All that glitters Assessing opportunities and risks in postsanctions Iran A report by The Economist Intelligence Unit All that glitters Assessing opportunities and risks in post-sanctions Iran Contents Introduction Background Economy Sectoral analysis Business environment © The Economist Intelligence Unit Limited 2016 18 All that glitters Assessing opportunities and risks in post-sanctions Iran Introduction January 16th 2016 will forever be viewed as a watershed for Iran On that day, the International Atomic Energy Agency (IAEA) judged that Iran was fully compliant with its internationally agreed nuclear obligations—a ruling that in effect restored the Islamic Republic to the global community of nations and removed a mass of international sanctions that had been piled on the country since 2006 Keen to make up for lost time, Iran’s president, Hassan Rowhani, has been urgently seeking to drum up new business On January 23rd he hosted a summit for China’s president, Xi Jinping, in Tehran, at which the two sides agreed to boost bilateral trade to US$600bn within a decade This was swiftly followed by a trip to Italy and France, where some €50bn (US$55bn) in contracts were signed However, even with Iran’s doors thrown open, it would be wise for businesses to keep in mind the ancient Persian proverb: “He who wants a rose must respect the thorn” Iran’s economy is unusual among the region’s oil exporters; it boasts the largest natural gas reserves in the world and the fourth-biggest oil reserves, and yet it has a diversiied economy (including a signiicant manufacturing sector), all backed up by a large, youthful, well-educated and welcoming population But the business climate is less welcoming Vested interests still permeate almost every aspect of the economy, typically operate outside the parameters of international commercial law—especially those businesses connected to the Islamic Revolutionary Guards Corps—and will jealously guard the gains they accrued during a decade of sanctions And the inger of blame for Iran’s tricky operating environment should not be pointed solely at Iran; an array of residual US sanctions can snare the more unwitting investor, and Iran’s economic momentum is still too dependent on the vagaries of the global oil market In this white paper The Economist Intelligence Unit will sketch out an economic road map of Iran’s future, outlining the most promising economic sectors within the world’s most exciting emerging market, but also detailing the country’s regulatory impediments to business We will also provide lessons from the past, and reveal where Iran sits among the world’s major economies in our business environment rankings © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran Background S ince 1979 Iran’s economy has been buffeted by the chaos of the post-revolutionary environment and the demands of the eight-year war with Iraq (1980-88), and more recently by international isolation, luctuating oil prices, sanctions and a ierce power struggle within the country’s political institutions As a result, economic policymaking has been haphazard for much of the postrevolutionary period; no consistent strategy towards economic development has been pursued, and the commitments of successive ive-year plans to support market-oriented reforms, boost the role of the private sector and diversify the economy away from its reliance on oil exports have not been honoured Iranian real GDP growth (at factor cost) (%) 16 16 12 12 8 4 0 -4 -4 -8 -8 -12 -12 1982 84 86 88 90 92 94 96 98 2000 02 04 06 08 10 12 14 Source: The Economist Intelligence Unit Ahmadinejad squanders his inheritance The country’s irst concerted economic liberalisation drive and global outreach effort occurred during the presidency of Mohammed Khatami (1997-2005), during which time Iran used windfall oil revenue to pay down most of its rescheduled foreign debt, abolished the country’s multi-tiered exchange © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran rate, relaxed import restrictions, launched a conservative privatisation drive and established an oil stabilisation fund (OSF) However, all the gains that were made during these years were largely squandered during the presidency of Mahmoud Ahmadinejad (2005-13), whose highly divisive presidency saw huge cash pay-outs and massive social housing programmes directed at the country’s poor, but also rocketing inlation, a collapse of the exchange rate and the depletion of the country’s OSF It was also during his presidency that Iran’s efforts to establish a civil nuclear programme with international acquiescence were abandoned and a more nationalistic and confrontational approach to the nuclear issue was adopted The consequent swathe of international sanctions led to the halving of Iran’s oil exports and the country’s inancial sector being almost entirely cut off from the rest of the world Not surprisingly, amid the tanking economy, the public yearned for change—culminating in the thumping presidential election victory for a moderate cleric, Hassan Rowhani, in the 2013 presidential election on a simple promise of diplomacy, dialogue and, ultimately, the ending of sanctions Rowhani inds a receptive audience in the White House With a receptive audience in the shape of the US president, Barack Obama, talks made rapid progress, and an interim agreement was signed in November 2013 that provided for a halting of new sanctions and the release to Iran of over US$4bn in frozen funds However, the short-term boost this provided to the economy soon dissipated as oil prices began their long downward lurch from September 2014, causing the Iranian delegation to redouble its efforts to reach a inal deal Eventually, after numerous postponements, on July 14th 2015 a inal agreement was reached, the Joint Comprehensive Plan of Action (JCPOA) The JCPOA immediately provoked outcries from hardliners on all sides, with Iranian conservatives decrying the neutering of the country’s nuclear programme and the perceived violation of Iran’s sovereignty; in the West, meanwhile, Republicans in the US banded with Israel to denounce the deal as being too favourable to Iran, arguing that Iran could not be trusted to keep its side of the deal Yet despite the scepticism, on January 16th the IAEA conirmed that Iran had implemented its commitments, including the shipment of 11 tonnes of Iran’s enriched uranium to Russia in late December, followed in early January by the redesign of its Arak heavy-water reactor With the onset of “Implementation