Overview
Today's Deep Dive is 1,482 words and a 9-minute read.
Following Israel’s historic airstrikes on Iran in late October, speculation has grown over how and when Tehran will deliver promised retaliation. While Iran’s foreign policy has been oriented around the destruction of Israel and its Western allies, Tehran has been careful not to provoke an all-out confrontation with Israel, highlighting a complex dilemma that the Islamic Republic faces. Recent setbacks for Tehran’s proxies in the region, particularly Hizballah, combined with Israeli Prime Minister Benjamin Netanyahu’s willingness to escalate (and recent lack of domestic or international brakes), leaves Iran’s leadership in a bind, as they seek to balance credible deterrence against Israel and the risk of a full-scale war, which could threaten the Iranian regime’s survival.
Amid this uncertain landscape, businesses, governments, and individuals are left to assess the implications of this instability for economic and political interests. As Iran grapples with mounting domestic pressures amid a conflict at risk of further escalation, the regime’s calculus in the coming months will prove critical in shaping the outcome of Iran’s ongoing conflict with Israel and its regional influence. The election of reformist Masoud Pezeshkian as Iran’s president in July and the re-election of Donald Trump as the next United States president add further unpredictability, with the potential to reshape regional and international strategies.
A Simultaneous Trifecta of Internal Crises
Iran’s ability to navigate external threats is limited by three interwoven crises inside its borders: economic hardship, a legitimacy crisis among the public, and a looming succession dilemma that raises uncertainties about the country’s next generation of leadership.
While Iran’s economy has faced challenges since the Islamic Revolution in 1979, a key turning point was the “maximum pressure” sanctions imposed by President Trump in 2018 following the US’ withdrawal from the Iran nuclear deal. The hardline policy led the country’s oil exports to plummet from two million barrels a day in 2017 to less than half a million barrels by 2020. Though this number has risen up to 1.5 million barrels per day in 2024, it is still lower than pre-sanction levels, and the majority of the oil is sold to China at steep discounts.
The fiscal impact has been severe. With oil revenues typically contributing nearly half of Iran’s national budget, the country has faced a major shortfall. To bridge this gap, the government turned to printing more money, a move that spurred inflation rates to spike to nearly 50 percent, where they have remained for the last five years. As a result, Iran’s poverty rate has essentially doubled since 2018, totaling around 30 percent of the population by some estimates. The IMF estimates Iran’s GDP per capita at roughly $5,000 today, down from $8,000 in 2011 and $11,000 in 1990.
Fueled in part by the government’s economic mismanagement, simmering public discontent within Iran has repeatedly boiled to the surface. Large-scale protests in recent years, including protests in response to the death of Mahsa Amini in 2022, demonstrate this dissatisfaction over the regime’s governance, while Iranians also increasingly question the government’s spending of limited taxpayer funds toward regional proxies instead of the needs of its population – a longstanding concern for the Iranian public exacerbated by rising regional conflict and falling national revenues.
The public dissatisfaction poses a serious challenge to the regime’s stability, testing the government’s ability to control and quell unrest in the deteriorating domestic environment. The majority of Iranians were born after the Islamic Revolution and view their economic well-being as more important than the ayatollahs’ ideological aims. While Iran’s leadership aims to project the ideals of the Islamic revolution abroad, public sentiment increasingly views the regime’s foreign policy agenda as prioritizing the interests of the regime over the needs of the citizens.
The Iranian regime’s legitimacy crisis is further compounded by uncertainty over the succession of Supreme Leader Ali Khamenei, who is 85 years old. Khamenei has not appointed a formal successor, and the death of former President Ebrahim Raisi in May, who was viewed as a potential candidate, has left a notable void. Some Iran analysts believe that Khamenei may be grooming his second son, Mojtaba, for the role, though this is politically risky, given that Khamenei’s predecessor and the founding father of the Islamic Republic, Ruhollah Khomeini, explicitly condemned hereditary succession as un-Islamic.
