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Country Report

Iran

Generated on November 13th 2017

Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom

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Symbols for tables "0 or 0.0" means nil or negligible;"n/a" means not available; "-" means not applicable Iran 1

Iran

Forecast Highlights

Outlook for 2017-21 3 Political stability 4 Election watch 4 International relations 5 Policy trends 5 Fiscal policy 6 Monetary policy 6 International assumptions 7 Economic growth 8 Inflation 8 Exchange rates 8 External sector 9 Forecast summary

Data and charts 10 Annual data and forecast 11 Quarterly data 12 Monthly data 13 Annual trends charts 14 Monthly trends charts 15 Comparative economic indicators

Summary 15 Basic data 17 Political structure

Recent analysis Politics 19 Forecast updates 21 Analysis Economy 25 Forecast updates 29 Analysis

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 2

Highlights Editor: Robert Powell Forecast Closing Date: February 27, 2017 Outlook for 2017-21 Iranian politics will become increasingly polarised as the president, Hassan Rouhani, seeks to use the 2015 nuclear deal and the strong showing of his supporters in the 2016 legislative election to eclipse the country's hardliners. Despite the new US administration's hostility to the nuclear deal (and intro duction of new sanctions), we expect Iran to remain committed to its terms in order to retain the economic gains of the agreement and to isolate the US. With the economy struggling because of low—albeit recovering—oil prices, the government will seek to take advantage of the lifting of sanctions and attract inward investment, with a focus on the oil and gas sector and infrastructure. We expect Iran's fiscal account to record modest (but widening) deficits in 2017-21 as a ramping-up of capital spending is partly offset by rising oil revenue on the back of higher prices (compared with 2016) and output. Real GDP growth in Iran is set to surpass that in the rest of the Middle East as (non-US) inward investment rises. We expect growth to pick up from an estimated 4.6% in 2016/17 to an annual average of 5.6% in 2017/18-2021/22. We expect the official rial rate to weaken markedly in 2017, in line with the government's plan to merge it with the market rate. But the pace of depreci ation will slow thereafter, with the rial averaging IR48,357:US$1 in 2021. We forecast that the current account will remain in surplus in 2017 21, buttressed by rising oil and non-oil exports, which will partly offset a growing import bill (on the back of pent-up demand and rising investment. Review On February 15th Mr Rouhani visited Oman and Kuwait. Although Iran and the Gulf Co-operation Council have common interests in oil and gas, regional geopolitical disagreements remain stark. On February 21st Russia's first deputy prime minister, Igor Shuvalov, visited Tehran to negotiate a free-trade deal between Iran and the Eurasian Economic Union. His visit came against a backdrop of growing Russian- Iranian bilateral trade, which increased by 60%, to almost US$2bn, in 2016. According to the central bank, the fiscal deficit widened to IR269trn (US$8.7bn) in the first nine months of 2016/17 (March 21st-December 20th). In response, the government has continued to pare back capital spending. A French supermajor, Total, has cautioned that its final investment decision on developing Phase 11 of the South Pars gasfield is dependent on the US administration maintaining its commitment to the JCPOA. Inflation rose to 9.6% year on year in January, led by rising foodstuffs prices, and prompting the government to reduce agricultural import tariffs.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 3 Outlook for 2017-21 Political stability Iranian politics will become increasingly polarised in the lead-up to (and, most likely, in the wake of) the presidential election in May 2017. The president, Hassan Rouhani, will seek to build public support for social and economic reform. In particular, he will attempt to leverage the 2015 Joint Comprehensive Plan of Action (JCPOA)—the international agreement over Iran's nuclear programme—to tackle vested interests, combat corruption and attract much-needed foreign investment. However, his reformist drive and diplomatic outreach will be threatened both by resistance among hardliners in Iran and by the presidency of Donald Trump, whose administration is adopting a far more confrontational approach with Iran than its predecessor. This US stance will encourage Mr Rouhani's opponents in Iran, who fear that the JCPOA might precede broader political change. Amid this in fighting, the position of the supreme leader, Ayatollah Ali Khamenei, will be crucial in maintaining stability. He will seek to strike a balance between the two sides: generally supporting the JCPOA and being non-committal on foreign investment, while maintaining a hostile stance towards social and political reform and the US. However, such an uneasy balance will prove difficult to maintain. In particular, the heightening of confrontational rhetoric between Iran and the US after Mr Trump's inauguration in January—and the subsequent introduction of new US sanctions— will see increased pressure from Iranian hardliners to withdraw from the JCPOA. The Economist Intelligence Unit expects Ayatollah Khamenei to stick with the JCPOA, however, reflecting a desire not to jeopardise rising investment from abroad and a calculation that Iran has an opportunity to divide the US from other world powers (which are likely to remain committed to the agreement). Nevertheless, even assuming a Rouhani victory in the election, the hardliners will continue to interfere in daily decision-making, with, notably, the intrusions of the unelected Guardian Council (a vetting body dominated by hardliners) proving a continual source of irritation for the president and his pro-business cabinet. This situation will be exacerbated by the unpredictable interventions of the Islamic Revolutionary Guards Corps (IRGC) in the country's political and economic spheres, as well as the residual dominance of vested business interests. As a result, political and social reform will be stifled, and economic liberalisation will proceed inconsistently. Amid these political machinations, speculation about the position and future of Ayatollah Khamenei will increase, reflecting his age and the state of his health; the 77 year old underwent prostate cancer surgery in 2014. Against this backdrop, we expect the supreme leader's attention to shift increasingly towards managing his succession. However, the identity of Ayatollah Khamenei's potential successor remains uncertain, with the orientation of the Assembly of Experts, which selects the supreme leader, highly unclear; although reformists performed strongly in the February election, the body subsequently chose a hardliner, Ayatollah Ahmad Jannati (who is also head of the Guardian Council), as its chairman. However, Ayatollah Jannati is too old to be a realistic prospect for supreme leader (he is around 90), and so Ayatollah Khamenei's successor will almost certainly come from the next generation; possible candidates range from hardliners such as Ebrahim Raeisi (aged 55, who heads the powerful Imam Reza Foundation in Mashhad and is an ally of Ayatollah Khamenei) and Ayatollah Mahmoud Hashemi Shahroudi (67, a former chairman of the Assembly of Experts) to centrists such as Mr Rouhani himself (67). Whatever the case, despite the support for the government's diplomatic overtures shown by the electorate in the 2016 parliamentary election, Mr Rouhani will need to bring about an improvement in the economy to cement these gains or he will risk a loss of authority and a hardline revival.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 4 Election watch The next major election will be the presidential election, scheduled for May 2017. With Mr Rouhani confirming in late February his intention to stand, we expect him to win, helped by the popularity of the JCPOA. However, he will be wary of adopting a dovish stance in the face of a more confrontational US administration. He will therefore occasionally adopt hardline positions, as when, in late January, his government barred US citizens (excluding those already holding visas) from entering the country. The Iranian ban was in retaliation for an executive order issued by the US president—subsequently suspended by the US courts—restricting entry to the US by refugees and nationals of seven predominantly Muslim countries (including Iran). Equally importantly, Mr Rouhani will be aware of the apparent failure of the JCPOA thus far to benefit the poorest in society, which will hand hardliners a chance to run on a populist economic platform. Nonetheless, as yet no obvious hardline figure has emerged who could unite the often competing trends within the bloc of "principlists" (hardline conservatives). As a result, it is probable that several hardliners will stand (as happened in the previous election in 2013), splitting the conservative vote and raising the chances of a first- round victory for Mr Rouhani.

