In a low interest world hot for yield and desperate for the next big thing, Iran would seem to have it all. Solid rate of growth? Yes. Ample reserves of a high-value commodity? Oil — yes. Large, educated populace, keen to earn and build a better future? Yes, yes, yes.
Any casual observer leafing through the business pages of the world’s media over the past 18 months would be forgiven for assuming that Iran’s long term economic and financial success was a done deal. The July 2015 Joint Comprehensive Plan of Action, in which the five permanent members of the UN Security Council plus the European Union agreed to eliminate sanctions on Iran in exchange for the country destroying its stockpile of medium enriched uranium, fomented much hope in the country’s future — and an awful lot of hype.
Some of this was well directed. Despite being pinioned by US-led sanctions for the past 37 years, the Islamic Republic of Iran boasts the world’s 18th largest economy (in nominal terms) and the 26th largest in terms of its relative purchasing power. The United Nations reckons it to be the world’s 26th largest consumer market thanks largely to the youthful nation’s obsession with spending. “Iran is a very significant market with a highly diversified economy and a large and well educated populace,” notes Charles Robertson, global chief economist at investment bank Renaissance Capital. “It ticks a lot of the boxes that usually attract investors.”
Since the 2015 nuclear agreement, which remains on track, investors and corporates have swarmed to the Persian Gulf to view the country’s potential first hand. Sometimes that results in more than mere glad handing. In January, Iran placed a $27bn order for 118 Airbus planes, later reduced to 112. Boeing is hoping to sell a fleet of jetliners to state-run Iran Air. Renault, which has run a joint venture with the government-owned IDRO Group since 2004, has pledged to double capacity and market share. In June another French carmaker, PSA Group, said it would revive a long-dormant alliance with another local automaker, Iran Khodro, investing €400m ($450m) and aiming to produce 200,000 vehicles a year by 2018. Another French giant, Orange, is in talks to form a joint venture with Mobile Telecommunication Company of Iran.
Yet as is so often the case when it comes to the hype surrounding recently opened or rapidly growing frontier markets, reality has struggled to keep pace with promise. In Iran’s case, it faces a host of problems, some interconnected and localised, others entirely unrelated and formed far from the country’s shores.
One is the sheer weight of positive publicity that Iran’s opening up has garnered. It is easy, when thinking of its potential in the abstract, to forget just how far this nation had slipped behind — and how much catching up it has to do. “There was a buzz around Iran in the wake of the nuclear agreements,” notes Ramin Rabii, chief executive officer of Iranian investment firm Turquoise Partners Group. “That has calmed down a great deal. It will take longer for Iran to open up and realise its potential than was originally assumed. It won’t be quick.”
Foreign equity investors have been quite slow to put their money to work onshore. Tehran Stock Exchange’s (TSE) main index, TEDPIX, has had a solid year, rising 24% in value through to September 19. But this has been driven, Turquoise Partners noted in its August 2016 Iran investment report, by “falling interest rates rather than the effect of foreign portfolio inflows”.
At the start of the year, RenCap’s Robertson tipped foreign institutional investors to pump $1bn into locally listed securities during the course of 2016. He now says: “I’d be surprised if the total amount was even $100m. I didn’t expect it to be such a challenge. I assumed foreign investors would be more comfortable” trading in Tehran. The TSE is reckoned to contain 50 sanctions-compliant stocks that are “safe” investment targets for foreign funds.
SANCTIONS STILL HURT
Analysts say what Iran lacks is the comforting presence of a major global custodian bank capable of calmly settling billion dollar trades. There is no State Street or JP Morgan operating in Tehran, no Citi or HSBC — nor is there likely to be so long as US financial sanctions remain in place.
US banks remain outlawed from doing business in the country while European lenders are prohibited from completing dollar transactions processed through the US financial system. “As a consequence, fund managers are saying it is too complicated for them to buy into the market,” notes RenCap’s Robertson. There are two ways to invest in onshore equities: via a local fund or using a Tehran-based broker and a foreign trading and investment code secured from the Securities and Exchange Organisation.
Then there is the lack of interest in Iranian stocks even among adventurous fund managers, who, while desperate for yield, are happy to find it in other, more accessible and better regulated emerging and frontier markets, from Mexico to Russia and Colombia to India. Yields on local bonds may be nudging the 25% mark while the simple process of depositing funds in a local bank account can generate real returns of 20%.
