With Sanctions Lifting, What’s In Store For Iran’s Economy?

Via Knowledge at Wharton, a report on Iran’s economic potential:

Following the landmark nuclear deal with Iran, plans for the lifting of economic sanctions are moving forward with “Implementation Day” planned as soon as late 2015 or early 2016. Not only is this move important for the United States for geopolitical reasons, observers say, but removing trade embargoes should boost Iran’s economy.

Called the Joint Comprehensive Plan of Action (JCPOA), the agreement between Iran and six countries (the U.S., the U.K., Germany, France, Russia and China), clears the way for Iran to sell oil, trade other goods and engage in financial services once again. While the U.S. has upheld sanctions against Iran for the last 35 years, Europe’s have been in effect only since 2012.

Wharton legal studies and business ethics professor Philip M. Nichols notes that the reopening of trade links is more like picking up where they left off after a “two-year hiatus from Europe’s perspective. For the U.S., it’s obviously a substantially more dramatic, hard resumption of trade,” but only in limited ways.

Iran is the second-largest economy in the MENA (Middle East and North Africa) region after Saudi Arabia, and the 18th biggest in the world, according to the World Bank. With a population close to 80 million people, it’s the second-most populous nation in the area, with 60% of its people under the age of 30. But youth unemployment is very high (17.9% for men and 39% for women), and that is one area the government wants to tackle. Its aim: Create 8.5 million jobs in the next two years, and fresh foreign investment should help.

Iran’s economy shrunk by 6.8% in 2012 and 1.2% in 2013, with sanctions blamed for a loss of $17.1 billion in export revenue in 2012-2014 — a 13.5% decrease, according to the World Bank. Since President Hassan Rouhani took office in July 2013, he has pulled the country out of recession and inflation is now down to 17% after skyrocketing to 40% two years ago, according to The Economist. When trade resumes, Iran’s GDP may rise to 5% from the current 2.8% rate, the World Bank forecasts.

Since the U.S. embassy in Tehran was stormed in 1979 and 52 hostages were held for 444 days, diplomatic ties between the two countries have been severed. The Americans still have not reopened the U.S. embassy in Iran. The American government froze Iranian assets, most of which have remained inaccessible — until the sanctions free up the funds.

American companies still have to be careful of how to tread into Iran since there are still sanctions related to human rights abuses and support for terrorism. Iran does not recognize Israel and has been accused of supporting Hamas and Hezbollah. Nichols says, “There are special reputational concerns in dealing with Iran. Iran is quite the punching bag for U.S. politicians. A firm deadline directly with Iran is walking into the teeth of political rhetoric. It’s not aimed at those [American] firms, but aimed at President Obama. And that’s difficult.”

The Oil Card

However, for the American consumer, the biggest impact might be a lighter bill at the gas pump. When Iran begins selling its oil more freely again, global oil prices may drop 14% by 2016. Bloomberg reported that Iran has already started producing 2.8 million barrels a day. Oil importers like the U.S. and Europe will benefit from lower energy prices while OPEC members, like Saudi Arabia, and other oil producers will lose out. Iran has the fourth-largest oil reserve in the world and the country’s oil revenues could rise $15 billion in the first year.

As much as 42% of Iran’s government revenues come from crude oil. Since sanctions with European countries have been in effect, exports have dropped by almost 50%. Prior to the Iranian Revolution in 1979, U.S. oil companies were major players in Iran, notes Wharton finance professor Bulent Gultekin. “Iranian oil fields are suffering in that they don’t have the technology for drilling in marginal fields,” he says. “American oil companies should have an interest … but it’s not going to be easily resolved. It’ll be an interesting competition to watch” between European and American companies.

Plus, as energy prices have fallen, oil has become a more volatile commodity to count on. “The oil industry is less interested now in Iran than it would have been five years ago because of the oil slump. Oil prices are low, and the oil industry is pulling back and cutting hundreds of thousands of jobs. Over the long term, because of the relative ease of oil extraction in Iran, the cost of getting on the ground [in Iran] is cheaper than going in the Arctic,” notes Kevan Harris, a UCLA sociology professor who studies Iran’s political economy.

With infrastructure investment, Iran could pump out even more oil — it needs about $185 billion for infrastructure development in industry. Nichols says, “Oil is one of the few Iranian industries that will need to get around financing sanctions. Bank sanctions have not been lifted, and the lifting that is happening is occurring in interesting ways.”

Doing Business with Iran

As Iran’s trade with Europe opens up, American companies will only be able to do business in specific sectors like aircraft, aircraft spare parts and carpets.

Is the U.S. missing out? “Probably,” says Nichols. “Although there are ways that U.S. firms are going to take advantage of what’s available, it’s not like the U.S. is missing out on a golden opportunity. ” He adds: “The Iranian market is a curious thing. Sanctions are being lifted slowly. The only sanctions being lifted are those for nuclear deterrence. Iran is essentially a command economy.