International relations Iran's foreign policy priorities will increasingly be focused on cementing the diplomatic gains it achieved after the lifting of nuclear-related sanctions in the face of a more hostile US administration. Notably, the Trump administration imposed new sanctions in February (in retaliation for an Iranian ballistic missile test, which it claimed violated UN resolutions), and vaguely warned the Iranian leadership that it is "on notice". Of arguably more practical importance, however, will be whether the US Treasury continues to grant US firms (and foreign firms with suppliers in the US) approval for doing business in Iran. Nonetheless, we assess that the US would not be able to reimpose the raft of international sanctions in place in 2015—reflecting the opposition of the major powers in Europe and Asia—and Mr Trump will be wary of entirely closing off commercial opportunities for US firms (including an agreed US$16bn sale of Boeing aircraft to Iran Air). Indeed, it was notable that the new sanctions imposed in February were modest in scope, encompassing 12 companies and 13 individuals connected to Iran's ballistic missile programme. As a result, we expect that Mr Rouhani's diplomatic approach and moderate image, combined with Iran's obvious economic appeal, should be sufficient to continue to lure major (albeit primarily non-US) international firms into the country. Iran's political ties with its regional peers will, if anything, be even more strained. Notably, mutual distrust and differing positions on the wars in Yemen and Syria will keep Iranian ties with Saudi Arabia, in particular, frosty, and ensure that both sides remain closely involved in the Syrian and Yemeni conflicts. (Iran recently revealed that it was considering setting up naval bases in both countries.) However, Iran will attempt to leverage its economic appeal to divide the Gulf Co-operation Council, as demonstrated by the visit of Mr Rouhani to Oman and Kuwait on February 15th (with both of which Iran is exploring natural gas supply deals). Meanwhile, a military clash between Israel and Iran over the latter's nuclear programme still looks improbable, but cannot be ruled out in the unlikely event of Iran withdrawing from the JCPOA.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 5 Policy trends With the economy struggling under the burden of low oil prices, the govern ment will seek to take advantage of the lifting of sanctions in attracting increased inward investment, with a focus on the hydrocarbons sector (given its importance to the fiscal and external accounts) and infrastructure. However, such a push will also probably have to be accompanied by revisions to the 2002 Foreign Investment Promotion and Protection Act (including updates to the cumbersome approvals process for investment applications). This overhaul of business regulation has made some progress in the oil sector, via the launch of a new and potentially more rewarding Integrated Petroleum Contract (IPC); 29 international oil companies were pre-qualified for a slew of exploration and development projects under the IPC framework in January. In addition, Iran is seeking to revive build-operate-transfer contracts for infrastructure projects, in order to ease spending pressure on the public finances. However, accommodating the myriad business networks of a range of interest groups, notably the bonyads (politically powerful Islamic "charities" that run large business conglomerates) and the IRGC, will prove difficult. The IRGC's business interests benefited from the absence of international rivals during the sanctions era, and they will seek to undermine the operations of foreign firms. With a raft of unilateral US sanctions also hindering global financial transactions with Iran, we believe that the goal of the sixth five­year plan (2016 21) to attract US$35bn a year of inward investment will prove overoptimistic.