Day”, the sanctions that had hobbled the economy for a decade were inally lifted © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran Timeline of sanctions August 2006 The UN Security Council passes Resolution 1696, which threatens economic sanctions against Iran, after the Islamic Republic fails to respond deinitively to a compromise from the P5+1 (the ive permanent members of the Security Council plus Germany) allowing it to conduct part of the nuclear fuel cycle in-country, in return for re-suspending uranium enrichment December 2006 The Security Council passes Resolution 1737 introducing limited sanctions March 2007 A second round of sanctions is agreed by the Security Council following a unanimous vote in support of Resolution 1747, which seeks to block Iranian arms exports and to tighten sanctions against Iran’s nuclear industry March 2008 The Security Council passes Resolution 1803, which includes an outright travel ban on Iranian oficials engaged in Iran’s nuclear and missile programmes September 2009 The US president, Barack Obama, reveals that Iran has been building a nuclear facility in the side of a mountain in Qom Iran counters that it had informed the International Atomic Energy Agency (IAEA) of the plant a week before June 2010 The Security Council passes Resolution 1929, which © The Economist Intelligence Unit Limited 2016 freezes the assets of the Islamic Revolutionary Guards Corps and Islamic Republic of Iran Shipping Lines, recommends that states inspect Iranian cargo and imposes inancial restrictions on individuals and entities connected with Iran’s nuclear and missile programmes January 2012 The EU introduces a phased ban on imports of Iranian oil, and, under pressure from the US, several Asian countries agree to reduce their imports of Iranian crude Subsequently, Iran is cut off from the Society for Worldwide Interbank Financial Telecommunication network November 2013 Iran and the P5+1 agree to the Joint Plan of Action, allowing for a partial freezing of Iran’s nuclear programme in return for an easing of sanctions on Iran’s automotive and air sectors and the unfreezing of funds held abroad July 2015 The Joint Comprehensive Plan of Action (JCPOA) is signed between Iran and the P5+1 Iran agrees to limit the capacity of its nuclear programme, meeting US demands for a minimum “breakout time”—the time it would take Iran to produce enough weaponsgrade uranium for a single nuclear weapon—of a year or more and a tighter inspection regime by the IAEA In return, all nuclear-related sanctions will be lifted, once Iran abides by its requirements January 2016 “Implementation Day” The IAEA conirms that Iran has met its obligations under the JCPOA and sanctions are lifted All that glitters Assessing opportunities and risks in post-sanctions Iran Economy Real GDP growth After ive years of sanctions-driven stagnation—during which the Iranian economy shrank by an aggregate 4%—The Economist Intelligence Unit expects Iran to witness a major turnaround in 201620, as the lifting of nuclear-related US and EU sanctions propels the country to the top of the regional growth rankings The most immediate driver of this growth will be a rapid recovery in oil exports (including oil long stored in tankers offshore), which, having been roughly halved by sanctions, are set to rise by around 700,000 barrels/day (b/d) by the end of 2016 There will be further increases in 201720, but the size of these will depend in part on whether Iran can persuade technologically advanced international companies to invest in the sector (An agreement with Total in January under which the French energy giant will explore development and exploration opportunities in Iran offers some early encouragement.) Investment in Iran’s underexploited natural gas reserves, in particular, could increase dramatically The lifting of sanctions on the inancial sector—which will see Iran’s reincorporation into the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network—will help to ease general trading and investment conditions, and will therefore provide a big boost to Iran’s sizeable non-oil sectors With rising inward investment and an improvement in the public inances, private consumption will also strengthen (as will import growth) Overall, given Iran’s hydrocarbons wealth, demographics and economic diversity, the comprehensive nuclear deal could herald a return to trend real GDP growth rates of around 5% However, growth will remain below potential given the challenging business environment and the ongoing slump in oil prices (which will prevent any post-sanctions budget giveaways) Equally, the positive outlook all depends upon the Joint Comprehensive Plan of Action sticking; the provision for a “snap-back” of sanctions should Iran renege on its commitments will remain a persistent risk to this brighter outlook for some years to come Economic growth 2015a 2016b 2017b 2018b 2019b 2020b GDP 0.9 4.5 5.4 5.2 5.1 5.5 Agriculture 0.5 1.5 1.2 4.8 5.9 5.4 4.4 4.6 6.5 % Industry Services -1.5 1.9 5.4 5.6 a Economist Intelligence Unit estimates b Economist Intelligence Unit forecasts © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran Exchange rate and inlation Years of iscal incontinence during the presidency of Mahmoud Ahmadinejad (2005-13), followed by the 50% devaluation of the Iranian rial in 2013, drove a surge in Iranian inlation, which peaked at 45% in mid-2013 However, with the administration of Hassan Rowhani restoring iscal prudence and global commodity prices slumping, consumer price growth fell to a ive-year low in 2015 We expect consumer price inlation to fall further, to 12.5% in 2016, as the onset of sanctions relief eases bottlenecks and services costs (insurance) on imports moderate—a trend that will allow average consumer price inlation to drop below 12% in the latter part of our 2016-20 forecast period Falling inlationary pressures will be supported by a more stable exchange rate, including a narrowing of the gap between the oficial and the black-market rates (the latter of which is currently about IR35,00037,000:US$1), as the lifting of sanctions and the subsequent uptick in inward investment boost conidence in the rial The ability of Bank Markazi (the central bank) to manage the exchange rate should improve as it gains access to foreign reserves currently frozen abroad Forecast summary (% unless otherwise indicated) Real GDP growth 2015a 2016b 2017b 2018b 2019b 2020b 0.9 4.5 5.4 5.2 5.1 5.5 Crude oil production (‘000 b/d) 2,862 3,349 3,426 3,529 3,620 