Iran: open for business

Published in Economia, 7 December 2016

Iran has been gradually returning to the international mainstream since January, when the nuclear deal went ahead. It offers Western businesses an enticing new market to expand into, but there are still plenty of hurdles to overcome

Since most international sanctions on Iran were lifted in January, there has been an endless stream of company executives flying into Tehran’s Imam Khomeini International Airport in search of deals. It’s not hard to see why. With the 28th largest economy in the world and a population of 79 million people, Iran offers a rare opportunity for businesses to expand into a huge and virtually untapped market. The population is also young (a quarter of Iranians are under 15 years old), well-educated and heavily urbanised.

But all that potential is matched by a lot of difficulty. To put it simply, doing business in Iran is not a straightforward exercise because of both domestic and international issues.

The first challenge for most companies is getting past the international barriers to trade. Although the majority of trade embargos were lifted at the start of the year, a few important ones remain. Until October, the most significant were the US measures preventing American companies or individuals from doing business with Iran in most circumstances, and its ban on banks clearing US dollar transactions involving Iran through the US financial system. All this made most banks in Europe and elsewhere wary of doing any business with Iran, for fear of incurring huge fines from the US authorities. And without decent banking links, it is hard for any company to engage.

The uncertainty around banking ties “is a terrible disincentive for Western companies”, says Roberto Toscano, a former Italian ambassador to Iran. “The Americans have not clarified what is allowed and what is not allowed.”

However, in October the US Treasury published new guidance for businesses that said some previously prohibited dollar transactions with Iran by offshore banking institutions will be allowed as long as they do not enter the US financial system. According to The Wall Street Journal, the Treasury also widened the potential business partners for non-American investors in Iran by announcing that US-sanctioned Iranian entities can partake in projects if they aren’t the controlling shareholder.

While the previous US position stifled the re-entry of Iran into the world economy, it has not entirely stopped it. Some small and mid-sized international banks have been willing to do business with Iran and their number is increasing. Where banking links have been unreliable, investors have sometimes been able to turn to other routes for sending money, such as local credit institutions known as exchange houses, which offer cross-border money transfers to and from Iran. As a result, investments are being made, joint ventures are being formed, and goods and services are being traded.

Among the large international firms to have dipped their toes into the Iranian waters are the likes of French car giant Renault; Italian industrial group Danieli; German conglomerate Siemens; US aircraft manufacturer Boeing and its pan-European rival Airbus; as well as South Korean construction groups Samsung C&T Corp and Hyundai Engineering & Construction Company.

Smaller firms are also engaged, such as Italy’s ItalTel, which signed a memorandum of understanding (MoU) in April this year with Iran’s largest telecoms firm, Telecommunication Company of Iran (TCI), to provide modern telecoms equipment. In May, German firm Henkel increased its stake in the listed detergent manufacturer Henkel Pakvash from 60% to 90% at a cost of around €51m.

International accountancy firms have been stepping up their efforts too, in line with their clients’ needs. Having pulled out of the country at the start of the decade, many of the big international groups are now re-engaging. A spokesman for EY, for example, says it has been “working closely with clients to support their commercial interests in Iran, consistently with applicable laws and regulations”.

As with the ItalTel deal, the first step for many international companies is to sign an MoU or similar, but turning that promise into something more concrete is an often slow and difficult task. The multi-billion dollar aircraft sales from Boeing and Airbus are a good case in point. In January, Airbus agreed to sell 118 aircraft to Iran and, five months later, Boeing agreed to sell more than 100 jets. However, both of these deals have been held up by the need to secure approval from the US authorities, which has been rather slow in coming.

Gradually though, some deals are moving ahead. One large recent one was announced at the Paris Motor Show on 30 September, when Renault signed a joint venture agreement with the Industrial Development & Renovation Organisation of Iran (IDRO) to set up a production plant with capacity of 150,000 vehicles a year along with a distribution network. Renault will be the majority shareholder in the venture.

The variety of deals that are being discussed and signed is a clear indication of how wide-ranging the potential is for Iran to modernise and for international companies to profit. Iran has been starved of international investment in numerous areas during the sanctions era and the government is keen to attract investment and expertise. As well as telecoms, automotive and aviation, other key industries that hold potential include the oil and gas, petrochemicals and power sectors. In a country with a large young population, consumer goods are another area of great promise. And healthcare and education are also likely to provide opportunities. The minister of health and medical education, Dr Hassan Hashemi, told a healthcare conference in May that the country needs to invest $25bn in its healthcare system, for example.