Fiscal policy We expect the fiscal account to return small but widening deficits over the forecast period, initially as a big uptick in oil exports is offset by the redirection of funds into the National Development Fund of Iran (akin to an oil stabilisation fund and not included in our revenue figures) and subsequently as capital spending resumes growth. However, with the government maintaining considerable spending discipline—the proposed budget for fiscal year 2017/18 (March 21st­March 20th) envisages a real spending increase of less than 2%—the deficit should remain relatively modest in 2017/18, at 2.1% of GDP. Although initially on investment (capital spending was almost two-thirds below budget in the first nine months of 2016/17), we expect the focus of spending cuts to steadily shift to the recurrent budget, reflecting ambitious government pledges to overhaul Iran's decrepit infrastructure. With capital spending rising, oil prices stabilising in 2019-20 and oil export volume growth slowing, we expect the deficit to widen slowly, averaging 2.9% of GDP a year in 2018/19 2021/22. In response, the government will seek to strengthen non­oil revenue, including by further raising the sales tax rate, raising duty on cigarettes and other import tariffs on protected industries (including the automotive sector) and attempting the politically tricky task of imposing new taxes on the bonyads. We expect the government to continue to rely mostly on domestic banks in order to finance its fiscal shortfalls, although it will struggle to find domestic buyers for state bonds issued to finance major projects (reflecting tight liquidity in the banking sector). As a result, the government is (optimistically) aiming to raise US$30bn a year in foreign financing, probably mostly in the form of bilateral soft loans.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 6 Monetary policy Bank Markazi (the central bank) will seek to maintain exchange-rate stability and lock in lower inflation. Even with the sharp slowdown in inflation in 2016, which pushed up real interest rates (known locally as "profit rates"), we now expect the central bank to maintain a cautious monetary approach as it seeks to manage any volatility resulting from the planned roll-out of a unified exchange rate in March (to replace the current dual rate, comprising a favourable official rate for public-sector firms and a market rate for everyone else). With inflation also rising in 2017 (and US rates rising), we expect interest rates to remain largely steady. Instead, in order to encourage increased lending to the private sector, we expect the central bank to shift its focus increasingly to banking sector reform. This will primarily be aimed at strengthening bank independence and governance—the urgency of which was highlighted by the recent collapse in the share price of Bank Mellat, after the central bank accused it of producing misleading reports.

International assumptions 2016 2017 2018 2019 2020 2021 Economic growth (%) US GDP 1.6 2.3 2.1 1.1 2.0 2.0 OECD GDP 1.7 1.9 1.7 1.3 1.7 1.8 World GDP 2.2 2.5 2.4 2.1 2.6 2.6 World trade 1.6 2.6 2.7 2.0 2.9 3.1 Inflation indicators (% unless otherwise indicated) US CPI 1.3 2.4 2.1 1.3 1.7 1.9 OECD CPI 1.0 2.2 2.0 1.6 1.8 1.9 Manufactures (measured in US$) -2.0 -0.1 3.0 5.8 3.7 4.4 Oil (Brent; US$/b) 44.0 56.0 60.0 59.9 61.3 64.0 Non-oil commodities (measured in US$) -2.8 7.8 -1.1 -1.1 -1.7 2.3 Financial variables US$ 3-month commercial paper rate (av; %) 0.5 1.0 1.5 0.8 0.2 0.5 Exchange rate IR:US$, official rate (av) 30,915 36,016 38,177 41,613 44,983 48,357 Exchange rate US$:€ (av) 1.11 1.06 1.07 1.11 1.13 1.15

