Iran’s economic landscape has for decades been dominated by the challenges posed by subsidies and sanctions. In 2009, the Iranian government spent more than a quarter of its $280bn state budget on subsidies, ranging from petrol, electricity and water, to foodstuffs.

[Tehran] is not for those looking for a low risk and safe return market … but there is a lot of potential here

Tehran-based analyst

The budget for the current Iranian year ending 21 March 2011 has been set at $368bn but with a series of infrastructure and energy projects requiring major investment in the months ahead, the government has moved to reduce the level of subsidies. In January, Iran’s Guardian Council approved a $20bn subsidy cut as the first step to introduce real market prices by 2015.

The removal of subsidies will lead to higher inflation in the short term and, potentially, rising unemployment and even unrest, but it is essential for long-term growth.

However, the political climate is playing a huge role in determining the country’s economic growth. The disputed elections and subsequent unrest in 2009 have cast a shadow of uncertainty over the country’s stability.

But Tehran’s policies are also at odds with its economic ideals. The country needs heavy investment in its energy and infrastructure sectors. To do this effectively, it needs help from international firms, but the sanctions are deterring them from investing.

President Mahmoud Ahmadinejad’s second term in office will only come to an end in 2013. But replacement of the existing government by a reformist one is the only likely way for sanctions to be lifted and the flow of foreign investment to begin.

Privatisation plans

Nonetheless, Iran’s privatisation plans have attracted much more attention during 2009-2010 than in recent years. The government’s plan to raise about $12.5bn by selling off 500 state-owned companies is the clearest sign yet that it is serious about improving the economy.

About 90 companies are to be privatised over the next three years, including national carrier Iran Air and several steel companies, including Esfahan Steel Company. Under the plan, the government will relax foreign investment regulations and rules on the percentage foreign investors can own in a company.

Privatisation in Iran currently calls for an initial public offering of 5 per cent of the firm being privatised. In recent privatisation cases, due to strength of demand, this has gone up to a 50 per cent free float.

Changes to participation on the stock exchange have also been implemented. Previously, international investors wishing to buy shares on the Tehran Stock Exchange would have had their money locked in for three years, but now this rule is being scrapped. There are even plans to allow foreign firms to purchase state-owned companies.

But Iran is for a brave breed of investor, a Tehran-based analyst admits. “[Tehran] is not suitable for those looking for a low-risk and safe-return market,” he says. “They must be prepared to take risks. [But] there is a lot of potential here and the government is going the right way in liberalising the economy.”

In addition, the Central Bank of Iran is relaxing its monetary policy. State-owned banks and those recently privatised, which had built up bad debt, will also be relieved of their debt under new regulations.

Increased lending

“Draft legislation is currently being approved that would see the government withdrawing money from the oil surplus fund and recapitalising some of the state-owned banks to write off their bad debt. This will improve the overall health of the banks, which will lead to an increase in lending,” says the analyst.

By eliminating subsidies, the government has promised to give 50 per cent of the money saved to Iran’s lower classes – a politically motivated move, given that the majority of the uneducated poor were the main supporters of Ahmadinejad’s initial rise to power. Another 20 per cent will go towards infrastructure projects. However, it remains to be seen how the plan is implemented and at what speed.

Ultimately, clearing the path of sanctions is the key needed to unlock investment and confidence in Iran. Analysts argue that it could learn a lot from Libya, a country also limited by sanctions for 23 years. Tripoli has since made huge advances in developing its infrastructure, including three airport projects, a planned merger of its two national airlines and its own refining sector. A number of international firms are now looking to build refineries across the country.

If Iran is to become self-sufficient and have a fair and competitive market, its plan to cut subsidies must go ahead, despite the likely backlash from the public. Beyond that, it must seek to allay international fears over its nuclear programme. If it can put bitter politics aside, it will be rewarded with an easing of sanctions and vast potential for economic growth.