It will be years before Iran's economy feels the benefit of the nuclear dealby Christopher de Bellaigue / September 17, 2015 / Leave a comment
Now read Bronwen Maddox on how the sanctions work
For the members of foreign trade delegations currently on prospecting missions to Iran, drowsy after a rich Iranian lunch and a bellyful of facts about the world’s last big unexploited economy, I recommend a refreshing ride on the Tehran metro. The network is far from extensive, and everyone complains about the Chinese engineering (no, the Iranians don’t like the pervasive influence of Cathay more than anyone else), but the air-conditioning works, classical airs trill pleasantly in the stations, and the division of trains into male and female carriages is regarded as a useful segregation—by the women at least. Down in the loam, furthermore, no one seems crotchety or argumentative as they do above ground.
When the trains come, which isn’t very often by western standards, the carriages are full, not just with passengers but also hawkers—dozens of them picking their way among the passengers, droning the virtues of toothbrushes, screwdrivers, mobile phone chargers and deodorants. In general these sellers are treated with indifference by their intended customers, who do not seem to be in a hurry to get to their destinations, but are absorbed in gaming or whatever is playing on their Samsung smartphones. To ride the Tehran metro is to observe precisely the amalgam of apathy and potential that has determined Iranian government policy over the past couple of years, and which will bear down on the country’s future.
For all the Iranian ministerial pronouncements that Iran is “open for business” following July’s nuclear deal with the United States and other world powers, it isn’t—not yet. It will probably be well into next year before Iran can claim to have complied with its commitments with respect to reconfiguring and downgrading key parts of its nuclear industry, which many other governments have suspected, despite Iranian denials, was designed to put it within easy reach of nuclear weapons. After that, the International Atomic Energy Agency (IAEA), will need to give its seal of approval.
Only then will sanctions begin to be lifted. (The votes of 34 Democratic members of the US Senate by President Obama on 2nd September mean he now has a veto on opposition to the deal from the Republican-controlled Congress). The many layers of sanctions have built up over years—American ones since the 1979 Iranian revolution, and those from the United Nations and European Union from 2006 onwards, as Iran refused to comply with demands to curb its nuclear programme. Much of the wrangling over this deal was in the small print over which sanctions would be lifted and when—and whether they would “snap back” if Iran didn’t comply. The answer is that they will, but Iran has also reserved the right to ramp its uranium enrichment back up again if the west reneges on its side of the bargain.
The effects of sanction relief will be felt gradually, and American businesses will continue to suffer constraints in their dealings with Iran due to the continued application of older, non-nuclear sanctions. In the meantime, the government will be able to preserve its plan of mending Iran’s terribly damaged economy only by effective management of popular patience and expectations. The man on the Tehran metro—the underemployed professional passing the time on a transport network that is operating woefully under capacity; the working class lad reduced to selling Chinese pap either because he has been laid off or drought has ruined the formerly well-watered and fertile village whence he comes—is the measure to watch.
“Every year between 800,000 and 900,000 young Iranians enter a labour market that can accommodate no more than a quarter of them”
There is a myth among the many who dislike the Islamic Republic that its decisions do not reflect the desires of the public. But the secret of the regime’s survival lies in its ability to act on those desires, albeit very conservatively. It was popular dissatisfaction with the country’s growing isolation and impoverishment that persuaded its Supreme Leader, Ayatollah Ali Khamenei, to clamp a clothes peg over his nose and accept severe restrictions to the country’s nuclear programme in return for the lifting of sanctions. Now, answering the same desperate plea for a livelihood from the Iranians who elected him in 2013, the instinctively reformist President Hassan Rouhani is trying to lay the ground for job creation in the short term and economic lift-off over the coming decade.
The country’s needs could hardly be more urgent. Every year between 800,000 and 900,000 young Iranians enter a labour market that can accommodate no more than a quarter of them. The World Bank has estimated that Iran needs to grow by at least 5.5 per cent annually and create a million jobs a year in order to reduce unemployment from its current level of around 16 per cent to a more manageable 10 per cent. It needs to do all this at a time when the prices of oil and other commodities on which the economy depends for export earnings have slumped—in part because of the hard landing in China, Iran’s biggest trade partner by far; and domestic demand has faltered.