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 7 Economic growth Iranian growth is set to surpass most of the Middle East region during the forecast period, lifted initially by further increases in oil exports and sub sequently by a sharp upturn in inward investment. Notably, in recent months Iranian companies have signed contracts with, among others, India (to develop the strategically important Chabahar port) and China (to upgrade Iran's biggest refinery, at Abadan). Although the victory of Mr Trump could theoretically jeopardise such investment— in February France's Total said that its involvement in Iran would probably cease if the US pulls out of the nuclear deal—we expect that Iran's continued adherence to the JCPOA should keep EU, Russian, Indian and Chinese firms engaged (even if most US firms will be deterred). As a result, we maintain our outlook for a sharp increase in inward investment from 2017/18, notably in the country's infrastructure, providing a host of knock on opportunities for the private sector. The impact of rising investment will be augmented by the continued expansion of the oil and gas sector, although the effect of this increase will be less dramatic than in 2016/17 (when we estimate that oil production rose by 25% following the lifting of sanctions). Investment in Iran's relatively underexploited natural gas reserves could also increase dramatically, and output at the South Pars field is set to rise sharply in 2017 following the upcoming inauguration of phases 17 21. With new refining capacity coming on stream, Iran will become self-sufficient in transport fuel from early 2017. Given these developments, we forecast that real GDP growth will accelerate from an estimated 4.6% in 2016/17 to an annual average of 5.6% in 2017/18-2021/22, with only a slight dip in 2019/20 in line with our expectations of a recession in the US and a hard landing in China (and an accompanying drop in oil prices) that year. Meanwhile, we expect the oil sector to be a positive contributor to real GDP growth over the forecast period. Despite the oil production cut agreed by OPEC in November, Iran managed to secure consent to increase its production, and thus we expect Iran's oil output to rise slightly to 3.86m barrels/day (b/d) in 2017/18. Although the pace of Iran's production growth is set to slow, given the age of the country's major fields, its oil output, at a forecast 4.4m b/d by 2021/22, will still be at its highest level since the 1970s. Economic growth % 2016a 2017b 2018b 2019b 2020b 2021b GDP 4.6 5.4 5.9 5.2 5.6 5.9 Private consumption 2.6 5.2 6.1 5.8 6.3 6.5 Government consumption -0.4 4.0 5.2 5.0 5.4 5.9 Gross fixed investment 6.3 10.1 11.0 7.0 7.1 7.7 Exports of goods & services 18.0 9.5 6.1 5.5 6.0 6.6 Imports of goods & services 15.9 15.0 11.9 8.0 8.6 9.7 Domestic demand 3.1 5.9 6.9 5.6 6.0 6.5 Agriculture 1.0 2.0 1.7 1.5 1.2 1.3 Industry 4.5 6.7 5.6 4.4 4.6 5.0 Services 0.6 5.0 6.5 6.1 6.7 7.0 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 8 Inflation Having declined to single digits in 2016, because of easing trade bottlenecks and lower foodstuffs costs, inflation is expected to rise once more in 2017, to an average of 10.8%. This uptick reflects the weakening of the official rate of the rial, which in turn will push up import costs (notably for those so-called "priority" goods that were given a preferential rate under the soon-to-be-abolished dual exchange-rate system). Subsequently, and notwithstanding a small dip in consumer price growth in 2019 (on the back of renewed com modity price weakness), we expect inflation to remain at an average of 10.4% during the forecast period, as the impact of a more stable exchange rate is offset by rising demand-pull inflation.

Exchange rates The market exchange rate of the Iranian rial plunged in late December, to IR41,500:US$1 (from around IR36,500 in November), amid speculation surrounding new US sanctions and uncertainty related to plans to end the rial's current dual exchange rate. Although Bank Markazi has since partially reversed the slide, reportedly by injecting US$5.8bn into the local market, we still expect the official rate to average IR36,016 in 2017—a sharp decline from the average rate of IR30,915:US$1 in 2016, and in line with comments by the central bank governor that a rate of IR36,000:US$1 would be appropriate for the new unified rate. Subsequently, however, as inflation stabilises and inward investment increases, we expect the pace of depreciation to ease, with the average rate of the rial reaching IR48,357:US$1 in 2021.

External sector Despite persistently weak oil prices, we expect Iran's current account to remain in surplus throughout the forecast period. However, the surplus will narrow gradually as import spending rises rapidly (on the back of years of pent up demand, when sanctions led to the imposition of import controls), offsetting rising petrochemical and automotive exports. Meanwhile, the non-merchandise deficit will continue to widen as rising imports push up services debits and the growing presence of foreign oil firms drives up income debits. Nevertheless, we forecast that the current account will remain in surplus, at an annual average of 2.7% of GDP in 2017 21.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 9 Forecast summary Forecast summary (% unless otherwise indicated) 2016a 2017b 2018b 2019b 2020b 2021b Real GDP growth 4.6 5.4 5.9 5.2 5.6 5.9 Crude oil production ('000 b/d) 3,680 3,864 3,995 4,099 4,242 4,416 Oil exports (US$ m) 44,204 54,305 57,754 60,140 63,085 64,927 Consumer price inflation (av) 8.6c 10.8 10.1 10.0 10.1 11.1 Consumer price inflation (end-period) 9.2c 10.5 10.1 10.1 10.5 11.5 1-year deposit rate (end-period) 13.0 13.0 12.5 12.5 13.0 13.3 Official net budget balance (% of GDP) -2.5 -2.1 -2.2 -2.7 -3.2 -3.4 Exports of goods fob (US$ bn) 85.4 100.0 107.1 112.7 119.7 126.0 Imports of goods fob (US$ bn) 62.1 73.9 83.1 89.9 98.8 109.6 Current-account balance (US$ bn) 19.8 19.6 16.1 13.6 11.9 7.2 Current-account balance (% of GDP) 4.4 4.3 3.2 2.6 2.1 1.2 External debt (end-period; US$ bn) 8.2 10.5 12.4 13.9 15.8 18.2 Exchange rate IR:US$ (av) 30,915c 36,016 38,177 41,613 44,983 48,357 Exchange rate IR:US$ (end-period) 32,376c 37,615 41,580 43,480 46,850 50,224 Exchange rate IR:¥100 (av) 28,425c 31,010 36,048 41,416 44,905 48,418 Exchange rate IR:€ (end­period) 34,128c 39,872 44,906 48,697 53,410 58,762 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 10 Data and charts Annual data and forecast

