Iran's economy is facing acute problems, exacerbated by record-low oil prices during 1998 and early 1999. For Fiscal Year (FY) 1998, which ended on March 20, 1999, Iran's gross domestic product (GDP) grew by 2.9%. For FY 1999, Iran's real GDP is expected to fall by 1%. Particularly during the second half of 1998, numerous factories throughout Iran were shut down, and industrial investment fell by 40%. Iran's inflation rate in 1999 is expected to remain approximately steady at 14.2%. Unemployment, which is officially estimated at 9%, is probably closer to 20%. In September 1998, Iran halted payments of its $5.9 billion debt to Germany, Italy and Japan. Iran is negotiating for an extension on repayment, but it is possible that a formal default on the loans may occur at some point.

President Khatami has presented a draft budget to the Majlis for FY 1999. The budget is based on a forecast price of oil at $11.80/bbl (Iranian crude was actually selling at about $9/bbl in January 1999, but this has risen with OPEC's March agreement to cut oil production). Low oil prices during 1998 exacerbated Iran's budget shortfall, which is a chronic problem in part due to large-scale state subsidies -- totaling some $11 billion per year -- including foodstuffs and especially gasoline (see below). Iran's budget for FY 1999 forecasts $12.1 billion in revenues from energy exports, including $10.61 billion from crude oil and $1.47 billion in oil products and natural gas.

The U.S. Iran-Libya Sanctions Act (ILSA), signed into law by President Clinton in August 1996, imposes mandatory and discretionary sanctions on non-U.S. companies investing more than $20 million annually (lowered in August 1997 from $40 million) in Iran's oil and gas sectors. Previously (in early 1995), President Clinton had signed two executive orders which prohibited U.S. companies and their foreign subsidiaries from conducting business with Iran. The orders also banned any "contract for the financing of the development of petroleum resources located in Iran." As a result, U.S.-based Conoco was obligated to abrogate a $550-million contract to develop Iran's offshore Sirri A and E oil and gas fields. After Conoco pulled out of the Sirri project, France's Total and Malaysia's Petronas were awarded the contract. On August 19, 1997, President Clinton signed Executive Order 13059 reaffirming that virtually all trade and investment activities by U.S. citizens in Iran was prohibited.

Despite ILSA, a corporate consortium including Total, Petronas and Russia's Gazprom proceeded with a $2 billion investment in Iran's South Pars offshore gas field in 1997. In May 1998, the U.S. government announced that it was granting a sanctions waiver to the consortium for South Pars. The United States emphasized that this waiver would apply only to firms of European Union (EU) countries, in return for high levels of cooperation on matters of U.S. national security concern, such as efforts to restrict the proliferation of weapons of mass destruction. The United States also clarified that the waiver policy did not apply to the construction of oil and gas pipelines through Iranian territory. For its part, the EU maintains that ILSA is "unacceptable" and has barred European countries from complying with it.