Thanks to Rouhani’s fiscal and monetary prudence—along with the improved diplomatic atmosphere—inflation was brought down to 14.3 per cent in the first quarter of 2015 (from a whopping 42 per cent in the same period in 2013), and Iran’s currency, the rial, has stabilised. But these achievements do not hide the fact that the real economy is receiving hardly any new investment and that the banking system remains crippled by loans that were insisted upon by the previous government, led by President Mahmoud Ahmadinejad, and which will never be redeemed. The popularity of unregulated lending institutions offering ridiculously high rates of interest—essentially pyramid schemes—testifies to the reluctance of the Iranian investor to get anywhere near the real, productive economy.
The reaction among equity investors to July’s nuclear deal exemplified the scepticism that nowadays obtains in Iranian life. Some portfolio managers had forecast a 15 per cent bounce in the event of a successful outcome to the negotiations; in the event, the main index of the Tehran Stock Exchange dropped by 5 per cent. As one economist put it to me: “Our steel, cement and tiles are piling up. People have yet to see a single tangible benefit from all the diplomatic achievements.”
And yet the procession of European foreign ministers accompanied by business people—most recently Philip Hammond reopening the British Embassy four years after it was ransacked by regime hardliners—continues. The international conferences that are designed to showcase Iran as a destination for investment proliferate and grow. Despite its problems, Iran’s economy is expected to grow by 3 percent this year, even as the country stands still, its oil stored offshore, some $110bn in frozen assets stuck abroad, and the economy still not liberated from the silver-tongued middlemen and “service” providers who were able in the conspiratorial atmosphere of sanctions to spirit billions of dollars out of the country.
A year from now, the majority of sanctions will be off, Iran will be selling oil to Europe once more, its companies will be able to send and receive money around the world, and its key industries will be legally investable. Only then will it be possible to gauge the credibility of those government assurances that a country which only two and a half years ago stood on the edge of economic and social implosion is set fair to become the economic powerhouse of west Asia–a country with Russia’s resources, Turkey’s entrepreneurship, and an elan all of its own.
Even if, as expected, the re-entry of Iranian oil into the market has the effect of further depressing prices, the country can expect an oil windfall of at least $15bn in the first year after exports are resumed, as well as some $29bn in immediately accessible unfrozen assets. Depending on the new oil and gas contracts that are currently being written, and which the international oil companies hope will offer more attractive terms than the service contracts they signed with Iran in the early 2000s, the oil and gas sector should experience a spurt of investment and productivity. If Iran is able to grow at 3 per cent now, cut off from the world, surely 5.5 per cent will not be beyond it when the playing field is even.
For many of the western money managers, company owners and deal-makers who have spent the past year and a half mugging up on Iran and its economy, the learning curve has been steep. One of the first misperceptions that people have had to shed is that Iran’s economic future lies in oil. True, ever since 1914, when the British government took a majority stake in the Anglo-Persian Oil Company, Iran has been an oil producer of strategic importance, and controlling the resource has been one of the country’s chief preoccupations. It has often had to do this in the face of western opposition; in the 1950s, a Prime Minister who dared nationalise the oil industry was ousted in a joint CIA/MI6 coup. But current Iranian fields are in decline, there has been little in the way of new field development, and it will require an improbable combination of massive investment and efficiently channelled political will if production, currently running at around 3.3m barrels per day, is ever to reach its 1976 peak of double that—let alone approach current Saudi levels of 10.5m barrels a day.
Iran is not a swing producer like Saudi Arabia, calibrating its production to meet changes in world demand. Its ambition is to attract large amounts of foreign investment in order to slow the decline in its existing fields and to exploit new ones, clawing back the market share it has lost through sanctions while all the time developing a more resilient and dynamic non-oil economy. Mining will be important—Iran is thought to have major reserves of iron ore, gypsum, copper and gold, and the world’s largest zinc deposits—but the government’s priority is to reduce its vulnerability to commodity price fluctuations and raise margins by becoming an exporter of finished goods. The most promising sectors are cars, pharmaceuticals and petrochemicals, but there is a need for capital investment and technology. At its zenith, before the intensification of sanctions in 2011, Iran was producing 1.6m vehicles per annum, many of them under licence from Peugeot and Renault, and virtually all absorbed by an insatiable domestic market.