2012a 2013a 2014a 2015b 2016b 2017c 2018c GDP Nominal GDP (US$ m) 587,209 511,621 425,326 416,663 447,201 451,757 495,760 Nominal GDP (IR trn) 7,150 9,421 11,034 12,088 13,825 16,270 18,927 Real GDP growth (%) -6.6 -1.9 4.3 0.9 4.6 5.4 5.9 Expenditure on GDP (% real change) Private consumption -1.7 -1.0 3.1 0.8 2.6 5.2 6.1 Government consumption -7.2 1.6 2.7 -2.2 -0.4 4.0 5.2 Gross fixed investment -23.8 -6.9 3.5 1.3 6.3 10.1 11.0 Exports of goods & services -20.5 0.0 12.0 8.0 18.0 9.5 6.1 Imports of goods & services -23.1 -18.7 -5.7 7.1 15.9 15.0 11.9 Origin of GDP (% real change) Agriculture 3.7 4.7 3.8 0.5 1.0 2.0 1.7 Industry -18.3 -4.7 4.9 2.7 4.5 6.7 5.6 Services 1.1 -1.5 2.4 -2.0 0.6 5.0 6.5 Population and income Population (m) 76.2 77.2 78.1 79.1 80.0 80.9 81.8 GDP per head (US$ at PPP) 16,854 16,582 17,388 17,526 18,349 19,550 20,947 Recorded unemployment (av; %) 12.2 10.4 10.3b 10.5 10.7 10.0 9.7 Fiscal indicators (% of GDP) Public-sector revenue 13.9 14.1 14.6 14.9 17.1 16.7 16.6 Public-sector expenditure 14.6 15.0 15.7 16.5 19.6 18.8 18.8 Public-sector balance -0.6 -0.9 -1.2 -1.6 -2.5 -2.1 -2.2 Net public debt 11.0 10.3 10.3 11.6 13.1 14.1 14.9 Prices and financial indicators Exchange rate IR:US$ (av) 12,176 18,414 25,942 29,011a 30,915a 36,016 38,177 Exchange rate IR:US$ (end-period) 12,260 24,774 27,138 30,130a 32,376a 37,615 41,580 Consumer prices (av; %) 26.0 39.3 17.2 13.7a 8.6a 10.8 10.1 Stock of money M1 (% change) 26.7 10.5 7.1 0.2a 33.0a 14.0 13.0 Stock of money M2 (% change) 32.0 28.1 34.8 24.6a 28.1a 25.3 18.3 Lending interest rate (av; %) 11.0 11.0 14.0 14.2a 13.0 13.0 12.5 Current account (US$ m) Trade balance 28,562 29,326 21,392 12,178a 23,285 26,115 24,057 Goods: exports fob 97,296 92,910 86,471 64,597a 85,402 100,034 107,142 Goods: imports fob -68,734 -63,584 -65,079 -52,419a -62,117 -73,919 -83,085 Services balance -7,360 -6,820 -6,985 -4,472a -6,248 -8,508 -9,858 Income balance 1,649 2,034 943 764a 2,223 1,578 1,513 Current transfers balance 509 565 511 547a 492 448 399 Current-account balance 23,362 25,105 15,861 9,016a 19,753 19,634 16,110 External debt (US$ m) Debt stock 7,406 7,006 5,441 6,321a 8,156 10,533 12,375 Debt service paid 601 439 501 820a 905 948 1,265 Principal repayments 446 396 463 742a 802 821 1,115 Interest 155 43 38 79a 103 127 150 International reserves (US$ m) Total international reserves 104,650b 107,950b 108,950b 109,952 135,451 134,301 144,301 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. Source: IMF, International Financial Statistics.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 11 Quarterly data 2015 2016 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Central government finance (IR

