Iran: Lifting sanctions is only the first step on a long journey to recovery

For Asia 2025, the Asia House publication launched on March 8, 2016, Vahid Alaghband wrote a piece titled Iran: lifting sanctions is only the first step on a long journey to recovery. Please read the full piece below. 

The recent agreement between Iran and the P5+1 (the US, Russia, China, France, Britain and Germany) provides a roadmap for lifting the draconian economic sanctions on Iran. The question as to whether it is a good deal or a bad deal is largely irrelevant. By definition, compromises do not deliver the optimum; second best will have to do if there is to be a deal.

As imperfect as this deal is, it sets a benchmark in the conduct of diplomacy and wise management of international relations. That is how the deal will be viewed with a historical perspective. More importantly, its successful implementation will reduce the risk of nuclear proliferation in the Middle East, impacting positively upon the future of Iran, and, with that, the future of energy security in the Persian Gulf.

As a result of the implementation of the agreement, with the exception of some remaining restrictions on US corporations and individuals, almost all sanctions will be lifted by mid-2016, enabling Iran to begin the process of reintegrating into the global economy.

The remaining US restrictions may add a degree of complication for financial institutions that have to ensure that Iran-related payments do not clear through the US banking system and avoid transactions with entities that have been flagged by the US Treasury. In spite of this, the deal largely permits the reopening of trade with Iran and, barring unforeseen circumstances, Iran can be expected to be transacting normally with most of the rest of the world before the end of 2016.

Will the lifting of sanctions enable Iran to achieve its significant economic potential? Considering Iran’s world-class assets and large population base, how significant a trading and investment opportunity would that prospect procure for the rest of the world?

Iran holds the world’s fourth-largest oil reserves and its second-largest gas reserves. With a GDP of US$1.4 trillion, adjusted for purchasing power parity, Iran is the world’s 18^th largest economy according to the International Monetary Fund’s 2015 World Economic Outlook. Even after years of being subjected to economic mismanagement and sanctions, Iran’s GDP per capita of US$17,000 makes its citizens wealthier than their peers in China and Brazil.

Contrary to popular belief, Iran is not an oil and gas economy: 50 per cent of the Iranian GDP derives from services; 40 per cent from industry (of which only 20 per cent is oil, gas and petrochemicals) and the remaining 10 per cent is mostly agriculture. Some 83 per cent of the population lives in urban centres and, at its peak, Iran’s automotive sector produced 1.65 million cars – more than Britain produces.

With a population of 80 million, the same as that of Turkey, Germany and Egypt, the Iranian consumer presents a significant market to multinational corporations, financial market operators and emerging market investors. The population is young: 65 per cent of Iranians are under the age of 35 and need everything from credit cards and houses to retail and travel services. They are educated and many speak a degree of English. That enables them to surf the net and be connected through social media. 4G and smart-phones are widely available and are heavily used. Iranians like to communicate: they produce more blogs each year than any other country in the world bar the US.

Human capital, not the extractive industries as is commonly assumed, is Iran’s most promising long-term enabler of economic growth. Iran has a staggering 4.4 million university students, 60 per cent of whom are women. More than 40 per cent of those students are enrolled in engineering, sciences, mathematics, and technology. Together with the US, Russia, China and India, Iran belongs to the top-five league of engineering graduates worldwide.

The cocktail of world-scale natural resources, a diversified and relatively advanced economy, reasonable infrastructure, favourable demographics and rich human capital suggests that there is a convincing case for a post-sanctions economic boom.

This explains why, ever since the nuclear agreement was reached, flights into Tehran are booked solid by businessmen and no hotel rooms can be found in popular urban and industrial centres in the country.

Yet this cocktail has failed to deliver prosperity over the past 10 years despite record oil revenues of US$900 billion, most of which was one way or the other accessible by the government of the day.

Unemployment among qualified university graduates exceeds 25 per cent, some say it is as high as 40 per cent – and, as a result, the country suffers from significant brain drain, especially among its best engineers and scientists. Hundreds of projects of national significance remain partially finished or are mothballed due to government funding shortages. The banking system is paralysed with record levels of non-performing debt. The local press is full of stories of economic incompetence, corruption and graft.

There is a myth that sanctions were the cause of the disastrous state of the Iranian economy. The myth argues that once sanctions were lifted, the economy would recover, create jobs and grow.

There is a second myth that the recovery will be kick-started by a windfall of US$150 billion in funds that are blocked and that these will make their way into the economy as soon as the sanctions are lifted.

Alas, both are just myths.