It’s not all nuts and bolts. With a young and educated population—70 per cent of Iranians are under 35, and illiteracy among the young is virtually unknown—the country’s internet and mobile penetration are among the highest in the Middle East, while internet start-ups have been happening apace and have attracted boutique investors from Europe. (The “Swift” financial messaging system remains sanctioned, and the banking system is off limits, so these pioneers have been transferring funds using money changers). Then there is tourism, which has been systematically neglected since the revolution, and which the Rouhani government wants to develop so it becomes a major source of foreign exchange.
The mantra among economic managers in Tehran is that the country has 15 neighbours, none of them enjoying Iran’s natural and demographic advantages, and that investors should see it not as a national market but as the hub of a region of 300m consumers.
Of all the things that need to happen if this dream is to be realised, perhaps the most urgent is the efficient exploitation of Iran’s natural gas reserves, which are probably the largest in the world. The uses of gas are many: maintaining reservoir pressure in the oil fields, heating the cities in winter, firing the power stations that the country needs in order to assure itself of electricity, fuelling cars using compressed natural gas, and feeding petrochemical plants. As the gas is Iran’s, it can price it as it sees fit—cheaply—giving its industries an inbuilt advantage over non-gas producing nations. But as a result of political tensions Iran is already late in becoming a major player in the gas market, with the US and its allies freezing it out of pipelines to the west, and sanctions starving the country of the investment and expertise needed to exploit the phases it owns of the gigantic South Pars field (shared with Qatar).
Rather than the likes of Shell, BP and Total—far less the coveted American majors—Iran has been obliged to collaborate in South Pars with Chinese companies, an experience that has sharpened doubts over the quality of their work and technology. Incompetence and corruption have slowed Iran’s goals of becoming self-sufficient in gas—incredibly, it is a net importer—and of going on to supply Pakistan and other gas-poor neighbours. If there is one message that resonates through the offices of the National Iranian Gas Company in central Tehran, it is the desire to reduce the number of Chinese firms involved upstream and welcome the Europeans—and eventually, the Americans—in their stead.
In the lobby of the same building there is a poster emblazoned with the words of senior ayatollahs urging Iranians to cut down on waste. Recent subsidy reforms have led to higher domestic gas and electricity prices, but so far without much effect on Iran’s lamentable patterns of consumption. For the well-to-do Iranian family it is considered fine to throw away vast amounts of food and no domestic kitchen is considered fully operational unless the kettle is chugging away for any visitor who drops in. This blasé attitude towards natural resources is writ large across all areas of life (in 2013, for instance, more gas was used in Iran than in China). It has done nothing to mitigate an ecological catastrophe that could have a big effect on the country’s economic future.
“In August the Minister of Energy disclosed that 8,000 hectares of pistachio plantation alone had dried up because of the drought”
For the past 15 years, Iran has been suffering from a drought that is presumably linked to climate change and therefore will not turn out to be cyclical. I witnessed its effects on a recent trip to southern Iran, where I saw ribbon developments empty of young people because there was no longer any water to grow crops. While the digging of unauthorised wells has contributed to lowering the water table, more water still is lost to evaporation behind dams that Iran spent billions to build. The traditional Iranian water channel, or qanat, which modern orthodoxy dismisses as outmoded, runs underground for precisely this reason.