bn)a Revenue 458,646293,200452,600416,400 635,000 254,800 n/a n/a Expenditure 490,753359,590478,600436,000 709,700 370,200 n/a n/a Balance -32,107 -66,390 -26,000 -19,600 -74,700 -115,400 n/a n/a Output GDP at constant 2004/05 prices (IR 531,939 n/a n/a n/a n/a n/a n/a n/a bn) GDP at constant 2004/05 prices (% 3.7 n/a n/a n/a n/a n/a n/a n/a change, year on year) Prices Consumer prices (2011=100) 214.4 222.3 224.9 229.1 233.5 238.3 245.1 250.1 Consumer prices (% change, year on 16.0 16.3 12.8 10.1 8.9 7.2 9.0 9.2 year) Financial indicators Exchange rate IR:US$ (av) 27,637 28,641 29,754 30,014 30,195 30,404 31,113 31,948 Exchange rate IR:US$ (end-period) 28,085 29,319 29,956 30,130 30,260 30,700 31,460 32,376 M1 (end-period; IR trn)b 1207.601123.701180.201158.10 1367.00 1364.40 1480.30 1540.70 M1 (% change, year on year) 1.0 -2.0 -1.7 0.2 13.2 21.4 25.4 33.0 M2 (end-period; IR trn)b 7823.908166.608727.509251.7010172.8010595.0011227.1011848.60 M2 (% change, year on year) 22.3 22.7 23.5 24.6 30.0 29.7 28.6 28.1 Sectoral trends Crude oil production (m barrels/day; 2.83 2.87 2.89 3.16 3.59 3.65 3.76 n/a fiscal year) Crude oil prices (US$/barrel) OPEC basket 50.30 59.89 48.35 39.71 30.14 42.39 43.00 47.52 Balance of payments (US$ m)a Exports fob 17,386 17,680 15,936 16,768 14,213 18,905 n/a n/a Oil & gas 9,461 10,633 9,432 7,028 6,476 11,640 n/a n/a Imports fob 16,685 12,902 13,171 12,510 13,836 12,383 n/a n/a Trade balance 701 4,778 2,764 4,259 377 6,552 n/a n/a Current-account balance -1,008 3,947 2,189 3,817 -3,937 5,231 n/a n/a a Iranian fiscal year (March 21st-March 20th). b 20th of month. Sources: Bank Markazi, Economic Trends; International Energy Agency, Oil Market Report; IMF, International Financial Statistics; Platts.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 12 Monthly data Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exchange rate IR:US$ (av) 2014 24,821 24,883 25,085 25,499 25,534 25,611 26,303 26,505 26,635 26,688 26,777 26,958 2015 27,372 27,600 27,939 28,256 28,562 29,106 29,509 29,798 29,956 29,954 29,974 30,113 2016 30,173 30,186 30,225 30,290 30,375 30,547 30,894 31,079 31,365 31,650 31,952 32,243 Exchange rate IR:US$ (end-period) 2014 24,866 24,898 25,444 25,403 25,580 25,651 26,303 26,601 26,668 26,706 26,816 27,138 2015 27,530 27,708 28,085 28,241 28,829 29,319 29,600 29,958 29,956 29,960 30,086 30,130 2016 30,183 30,197 30,260 30,310 30,460 30,700 30,952 31,253 31,460 31,778 32,091 32,376 M1 (% change, year on year) 2014 4.4 1.7 6.3 9.2 4.7 7.9 10.9 11.1 10.8 10.7 11.0 9.2 2015 3.3 1.7 1.8 -0.9 -0.7 -0.9 -4.1 -1.8 -1.7 -0.8 1.9 -0.4 2016 5.8 9.7 12.8 11.8 13.9 20.0 23.0 28.7 24.3 24.3 n/a n/a M2 (% change, year on year) 2014 4.5 1.8 6.4 9.3 4.8 8.1 11.0 11.2 10.9 10.9 11.1 9.3 2015 3.4 1.9 1.9 -0.8 -0.5 -0.8 -3.9 -1.6 -1.5 -0.6 2.0 -0.3 2016 5.9 9.8 12.9 11.9 14.0 20.0 23.0 28.7 24.4 24.3 n/a n/a Deposit rate (av; %) 2014 14.8 14.7 14.9 14.8 14.8 14.7 14.7 14.7 16.9 16.9 16.9 16.9 2015 16.9 16.9 17.5 17.5 17.7 17.7 16.4 16.4 16.4 16.3 16.3 16.3 2016 16.1 16.4 14.8 14.8 14.8 14.9 14.9 14.9 12.9 12.9 n/a n/a Lending rate (end-period; %) 2014 11.0 11.0 11.0 11.0 11.0 11.0 14.0 14.0 14.0 14.0 14.0 14.0 2015 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 2016 14.2 14.2 18.0 18.0 18.0 18.0 18.0 18.0 18.0 18.0 n/a n/a Consumer prices (av; % change, year on year) 2014 28.8 22.8 19.7 17.4 16.6 14.6 14.6 14.7 14.4 14.6 15.1 16.7 2015 15.7 16.2 16.2 16.5 16.2 16.2 14.2 12.6 11.7 10.8 10.1 9.4 2016 9.6 8.9 8.3 7.4 7.3 6.8 8.1 9.4 9.5 9.3 9.1 9.2 Sources: IMF, International Financial Statistics; Haver Analytics.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 13 Annual trends charts

