Six months ago, Iran considered itself well insulated from the financial crisis unfolding across the world. Political isolation and economic exclusion were shielding the Islamic Republic’s banking sector from the contagious losses piling up elsewhere.

But the collapse in the oil price between October and December last year quickly erased the country’s hopes of escaping unscathed from the global financial downturn.

Since then, oil revenue projections for the next Iranian year, which begins on 20 March, have been slashed to $37bn, compared with crude sales totalling more than $70bn this year. This is raising doubts over whether Iran will be able to continue its investment programmes to improve the country’s road, rail and ports infrastructure, and to increase oil and gas production by upgrading the country’s industrial infrastructure.

“The financial crisis has had little direct impact on the Iranian economy,” says Ramin Rabii, managing director of Tehran-based investment house Turquoise Partners. “But the aftermath, the fall in commodity prices, that is having an impact on the economy.”

Creating employment

Over the past four years, under the leadership of President Mahmoud Ahmadinejad, Iran has initiated billions of dollars worth of infrastructure and development projects to improve living standards and generate employment for its rapidly growing population.

But faced with the prospect of a budget deficit of almost $50bn and soaring inflation, Ahmadinejad was quoted by the state Islamic Republic News Agency in December 2008 as saying the government might have to abandon many of its public projects.

Iran relies on crude oil earnings for 80 per cent of its gross domestic product (GDP), making its plans vulnerable to the current oil price of less than $40 a barrel.

Because of the economic sanctions against the country, the majority of these projects have been unable to secure financing from foreign investors, forcing the government to choose between funding them itself or cancelling them.

With so many projects competing for limited funds, Iran has had to prioritise, and has therefore largely focused on schemes that will boost trade with neighbouring countries, such as Iraq.

“The Basra to Khorramshahr railway is not a very big project,” says Jafar Bagheri, project manager at the local Metra Consulting Engineers. “But because of the political situation, it is very important.”

The 30-kilometre rail link to Iraq is set for completion by the end of March, and is expected to boost trade between the two countries. A railroad connecting Iran with Pakistan is also expected to be completed in the next six months, while a line to the border with Afghanistan is due to be completed in 2010.

In total, about 1,000km of railroad was due to be opened between December 2008 and mid-March 2009. The first phase of the Esfahan to Shiraz rail project, the 230km Esfahan to Eghlid stretch, was opened on 2 February. The remaining 270km of the route is due to be finished in May. But there is concern that with the government so heavily reliant on oil revenue, the funding for the next round of projects could dry up if the price of crude remains below $50 a barrel for a prolonged period.

“If it becomes a choice between retaining employees or investing in development projects, the government will probably stop projects first,” says Rabii.

The construction of high-speed links from Tehran to Esfahan via Qom, and to Mashhad on the border with Turkmenistan, in particular is under threat. In the absence of foreign backing, the government has already scaled back these plans, choosing to upgrade the existing tracks to handle faster trains rather than install new high-speed tracks at a cost of about $5m a kilometre.

The electrification of the 1,000km double-line track line from Tehran to Mashhad is being carried out by Barsan, an engineering subsidiary of the local Tam Iran Khodro. The contract award includes delivery of 70 electric locomotives for the railway, and the project is scheduled for completion in 2012. Work is also set to begin in February on the electrification of the track from Tehran to Tabriz.

But a 20km stretch of line on the Tehran- Esfahan railway is having to be torn up and relaid along a different route because some of the bends are too tight to accommodate a faster rail service.

Bagheri says the soil preparation for the new line location is on schedule. However, he fears subsequent phases of this modified project, including track laying, electrification and signalling systems, could be delayed because of financing issues. “About 70 per cent of the cost of this project is parts that need to be imported from Europe or Japan, so the low oil price could have an impact,” he says.