3,801 Oil exports (US$ m) 41,615 48,672 63,749 73,540 75,304 78,720 Consumer price inlation (av) 13.7c 12.5 12.9 12 11.5 11.5 Consumer price inlation (end-period) 9.4c 12.7 12.5 11.8 11.5 12 16 13.6 13 13 12.5 13 -3.5 -2.9 -2.7 -3.1 -3.5 -3.8 29,011c 31,187 33,059 34,877 38,016 41,095 Exchange rate IR:US$ (end-period) c 30,130 33,032 35,537 37,986 41,125 44,204 Exchange rate IR:¥100 (av) 23,762c 25,075 26,877 28,588 31,680 34,795 49,761 53,929 1-year deposit rate Oficial net budget balance (% of GDP) Exchange rate IR:US$ (av) c 35,840 41,045 45,013 Exchange rate IR:€ (end-period) 32,239 Economist Intelligence Unit estimates b Economist Intelligence Unit forecasts c Actual a © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran Sectoral analysis Energy sector Introduction Until a raft of US and EU sanctions on Iran’s oil and gas sector was imposed in 2012—as part of an effort to curb the Islamic Republic’s nuclear programme—Iran had long been OPEC’s second-largest oil producer Iran was producing 3.6m barrels/day (b/d), of which 2.3m b/d was exported, just prior to the imposition of those sanctions By the time “Implementation Day” occurred on January 16th— the day nuclear-related sanctions were lifted—Iran had been overtaken by Iraq as the number two producer in OPEC, with its oil production falling to 2.9m b/d and its exports more than halving to 1.1m b/d Iran is now set, however, to witness a major recovery in its oil and gas sector in a post-sanctions environment In addition to restoring oil production and exports to pre-sanctions levels in the short term, Iran also hopes to attract signiicant foreign investment in the long term, of tens of billions of dollars, in order to boost oil production to nearly 6m b/d in ive years Besides oil, Iran is also seeking to exploit its hugely underexploited natural gas reserves in order to become a major global exporter of natural gas as well Iran will struggle to reach its longer-term production targets The Economist Intelligence Unit considers it entirely realistic for Iran to return to pre-sanctions production levels of 3.6m-3.7m b/d; however, its goal of reaching output of 5.7m b/d—a production level not achieved since before the 1979 revolution—will not be realised until well into the future, if ever Nonetheless, sanctions on energy investment in Iranian oil and gas have been lifted (apart from some US prohibitions, which have been kept in place), and Iran will be able to export crude oil to all customers (except the US) without restriction, resuming sales to the EU and increasing sales to Asia Low oil prices and a supply glut make the timing of Iran’s return to the oil market dificult, but it can be expected that production and exports will be able to creep up to pre-sanctions levels Iran is also a major natural gas producer, although it mostly supplies the large domestic market With additional investment Iran could become a more signiicant exporter of natural gas, especially given its huge resource base, although this is likely initially to be restricted to supplying nearby © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran Iran oil production ('000 b/d) 4,500 4,500 4,000 4,000 3,500 3,500 3,000 3,000 2,500 2,500 2,000 2,000 1,500 1,500 1,000 1,000 500 500 0 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15(a) 16(b) 17(b) 18(b) 19(b) 20(b) (a) Estimate (b) Forecast Source: The Economist Intelligence Unit Iran gas production (bn cubic metres) 250 250 200 200 150 150 100 100 50 50 0 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15(a) 16(b) 17(b) 18(b) 19(b) 20(b) (a) Estimate (b) Forecast Source: The Economist Intelligence Unit markets in the region (such as Oman and Pakistan) In the longer term, however, Iran could be a supplier of natural gas to other markets such as Europe Yet even after its return to the global energy scene, Iran will not be receiving an early windfall The state of the oil and gas markets is quite different from what it was four years ago, when energy sanctions against Iran were tightened In 2011 dated Brent Blend averaged US$111/barrel and Iran’s oil revenue was US$120bn; in contrast, today oil is struggling to stay higher than US$30/b owing to a glut in supply Nevertheless, over the next decade Iran will play a greater role in the global oil and gas market, but the extent to which it does will depend on a host of factors Most notably, its continued © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran commitment to limit its nuclear activities as outlined in the Joint Comprehensive Plan of Action is vital, as failure to so would result in energy sanctions being reimposed, or “snapped back” Another key factor will be Iran’s domestic business environment and its ability to attract foreign investment Iranian oil exports With Implementation Day completed, Iran will resume oil exports to EU buyers Iran was exporting 600,000-700,000 b/d before the EU imposed a ban on Iranian oil imports in early 2012 Iran will also be able to export oil to other markets, such as China, Japan, South Korea, India and South Africa, without restriction Some US and EU sanctions were aimed at discouraging non-EU customers from buying Iranian oil, such as preventing them from insuring tanker deliveries or paying Iran for oil through the international inancial system What has not changed, however, is the US ban on Iranian oil imports, which has been in place since the 1980s Iran aims to boost output by 1m b/d within 12 months Iran has said that it will boost output by 500,000 b/d now that sanctions have been lifted and, more optimistically, that it will increase output by a further 500,000 b/d six months after that However, with the oil market well-supplied and weaker demand growth expected this year, the global environment is hardly ideal for Iran’s attempts to regain market share With this in mind, Iran is likely to offer very competitive pricing, as well as crude for product swaps or deferred payments to encourage further sales At any rate Iran is unlikely to lood the market and risk contributing unnecessarily to a prolonged period of depressed prices; the process of lifting Iran’s oil output will therefore almost certainly be gradual Iran has also placed tens of millions of barrels of crude oil and condensates in storage, because its ability to sell oil under sanctions was curtailed According to Platts, an energy information provider, Iran could be holding anywhere between 30m and 50m barrels of condensates and 10m-15m barrels of crude oil Iran will focus on ofloading