At least the current government, unlike the previous one, recognises the scale of the problem. In August the Minister of Energy disclosed that 8,000 hectares of pistachio plantation alone had dried up because of the drought, and went on: “The figures show that the crisis is growing year by year. If a solution is not sought out, not only will agriculture suffer but migration to the cities and outlying areas will also grow.” The consequences of the water crisis on the farming sector and urban infrastructure have not been quantified. I have also yet to see a proper estimate of what effect the drought will have on industry—it is no secret that almost all the processes upon which Iran hopes to build its new economy require large amounts of water, and logic suggests that as water becomes scarcer its price will go up. In August, I was told of an industrial unit in the south of the country that was no longer being supplied by a neighbouring well—it was dry—but from a reservoir 50km away. No feasibility study commissioned by a potential foreign investor in Iranian industry will be complete without addressing the subject of water.
Will the foreigners come? From oil to vehicles and from power-generation to insurance, advertising and consumer goods, the expectation is that the western investor will find the virgin territory of Iran irresistible. No issue of the country’s main financial newspaper, Donya-ye Eqtesad, or “Economics World,” is complete without an official putting a vertiginous number to the investment required by his sector—$100bn over three years into oil and gas, according to the official in charge of rewriting the new contracts; $85bn into petrochemicals, in the estimation of the head of parliament’s petrochemicals committee—and outlining measures such as the cutting of red tape and the improvement of contracts that will facilitate the rush.
Of course there is a lot of interest; there has been from the moment Rouhani came to power, promising to reintegrate Iran into the capitalist world. In July, at a conference in Vienna, the head of Iran’s investment authority, Muhammad Khazaei, boasted that he had approved $2bn worth of “mega-projects” with EU companies in the past two weeks, while outside the conference hall a senior petrochemicals official discussed gas liquefaction opportunities with an executive from the German technology company Linde. But later, a spokesman for Linde described these discussions only as “pre-business talks,” while a European oil executive I met said he was attending the conference in a strictly “unofficial” capacity. As for the Italian, French, German and Austrian companies that have been trooping into Tehran over the past few months—a roll call of blue chip Europeans, including Alstom, Daimler, Siemens and Eni—they seem for the most part to have contented themselves with sizing up partners or re-establishing older relationships (Siemens, for instance, has been in Iran on and off since the 1930s and began work on the country’s first nuclear reactor under the Shah). It will be some time before those “mega-projects” are sealed with meaningful contracts.
A pattern is emerging, one of caution. In August, one of Tehran’s top portfolio managers told me he had commitments for capital market investments from foreigners totalling around $125m, but conceded that current investments were a lot less. Iran’s banking sector remains beyond the pale, with just a few foreign boutique banks exploring correspondent relationships. Parviz Aghili, the country’s premier private banker, does not expect the big European banks—“the Commerzbanks, the Deutsche Banks, the Standard Chartereds”—to establish themselves in Iran for several years.
This stand-offish behaviour cannot be ascribed only to the fact that sanctions are still officially in force—and will remain so until what the diplomats are calling “Implementation Day,” probably in the first half of 2016, when the IAEA confirms that Iran has made the necessary adjustments to its nuclear facilities.
Independent of the various sanctions that have been enacted over the past few years by the EU, the UN and unilaterally by countries like Canada and Australia, investing in Iran is associated with a wider risk that few companies with international reputations are willing to entertain. There are good reasons for this. In recent years, foreign firms that have taken on Iranian business—even business that is not sanctioned in their own countries—have found themselves hammered under extra-territorial sanctions enacted in the US. In the most dramatic case, in July last year, the French bank BNP Paribas paid out $9bn and was barred from US-dollar clearances after a US court found it guilty of transacting with three hostile countries, including Iran, even though the transactions were legal under French and EU law.
This policy of punishing non-US companies that have done business with Iran is part of a long-standing strategy by the Office for Foreign Assets Control, or Ofac—the branch of the US Treasury that administers sanctions—aimed at reducing third party trade with Iran to negligible levels. This strategy has been brilliantly successful; the strong arm of Ofac probably did more than anything else to bring Iran to the negotiating table. However, according to the July nuclear agreement, Ofac must change course after Implementation Day and must now do everything in its power to remove impediments to third party trade with Iran.
You can understand why the board at BNP Paribas and other big international companies might be sceptical about the proposed volte-face. Their attitude is very likely to be, “we’ll believe it when we see it.”
