MACRO ADVISORY: Can new political allies help revive Iran’s old economy?

MACRO ADVISORY: Can new political allies help revive Iran’s old economy?
Iran is emerging from international isolation with agreements to join important geopolitical and trade organisations. / bne IntelliNews
By Chris Weafer CEO of Macro-Advisory September 22, 2023

Iran is emerging from international isolation, not with former partners in Western nations but with countries in the Eurasia region, Asia, other Middle Eastern states, and Africa. Over the past year, Iran has joined, or has secured an agreement to join, several important geopolitical and trade organisations which will help it expand trade and investment cooperation and allow it to have a voice in issues of importance to the Republic:

  • Iran officially became a full member of the Shanghai Cooperation Organization (SCO) during a virtual summit hosted by India on July 4 this year.
  • Iran is nearing the end of a formal free trade agreement with the Eurasian Economic Union (EEU) and a deal is said to be within reach by the end of 2023. A temporary deal, which allows 80% of existing trade to be free of tariffs, is in place.
  • Iran will join BRICS+ from January 1 – a major event for the country as it tries to lessen the impact of sanctions and expand diplomatic relations. 
  • On March 10 Iran and Saudi Arabia announced the normalization of political ties in a deal brokered by China, ending years of tensions between the two and re-establishing diplomatic relations that were broken eight years previously.
  • Most recently, President Raisi has extended an invitation to the President of the UAE to visit Iran to talk about investment and trade cooperation as well as areas of mutual political interest.

These new political ties are expected to result in more bilateral trade volumes and co-investment opportunities. However, the latter will continue to move slowly so long as the US threatens secondary sanctions on those violating the existing sanctions regime.

Relations with the West remain as cold as ever although at least the rhetoric between Tehran and Washington is calmer than it used to be, as Washington and Tehran moved towards the recent exchange of prisoners and has been easing back on actions to enforce the ban on Iranian oil exports.

Russia has significantly increased political engagement with Iran and both sides have said they are working on a comprehensive agreement aimed at expanding bilateral trade and investment. The auto-manufacturing sector is one area of growing cooperation and some deals have been made in the oil and gas sector, although a long way short of the $30bn worth of projects agreed over 12 months ago.

Iran is a very strategic location when it comes to the rapidly expanding cargo routes in and around Central Asia and the Caspian. China, Uzbekistan, and others are planning to use Bandar Abbas or Chabahar port to access the Indian Ocean. Currently, these routes must go by Turkmenistan, but the hope is to get safe access across Afghanistan. However, the major new route is the International North-South Transport Corridor (INSTC) which links Russia with India, via Chabahar and a ferry link to Mumbai. This route also allows Iran much greater access to India and both Russia and the other transit countries.

But, despite the recent apparent easing of rhetoric there is almost no hope that the Joint Comprehensive Plan of Action (JCPOA) deal can be revived, especially ahead of the US Presidential election in November 2024. Iran has reportedly raised enrichment to 60% and officials made clear there is no going back on this program. The UK, France, and Germany said they will maintain the weapons embargo against Iran after the international ban ends in mid-October.

That said, there appears to be some willingness to try and secure a new agreement. President Raisi and Supreme Leader Khamenei have said they hope some format of a new deal can be agreed with the JCPOA partners which would accept the current reality of the enrichment process and allow some sanctions easing. Contacts between Iran and the International Atomic Agency have improved. The fact the US has eased back on its previous tight enforcement of sanctions against oil exports may indicate some opportunity for progress, even without a return to the previous JCPOA agreement.

The economy is now more stable, the “street-exchange rate” is more stable, and inflation, although still close to 40% y/y, is slowly declining from the peak of over 50% at the end of the Persian year (March 20). The Central Bank is much more proactively taking action to curb currency speculation and illegal currency movements. Export receipts are rising steadily and helping to fund other economic programs. Oil exports reached almost 1.9mn barrels per day in August and the value of petrochemical exports continues to rise steadily. President Raisi recently inaugurated phase 11 of the Iranian side of giant Pars gas field (which it shares with Qatar) which will allow the country to eventually build LNG export infrastructure.

In contrast to the optimism about Iran’s new geopolitical engagements and trade expansion, the government’s suppression of political and social freedoms is as bad as ever – if anything, much worse. The state has much greater control over the internet and has taken a hard line against any official or educator they suspect of having sympathy for the protestors. This will make it difficult for most international investors to engage with the current regime, even if sanctions risk were to moderate or decline.

The other major domestic threat to economic revival is from the shrinking water supply because of a combination of 1) several straight years of drought, 2) the damage caused by dam construction, and  3) restrictions on water supply from the Helmand River caused by actions taken in Afghanistan. 

A shortage of drinking water has already led to fatal clashes in some provinces. Agriculture output has also been affected. In May this year, several soldiers were killed in a clash over the Helmand River with the Taliban. These incidents are expected to get worse and more frequent as the water crisis seems inevitably to worsen.

Are There Investment Opportunities? Most major companies and investors (including those from countries not applying Western sanctions) are avoiding Iran for fear of secondary sanctions risk. The question is whether companies from these countries now improving political ties with Iran – such as Russia and others in BRICS - will start to engage more directly with Iran. Russian and Chinese companies are starting to appear in Iran (autos, aircraft, and energy for the former and chemicals for the latter).

If / when sanctions risk eases, the major areas of interest will be in the gas sector, petrochemicals, transport sectors, machine building, and agriculture. The consumer sector, serving a population of almost 90mn, will also be of interest when the risk of doing business eases. But, until secondary sanctions risk eases, it is more likely that the more obvious investors and partners will come from Russia and China. Others, especially in the expanded BRICS, will be eager to follow.



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