“It’s not like going into a free, open market. It’s not like a fairy godmother has tapped Iran with a wand and declared, ‘Now you are open.’ It’s still a pretty closed and difficult market.?Twitter  It’s not a vast, untapped market. The firms going in, for the most part, are resuming relationships rather than forging new relationships,” says Nichols

Harris adds that Americans “will have one less mortal enemy. Hopefully, this will change the dynamics in the Middle East. The U.S. hasn’t had an economic advantage in 35 years. Any trade will be beneficial, but that won’t be the real benefit. The U.S. didn’t do this for economic reasons. The U.S. is doing this for geopolitical reasons.”

In the past, Iran had a very large public sector that began a process of shifting ownership to other actors, like semi-public entities such as pension funds, state banks and foundations linked to the Armed Forces and Revolutionary Guard Corps, notes Harris. These groups got even bigger under the sanctions. At present, around 50% to 60% of the Iranian economy depends on these quasi-governmental enterprises.

Firms may want to proceed with caution, says Marvin Zonis, professor emeritus at the University of Chicago’s Booth School of Business. These semi-public entities are “wired right into the center of power. If there’s a business dispute, companies will have very little recourse. If they don’t pay attention to this reality, they will end up in a very bad position,” he notes.

Different Stories for Different Sectors

The airline industry is one of the Iranian industries in dire need of help. Under the Shah of Iran who ruled from 1953 to 1979, all the planes purchased were Boeings, notes Zonis. There have been no Boeing spare parts sold to Iran since the Iranian Revolution happened in 1979. “We don’t want planes falling out of skies,” adds Zonis. As a result, “Boeing is going gangbusters over there,” says Nichols.

“Iranians are smart enough to spread their largesse around and my guess is they’ll buy Boeings and Airbusses [the European rival],” Zonis notes. “They’ll also be smart enough to play regions against one another: China, America, Russia, and Europe. They’re going to play that game.”

Moreover, some American companies are already there. Nichols notes, “The most popular drink is Coca-Cola. Second is Pepsi. The trade barriers are there and sanctions apply to what goes in and out of Iran.” The way the country gets around that is Coca-Cola and Pepsi have domestic licensing deals so the products are manufactured in Iran, adds Harris.

Looking forward, Iran will see more multinationals hunting for opportunities. The World Bank estimates foreign direct investment may double to $3 billion a year, which is still below the 2003 peak. Many countries in the EU stand to benefit. Gultekin notes that Iran has a “very sizable economy with an absorption capacity much higher than many. It invariably will be an economy that will attract interest from everywhere. [Other countries] will have the first-mover advantage.”

“Large trade delegations from Europe — Germany, France, Italy — including CEOs and chambers of commerce, are calling on Iranian businessmen and advancing the cause of European businesses,” notes Zonis.

“It’s not like going into a free, open market. It’s not like a fairy godmother has tapped Iran with a wand and declared, ‘Now you are open.’ It’s still a pretty closed and difficult market.”–Philip M. Nichols

Nichols explains: “First of all, about $58 billion of assets were frozen as part of the nuclear deterrent program. In accordance with the agreement, the U.S. is unfreezing those assets. Iran will have a surge of money to play with. It’s what the Europeans are counting on. [Iran] is going to have a bunch of money to play with right away. After that, it’s back to oil and petrochemicals.”

For example, Germany fulfilled a vast majority of Iran’s industrial requirements before the sanctions and the country is quickly moving back into Iran to resume business. German companies like Siemens, Daimler, Volkswagen and ThyssenKrupp, all sent executives to Iran over the summer.

One element that’s attractive about Iran is companies are not looking at greenfield investments. “They don’t have to build whole new factories, which is one of the good things,” says Harris. “It’s not underdeveloped — as if it needs a whole new sector. Iran has it all. It has capital goods, it has transportation infrastructure. It has a well-developed industrial base that investors can upgrade rather than build from scratch. It’s a better [scenario] than Sudan and Angola where you have to build from scratch.”

Meanwhile, Asia has maintained its business links with Iran. Throughout the embargo, China has been Iran’s biggest trade partner. Japan has already agreed to more than triple its import of crude oil to 350,000 barrels a day, according to Bloomberg. Japan Tobacco International recently bought a privately owned Iranian cigarette company in a move to gain market share before the American maker of Marlboro, Philip Morris, enters Iran’s market legally. With alcohol banned, smoking is one of the few vices allowed.

And then there’s always the possibility that sanctions might return. Nichols explains, “Everyone is concerned about snapbacks. It’ll be interesting how they negotiated around those with existing partners. I imagine partners will be accommodating. Boeing transactions are being set up with a non-Iranian company, and then maintenance contracts set up with an Iranian company. Those arrangements will be beyond snapback provisions.

“My takeaway is it’s not like a vast market has magically opened up,” Nichols adds. “It hasn’t opened up. It’s going to be a long time before it opens up. It’s not like the Europeans are rushing where the Americans fear to trade. They’re just resuming relationships that existed until only a couple years ago.”


This entry was posted on Thursday, October 29th, 2015 at 5:11 am and is filed under Iran.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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