Fall and Rise? Can Iran become the new star of frontier markets?

After 30 years of sitting on the side lines, the former economic star of western Asia is set to make a major comeback if as hoped the lifting of international sanctions goes ahead as planned. Iran has a large young and restless population with an underperforming economy, but the resumption of international trade could mean it becoming the most important frontier market of the next decade.

Rekindling the flame

Despite huge uncertainty international firms have been busy rekindling long lost commercial contacts and forging new ones, discreetly meeting with Iranian firms, circling the country waiting for the right moment to act. For example car marker Peugeot has long standing ties with a local car maker Khrodo, which produces the French designed cars in Iran. The full lifting of sanctions could see Peugeot reinvest in car production in the country, provding an obvious boost the local economy. But are these hopes premature? A new US administration in 2017 could take a harder line and bring back sanctions, the Iranian economy is riddled with long term problems such as inflation, cronyism and protectionism, all this could mean investors are eventually left disappointed.

Economic Profile

At first sight the economics and business potential of Iran are compelling, it has the world’s second biggest gas supplies and fourth largest oil reserves, the country has around 80 million young well educated people, a large stock market with similar market capitalisation to Poland. It is the second largest economy in the region after Saudi Arabia and no other country in the world is as large and untouched by foreign investors as Iran.

But high inflation a recent recession and a crumbling banking sector with high non-performing loans NPLs (15% to 30%) are alarming signs for any economy, while these can be blamed on sanctions the country also has a reputation for mismanagement and corruption. The rial has dramatically depreciated in recent years and inflation has rapidly increased, making life hard for ordinary people across the country increasingly unable to buy anything but the basics.

Unemployment is also major problem in the country, the official rate of 10% hides the real rate of 20%, this is partly poor economic performance, but also down to a youthful population which means 750,000 new entrants into the workforce every year. There are signs the economy is turning a corner as growth increases and inflation eases thanks to the part lifting of sanctions but the future of the country still hangs in the balance, waiting for the full resumption of trade and investment ties.

Sanctions Explained

We know sanctions have hit the country hard, companies like BNP Paribas who were doing business with Iran have also been affected, recently slapped with a US $ 9 billion fine by US authorities for dealing with Iranian banks. So what are the sanctions and what sectors did they effect:

The UN agreed to: Ban supplies of arms and nuclear related technology as well as an asset freeze on certain Iranian individuals

The EU went further: Its members agreed to ban more individuals, but crucially all oil and gas imports and financial transactions with Iranian institutions.

The US went even further: banning nearly all trade with Iran (except humanitarian assistance and cultural products).

The oil sanctions were estimated to be costing the Tehrani government around between US$ 4 to US$ 8 billion dollars a month, a significant sum for a developing country. The financial restrictions also meant a freeze in overseas assets worth approximately US$ 100 billion. These restrictions in trade have already been eased in the petrochemical, food and beverages, motor vehicles and other sectors, however perhaps most onerous are sanctions targeted at Iranian banks and financial insitutions, as well as anyone doing business with them, this makes it extremely tricky to move money in and out of the country.

Now the world must await the US Congress and Iranian parliament to approve the deal which will confirm the lifting of the sanctions, subject to Iran fulfilling its side of the deal and not developing nuclear material for weapons.

Geopolitics

If trade is rekindled and economic growth follows, Iran will be have the means, should it desire, to further expand its overseas power, which could well lead to more clashes with its neighbours and rivals in the Arab world. Already many feel it is fighting a proxy war with Saudi Arabia and other Gulf countries in Yemen and Syria and that a resurgent Iran would further draw the wrath of many Arab countries and Israel, leading to even more conflict in a region already beset by violence.

Iran is on the rise right now, but politics can change quickly, the Saudis and their allies in the Gulf Cooperation Council are a powerful force and could yet undo all the progress made in bringing the country back into the international fold.

Challenges for Iran and international investors

The government faces the challenge of welcoming foreign investment to country which has been relatively closed for many years, creating jobs for a youthful population, increasing economic growth and reducing inflation, no small task. The government is interventionist, which may rankle with outside (and local) entrepreneurs keen to work outside the shadow of the state. Isolation rarely has a positive effect on an economy, cut off from different business practices and ideas, Iranian business can doubtless benefit from exposure to the rest of the world.

The oil industry is the most obvious starting point, the country has massive reserves and the western majors will be keen to take a slice of the action, plus it is clear that Iran needs the investment, technology and capital to upgrade and modernise its industry and only the large oil majors can provide this. At the same time falling prices have meant that oil companies have scaled back their more ambitious expansion plans and for now will be less willing to take on projects in Iran.

Other sectors may prove to be more promising, Iranians I spoke too recently see prospects in long term partnerships with foriegn firms in sectors like agriculture, tourism, machinery, food and beverages and financial services. Iran has great potential in all these sectors but needs injections of foriegn capital, ideas and international connections to allow them to suceed.

While Europeans and Americans are keen to get a cut of the action, there are others in Asia and beyond who are also eager to invest, Turkish bankers, Russian agri-producers and Indian entrepreneurs will competing with westerners for business. Assuming its international relations remain reasonably stable Iran looks set to be a very exciting place to be doing business in the next decade.