Iran: Risks and opportunities in the world’s most promising frontier market

Five years ago Iran was in deep international isolation. US and European imposed sanctions had largely wiped out foreign investment, plunged the country into recession and the country looked increasingly dependent on Chinese economic and diplomatic ties to keep itself afloat. Long and tortuous negotiations resulted in a new agreement signed in 2015. Iran agreed not to pursue nuclear weapons in exchange for the lifting of economic sanctions. This grand diplomatic bargain is now beginning to bear fruit.

International investors are once again flying to Tehran to talk business and investment. Many are still wary and unwilling to commit to investing straight away while others are eager to cut deals quickly. One of those potential investors is Johan Elmquist, portfolio manager and partner at Tundra Fonder, a frontier market expert and recent visitor to Iran. I was lucky enough to talk to Johan about his trip to Iran and get his views on the pros and cons of investing in the country.

Johan outlined the huge promise Iran holds for international investors. Tehran’s stock market is nearly all domestically held and despite years of economic strife and isolation is worth a hefty US$100 billion. The Tehran exchange and the country’s economy as a whole represent the world’s biggest untapped frontier market opportunity. Other small countries like Cuba are also opening to investors. But with an 80 million population and half of those under thirty Iran has demographics and a large consumer market on its side. Iran may be classed as a frontier market, but it is a relatively wealthy one, with a per capita income of around US$ 5,000 or US$ 16,000 using the purchasing power parity method.

Surprisingly for some observers it also has a relatively diverse economy, not the oil and gas mono-focused economy that many assume and which characterises many of its Arabian neighbours. Another interesting signal of a fast changing economy and perhaps society is the rapid uptake of smart phones, from in 2014 when there as just 2 million handsets to the present where there are 48 million phones in use, meaning well over half the country now own one.

The widespread use of virtual private networks (VPNs) which allow users to circumnavigate government censorship was shrewdly noted by Johan on his travels and is an intriguing signal that Iranians are increasingly reconnnecting with the rest of the world.

For foreign investors traditional sectors like petrochemicals, mining and finance are currently the most alluring in terms of placing funds. However, in the longer term other areas like pharmaceuticals, fast moving consumer goods and tech related ventures could be the long term winners. As these are more dependent on long term demographics and middle class demand rather than commodity cycles and less likely to face government interference. The Tehran exchange is open and ripe for new investment and the country’s companies and people are eager to take on funding, new ideas and foreign partners.

Unfortunately a shadow lies over the country, namely the fragile 2015 sanctions deal. The Trump administration appears eager to use any excuse to end the deal and many hardliners in Iran want to break with the agreement which they see as a violation of the nation’s sovereignty. It remains to see whether Trumps’ bark is worse than his bite but if the US does push for a full resumption of sanctions. It may struggle to bring its European allies on board, forcing the US to act alone, thus potentially weakening the power of any new sanctions.

Geopolitics is the obvious risk for any investor considering investing in the country, but Johan Elmquist also explained some other issues that should be considered before rushing to place funds in Iran.

Iran’s lengthy disconnection from the international banking system means that it lacks access to modern financial custodial services. The nation’s banking sector is behind its international peers in areas like know your customer (KYC) processes and most firms do not yet adhere to international accounting standards. Iran still also lacks an efficient foreign exchange market and for a fund like Tundra that trades daily the ability to move money in and out of a country with ease and low cost is vital.

All of these issues make it impossible for a firm like Tundra to do business in the country yet, but it is hoped that the relaxation of sanctions will allow the Iranian financial sector to catch up with the rest of the world.

The Iranian banking system as a whole also faces major challenges it has long suffered from an unhealthy level of nonperforming debt and excessive government intervention in its lending policy, all of which is acting as drag on the economy as a whole.

China has been a major fixture in Iran for many years, a close ally which largely ignored the Western sanctions regime. While European and US firms fled Chinese companies moved in to fill the gap heavily investing in the oil and gas sector and many other areas of the economy. As a result China is now Iran’s main trade partner and number one foreign investor.

Iran is a central part of China’s Belt and Road Initiative, a rail route now runs from Tehran to Urumqi in Western China and there are plans for Chinese backed high speed rail lines across Iran. However many Iranians fear that China has become over dominant and traders grumble that Chinese goods are poor quality in comparison to European equivalents and there is a belief that Iranian companies were sold too cheaply to Chinese firms in the past. Iran has looked to rebuilding relations with the West as part of a rebalancing act. The government is also shrewdly forging closer ties with India, which has invested heavily in Iran’s Chabahar port which will also give India easier access to Central Asian gas and oil.

Geopolitical flashpoints aside, Iran represents a sweet spot in terms of opportunity among frontier markets, bright demographics, largely untouched by foreign investors and with large relatively liquid stock exchange. If the country can overcome internal economic problems and keep its foreign relations on an even keel it can crystallise into the economic powerhouse it has long promised to become.

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