its condensates and crude oil from storage in vessels in the Gulf, if for no other reason than to make additional vessels in its tanker leet available for greater levels of crude oil deliveries Iranian energy investment Given its substantial reserves of oil and gas, Iran has the potential to be a much greater player in global energy markets Iran has 157bn barrels of oil in proven reserves (the fourth-largest in the world) and 1,201trn cu ft of proven reserves of natural gas (by some measurements the largest in the world) Iran produced over 6m b/d of oil in the mid-1970s, but since the revolution its crude production has been affected by conlict, sanctions and economic isolation Iran is also a major natural gas producer, but the vast majority of its gas output is focused on supplying the domestic market (Iran is the fourthlargest gas consuming economy) Only small volumes of gas are exported via pipeline to neighbouring Turkey and Armenia (although Iran plans to export gas to Iraq, Pakistan and eventually Oman) On paper Iran, with its substantial resource base, is a potentially bright prospect for energy investment, but the extent to which the country is able to capitalise on this will depend on its ability to attract the necessary investment 10 © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran On Implementation Day, EU sanctions on investment in, and the provision of technology to, Iran’s oil and gas sector were lifted US energy investment sanctions, which date back to the 1990s, are still in place, although secondary sanctions aimed at non-US entities are no longer in force (US inancial sanctions are still in place, however, which for example would prevent a US bank from inancing investment in Iran’s energy sector.) The lifting of sanctions thus reduces some of the risk of investing in Iran’s energy sector, but by no means all In reality, a number of legal grey areas—relating to inancial transactions and technology transfer—still persist even after Implementation Day, and, in any case, Iran’s investment environment has long been unconducive to signiicant foreign participation The post-revolutionary Iranian constitution prevents the awarding of concessions to foreign interests, but in the 1990s “buyback” contracts were devised by the Iranian authorities Under buyback contracts, companies were rewarded for their investment with a share of production from the ield that was being developed with their help These models were not particularly attractive to foreign energy companies, and Western interest in Iran’s energy sector (apart from the key South Pars gas project) was fairly limited even before sanctions were imposed Transparency over new Iran Petroleum Contract is still lacking As a result, in 2015 Iran released the outlines of a new contract, called the Iran Petroleum Contract (IPC), to replace the buyback model Although the details of the contract have not yet been released, the IPC would offer more attractive terms than the buyback contract, allowing for longer contract durations and a fee paid per barrel based on the amount of risk involved by the contractor Foreign companies would be required to form a joint venture with a local partner approved by the National Iranian Oil Company At a conference in November in Tehran, Iran announced that it would offer 52 oil and gas development projects and 18 exploration blocks under the IPC It is clear that industry interest in developing Iranian oil and gas reserves is huge, as is Iran’s need for outside capital and technology However, a conference that was to be held in London at the end of February, which would have shed more light on the details of the IPC, has been cancelled, reportedly because Iranian oficials were unable to get visas to enter the UK The postponement of the London conference is symptomatic of the uncertainty that persists over Iran’s business environment, which will need to be addressed if there is to be a lood of investment to develop Iran’s energy sector Some elements within Iran are sceptical of allowing foreign participation in the energy sector, and there is always the chance that sanctions could be reimposed Even if all goes well, however, it will not be until the next decade that Iranian oil production rises signiicantly above its pre-sanctions level of just under 4m b/d Automotive Iran has the largest automotive industry in the Middle East, and it is the country’s second-largest economic sector (after oil and gas), currently accounting for 10% of GDP It has been deemed a priority industry by the Iranian government over the past 15 years and was growing strongly until a dramatic slump in 2012-13 as international sanctions affected companies, consumers and foreign investors © The Economist Intelligence Unit Limited 2016 11 All that glitters Assessing opportunities and risks in post-sanctions Iran The country produced over 1m cars and commercial vehicles in 2014 (protected by high import tariffs), according to the International Organisation of Motor Vehicle Manufacturers However, with foreign investment set to return, production could revive to its 2011 levels of 1.5m vehicles by 2020 Iranian vehicle sales, which have already rebounded rapidly since the interim nuclear deal of November 2013, should also be set for strong growth Even under sanctions, the Iranian market was about one-third the size of that of Germany, which is the largest in Europe, and it has the potential to grow quickly during our 2016-20 forecast period, as the economy improves We expect pent-up demand to spur car sales, particularly in 2016-18, since even the partial relaxation of sanctions in 2014 has resulted in strong growth As a result, we expect annual average growth in new passenger car registrations to reach 10.6% in 2016-20, pushing annual sales up to 2m in 2020—almost double their 2013 level Passenger car registrations ('000) 2,500 2,500 2,000 2,000 1,500 1,500 1,000 1,000 500 500 0 2011 12 13 14 15 16 17 18 19 20 Source: The Economist Intelligence Unit The battle among the automotive manufacturers to reap the rewards of this rapid growth will prove absorbing Before 2012 European producers, alongside their Iranian partners Iran Khodro and Pars Khodro, had dominated the market, with France’s PSA Peugeot Citroën the market leader However, after their French peers were forced by sanctions to withdraw, Asian manufacturers have sought to ill the gap In particular, Chinese marques such as Chery, Changan and Lifan have made substantial inroads, while the South Korean manufacturers