Window of opportunity opens for Iran

While the easing of some sanctions offers a chance to halt the slide in the Iranian economy, a return to strong growth will depend on the progress made in negotiations. Published in MEED, 29 December 2013

President Hassan Rouhani may well have been guilty of hyperbole when he told a television audience on 26 November that “we broke the structure of sanctions”, but there is no doubt the deal agreed with the US and other international powers in Geneva two days earlier has some important consequences for Iran’s economy.

In exchange for reducing its stockpile of enriched uranium and allowing more intrusive inspections of its nuclear facilities, the negotiating team led by Foreign Minister Mohammad Javad Zarif secured a modest scaling back of some sanctions, most notably on the country’s petrochemicals industry, its car manufacturing sector, and gold and precious metals traders.

Warm reception

Far bigger prizes remain out of reach for now, with the sanctions on the oil and banking industries remaining largely in place. But, even so, the deal was greeted warmly by most of those in Iran. “People accept that things are on the up, even though it may take a little time,” says one local resident in the Iranian capital. “The policies make sense. The question [concerns] the speed of achieving results.”

The reaction on the stock market was also positive. The main market index, the Tedpix, has been rising in an almost unbroken run all year and has continued to make gains in the weeks since the deal was signed, closing on 15 December at a record high of more than 87,000 points. According to local broker Mofid Securities, trading volumes were more than 70 per cent higher in the week ending 27 November, compared with the week before, and remained well above the three-month average in the following two weeks.

“The agreement significantly reduced risks and raised optimism, especially in sectors like banks, petrochemicals and vehicles,” the broker said in a market report issued on 27 November.

The US estimates that the deal could benefit the Iranian economy by up to $7bn over the six-month period covered by the interim Geneva agreement, although the White House says this figure is on the optimistic side. Its calculations include $1bn in revenues from higher petrochemicals exports and a possible $500m from automobile exports. Iran is also being allowed to repatriate $4.2bn from oil sales currently held abroad in restricted accounts and the US has promised to pause its efforts to further reduce Iranian oil exports. That means its international oil sales are likely to stay at about 1 million barrels a day (b/d), still far lower than the 2.5 million b/d average in 2011.

Others, however, suggest the gains for Iran’s economy could be far greater. “In my view, the Iranian economy will benefit in the range of $20-30bn,” says Nader Habibi, professor of Middle East economics at the US’ Brandeis University. He says the auto industry is an area that could do particularly well, but points out that it should also become easier to secure insurance for shipping goods to and from Iran, which will have a significant impact on a wide range of sectors.

“The impact is already visible,” he adds. “We see some readiness, especially from Europeans, to take advantage of any opportunities to boost their trade and investment relations with Iran. The business community expects a lot from this interim agreement.”

Iranian officials have said they are keen to see international oil companies return to the country, including the likes of France’s Total, Italy’s Eni, Statoil from Norway and the UK/Dutch Shell Group. But with oil sanctions still firmly in place, any talks between these firms and Tehran will have to be on a purely hypothetical basis.

Strong position

However, companies in other sectors should be able to move quickly in the wake of the recent reduction in sanctions. The European firms most often cited as being in a good position to take advantage of the better trading environment are French car firms Renault and Peugeot, both of which had a strong foothold in the Iranian market until the US imposed sanctions on its car industry. The scale of their involvement was highlighted in July when Renault made a provision of E512m ($704m) in its results for the first half of the year to cover its entire exposure to Iran.

Local car makers such as Iran Khodro and Saipa rely heavily on imported parts for models licensed from European and Asian companies, but production levels have been tumbling under the weight of sanctions. Local investment firm Turquoise Partners says that the production rate of passenger cars was down 37 per cent in the first half of the current Iranian year, which began in March. It says the main problem has been sanctions, which have made it expensive or even impossible to bring in spare parts from abroad. “Even Chinese suppliers no longer provide Iranian manufacturers with their required parts like they used to,” it said in a report released in November.

Such problems should ease in the coming months, but these gains will be fleeting if the interim deal is not followed by a more permanent agreement to end the dispute over the Iranian nuclear programme. In an interview with the Europe 1 radio station on 25 November, France’s foreign minister, Laurent Fabius, said the EU would be able to lift sanctions in December, but he also warned that “this suspension of sanctions is limited, targeted and reversible”. US officials have made similar statements.

Fiscal pressures

Any reversal would be very bad news for Iran. As sanctions have been gradually tightened in recent years, so the cracks have started to become ever more obvious in its economy. Inflation has been running at more than 30 per cent this year and the government’s fiscal balance has been coming under pressure as a result of lower oil output.

Alongside the diplomatic efforts to reduce the impact of sanctions, Rouhani’s administration has also been trying to bring a more professional approach to domestic economic policy-making to help address some of these problems.

On 8 December, he presented his first budget to the Majlis (parliament), which has 15 days to amend or approve it. According to local media reports, the draft budget is based on an average oil price of $100 a barrel. That is slightly lower than the average price that many economists are expecting for next year, but if sanctions are reduced further and Iranian crude starts to be traded freely on international markets once again, then prices could drop below that level.

Further details of Rouhani’s budget proposals have not been officially released, and in any case may yet be amended by MPs, but his broader approach since he took office in June has been clear. In particular, his government has focused on reducing inflation and dealing with some of the fiscal pressures the government is under.

“On the surface, it seems to be a conservative budget,” says Habibi. “It reflects the priority that the government gives to reducing fiscal pressures and bringing inflation down. The government is emphasising the need to focus on finishing incomplete projects rather than starting new ones. With respect to subsidies, it has not clearly said what it will do, but it seems to be moving to more targeted subsidies to reduce the burden on the budget.

“I think it is going to cause tension because there is going to be intense competition for fiscal resources. We’re already seeing examples of that. Representatives of some provinces have protested about the proposed budget by arguing that their share of the development budget in real terms has declined.”

Despite such criticisms, after the success in Geneva there is a certain amount of optimism in Tehran and Rouhani should have enough political capital to be able to push his spending plans through parliament. His critics and supporters will be watching closely to see if Iran is able to make the most of the window of opportunity it now has.

Policies working

Official data suggests his policies are already starting to help. Inflation has been dropping this year and the economy is at least predicted to grow again in 2014 after contracting this year. A Finance Ministry spokesman, Mohammad Baqer Nobakht, said on 9 December that it expects gross domestic product (GDP) to contract by 0.8 per cent for the current financial year, which ends in March, but to then expand by 3 per cent next year. Others outside Iran are not quite so optimistic, with the Washington-based IMF predicting a more modest 1.1 per cent growth in GDP next year.

Such forecasts will have to be revised upwards if a permanent deal is agreed with the US and its negotiating partners. But equally, if the two sides fail to build on the breakthrough they made in Geneva in November, then the prospects for Iran’s economy are likely to quickly deteriorate.

“If the economy was declining now, at least it is becoming more stable or declining less,” says Habibi. “There is improvement. It doesn’t mean rapid growth, but it is better than the situation we were in two months ago. [The Geneva deal] has created a more positive environment for the economy, no doubt about it. But the performance of the fiscal budget and of the economy will depend on the progress in negotiations.”