Djavad Salehi-Isfahani, Philip Nichols and Nicholas Gilani discuss Iran's prospects for foreign investment.
The lifting of international economic sanctions against Iran on January 16 potentially opens up attractive big opportunities for foreign investors and businesses looking for a new emerging-economy market with a large middle-class population. The deal allows Iran to resume oil exports and recover assets that were frozen during the sanctions, estimated at between $30 billion and $100 billion. In addition, Iran offers opportunities in the automotive, tourism and financial services industries, among others, according to exports.
However, Iran’s attempts to rejoin the world economy could be thwarted by religious conservatives including the Iranian Revolutionary Guards, which is averse to foreign investment, experts cautioned. Countries like Saudi Arabia, which has had frosty relations with Iran, could also interfere, they said. Further, Iran is strapped for cash, with its banking industry nursing significant bad debts and its government coffers dry, which means the country must attract foreign direct investment to finance economic growth.
“The private sector [in Iran] may have all these nice prospects with the opening up for the global economy, but with real interest rates upwards of 5%, and 10% for some businesses, it is difficult for them to borrow and to expand their businesses,” said Djavad Salehi-Isfahani, economics professor at Virginia Tech University. “That is where the economy is stuck. They need to fix that before they move forward.”
Wharton professor of legal studies and business ethics Philip Nichols cautioned against looking at the Iranian economy like one would evaluate any other country. “This is an economy where 20% of the GDP is in the hands of structured, religious body,” he said, explaining that much of the economy is state-controlled, either officially or through the Revolutionary Guards. “It’s not an economy that you can just flip a switch, fix a couple of fiscal issues and the economy is up and running. This is an economy that is going to take maybe decades to normalize and fit into the global economy.”
The reaction within Iran to the lifting of the sanctions is “overwhelmingly positive,” according to Nicholas Gilani, co-founder and senior partner at Arjan Capital, an investment and advisory firm that helps global investors contemplating entering the Iranian market. He said that while foreign business delegations have already begun arriving and negotiating deals, financing remains a hurdle. “The focus of the economy, at least in the short run, is cash, cash, cash, [and] liquidity, liquidity, liquidity,” outside of the oil industry, he said. “The country is not insolvent, but it has thousands of incomplete projects and the banking sector is in a state of deep trauma. The economy needs liquidity and the opportunity is wide open for foreign investment Twitter .”
“With real interest rates upwards of 5%, and 10% for some businesses, it is difficult for them to borrow and to expand their businesses.”–Djavad Salehi-Isfahani
Salehi-Isfahani, Nichols and Gilani discussed the opportunities and challenges for Iran’s economy on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
The U.S. had imposed sanctions against Iran after the Iranian Revolution of 1979, tightening them progressively over the years as the country went ahead with its uranium enrichment program. U.N. sanctions came in 2006 over those nuclear ambitions. The lifting of most of the sanctions came about after an agreement in April 2015, under which Iran agreed to fulfill conditions, including dismantling centrifuges.
Although the International Atomic Energy Agency has verified that Iran has completed the necessary steps, the country must continue compliance under strict international vigil. If Iran were to violate any of the conditions of the so-called Iran Deal, the U.S. could snap back U.N. sanctions on the country on its own, and cannot be prevented from doing so by another member of the U.N. Security Council, including Russia and China.
Opportunities Beckon
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According to Salehi-Isfahani, outside of the oil industry, Iran could focus on promoting tourism with its “first-class historical sites” and recharging its automobile industry to recapture markets in neighboring countries. He said Iran’s auto industry is its largest manufacturing segment that at one time produced 1.6 million cars annually (that has since fallen to around one million cars) and employs directly or indirectly about a million people.
“[With] the right macroeconomic management and the right exchange rate, Iran could get back to 1.5 million cars a year” and reclaim its spot among the global top 10 in the number of cars produced, said Salehi-Isfahani. He noted some traction on that front with Mercedes-Benz parent company Daimler recently announcing that it would invest in Iran to make cars and trucks.
Gilani, who spoke from Tehran, saw optimism all around. “No more hotel rooms [are] available,” he said. “Foreign delegations from Germany, Switzerland [and] Japan — everybody is in town. Everybody is busy trying to do deals here. Boeing and Airbus are busy negotiating.” He said Iran is witnessing these “exciting times” when the Gulf Cooperation Council (GCC) countries are facing “a major recession.”