Hyundai and Kia accounted for 60% of imports into Iran in the irst quarter of 2015 Peugeot Citroën is set to return to Iran Yet, with the lifting of sanctions, the market is set to become crowded once more Iran’s president, Hassan Rowhani, visited Italy and France in late January, and one of the many business announcements made during the trip was about the much-anticipated return to Iran of Peugeot 12 © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran Citroën, with the French irm agreeing to produce 200,000 cars a year with Iran Khodro Peugeot Citroën will no doubt be keen to act fast, aware that another French irm, Renault, had resumed the shipment of car parts to Iran as far back as January 2014 (in the wake of the interim nuclear deal of November 2013) Intriguingly, the presence of Fiat Chrysler’s chief executive, Sergio Marchionne, at a dinner for Mr Rowhani in Rome on January 25th raised speculation about the possibility of Italy’s Fiat also building an automotive production facility in Iran Nevertheless, returning foreign irms should not expect a rapid windfall—local vehicles are based on foreign models developed as much as half a century ago, and their domestic production partners will therefore require revamping, which will take time and considerable expense Consumer goods One of the early visible changes that will accompany the lifting of sanctions will be the reappearance of Western goods on shop shelves The availability of goods, and consumer spending more broadly, had been constrained by the impact of sanctions, but now that inancial, trading and investment restrictions are to be lifted, the Iranian consumer market is likely to show vigorous rates of growth This growth will be supported by the youthful demographic proile in Iran, where the median age is 27 and 43% of the population is aged below 25 Iran’s population is forecast to reach 83.4m by 2020, making it the second-largest consumer market in the Middle East and North Africa region However, cracking the Iran consumer market will not be an easy task The market is fragmented and underdeveloped, dominated as it is by small and medium-sized independent traders, typically operating in traditional bazaars Equally, a signiicant portion of Iran’s consumers live in villages or small towns, with the rural population accounting for just over one-quarter of the total population Foreign retailers form an orderly line Nonetheless, the lifting of sanctions should accelerate the shift towards larger retail units, including the entry of international operators and brands Dubai-based retailers are likely to feature prominently in the irst wave, with Majid Al Futtaim Group, which in 2009 opened its irst hypermarket in the country, well-placed to beneit Other Dubai-based players are also likely to be early movers, including the Al-Futtaim Group, which has set up a number of malls and Ikea stores across the region Turkish retailers will also seek to set up stores in Iran However, displacing the Iranian incumbents will not be easy In the face of sanctions, Iranian consumers have grown accustomed to local versions of international brands, with, for instance, hundreds of copy-cat restaurant establishments that imitate brands such as McDonald’s, Starbucks and Chipotle With this in mind, foreign brands will have to advertise their edge in terms of quality, while others may be forced to make an uneasy accommodation with some of the bootleg operators, given the dificulty in taking legal action However, not expect US companies to share in the windfall; in November 2015 Iran’s government introduced a blockade of US consumer goods, on the direct orders of the supreme leader, Ayatollah Ali Khamenei, who was apparently concerned about shielding national producers from competition The ban on US consumer brands highlights one of the primary risks associated with entering Iran’s © The Economist Intelligence Unit Limited 2016 13 All that glitters Assessing opportunities and risks in post-sanctions Iran market Although we are upbeat about Iran’s prospects, with retail sales expected to reach US$167bn in 2020, if the pent-up demand and increased prosperity result in a lood of imports, the government may introduce tariff and non-tariff barriers, to protect both local suppliers and the balance of payments Consumer goods at a glance 2011a Retail sales (IR trn) 2012a 2013a 2014a 2015b 2016c 2017c 2018c 2019c 2020c 1,360.80 1,657.80 2,225.00 2,538.00 2,784.60 3,284.30 3,967.30 4,782.60 5,694.20 6,888.40 Retail sales (US$ bn) Retail sales, volume growth (%) 128.2 136.2 120.8 97.8 95.4 104.7 119.3 136.3 148.9 166.6 -3.3 -3.6 -2.7 -4.3 3.5 6.3 6.8 8.1 Retail sales, US$ value growth (%) 21.2 6.2 -11.3 -19 -2.5 9.7 14 14.3 9.2 11.9 Non-food retail sales (US$ bn) 55.2 59.3 53.4 43.7 42.1 46.7 54.3 62.8 68.8 77.3 57.9 65 73.5 80.1 89.4 Food retail sales (US$ bn) 73 76.9 67.4 54.2 53.3 a Actual b Economist Intelligence Unit estimates c Economist Intelligence Unit forecasts Infrastructure During Mr Rowhani’s high-proile tour of Italy and France in January, his investment push focused primarily on one area: infrastructure This was no surprise; Iran requires massive investment in, primarily, power generation, water supply, air and rail In the three-and-a-half decades since the Islamic revolution, Iran’s government has spent considerable sums on its infrastructure, most noticeably roads, public housing, airports and rural electriication, but improvements have failed to keep pace with oficial plans or population growth The sky’s the limit The biggest single deal during Mr Rowhani’s tour was Iran’s purchase of 118 aircraft from the panEuropean (but French headquartered) Airbus, including 12 A380s (or Superjumbos), at a total cost of US$25bn Since the US’s imposition in 1995 of a ban on aviation companies selling aircraft and spare parts to Iran—a ban that also affected Airbus, given that its aircraft incorporate US-built parts—stateowned Iran Air’s leet has suffered worsening maintenance problems As a result, reaching agreement on updating the country’s leet has been a priority, and more such purchases, potentially even from US-based Boeing, are possible Iran’s transport minister, Abbas Akhoundi, has remarked that Iran is in the market for some 400 medium- and long-range aircraft, as well as 100 short-haul aircraft The irst vice-president, Eshaq Jahangiri, has revealed that, in addition to updating the leet, Iran is planning to build seven new international airports over the next decade As part of this drive, Memorandums