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 14 Monthly trends charts

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 15 Comparative economic indicators

Basic data Total area 163.6m ha Population 73.6m (2010, Statistical Centre of Iran) Towns with populations in excess of 500,000 Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 16

Population in '000 (2007, Statistical Centre of Iran) Tehran (capital): 7,705 Mashhad: 2,411 Isfahan: 1,583 Tabriz: 1,379 Shiraz: 1,205 Qom: 1,042 Ahvaz: 790 Bakhtaran (formerly Kermanshah): 643 Climate Continental, with extremes of temperature Weather in Tehran (altitude 1,220 metres) Hottest month, July, 22­37°C (average daily minimum and maximum); coldest month, January, minus 3 7°C; driest month, July, 3 mm average rainfall; wettest month, January, 46 mm average rainfall Official language Persian (Farsi) Measures Metric system. Some local measures are used, including: 1 jerib=0.108 ha; 1 artaba=0.66 hl; 1 rey=11.88 kg Calendar The Iranian year begins on March 21st, and contains 31 days in each of the first six months, 30 days in the next five months and 29 in the 12th month (30 in every fourth year). The system relates to the Prophet Mohammed's flight from Mecca in 622 AD, but, unlike the Islamic calendar, follows solar years. The Gregorian equivalent can be found by adding 621 years to the Iranian date. The Iranian year 1392 began on March 21st 2013 Currency Rial (IR); IR10 = 1 toman. (Although all government statistics are given in rials, in conversation Iranians refer to tomans.) The multiple exchange rate was replaced by a single floating rate at the start of fiscal year 2002/03; IR29,011:US$1 (2015 average) Time 3.5 hours ahead of GMT Public holidays Many holidays are religious and based on the Islamic year. Exceptions include New Year (Nowruz) celebrations (March 21st 24th)

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Political structure Official name Islamic Republic of Iran Legal system Based on the constitution of 1979, which was amended in 1989 Legislature 290-member Majlis-e-Shuray-e Islami (National Assembly). All candidates for the Majlis must be approved by the 12-member Guardian Council, six of whom are appointed by the supreme leader (rahbar) and six by the judiciary. Majlis legislation must also be approved by the Guardian Council. The Expediency Council mediates between the Majlis and the Guardian Council Electoral system Universal adult suffrage for elections to the Majlis, the Assembly of Experts (the body that chooses the rahbar) and the presidency National elections Next elections: May 19th 2017 (presidential); 2020 (legislative) The supreme leader (rahbar) Ayatollah Ali Khamenei Head of state

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 18 President, elected by universal suffrage for a four-year term for a maximum of two terms. Hassan Rouhani was elected as president in June 2013 and took office in August 2013 Executive The post of prime minister was abolished in 1989. The current cabinet was approved by the Majlis in August 2013 Main political trends Parliamentary factions are loose. The new Majlis is dominated by the United Fundamentalist Front and the Stability of Islamic Revolution Front, both conservative groups close to the supreme leader Key ministers President: Hassan Rouhani Head of presidential office: Mohammed Nahavadian Commerce & industries & mines: Mohammed Reza Nematzadeh Culture (acting): Abbas Salehi Defence: Hossein Dehqan Economy & finance: Ali Tayebnia Education (acting): Mohammad Bathaei Energy: Hamid Chitchian Foreign affairs: Mohammed Javad Zarif Health: Hassan Qazizadeh Hashemi Intelligence: Mahmoud Alavi Interior: Abdolreza Rahmani Fazli Justice: Mostafa Pour-Mohammadi Petroleum: Bijan Namdar Zanganeh Speaker of the Majlis: Ali Larijani Head of the Supreme National Security Council: Ali Shamkhani Adviser for Supervision & Strategic Affairs: Mohammed Bagher Nobakht Head of the Iranian Atomic Energy Organisation: Ali Akbar Salehi Central bank governor Valiollah Seif

