Expert View: Iran's talk is full of fire but its economy is burning

In the nuclear stand-off between the US and Iran, President Mahmoud Ahmadinejad talks a good game. But his bellicose words hide a weakness - the meltdown of the Iranian economy. As the situation becomes ever more desperate, so does Mr Ahmadinejad's rhetoric.

It's hard to know what's really going on in an Iran full of Orwellian doublespeak. The Expediency Council is pursuing a 20-year plan to create an "Islamic Economy". At a recent conference of the Elite Society of Self-Sacrificers of the Islamic Revolution, economic discussions were pretty theological with calls for "economic jihad".

And yet, behind the scenes, it is becoming clear that all is not well inside Iran, even in the middle of an oil price boom. At 3.9 million barrels a day, oil production remains stubbornly below its level at the time of the 1979 revolution.

A complete failure to invest in refining and the hostility to the use of Western technology has ensured that Iran imports much of its refined oil from the United Arab Emirates (UAE). Rather bizarrely, petrol has recently been rationed in some instances and is subject to strict government control - a whopping 86 per cent price increase has been proposed. On current trends, Iran would cease to be a net oil exporter altogether in 2015.

This seems to be extraordinary economic mismanagement. Despite a 20 per cent increase in the national budget last year, Mr Ahmadinejad had to go back to Iran's parliament, the Majlis, six times to ask for more money. Government expenditure is extremely high and rising - a pledge to reduce budgetary dependence on oil supplements by 10 per cent each year has been thrown aside as the government has resorted to using the Oil Reserve Fund as its piggy bank. Commentators speculate that Iran has inadequate foreign currency reserves to negotiate the demands of the coming year.

In fact, the extent of government borrowing from Iranian banks is jeopardising the solidity of the Iranian banking system. The borrowing increased by nearly 50 per cent last year and this swollen government sector carries significant knock-on inflationary implications. The official target for inflation is 9.9 per cent but the current rate is thought to be at least 20 per cent, and rising. In certain foods it is closer to 40 per cent and some fresh vegetables are disappearing in Tehran.

A large part of this economic crisis is home-grown but the tightening of American sanctions must give the economic planners even greater head-aches. The US has become much more adept at using its financial muscle to persuade non-American banks to withdraw financing from its chosen enemies. This is what lay behind the Palestinian Prime Minister, Ismail Haniyeh, being caught bringing $35m across the Egyptian border into Gaza.

Since September, the US has gradually cut off access to the American financial system for the two leading Iranian banks, Sederet and Sepha. Germany's Commerzbank suddenly announced it would stop handling Iranian dollar transactions. Many other, smaller, European banks have quietly followed suit.

Iran has taken steps to mitigate these effects, of course. Some of these are symbolic (it has announced plans to open an oil futures exchange), others more sensible - switching away from dollar-based contracts and pledging to privatise the banking system. But in the current situation, further economic sanctions could push Iran over the edge. What if UN sanctions stop that petrol coming in from the UAE?

Not surprisingly, criticism of government policy is mounting - and it goes right to the top. Iran's supreme leader, Ali Khomeini, made an extraordinary intervention on economic policy last week, stating that Mr Ahmadinejad's "trial period is over".

Given the theocracy which is Iran, Mr Ahmadinejad has every reason to be worried. In taking on the US, he seems to be following Shakespeare by trying "to dizzy giddy minds with foreign quarrels".

Christopher.walker@tiscali.co.uk