of Understanding (MoUs) to upgrade the country’s major airports were also signed during Mr Rowhani’s tour, with Italy’s Vinci signing a deal to build and operate new terminals at the Mashhad and Isfahan airports, and Aéroports de Paris and Bouygues of France agreeing to build a new terminal at the Imam Khomeini International Airport in Tehran As well as plans to improve the country’s air infrastructure, Iran intends to invest some US$25bn to modernise and expand its rail network (although it has also made it clear that air infrastructure will be the priority) During his tour of Europe, Mr Rowhani reached deals with a slew of companies and 14 © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran state departments, including France’s state-owned rail operator, SNCF, and Italy’s Itinera, to look at overhauling the Iranian rail network and providing new rolling stock and engines for the Islamic Republic of Iran Railways However, all of this will be fruitless without suficient electricity to power the country’s transport network The head of Iran’s Power Transmission, Generation and Distribution Company, Arash Kordi, has said that Iran needs to invest some US$7bn-8bn a year in its power generation and distribution Selected deals announced during Mr Rowhani’s EU visit (€, unless otherwise indicated) Description of deal Company Country Value Purchase 118 passenger aircraft Airbus France 22.8bn Build pipeline and upgrade two reineries Saipem Italy 4.6bn Danieli Group Italy 5.7bn Itinera Italy 4bn Metals joint venture and delivery of equipment MoU to jointly develop infrastructure in Iran, notably in transport a Iran to repay monies owed to Italian companies ; b SACE Italy 564m Produce 200,000 cars a year in Iran Peugeot-Citroen France 400m Provide Iran with 70 rail locomotive engines & 600 marine engines Isotta Fraschini Italy 400m Study into modernising three rail stations Arepc France 7m MoU to import 200,000 b/d from Iran Total France N/A Vinci Italy N/A Aeroports de Paris & Bouygues SA France MoU to operate and expand Mashhad and Isfahan airports MoU to renovate and expand Iman Khomeini International Airport in Teheran N/A Payments had been frozen during sanctions, requiring SACE to reimburse the affected Italian irms Export credit agency Subsidiary of French state-owned rail irm, SNCF a b c Source: Press reports sector—a sum that will require signiicant private and foreign inance Although China has loated the idea of inancing two nuclear plants, the overarching need for greater investment is likely to see the revival of the build-own-operate (BOO) and build-operate-transfer (BOT) contracts that were favoured during the presidency of Mohammed Khatami (1997-2005), and have also been popular in the Gulf Arab states The BOT model allowed private irms to build a power plant and operate it for some 15-20 years, before inally handing it over to the Ministry of Energy The BOT approach is also likely to be adopted for desalination plants—a major priority, in light of Iran’s worsening seven-year drought (20 of the country’s 32 provinces are now listed as having a “water shortage” or being “water critical”) Indeed, so acute has the country’s water shortage become that the government is seeking foreign investment to part-inance a plan to ilter and transfer 200m cu metres/year of water from the Caspian Sea to the middle of the country Financial sector Battered by years of state-directed lending—especially during the presidency of Mahmoud Ahmadinejad (2005-13)—and international sanctions, Iran’s banking system is a mess Although © The Economist Intelligence Unit Limited 2016 15 All that glitters Assessing opportunities and risks in post-sanctions Iran Telecoms and technology Like other countries in the region, Iran has a young and technologically savvy population, but a government that is keen to control access to the Internet and social media And, again as in other countries, the censors are losing the battle for control; according to UAE-based Edoramedia, some 35% of the population uses Facebook (despite the fact that it is banned), and Instagram has witnessed an explosion in growth In part, the authorities’ failure to control Internet usage is an indirect consequence of their own success; Internet capacity in Iran has been boosted by the launch of the EuropePersia Express Gateway, a 5,000-km ibre-optic cable system, and the country has had 3G and 4G since 2014 (which helps to explain why some 55% of Iranians have smartphones) And in some instances Iran has advantages that other countries lack; notably, the Shetab electronic clearing and payments system, introduced in 2002 for domestic banks, has proven a boon for e-commerce by raising public trust in making purchases online However, the upcoming launch of another uniquely Iranian service, referred to as the “Pure” Internet (known as Internet-e Pak, or SHOMA in Persian), will see the state seek to reassert some of its authority over the Internet SHOMA will act as a national Internet service, and will be separate from the global Internet Although use of SHOMA is not expected to be mandatory, the government plans to reduce regular Internet connections and increase the cost of Internet service providers to encourage individuals to move to SHOMA In reality, Iran is not going to be a friendly market for technology irms, especially Western ones, for some time yet 19 technically private banks now operate branches around the country, under a law passed in 2002 allowing their formation, state-owned banks, in particular Bank Melli and Bank Sepah, still dominate the domestic banking sector Banks are saddled with large numbers of non-performing loans (NPLs)—Bank Markazi (the central bank) estimates that NPLs make up around 16% of total loans—and the dificulty of reducing the banks’ stock of bad loans is increased by their nature According to a presidential adviser, quoted in mid-2o15, half of overdue loans (almost US$40bn) are owed by the government and state-owned companies, US$30bn by private and quasi-private enterprises and US$17.5bn are related to Mr Ahmadinejad’s Maskan-e-Mehr social housing scheme Meanwhile, foreign banks have avoided the country, wary of the ines levied on HSBC and Standard Chartered, among others, by the US for breaking Iran-directed sanctions The impact of Iran’s inancial isolation is evident in the huge fall after 2012 in Iran’s short-term debt stock (which primarily comprises trade inance), which declined from US$10.3bn in 2011 to just US$486m in 2014 according to the World