Coface Iran Outlook: Sharp Turn Ahead, Drive Carefully
After five years of sanctions, Iran is finally rejoining the global community. While this return should have an effect on international growth via the oil channel, it will also bring huge changes to the county itself, according to Coface’s Iran Panorama report.
The lifting of sanctions following the P5+1 agreement will have a significant effect on raising Iran’s output, reviving the economy through the recovery of foreign trade and investment. But the move from isolation to openness is tricky to manage and Iran faces a number of challenges.
Iran is the second largest economy in the Middle East and North Africa (MENA) region with a GDP of $416.5 billion. After two years of recession, Coface expects real GDP growth to hit 3.8 percent this year, following the lifting of sanctions. Post sanctions, Iranian government authorities expect to attract foreign investment of at least $50 billion a year. This amount is far above the $2.1 billion of foreign direct investment that the country attracted in 2014.
“Key sectors that should lead the economy’s recovery in the post-sanctions period include transportation, housing and urban development,” commented Seltem Iyigun, Economist for the MENA and Turkey Region at Coface. “Besides these industries and the predominant oil and gas sector, the country has opportunities in almost every industry.”
In the short term, Iran’s return to global trade should be gradual, the Coface report said. The country is relatively closed and the authorities will favor a gradual opening of tariff and non-tariff barriers. Weaknesses in the banking sector will also limit export growth.
“Imports valued at over $50,000 are subject to a pre-shipment quantity and quality inspection,” said Sofia Tozy, Coface Middle East Economist. “In addition to the policies on tariffs, regulatory constraints and bureaucratic inflexibility are likely to hamper trade growth in the short term.”
The sudden shock of trade openness may likewise have an adverse effect on the country’s exchange rate. An appreciation of the real exchange rate would be detrimental to local businesses.
The shaky global environment and Iran’s structural problems may also delay any expected gains, said the report. Sluggish world trade and regional turmoil are likely to dampen the initial positive impacts from the lifting of sanctions and the reduction in trade costs.
The Iranian economy is heavily dependent on the oil sector to boost its domestic economy. The fall in revenues from low oil prices could constrain public investment and the government’s policy support for post-sanction growth. Finally, Iran’s weak infrastructure and fragile banking sector will continue to hamper long-term growth prospects.
With regard to industry sectors, Coface has highlighted two sectors that are good illustrations of both the untapped economic opportunities and the challenges faced by Iran on entering the market.
Energy: The lifting of sanctions should lead to an increase in production, but this could be constrained by the poor prospects of the oil market. According to the International Energy Agency, Iran’s crude oil production, which averaged 2.8 million barrels per day in 2015, is forecast to average over 3.1 million barrels per day in 2016 and almost 3.6 in 2017.
“The gradual opening of the country should also encourage investment into the oil sector,” said Tozy. “With the proper investments, Iran could eventually reach a production of four million barrels per day. However, infrastructure upgrades will be costly and Iran’s entry into the global market may further accentuate the imbalance between supply and demand.
Automotive: The automotive industry, which accounts for more than 10 percent of Iran’s GDP, will be one of the biggest beneficiaries from the lifting of sanctions. Iranian consumers are hungry for international brands and the removal of sanctions will provide further opportunity for western car producers to enter the market. However, this influx of foreign car manufacturers will create tough competition.
“The arrival of new brands could make it difficult for the companies already present to maintain their market share,” said Iyigun. “This could be the case for Chinese producers if European car makers manage to provide vehicles to the market that are cheaper and of higher quality.”