In light of these internal pressures, Iran would appear to be ill-prepared for a large-scale military conflict. Its economy is strained, public support for further regional entanglements is limited, and political uncertainty looms. These factors all constrain Iran’s foreign policy options, as the leadership seeks to avoid actions that could exasperate this trifecta of internal crises.
Balancing the Need for Deterrence While Avoiding All-Out War
While some commentators, particularly in Israeli political circles, suggest that Iran may be actively seeking a full-scale war with Israel, Tehran’s actions so far suggest that its recent missile strikes on Israel are part of a broader strategy to maintain deterrence rather than outright bid for war. Despite hostile rhetoric against the West and Israel, such as “Death to America” and “Death to Israel” remaining staples of Iranian foreign policy, Tehran’s underlying approach has been to prevent direct conflict with Israel from escalating into a conventional war.
The Islamic Republic’s foreign policy has traditionally centered on a strategy of “no peace, no war,” which allows Iran to undermine Israel and Western interests in the Middle East indirectly through proxy groups and hybrid warfare. This strategy necessitates a delicate balancing act, with a strong deterrence posture checking any direct Israeli response to Iranian provocations. The missile strikes demonstrated Iran’s military capability while at the same time, stopping short of causing high numbers of Israeli fatalities that would lead to a full-scale Israeli response.
However, maintaining this balance is becoming increasingly challenging for the Iranian regime. Tehran’s regional proxy groups have been severely weakened since the commencement of the current Israel-Hamas war in October 2023. Hamas has suffered significant losses in Gaza, Hizballah’s leadership has been decimated, and US forces have intensified their operations against the Houthis in Yemen. The erosion of proxy strength undermines Iran’s ability to project power indirectly, leaving it more vulnerable to direct challenges from Israel.
At the same time, Netanyahu has signaled a willingness to escalate in response to Iranian provocations, making it difficult for Tehran to gauge Israeli red lines. Iran’s limited options mean that doing nothing undermines its deterrence posture, yet any further escalations from Tehran risk sparking a broader conflict that the country can ill afford.
What to Expect Looking Ahead
Iran has vowed a “crushing response,” to the latest round of Israeli retaliatory strikes, dashing hopes that the escalatory cycle would pause. While such rhetoric is necessary for Tehran to avoid looking weak, the actual content of the retaliation could range from a relatively pro forma response, to an attack on Israeli interests in a third country executed by proxies, or a larger-scale attack targeting Israeli territory – the latter hinted at by Arab officials briefed on the plan who spoke to The Wall Street Journal, saying Iran planned to use more powerful warheads than had previously been deployed. Iran has multiple options, but has more than Israel’s response to weigh.
The actions of a second Trump administration in the United States could play a significant role in shaping Iran’s decisions moving forward. A second Trump administration is likely to adopt a hardline stance similar to Trump’s previous policy, ramping up further pressure on Iran through sanctions and other punitive measures and potentially expanding military cooperation with Israel and Iran’s Arab rivals. Additionally, other global actors, namely China and Russia, may influence Tehran’s calculus, especially if they offer greater economic support or diplomatic backing to offset pressure from the West. Finally, Iran’s progress on acquiring a nuclear weapon stands as a substantial variable that could alter the strategic calculus, as a nuclear-armed Iran would fundamentally shift the balance of power in the region and risks of failed deterrence.
For international stakeholders, these uncertainties indicate a period of heightened risk. The potential for a conventional war in the region threatens to further disrupt trade and investment, particularly if key oil-producing areas are affected or shipping routes are disrupted. An Iranian blockade in the Strait of Hormuz would trigger a global energy shock, as the waterway is a key chokepoint for the transit of around 20-to-30 percent of the world’s oil supplies. Countries, especially those in Europe and Asia with significant external energy dependencies, may face shortages, not just price instability.
Tehran and the region are at a crossroad. If Iran opts for de-escalation, this could mark a turning point toward a more restrained foreign policy, influenced by its domestic considerations. Conversely, should Tehran decide to press forward with another round of retaliatory escalation, it risks further destabilization of the region and more discontent at home. Either path will have implications for the future of the Islamic Republic and the balance of power in the Middle East.