Bank Iran makes a SWIFT return Yet, with the lifting of sanctions, the tide is turning On January 19th the Society for Worldwide Interbank Financial Telecommunication (SWIFT) announced that, after talks involving Iranian, EU and SWIFT oficials, Iranian banks would shortly be reconnected to the SWIFT international electronic clearing system In addition, although foreign banks will remain wary about entering the country (given that a welter of US sanctions on Iran remain), non-Western banks may be less nervous, with Hossein Yaqoubi-Miab, an oficial at Bank Markazi, saying on January 21st that the Industrial and 16 © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran Commercial Bank of China (the world’s biggest bank by assets) has applied to open a number of branches in Iran Nevertheless, trade inance is likely to be the most promising early area for foreigners considering entering Iran’s inancial sector; rules on retail banking remain stiling, and the appeal of investing in the stockmarket, although open to foreigners, is limited by the low number of listings and the risk of inadvertently purchasing equity in a company that is sanctioned by the US The pitfalls of investing in Iran International companies seeking to take advantage of the array of opportunities presented by Iran following the lifting of sanctions need to weigh up the risks of dealing with a political and administrative system that has undergone some signiicant changes, but that also has powerful currents of continuity Among the deals signed during a visit to Europe by Iran’s president, Hassan Rowhani, in late January were Memorandums of Understanding (MoUs) with French companies to develop and operate Iran’s airports: Vinci for Isfahan and Mashhad; and a partnership of Aéroports de Paris and Bouygues for a new terminal at Imam Khomeini International Airport (IKIA) in Tehran These airport projects could reveal how much Iran has changed for international business The irst terminal at IKIA was completed in 2004 by a local construction group It was to have been operated by Tepe Akfen Vie, a Turkish-Austrian consortium, as part of a deal that included building a second terminal, but its opening was delayed by the intervention of the Islamic Revolutionary Guards Corps, after objections were raised to a foreign consortium being involved in managing such © The Economist Intelligence Unit Limited 2016 an important strategic asset The then transport minister, Ahmed Khorram, was subsequently impeached by the Majlis (parliament), and the airport eventually opened one year later under Iranian management Another notorious case in 2004 related to the award of a second mobile-phone licence Turkey’s Turkcell was initially adjudged the winner in the tender, which speciied a ixed fee of €300m (US$328m) and was evaluated on the basis of the investment plan and projected revenue streams According to a law passed in September 2004, all contracts in which foreign companies held a majority stake required Majlis approval This applied to Turkcell, as it proposed to hold a 70% stake in the venture The Majlis blocked the deal, and the licence was instead awarded to South Africa’s MTN, the second-placed bidder, after it agreed to lower its stake to 49% Turkcell tried various legal means to contest the decision, but to no avail In light of these and other cases, investors are likely to watch closely the course of the new MoUs, and the forthcoming elections for parliament and the Assembly of Experts, for indications of how powerful vested interests in Iran will react to greater involvement of foreign companies in the Iranian economy 17 All that glitters Assessing opportunities and risks in post-sanctions Iran Business environment Business environment rankings Value of index Global rank Regional rank (out of 10) (out of 82 countries) (out of 17 countries) 2011-15 2016-20 2011-15 2016-20 2011-15 2016-20 Overall position 3.86 4.81 80 78 15 14 Political environment 3.6 4.3 75 70 13 13 Political stability 4.0 5.1 75 60 14 Political effectiveness 3.3 3.6 74 71 13 13 Macroeconomic environment 5.2 6.6 73 59 13 Market opportunities 4.4 6.7 57 14 11 Policy towards private enterprise & competition 1.8 2.8 82 79 17 15 Policy towards foreign investment 1.9 3.7 82 77 17 15 Foreign trade & exchange controls 2.8 4.2 81 77 17 14 Taxes 5.1 4.4 69 80 12 16 Financing 2.5 3.6 80 77 15 15 The labour market 5.2 5.8 65 63 Infrastructure 6.1 6.1 53 61 According to The Economist Intelligence Unit’s business environment rankings, Iran is ranked the fourth-lowest of the countries in the Middle East and Africa for the forecast period (2016-20) Iran is 78th (out of 82 countries) in the global rankings, although this is higher than its ranking for the historical period (201115), relecting the beneicial impact on the country’s business environment of the implementation of the Joint Comprehensive Plan of Action The removal of sanctions will ease trading and payment conditions substantially and allow for higher levels of foreign investment Positive trends also include a demographic shift heralding a decline in Iran’s surplus-labour dynamic, a more responsible (less populist) government and a realisation by the government that Iran can no longer rely as heavily on revenue from oil exports as it has in the past However, structural impediments to progress in the business environment will take a long time to overcome We expect some reform efforts, but these will be limited by vested interests Hence, 18 © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran although we expect some improvements to policies towards the private sector and foreign investment, these will remain areas of weakness in the business environment The tax system remains complex and ineficient, and inancing options are currently limited Infrastructure is facing serious capacity constraints and needs substantial investment Regulatory environment Organising an investment Iran has two types of laws concerning foreign companies The irst type, such as the Foreign Investment Promotion and Protection Act (FIPPA) of 2002, addresses issues that directly concern foreign companies The second type includes general laws with speciic articles or bylaws that address foreign companies, such as the Direct Taxation Act of 1988, amended in 2002, and the Labour Law of 1979, amended in July 1989 Although FIPPA limits the market share that foreign investors allowed to have, it also provides, among other things, the following protections to foreign investors in Iranian companies: l