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Iran: Were Expectations of Sanctions Relief Too High?

Saturday, October 22, 2016

Nina Mamedova

The July 2015 Vienna Agreement and its implementation in January 2016 raised hopes in Iran that there would be an immediate influx of foreign investment which, along with higher oil revenues following the lifting of the EU embargo on oil imports, would soon enable it to emerge from economic crisis.

The sanctions were certainly the main reason for the dramatic economic slowdown characterized by negative GDP growth rates before the Vienna talks (2012-2013). The Rouhani government’s negotiations with the six world powers alone helped to reverse this trend, convincing all Iranian political forces, including conservatives, to accept further negotiations and rather stringent restrictions on the Iranian nuclear program.

Numerous foreign companies that had withdrawn from Iran during sanctions responded by signaling their interest in returning to Iran and making badly needed investments.

By that time, however, all petroleum producers felt the pinch of the “oil shocks” (a more than 30-percent drop in oil prices) that occasionally threw both exporters and importers off balance. The dramatic decline in oil prices (by almost 50 percent between June and December 2014 and by more than 50 percent between May 2014 and May 2016) naturally affected how much investment actually flowed to Iran.

The oil and gas industry accounted for the bulk of direct foreign investments even during sanctions (nearly 70 percent of total accumulated foreign investment). The interest in Iranian oil remains (production costs in Iran average $12.6 per barrel and fall below $1 per barrel in some fields) but the price slump means there are fewer places for investment to go. This is why Iran drafted and enacted in 2016 new regulations for foreign investment in the oil and gas industry, which provide for more rights and benefits in production and production-sharing. Iran also needs direct foreign investment in manufacturing industries, particularly export-oriented ones like petrochemistry, car making and iron-and-steel.

Visits to Europe and Asia by high-ranking officials, including President Hassan Rouhani, as well as numerous trips to Iran by representatives of major Western companies, do much to create a favorable psychological climate for greater foreign investment in Iran.

Deals on multi-billion-dollar projects in the most varied areas of the economy have been signed. But they are not contracts. The amount of real direct investments coming into the country is a far cry from what was expected and can hardly be described as an “influx.”

Nevertheless, the new government is trying to create an attractive investment environment. In industry the focus is on private business (even revising some privatization deals), more active attraction of foreign investment, reduction of tariff constraints, relaxation of monetary control, and so on. There are certain results evident even from the indices characterizing the intensity of business activities, legal protection of businesses and their competitiveness. The clearest sign is Iran’s improved rankings on Global Competitiveness Index (it increased from 83 in 2014-2015 to 74 in 2015-2016.

In 2016, Iran restored former levels in oil production (exceeding 4 million barrels per day in the first quarter of 2016) and exports (Iranian oil sold to Europe). Now Iran is ready to negotiate reducing oil production quotas. The growth in production will largely go toward oil refineries and petrochemical plants. Iran is primarily interested in investment in these industries, as is evident from contracts with a number of European and Asian companies for the construction of relevant plants in special industrial zones. Iranian gas is most likely to be used in regional gas projects, such as the Peace pipeline to Pakistan and TANAP and TAP pipelines crossing Turkey to Europe.

An iron-and-steel industry modernization program was launched in 2015, with its steel smelting capacity set to reach 55 million tons by 2025, including 47 million tons by direct reduction. In the auto industry, contracts have been signed with French and Italian companies that are returning to the Iranian market, mostly to work with Iranian giants Iran Khodro and SAIPA.

Iranian economic policy is eyeing a breakthrough in developing and applying advanced technologies. The country will create special industrial areas and industrial parks focusing on aerospace, information, communications, nuclear, oil-and-gas, nano- and micro technologies. There are plans to invite medium and small businesses to participate. By 2025, the share of hi-tech products is likely to reach 50 percent of the GDP. But again domestic and foreign investment is a priority.

The government is seeking to modify its tax policy and increase budget revenues through taxation. So far, however, oil revenues are still the main source of government earnings. The economic situation in the country remains complicated because reserves are being depleted both in the Oil Stabilization Fund and National Development Fund, which are replenished from oil revenues (anything in excess of the budget price of $40 per barrel in 2016) and which both invest in major projects. Pursuing social policy on a grand scale is difficult even with the help of Islamic funds and charities. While in 2014-2015 GDP grew somewhat after years of stagnation, it is most likely simply to retain this positive trend in 2016, if not rising above 4 percent.

Apart from current oil prices, economic growth and investment is hampered by persisting US sanctions, because the United States has only lifted the nuclear-related sanctions. Hopes for rapid economic progress after the signing of the Vienna Agreement in July 2015 have not fully materialized. The Rouhani government is increasingly criticized by the supporters of the former president. This is also a brake on the investment process.

Nevertheless, a lot can be said for the positive shifts in the economy after the lifting of sanctions stipulated by the UN Security Council resolutions, removal of the EU embargo on Iranian oil purchases and particularly the reinstatement of Iranian banks in SWIFT. Iran’s objective need for closer contacts with the world market and the world market’s interest in Iranian energy, Iran’s transit potential and vast domestic market suggest that the trend toward less confrontation between Iran and the leading world countries, including Russia, will continue for the long term.

Nina Mamedova is Chair of the Iran Section, Institute of Oriental Studies of the Russian Academy of Sciences, Associate Professor at the Department of World Economy, MGIMO University.

Source: Valdai Club Foundation

* These views represent those of the author and are not necessarily Iran Review's viewpoints.

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