advance of the Taliban’s seizure of Kabul, and the Biden administration has made clear that the Taliban will not have access to the reserves Afghanistan holds in the United States. Iran will have a harder time meeting demand for the US dollar at home by sourcing those dollars from Afghanistan – a reality that is likely to add upward pressure to exchange rates in Iran, subsequently increasing inflationary pressure. 

Secondly, the end of dollar deliveries will also create an inflationary environment in Afghanistan. As prices rise, Afghan businesses and households will need to curtail demand – including for Iranian goods. In recent years, Afghanistan has emerged as one of the largest destinations for Iranian non-oil exports, with exports totalling around $2 billion a year. Iran’s own economic troubles, which saw the rial depreciate significantly, made Iranian goods more affordable for Afghan buyers. Iranian exporters were increasingly targeting Afghanistan, with its population of 38 million, as a priority market. But, already, the unrest in Afghanistan is having an impact on trade, which will be exacerbated as demand falls among Afghan consumers. 

Ajmal Ahmady, until recently the governor of Afghanistan’s central bank, noted on Twitter that his “base case” is higher rates of inflation in Afghanistan. In his view, the move to prevent the Taliban from accessing Afghanistan’s foreign exchange reserves – estimated at around $9 billion and mostly deposited with the Federal Reserve in New York – will cause Afghanistan’s currency to fall in value. This in turn will spur inflation and hit the consumption of Afghan households, especially those in the lowest income brackets.

Taken together, higher inflation and lower incomes in Afghanistan bode ill for Iranian non-oil exports to the country.

Thirdly, the Iran-Afghanistan economic relationship looks set to be hit further as international aid dries up, impacting on the economic welfare of ordinary Afghans. Employment in Afghanistan depends on agriculture, which contributes income to 60 per cent of households, and on what the World Bank describes as the “booming aid-driven services sector.” The US spent $24 billion on economic development during the course of the war. International aid, if not international investment, made a meaningful contribution to Afghanistan’s economy: GDP per capita more than doubled since 2002, rising from around $900 to around $2,100 last year. But the growth in GDP per capita has been relatively stagnant since aid flows began to taper. In 2009, aid flows were equivalent to 100 per cent of GDP. By 2020, aid flows had decreased to 42 per cent of GDP – a concerning decline in a country where around three-quarters of public spending is furnished by grants and where there exists a very limited private sector. Taken together, higher inflation and lower incomes – an undeserved hardship for ordinary Afghans – will mean less demand among consumers and business alike. This bodes ill for Iranian non-oil exports to the country, which largely comprise consumer and agricultural goods. A decrease in bilateral trade may also impact on Taliban earnings. A recent study from Graeme Smith and David Mansfield determined that the Taliban earned $84m in 2020 by imposing duties on cross-border trade with Iran.

Finally, the long-term prospects for Iran’s economic development will be dimmer so long as the political and economic outlook in Afghanistan remains uncertain. A recent push among governments in the region to promote a common agenda for connectivity now appears in doubt. Iran’s role in this agenda centred on the port of Chabahar, which was seen as a way to connect India to new trade opportunities, principally by providing a trade corridor to central Asia and Afghanistan that circumvents Pakistan. Not only will India-Afghanistan bilateral trade suffer should demand fall in Afghanistan, but the necessary upgrades to transport infrastructure required to fully realise the envisioned corridor, such as additional connections between the Afghan and Iranian railway systems, are unlikely to be completed – the first railway connection between Iran and Afghanistan was only finished in December 2020. Aside from the general security concerns that will prevent the construction of new infrastructure, the multilateral development banks, which provide the crucial financing for many transport and energy projects, will be unlikely to lend to Afghanistan should the Taliban remain the dominant political force there. Iran, which cannot avail itself of development finance due to US sanctions, had stood to benefit indirectly from upgrades to Afghan infrastructure, especially when that infrastructure was completed with a view to regional connectivity.

Iran is a country that has long been battling an imposed economic isolation. While some Iranian leaders may be celebrating the withdrawal of American forces, the Taliban ascendancy, in economic terms, serves to deepen Iran’s economic isolation. Iran will find itself deprived of a convenient proximity to the foreign governments and international organisations that had an outsize presence in Afghanistan and to the significant financial flows that had buoyed the Afghan economy.