equal treatment with local investors; l no licences are required for foreign investments, other than the FIPPA investment licence; unless stipulated in the investment licence, there is no limit to the proportion of foreign capital in an investment; and l in the event of nationalisation or expropriation, the foreign investor is entitled to compensation in an amount equal to the real value of the investment immediately prior to the event; Labour market The labour force is generally well educated and highly skilled Nevertheless, wealthier Iranians have opted to send their children abroad for education since the 1979 revolution, which has created a brain-drain problem for the country Government social policies encouraged a massive “baby boom” after the revolution and especially during the Iran-Iraq war (1980-88) As a result, the country has a very young population, with a median age of 27.4 years in 2012, according to the latest estimates by the US government As the birth rate has plummeted in recent years, the median age is expected to rise signiicantly There is a large differential in employment between males and females; in the fourth quarter of 2014 the economic participation rate of the population aged ten and over was 62.9% for men and only 11.8% for women Of the total employed population of 21.4m, the agriculture sector accounts for 16.8%, manufacturing for 34.4% and services for 48.8% Labour law The Labour Law of 1991 covers all labour relations in Iran, including the hiring of local and foreign staff The Labour Law provides a very broad and inclusive deinition of the individuals it covers; it recognises all written, oral, temporary and indeinite employment contracts A 1991 regulation under section 35 of the Labour Code prohibits employers from paying employees less than the authorised © The Economist Intelligence Unit Limited 2016 minimum wage (IR7.124m, or US$240, a month, in 2015/16) It stipulates that employees are entitled to paid leave and holidays, as well as an additional 40% of their usual pay for work completed on Fridays, oficial holidays and during paid-leave periods On paper, current labour regulations in Iran are fairly welldisposed towards the concerns of workers However, the trade union system is highly undeveloped, and there is no legal room for the emergence of truly independent unions 19 All that glitters Assessing opportunities and risks in post-sanctions Iran Taxes There is a lat corporation tax rate of 25% on all taxable income, with no distinction made between local irms and those that are partly, largely or wholly foreign owned Personal taxation rates are progressive, with the maximum rate at 35% There is no separate capital gains tax Value-added tax (VAT) was raised in March 2015 from 7% to 9% to offset the fall in revenue resulting from the collapse in oil prices during 2014 Foreign companies “residing abroad” that are contracted to work in Iran in areas such as construction, installation, transport, design and training are taxed at a rate of 12% of annual proits However, overall, the tax system in Iran suffers from rampant non-compliance, owing to its complexity, often arbitrary nature and lack of a comprehensive, accurate national tax information system As a result, the tax burden, measured as a percentage of GDP, is a very low 9.3%, compared with 35.5% in the UK and 44.2% in France, according to igures compiled by the US-based Heritage Foundation Trade policy Iranian tariffs are high, in order to protect domestic producers—a state of affairs that will require many foreign irms to either set up production facilities within Iran or seek domestic partners According to the World Bank, Iran’s simple mean applied tariff rate for all imported products was a high 25.36% in 2011 (latest data available); primary goods attract slightly lower rates Medicines, wheat and “strategic” goods are zero rated Tariff rates and customs levies are subject to frequent change, often at the whim of state-owned producers Therefore, it is imperative to verify speciic information on a regular basis Remaining US sanctions after the JCPOA Although the bulk of the US’s nuclear-related sanctions are being lifted after the full implementation of the Joint Comprehensive Plan of Action (JCPOA), which was signed on July 14th 2015, a range of others, related to human rights, terrorism and weapons of mass destruction, remain in place These include: l US inancial institutions are prohibited from clearing US dollar transactions involving Iran This also applies to non-US inancial institutions assisting US citizens or entities in clearing US dollar transactions l US irms cannot business with the Iranian government or Iranian inancial institutions This prohibition also applies to the bulk of Iranian stateowned irms 20 l Foreign inancial institutions will still be sanctioned if they business with any Iranian person or entity on the US’s SDN (Specially Designated Nationals) list This list typically includes irms and individuals with links to the Islamic Revolutionary Guards Corps It also includes 11 individuals and entities, including UAE-based Mabrooka Trading, that were sanctioned in January after Iran conducted two ballistic missile tests in late 2015 l Even after the JCPOA, all US irms will have to apply to the US Treasury in order to receive permission to business with Iran As the US Treasury itself said on its website: “The US embargo will generally remain in place, even after Implementation Day, because of concerns outside of Iran’s nuclear program” © The Economist Intelligence Unit Limited 2016 While every effort has been taken to verify the accuracy of this information, The Economist Intelligence Unit Ltd cannot accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in this report Cover image - © Mansoreh/Shutterstock LONDON 20 Cabot Square London E14 4QW United Kingdom Tel: (44.20) 7576 8000 Fax: (44.20) 7576 8500 E-mail: london@eiu.com NEW YORK 750 Third Avenue 5th Floor New York, NY 10017 United States Tel: (1.212) 554 0600 Fax: (1.212) 586 1181/2 E-mail: americas@eiu.com HONG KONG 1301 Cityplaza Four 12 Taikoo Wan Road 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(end-period) 32,239 Economist Intelligence Unit estimates b Economist Intelligence Unit forecasts c Actual a © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and... January 21st that the Industrial and 16 © The Economist Intelligence Unit Limited 2016 All that glitters Assessing opportunities and risks in post-sanctions Iran Commercial Bank of China (the world’s