Iran looks to nuclear deal for economic resurgence

24 June 2015

Lifting of sanctions will enable Tehran to increase exports, help control inflation and boost economic growth

  • Potential deal promises a fresh start for the Islamic Republic’s economy
  • Tehran has been buzzing with representatives from overseas companies, looking into potential investments
  • A comprehensive agreement on 30 June will help Iran keep a lid on further rises in inflation

Although an Iranian nuclear deal at the end of June is far from a certainty, there is a sense of anticipation as business leaders prepare for the potential re-emergence of a major player to the regional and world economy.

The potential deal also promises a fresh start for the Islamic Republic’s economy, which has been crippled by intensifying sanctions, mismanagement and, recently, the drop in oil prices.

The Washington-based IMF estimates Iran’s real GDP expanded by 3 per cent in 2014; this was preceded by drops of 1.9 per cent and 6.6 per cent in 2013 and 2012 respectively.

Further forecasts of 0.6 per cent this year and 1.3 per cent for 2016 highlight the weak prospects for a resurgent economy in the coming years.

The likelihood of Iran and the P5+1 group of world powers – the US, France, Germany, the UK, China and Russia – reaching a comprehensive deal improved on 2 April, when the two sides reached a framework agreement after days of negotiations in Lausanne, Switzerland.

Investors gather

Over the past two months, Tehran has been buzzing with representatives from overseas companies, looking into potential investments in Iran if the sanctions regime is removed.

The heads of several major international oil companies (IOCs), including the UK’s BP, UK/Dutch Shell and France’s Total, recently declared interest in re-entering a sanctions-free Iran.

At the same time, the country’s Petroleum Ministry is focused on restructuring development contracts to make its oil assets more attractive to overseas investment, scrapping the buy-back agreements that have struggled to attract interest in the past.

Under the new contracts, IOCs will be rewarded for increasing production, but will also be expected to share more technology and management expertise.

In May, Petroleum Minister Bijan Zanganeh estimated that Iran needs $200bn-worth of investment to rebuild and expand its oil sector, after years of damaging sanctions and underfunding.

Production push

Regardless of long-term investment in the oil industry, Iranian officials believe the country can increase production and exports by an additional 500,000 barrels a day (b/d) within a month of sanctions being lifted, and by 1 million b/d within six months.

According to oil producers’ group Opec, the annual value of Iranian petroleum exports dropped from $114.75bn in 2011 – the second-highest in the organisation – to $61.92bn in 2013, as the US and EU introduced new sanctions affecting Iran’s oil industry.

Some analysts believe Tehran’s targets for recovering crude production and revenues are unrealistic, and that it will take longer for the country to return to the levels seen before the 2012 sanctions.

“Realistically, Iran can rehabilitate about 400,000 b/d of production relatively quickly… within months,” said Bijan Khajehpour, managing partner at Vienna-based consulting group Atieh International, in a presentation on 2 June at the US think-tank Wilson Center.

Khajehpour forecast that within 18 months of the lifting of sanctions, oil production capacity could go back to where it was before 2012.

“If current prices persist in the medium term and unconventional oil production declines, and if there is a comprehensive nuclear agreement, Iran could restore its pre-sanctions market share by 2017,” he said.

If sanctions are lifted, the resulting increase in revenue from crude will be a major boost to the government, especially at a time of lower oil prices, when budgets are already squeezed.

According to Atieh International, the nuclear agreement could be the difference between $65bn in annual oil revenues in 2017/18 with a deal against $45bn without a deal.

It is also estimated that Iran will be able to tap $100bn in restricted oil funds if sanctions against its banking system are lifted.

Mismanaged economy

But oil revenues are by no means the only problem facing the Islamic Republic’s economy. When Hassan Rouhani took over as president in August 2013, he inherited an economy that had been undermined by years of mismanagement.

One of Rouhani’s first priorities was to contain the spiralling inflation rate, which was at 40 per cent when he entered office. This has been reduced to about 16 per cent, but there is still work to do.

“While the agreement will have an impact on the economy of Iran, a lot of what happens will be a function of policies and measures that are put in place within the country itself,” said Masood Ahmed, director of the IMF’s Middle East and Central Asia department, speaking in April.

“If you look at what’s been happening in Iran over the past couple of years, you see that the combination of prudent macro-economic policies and some easing that has come about from the interim agreement have led to a stabilisation of the economy.

“Already, you see that a combination of good policies and a better environment internationally can have an impact, but there’s a lot to be done to continue with the reform of the industrial and productive infrastructure in Iran, as well as to continue with the framework of monetary and fiscal policies.”

Controlling inflation

Controlling the inflation rate has been one of the major achievements of the Rouhani administration so far, but the target is to reduce the rate to single figures.

Khajehpour believes the impact of the nuclear deal on the inflation rate will be indirect, through the improvement of the government’s financial position and exchange rate developments. A comprehensive nuclear deal could bring further inflationary pressures such as pushing up housing prices, while the government could be pushed into further subsidy reforms that would increase fuel prices.

While Tehran is unlikely to manage single-digit inflation, a comprehensive agreement on 30 June will help it keep a lid on further rises.

Iran’s banking sector is set to be one of the biggest winners from the negotiations. Under current restrictions, foreign lenders are not able to work with Iranian banks unless the transaction falls within very specific sectors and secures specific approvals.

Not only do European regulations forbid international lenders to deal with Iranian banks, US sanctions also penalise international banks that do business in the Islamic Republic outside the narrow band of exceptions.

Iranian banks are also excluded from the international electronic financial-messaging service, the Society for Worldwide Interbank Financial Telecommunications (Swift).

Banking potential

Iran’s Islamic banking assets are $482bn, according to Dubai government data from 2014. That is more than in Saudi Arabia, Malaysia and the UAE combined.

Relief from sanctions against Iran’s banks should facilitate a resurgence in overseas trade. Iranian importers have had significant difficulty importing high-demand goods due to sanctions restrictions, leading to a slowdown in imports from its historical trade partners, including the UAE.

At the same time, exporters in Iran will be able to enter new markets and investment in export-led manufacturing and heavy industry would become feasible again.

Tackling unemployment

Another long-term challenge for the government is reducing joblessness. The Statistical Centre of Iran estimated the unemployment rate at 10.3 per cent in 2013, but unofficial sources have put the future as high as 20 per cent. The rate is particularly high among women and youth, with 24 per cent of young people eligible for work estimated to be unemployed.

“A comprehensive deal will generate a boost in new economic activity, especially through new investments by domestic and foreign private sector companies,” said Khajehpour in his presentation. “In some sectors [such as tourism], the expectation of greater employment is already leading to job creation.”

But demographic pressures will make it difficult to reduce unemployment below 8 per cent in the next decade, he added.

Sure benefits

There is no doubt the lifting of sanctions will benefit many sectors and institutions in the Iranian economy as long-anticipated overseas investment enters the country.

GDP growth will likely accelerate as oil exports increase, international trade returns to pre-sanctions levels and Iran begins to spend the significant windfall payments from frozen overseas oil funds.

However, sanctions relief cannot make the long-term economic problems facing Tehran go away and the government will still face major challenges such as controlling high inflation, job creation for the youth and stopping the devaluation of the Iranian rial.

Nevertheless, a comprehensive nuclear agreement on 30 June will give Rouhani’s government a golden opportunity to get the country’s economy back on the right track.

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