Obstacles En Route
In order to take advantage of its new opportunities, Iran needs to dismantle bottlenecks that were created after its economy began to decline as a consequence of the sanctions, said Salehi-Isfahani. “The biggest problem is the banking system,” he added. “Iran had, like several other oil exporting countries, a real estate boom. It borrowed money from banks and put it in real estate. All those loans have gone bad. Banks are stuck with toxic assets they cannot unload and cannot lend to the private sector.”
“It’s not an economy that you can just flip a switch, fix a couple of fiscal issues and the economy is up and running.”–Philip Nichols
Gilani recalled that in the regime of Mahmoud Ahmadinejad, who was Iran’s president from 2005 to 2013, banks were forced to lend to unprofitable projects, and they also invested speculatively in real estate. “I don’t have much hope for Iranian banks,” he said, explaining that they are unable to comply with the Basel norms on capital adequacy.
However, Gilani said the difficulties faced by Iranian banks opens opportunities for foreign banks to invest in the country. “[It is a] perfect opportunity for major European banks and others to set up banks with clean balance sheets,” he added. He said that Iranian President Hassan Rouhani recently told businesses at a meeting that “the government is sick and tired of being a big player in business and commerce.” He said Rouhani encouraged the private sector to “take charge,” adding that his government preferred to be “just regulators.”
The Other Establishment
Nichols said he did not want to discourage investors from heading to Iran. “[However,] coordinating reform efforts in Iran – economic, political or social — presents complex and difficult problems,” in an economy where large portions are controlled by the religious establishment, he added. “We haven’t seen that coordination yet, particularly in the economic sphere.”
“Part of the problem is that foreign investment draws the ire of the religious conservative establishment that doesn’t like to see too many foreigners,” said Salehi-Isfahani. Those sentiments could even hurt prospects for tourism, he added. He was therefore cautiously optimistic about FDI prospects for Iran.
Gilani said the Iranian government realizes that it “cannot do anything” without FDI and the private sector’s participation in growing the economy. The quasi-state actors and the religious establishment that control large chunks of the economy would also come to accept those realities, he added. “Under the gravitational forces that are at play right now, they will sooner or later come to their senses. But I would not be too much worried about it.”
The Saudi Factor
Nichols pointed to other obstacles Iran faces, such as Saudi Arabia’s likely disenchantment over the sanctions being lifted. He noted that tensions between Saudi Arabia and Iran have escalated in recent months. “Saudi Arabia has long been a strong ally of the U.S. and doesn’t get along with Iran, to put it mildly,” he said. “The U.S. very much wants Iran’s help with Syria and the Islamic State. [It is] difficult to predict how this will all play out … particularly with the ebbing of strength of some of these countries with the diminishing price of oil.”
Salehi-Isfahani said that in the long run, Iran could prove to be “a better partner for the U.S. than Saudi Arabia.” He explained that while Iran is “determined to fight ISIS and Sunni extremism … Saudi Arabia is ambivalent about that.” Iran also has a large middle class that is pro-West, even if that may not exactly mean pro-U.S., and is looking for stable global economic relationships and peaceful trade, he added.
Nichols said he would be cautious with that logic. “Iran … has a strong culture that is thousands of years old and has good reason not to trust the U.S.,” he said. “The Iranian people are looking for a different path that isn’t necessarily in the warm embrace of just the U.S.”
“The economy needs liquidity and the opportunity is wide open for foreign investment.”–Nicholas Gilani
Watchwords
Nichols said there was similar enthusiasm about opportunities in Russia after the Soviet Union collapsed in 1991. “Hotels in Moscow were full to the brim, everybody was talking to everybody and ownership laws were wide open,” he recalled. “Twenty years, later we are still trying to untangle how to effectively long term invest in Russia.” Another vulnerability foreign investors in Iran would have to factor in is the potential for a snap-back of the sanctions if the country violates the terms of the deal. A snap-back would result in “an immediate cessation of the ability to have relationships with financial institutions,” he said.
Salehi-Isfahani said much will depend on the outcome of parliamentary elections in Iran in February. “The February election is crucial to see if moderation will penetrate deeper into the Iranian political structure than just the government,” he added. Gilani said the Rouhani regime will not risk its own survival by allowing the economy to return to the state it was in during Ahmadinejad’s administration. “They don’t want to make any more mistakes again and they just want to move and rejoin the world community.”
Source: http://knowledge.wharton.upenn.edu/article/nichols-isfahani-iran/
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