Courtesy of the Financial Times, an interesting article on Iran:

A great deal has been written about the opportunities waiting for both strategic and portfolio investors in post-sanctions Iran. There is no denying that the country of almost 80m people, holder of the world’s third largest reserves of oil and its second largest reserves of mostly untapped gas, has enormous potential. GDP is expected to be $430bn for the current fiscal year (to March 2016) and is certainly capable of more than doubling over the next seven years if sanctions are taken down as per the agreement with the UN, and they stay down.

But Iran is still a state dominated by religious leaders and institutions and this means there are fundamental differences between the way business and investment is carried out compared with practices in OECD countries. The economy is also heavily dominated by entrenched insiders, many of whom have very close political connections, if they are not actually part of the state structure. Of course investors in any developing economy need to be mindful of local conditions and be ready to adapt. This is much more so in Iran; the patient and the prepared will make a great deal of money, while those who rush in with ill-prepared due diligence will quickly falter.

The first point to understand is that despite the years of sanctions, the economy and business have developed, albeit less efficiently and more slowly than would otherwise have been the case. This means that structures are in place that foreign investors will have to either try and compete against or, in most instances, work with.

The Revolutionary Guards (IRGC) have a significant stake in the economy through such structures as Khatim Al-Anbiya, a sort of industrial holding company, and Ghorb, which is the largest construction company in the country. The IRGC will remain best positioned to get the most lucrative contracts, leaving foreign companies with the option of looking for second tier projects or engaging with IRGC companies in joint ventures. Many international companies may be wary of reputational risk of associating with the IRGC given how it is perceived in the west, but those that delay will lose out.

Another firmly entrenched source of competition or potential partnership is the Bonyards. These are charitable trusts that pre-date the 1979 revolution but which have grown very strong since as the government handed over privatised assets. Reportedly, the Bonyards now control a fifth of the country’s total economy, or over a third of the economy outside oil and gas. They are firmly established in some of the sectors with greatest potential for growth, such as aviation, agriculture, automotive, transport and logistics and financial services. Foreign strategic investors will most likely have to engage with either the IRGC or a Bonyard as competing with them will be impossible, or ill-advised, for a very long time.

That said, opportunities to work with the existing controlling structures are expected to open up quickly. Most sectors of the economy and many important industries are inefficient and under-developed when compared with western counterparts because years of sanctions starved them of modern technology and best practice management. As has been seen in China and other developing economies, such as in Russia’s automotive sector, the government is expected to encourage joint ventures with international companies rather than hinder them. The problem for foreign companies will be how to navigate the notoriously inefficient Bonyards and other politically linked structures, the leadership of which is more likely to be focused on preserving the status-quo and their lucrative and protected lifestyles. Initially, operating out of one of the country’s several economic zones, which offer zero tax and visa-free entry for foreign investors and a light bureaucratic touch, may offer at least an interim solution.

The consumer sectors also rank high on the list of economic activities with greatest potential for growth. The retail and consumer service sectors are expected to turn over $150bn in this fiscal year, and that figure will expand greatly in the post-sanctions economy. Supermarkets and hypermarkets, for example, have only a 4.5 per cent market share in the food retail sector. But when you walk down a street in Tehran, the familiar double yellow arches are not what you think. In many Iranian cities this is the logo for MashDonalds, a local clone of the international fast-food chain. The same issue exists across most areas of the consumer sector, with well-established replicas of such chains as Starbucks, Pizza Hut and many international clothing chains. Ecommerce is also well established in Iran but with the local equivalents of PayPal, eBay and others ready to defend their positions and repel new entrants.

For foreign investors Iran also has the usual list of problems associated with developing, or frontier, economies. Corruption is widespread and the country’s low ranking in the World Bank’s Ease of Doing Business Survey, at 118th, illustrates the difficult administrative and legal backdrop. The country is hydrocarbon dependent and this, plus the accumulation of sanctions, has led to a loss of two thirds in the exchange rate of the rial against the US dollar since early 2012. The central bank has adopted a very hawkish response and its benchmark interest rate is currently 21 per cent. There is little useful clarity as to what the monetary policy stance will be once sanctions are removed.

The one encouraging factor for investors is that the balance within government has shifted to a pro-business and pro-foreign investment position. If their actions to get the nuclear deal agreed are relatively quickly rewarded with inward investment and progress towards the 4.5 per cent GDP growth targeted for 2016/17, then foreign investor optimism may start to be validated and the headline risk of a return to sanctions start to recede – provided of course investors pick the right sectors and align with the right partners.