Sanctions have obviously not helped and, in some instances such as depriving the oil industry of foreign investment, they have hurt. However, Iran’s economic failure owes much more to the combination of failed and fanciful economic policy, a reckless regime of unaffordable energy and food subsidies, the wholesale nationalisation of industry at the outset of the revolution, and the half-hearted and mostly corrupt attempts at subsequent privatisations. There is a lack of accountability by state and quasi-state entities, which operate in strategic sectors of the economy, act outside the remit of the law, and pay no tax. Institutionalised corruption, now especially endemic in the judicial branch of the government, makes a mockery of the assumed fairness of the legal process and a fair playing ground, both of which are mandatory for attracting foreign investment.

As to the second myth, the reality is that much of Iran’s blocked funds are already committed to existing transactions, mainly with China and other Asian counterparts that continued to transact with Iran during the sanctions. A more reliable estimate of the freed funds is US$50 billion, a figure mentioned by the Central Bank of Iran officials. Iran, of course, will not spend all of its freed reserves in one go. Therefore, a better estimate of what can become available for investment is US$25 billion. This is significant but nowhere near the US$1 trillion that Iran says it needs in order to invest in its economy over the next decade.

The Rouhani cabinet economics team are experienced technocrats and realists. They have inherited an economy devastated by years of mismanagement and adventurism, especially during the disastrous presidency of Ahmadinejad. The low oil price, a significant contributor to the government budget, has further reduced their room for action.

The cabinet knows full well that the lifting of sanctions will neither kick-start the economy nor, short of drastic economic reform and attraction of foreign investment, allow the economy to achieve sustainable growth and reach its potential.

They also know that the domestic savings rate is too low to fuel sufficient levels of domestic investment. That is why, despite political reservations by Iran’s hardliners, the cabinet is now actively reaching out to Iran’s old partners and encouraging them to bring their capital and technology to the country.

Some multinationals have already responded positively. Renault and Peugeot, historically Iran’s two largest automotive counterparts, have offered to invest hundreds of millions of euros. Japan Tobacco, also a long term player in Iran, announced the acquisition of a major Iranian cigarette producer in October 2015. Danone and Nestlé are already producing in Iran and Accor recently opened its first hotel near Tehran’s international airport.

However, the government is only one component of the state in Iran and faces a fierce, uphill battle with other powerful institutions of the state that have been the prime beneficiaries of the sanctions regime. Success cannot be taken for granted.

Even if the Rouhani Cabinet and its allies win the battle, they will have to work hard to achieve the conditions necessary for the attraction of desirable levels of foreign investment.

Their starting point is low indeed: the World Bank’s Ease of Doing Business Index for 2015 ranks Iran 130 among 189 countries. Property Rights Alliance, a US-based advocacy group, ranks Iran 111^th out of 131 countries for respecting property rights. Transparency International’s 2014 Corruption Perceptions Index ranked Iran 136^th out of 174. The World Economic Forum’s latest Global Competitiveness Index ranks Iran 83^rd out of 144 countries, specifying particular weaknesses in financial markets development, labour market efficiency, institutions and rule of law.

Sanctions relief is therefore only one step forward on the long road to the sustainable economic recovery of Iran. It is a necessary, rather than sufficient, condition for the country to start the journey.

The best ally of the reform movement is the dynamic of Iran’s demographics. The vast majority of Iranians, especially the young and educated, most particularly the women among them, demand change. They will be patient but relentless, because at stake is their wellbeing and the wellbeing of their children. The power of the dynamic of the demography is what will define the future course of Iran.

The Iran that will emerge in 2025 will be seasoned, rational and integrated in the global economy. It will be driven by a whole new generation of younger leaders whose core objective will be to deliver to the Iranian people the economic prosperity that they deserve. In time the cocktail will work, but progress will be slow and painful.

The trade and investment proposition in Iran is therefore long term and strategic. Adventurers and short-term enthusiasts should tread cautiously.

Vahid Alaghband is the Chairman of Balli Holdings Limited.

He is Founder and Chairman of the Balli group of companies which own and operate businesses in the industrial, mining and services sectors. He Chairs the Iran Heritage Foundation, a non-political UK registered charity with the mission to promote and preserve the history, languages and cultures of Iran and the Persianate world.  

Balli Holdings Limited is a member of the Asia House Chairman’s circle. Vahid Alaghband is the Vice Chairman of Asia House.

For further information on Asia 2025, or if you are interested in working with Asia House on a future publication, please click here or email Samantha Deave at samantha.deave@asiahouse.co.uk.