Simultaneously, Tehran has been expanding and redeveloping its major commercial ports, again with the aim of boosting trade links with its neighbours. A second expansion of the Shahid Rajaee container port at Bandar Abbas, in the south, is under way, and a third phase is being planned. “We have a shipping line that is interested in having a dedicated terminal there,” says Mohammed Ali Hassanzadeh, head of the investment office at Iran’s Ports & Maritime Organisation (PMO).

The port is of immense strategic importance for the country, with more than half of Iran’s cargo trade passing through it. The phase-two project will expand its capacity to 6 million 20-foot equivalent units (TEUs) by 2010, from 1.8 million today.

Government priorities

Hassanzadeh says the government is determined to push ahead with plans to improve port facilities, despite the global slowdown and the country’s failure to sign up foreign operators to fund the expansions.

“There is a temporary downturn for the large shipping lines, but we as PMO have to build this infrastructure and we have to find other financial means to continue this construction,” he says. “To help the private developers, we are willing to postpone their payments to next year.”

According to Hassanzadeh, state investment in ports infrastructure was less than $2bn in 2008. This includes a $500m investment to upgrade the Chabahar port on the Gulf of Oman, raising capacity from 100,000 TEUs to 500,000.

The priority for the government in the coming year will be to complete projects that are already under way and, given the reduced access to finances, new schemes, such as rail links to Chabahar, are unlikely to be launched.

“One big lender was saying to me recently that even before the credit crunch, if there was an option of investing somewhere with lower risk than Iran, they would do that first,” says one project consultant in Iran. “But banks are even more reluctant to invest now.”

The future direction of crude prices will be a major factor in whether infrastructure investment continues at the current pace in Iran over the next few years.

“I think that next year we need not expect a halt to projects, but if the low oil prices drag on longer, things might change,” says Rabii.

“It will depend on the strategic importance of the project. If it is important for trade they will not halt it. But if it is for the welfare of a small town then it would be easier to stop.

“The high-speed link between Tehran and Esfahan is a luxury development and is not a necessity in terms of trade, so those kinds of projects will be halted in the event the government runs out of cash.”

Infrastructure investment in Iran has often sparked intense political debate, with government ministries disagreeing over which projects to prioritise. So the presidential elections scheduled for 12 June add another element of uncertainty to the investment climate.

“The election will definitely have an impact on the overall strategy of the government, but there are some national projects that would go on regardless of who is in power,” says Rabii.

With the initial draft budget for 2009-10 yet to be approved by parliament, the size of any cut in infrastructure investment remains to be seen. But as the government has in the past budgeted well below the actual price of oil, which resulted in a budget surplus to spend on projects, the news that it is proposing a $37.50 a barrel benchmark - equal to the current oil price - for the new budget suggests there will be no spare income to set aside for expensive projects.

“It is very hard to say how big the impact will be next year, but I think they can get through alright if the oil price remains at what it is today,” says Rabii. “However, if it remains at this level [for longer], then I think it will be more problematic and they will have to significantly cut spending on infrastructure.”

In the meantime, the ports and railways authorities are trying to find affordable ways to enhance the country’s transport links.

The PMO recently appealed to its regional counterparts to improve co-operation between ports and to use Iran as a hub to access other markets. It said this would help the Gulf region weather the slowdown in shipping traffic, but more crucially, it would drive much-needed international trade in Iran’s direction.

Plans have also been announced to expand Iran’s oldest port, Anzali, which, with its location on the Caspian Sea, is a vital link for Russian-Iranian trade.

Railway chiefs are also discussing the feasibility of connecting up with Armenia’s network, and recently reiterated interest in setting up the Istanbul-Almaty passenger and freight rail corridor.

The country’s strategy for improving its rail and ports infrastructure as a way of boosting trade relies on the government being prepared to spend public money on these expensive projects. Tehran has shown willingness to do this in recent years, but decisions taken this year to cut back on the biggest infrastructure projects show that the country’s ambitions are likely to be constrained as long as the slump in oil revenues lasts, because of its heavy reliance on oil exports for income.