But even companies with long-standing operations within Iran can sometimes find it difficult to do what would be considered normal in other parts of the world. For example, South Africa’s MTN Group, which has a 49% stake in Iran’s second largest mobile phone network, MTN Irancell, says it has ZAR15.4bn in cash inside Iran which it is struggling to repatriate.

That is a consequence of the poor banking links between Iran and the outside world. But the problems of doing business in Iran go further than cross-border payment issues. Iran is ranked 118 out of 189 countries in the World Bank’s Ease of Doing Business report, with low scores in areas such as protecting minority investors (150th) and trading across borders (167th). It is also ranked a lowly 130 out of 168 countries in Transparency International’s Corruption Perceptions Index.

Sanctions

Businesses also need to ensure they don’t end up working with groups and individuals that are still under sanction, not least the Islamic Revolutionary Guards Corp (IRGC), whose affiliates control an extensive business empire. This is made all the harder because Western-style due diligence is still a fairly alien concept in Iran and ownership structures are often opaque.

The economy is slowly adapting to international norms though. Iran’s first credit rating agencies are due to be licensed soon, according to the country’s Securities & Exchange Organisation, which should help to some extent, but the wider business culture will take time to change.

Inflation and interest rates are coming down but are still high, with inflation running at 9.4% and interest rates on bank loans at 18%. That makes international investment all the more welcome for local businesses who find it too costly to borrow money. However, there is plenty of potential to expand even without that investment. Mehrdad Emadi, an economist at BetaMatrix International Consultancy, says Iran’s manufacturing industry was operating at around 35% of its capacity as of 2015, before the sanctions were lifted. Labour productivity was around a fifth of the level in the EU, due to companies operating old equipment and around 64% of firms were owned by state or pseudo-state entities.

Investment in the oil and gas sector has been held back while the government puts together its new model for hydrocarbons investment, known as the Iranian Petroleum Contract (IPC). The first deal signed under this model went ahead on 4 October, when the local Persia Oil & Gas Industry Development Company signed an agreement with the National Iranian Oil Company to develop the north and south Yaran, Marun and Kupal oil fields using enhanced oil recovery techniques. The estimated investment is $2.2bn.

The critical issue for the future of Iran’s oil and gas sector is whether major international companies will be willing to follow suit. Many have signalled that they are keen to get involved, from France’s Total to Russia’s Lukoil and China National Petroleum Corporation, but as yet none have signed any deals under the new IPC. The current low oil price environment doesn’t make it any easier to push ahead with large, risky investments.

There have been some signs of movement though. On 9 October, Iran’s National Petrochemical Company (NPC) signed a letter of intent with UK-Dutch oil giant Royal Dutch Shell to study petrochemical projects in Iran. Deputy oil minister Amir Hossein Zamaninia said on the sidelines of the signing ceremony that Iran was planning to sign $10bn worth of oil contracts before the end of the current Iranian year, on 20 March 2017, according to remarks reported by the local Shana news agency.

Whether that will be possible depends on how comfortable international businesses are with the political situation in Iran. A presidential election is due to be held on 19 May next year. As it stands, the incumbent Hassan Rouhani looks the favourite to win. However, Iranian politics are notoriously difficult to predict and he may yet be excluded from the race by the Guardian Council, which vets all candidates.

Alternatively, he could lose to a hardline opponent. Supreme Leader Ali Khamenei has already told one former president, the populist Mahmoud Ahmadinejad, not to stand as he would be a polarising figure. Another conservative figure, the leader of the IRGC’s elite Quds force, Major General Qasem Soleimani, has also ruled himself out, but there are plenty of other potential rivals who could mount a serious challenge, including parliamentary speaker Ali Larijani and the mayor of Tehran, Mohammad Bagher Ghalibaf.

The result of the election will help to determine whether the current opening up of the economy continues, or whether it will be scaled back. There are many competing centres of power in the country and not all are enthusiastic about the current process of reform and openness.

“Technocrats in government see this as the only way to reinvigorate the economy, but the elite
are sceptical that opening up will see them lose control. However the example of Chinese economic transition indicates it is possible to open up the economy to foreign investment and competition without losing political control,” says Emadi.

The delicate balance of the situation leads some observers to suggest that caution is the best approach for now.

“In general, for long-term investment, you should be cautious with companies where ownership includes a government entity,” says Ali Nassersaeid, co-founder of the American Iranian Business Council. “The Iranian government is still in a state of flux as far as supporting the needs of foreign investment. They are making many of the right moves and their goal is to be a good place to invest. However, political issues could hamper these efforts.”