But that does not make the process of getting money into and out of the country any easier. All share trading has to be settled by the Central Securities of Depositary of Iran, a system that is, notes one local investor, “fraught with risk”. And no one wants to be accused by The US, at this stage of the opening-up process, of breaching sanctions and slapped with a hefty fine. Little wonder even frontier investors have decided for the time being, to give Iran a wide berth.
The problem of the country’s lack of financial infrastructure doesn’t stop there. Iran’s banking sector is in a terrible state. Failed or soured loans account for 15% of total bank lending, according to figures from Fitch Ratings, far above the international average of around 4%. In March 2016, the financial authorities unveiled a raft of proposals to strengthen the financial sector ranging from plans to launch a maiden sovereign Eurobond to the launch of a bad bankdesigned to sluice a huge backlog of toxic loans out of the system.
Again, many of these problems are a net result of the grinding effect of sanctions. There are a few well run local lenders — Tehran-based Middle East Bank is one. But too many have spent recent years extending loans to companies run by individuals with impeccable connections but little financial acumen or willingness to meet their financial obligations.
Analysts say change can and will only come from outside, in the shape of more foreign lenders setting up shop in Tehran and second-tier cities and providing a more worldly financial education to local banks and bankers. A few foreign and semi-foreign lenders already have onshore operations including Hamburg-based Europäisch-Iranische Handelsbank, Germany’s DZ Bank, Belgium’s KBC and Geneva-based Hinduja Bank (Switzerland). Austria’s Erste Bank is also preparing to set up a representative office.
But most of these are either small private banks or smaller European lenders offering a simple, bare bones set of services such as letters of credit. “These are tiny, small banks,” notes Turquoise Partners’ Rabii. “We need large global banks to come back into the country. Only then will we see large flows of capital entering and leaving the country. That will happen but not for another two to three years. Until then Iran will struggle to have ‘normal’ banking relations with the outside world.”
There is much to admire about Iran — and many reasons to believe in its future. The World Bank expects economic output to expand by 4.2% in 2016 and 4.7% in 2017. Middle East Bank CEO Parviz Aghili tips the growth rate to average out at “somewhere between 5% and 8% over the next 10 years. If China managed to have 25 years of double digit growth, there is no good reason why Iran should not have a similar growth rate.” Much of this additional growth will stem from the natural resources sector space: Iran boasts the world’s fourth largest proven stocks of oil, at 157.8bn barrels, according to the CIA World Factbook.
And as sanctions ease, domestic capital markets should broaden and deepen. Investors hope to see a host of industries ranging from petrochemicals to cement to mobile telecommunications liberalised and deregulated, creating a slew of listings by increasingly powerful corporate vehicles. A good start, bankers say, would be the break-up and listing of the sprawling state-run concern Persian Gulf Petrochemical Industries.
In an ideal world, this would help Tehran Stock Market become one of the region’s more influential bourses. “I believe it will be the best performing stock market over the next five to 10 years,” says Turquoise Partners’ Rabii. “The quality of listed companies on the bourse will continue to improve. As sanctions ease, the price earnings ratios will rise from seven times forward earnings at present to 11 or 12. Stock values will rise, dragging in more foreign investment.” In time, investors say, Iran’s leading corporates will eye dual listings in cities ranging from New York to Shanghai via London, Dubai and Hong Kong.
FRIENDS REUNITED
One final question: who are Iran’s sovereign friends now and down the line? Through the sanctions era, Tehran’s hardliners have made much of their enmity with the US and UK, yet less clear is whom they like and admire. So convoluted and conflicted are Iran’s relations with the wider world that its leaders, from the clerics to president Hassan Rouhani on down, may not know.
Many of Iran’s strongest ties are with European nations including France, Germany, Switzerland and Italy — the latter a constant voice urging mediation with the country even during the wilderness years. Closer to home, there are Iraq, Turkey and the United Arab Emirates, each crucial in its own way to Iran’s hopes of becoming a major regional export and trading hub.
Elsewhere, the picture becomes more blurred. Iran may rail against the Anglophone reaches of the West but it needs Britain and America onside for a host of reasons, from financial to commercial to political. Then there’s the world’s rising economic giant, China. The Asian country, says Middle East Bank’s Aghili, “is ahead of everyone else” but only because Chinese businessmen “took advantage of their monopolistic position in the recent past and badly treated their Iranian counterparts. Now they are concerned that they may lose the market and have become over aggressive.” Adds Rabii at Turquoise Partners: “The Chinese tried to take advantage of Iran during the difficult times and that left a bitter taste in our mouths. The perception of China among Iranian businessmen is not positive.”