Another complication concerns the US’s unilateral sanctions against Iran—and the survival of most of them beyond Implementation Day. Nuclear-related sanctions will be suspended or struck down, but most of the laws prohibiting business contacts between the two countries predate the nuclear issue, and relate to Iran’s alleged human rights violations and support for terrorism. These will stay on the statute book, establishing an imbalance between a Europe that is free to transact with Iran and the US, which is prevented from doing so (except in a few exempted sectors such as commercial aircraft). To all intents and purposes the US trade embargo will remain.
If you take into account China’s problems, turmoil in the Middle East and uncertainty over the terms of Iran’s new oil and gas contracts (which the government has repeatedly delayed unveiling), the most likely scenario for the Iranian economy is a slow, somewhat unspectacular opening to the world, with Europe going in first and US businesses finding their voices and lobbying for the repeal of the Clinton-era sanctions. This could take time, though, and face much political opposition, as the vigour of Congress’s (unsuccessful) attempts to derail the July agreement has shown.
Although a picture of hesitant integration might disappoint the would-be architects of Iran’s new economy—and in Tehran there are plenty of apostles of Chinese rates of growth—it will not displease those Iranian leaders who regard economics as the servant of politics, and who would bend politics to the preservation of the revolution’s soul. For these men, engagement with the west is a necessary evil in the interests of creating jobs and buffering the country against American hostility. It must not go too far.
The most important of these pragmatic ideologues is, of course, the Supreme Leader himself. Lest anyone confuse his support for the diplomatic effort of the past two years with a desire for détente with the US, in August Khamenei once again denounced American designs in the Middle East, which, according to him, consist of trying to break Syria and Iraq into smaller, more biddable blocks. He also warned that the US would use the nuclear deal as a way of inserting itself into Iran, and promised that the Islamic Republic would not permit America to exert “economic, political and cultural influence” in the country, or to have a “political presence” there—code for a functioning US embassy.
The irony of the recent diplomatic breakthrough is that with significant parts of Iran’s nuclear industry in mothballs for a decade at least, it is not through acquiring a bomb—or getting close to one—that the country will validate its claim to be the Middle East’s natural superpower. This will only happen if Iran exerts itself to become the region’s major producer and consumer, which is, after all, a not unrealistic goal. Ceramics and cement to Iraq; gas to Pakistan, Oman and Kuwait; cars to central Asia; tinned food to Afghanistan; oil and petrochemicals to all—one could easily mistake the export routes radiating outwards on the wall maps of Tehran’s companies for a rising sun.
Is Iran’s foreign policy establishment prepared to subordinate the pure priorities of the revolution, which have included threatening Israel with destruction, to the grubby matrix of the win-win? Over the past two years of pressured diplomacy, Iran’s beleaguered foreign ministry has at least taken back some prestige from the Revolutionary Guard and other hardline organs of the deep state, and no amount of anti-American rhetoric from Khamenei can hide the fact that between his diplomats, and those of the US and Europe, there now exists more respect and cordiality than at any time since the revolution.
Iran’s opposition to Israel is unlikely to change soon, but it is possible to imagine it becoming less bellicose; likewise, belying its image of a sectarian troublemaker, Shia Iran has repeatedly offered to settle its differences with Sunni Saudi Arabia—offers that the US would do well to encourage its main Gulf ally to take up. There are signs, even, that the Revolutionary Guard is prepared to offload the strategic riches it picked up during the worst years of sanctions; in July, the Guard put its major asset, the nation’s $7.8bn telecommunications monopoly, up for sale.
Looking at the growing number of foreigners who are coming to Tehran these days, it seems remarkable that as recently as 2013 travelling to the Islamic Republic was a vaguely hazardous enterprise, whether for a journalist, a businessperson, or anyone who wanted to know more about the country. Distrust of the west was enshrined in state policy and thanks to the belligerence of many of Iran’s leaders, and hawks in Israel and the US, war seemed more than likely. Now it looks as if there will be peace, and perhaps prosperity. There are worse ways to end a revolution.