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 19 Recent analysis

Generated on November 13th 2017 The following articles were published on our website in the period between our previous forecast and this one, and serve here as a review of the developments that shaped our outlook. Politics Forecast updates February 16, 2017: International relations Rouhani visits Oman and Kuwait Event Iran's president, Hassan Rouhani, visited Oman and Kuwait on February 15th—his first visit to any Gulf Arab state since he became president in 2013. Analysis The visit builds on a flurry of diplomatic activity that began in January with a letter to Mr Rouhani from Kuwait's emir, Sheikh Sabah al-Ahmed al-Jaber al-Sabah, recommending that Iran and the Gulf Co operation Council (GCC) identify a "basis for dialogue" after a year in which tensions spiralled. The emir's letter was followed up by a visit to the Islamic Republic by Kuwait's foreign minister on January 26th and a statement of strong support for rapprochement by Iran's own foreign minister, Javad Zarif, on February 7th. The choices of Oman and Kuwait for Mr Rouhani's visit are unsurprising, as both countries have—along with Qatar—had a less confrontational relationship with Iran than Bahrain, Saudi Arabia and the UAE. Oman played an important part in the international negotiations for Iran's nuclear deal. Furthermore, Oman and Iran are in advanced negotiations over a natural gas pipeline between the two countries and are aiming to begin the tendering process within months; representatives of Mitsui & Co (Japan), Royal Dutch Shell (Netherlands/UK), Uniper (Germany) and the Korea Gas Corporation (South Korea) have already presented project development proposals. The visit thus confirms the good relations between the two countries and highlights the continuity of Oman's foreign policy objective of regional conflict resolution. While energy and investment probably form the core of Mr Rouhani's visit to Oman, it is likely that Kuwait will focus more on how to build on the nascent olive branches and expand the Kuwaiti feelers into a truly GCC-wide initiative. With 40 years' experience as his country's foreign minister, Sheikh Sabah is well placed to act as mediator between Iran and the GCC. Moreover, with a sizeable Shia population, the Kuwaiti authorities are wary of the sectarianism that friction with Iran can bring. However, Saudi, Emirati and Bahraini leaders adopt hawkish positions toward Iran, viewing it as a major domestic and regional security threat, in turn limiting the chances of any significant rapprochement with the GCC as a bloc. Impact on the Forecast The move supports our view that Oman (in particular) and Kuwait will remain the most neutral GCC states toward Iran. However, we continue to forecast a GCC- Iranian rapprochement as unlikely.

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February 22, 2017: International relations Russia and Iran ramp up bilateral trade Event On February 21st Russia's first deputy prime minister, Igor Shuvalov, visited Tehran to negotiate a free-trade deal between Iran and the Eurasian Economic Union (Russia, Belarus, Kazakhstan, Armenia and Kyrgyzstan). Analysis Mr Shuvalov's visit comes against a backdrop of growing Russian-Iranian bilateral trade, which increased by 60%, to almost US$2bn, in 2016, according to the Intergovernmental Russian-Iranian Commission on Trade and Economic Co operation—although this is below the record US$3.7bn in 2010, before stringent US and EU sanctions against Iran were imposed. Russia's exports to Iran include machinery, military supplies (notably the S 300 missile defence system, whose delivery began last year) and grain. Since sanctions were lifted after the 2015 nuclear agreement, Russian companies have signed many Memorandums of Understanding with Iran—including seven for oilfield development. With finance scarce in Iran, Russian state backing will play a central role in advancing joint investment projects (including a US$1.6bn thermal power plant in Bandar Abbas and the Rasht-Astara railway). However, Russian companies are also investing in Iranian internet companies and pharmaceuticals. Although the balance of trade is in Russia's favour, Iran is exporting mainly agricultural products, including seafood. Russia and Iran also share political interests. Notably, the two countries are allies in Syria (where they are militarily backing the regime of Bashar al Assad) and share an antipathy to Sunni militancy—whether in Iraq and Syria (in the form of Islamic State) or in Chechnya and Central Asia. Contacts between the two countries' presidents, Vladimir Putin and Hassan Rouhani, have been frequent, with Mr Rouhani expected to visit Moscow soon. The growing links between Iran and Russia bode ill for any attempt by the US administration of Donald Trump to isolate Iran, which the US president has described as the world's "number one terrorist state". Arguably, there are areas of difference between Iran and Russia that the US could exploit, including Russia's relationships with Israel and Saudi Arabia, and mutual suspicions that can be traced back to the 1828 Treaty of Turkmenchay (when Russia acquired Iranian-held territories). However, although Russian officials have welcomed Mr Trump's stated desire for improved relations, they have rejected any talk of renegotiating the 2015 nuclear agreement, as well as US criticism of Iran's missile tests in February. Impact on the forecast Mr Shuvalov's visit to Tehran reinforces our forecast that Russian (along with EU, Indian and Chinese) firms will continue to explore investment and trade opportunities with Iran, even if most US firms will be deterred.

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February 28, 2017: Election watch Rouhani to run for second term as president Event On February 26th the vice­president for parliamentary affairs, Hossein Ali Amiri, confirmed that the president, Hassan Rouhani, will seek a second term in the election due on May 19th. Analysis Polling by Canada-based IranPoll and the University of Maryland found that Mr Rouhani's approval rating had fallen from 82% last June to 69% in December. Worryingly for Mr Rouhani and his supporters, 51% of those surveyed in December said that economic conditions were worsening, and around 75% agreed that the 2015 nuclear agreement had not improved their situation. However, multiple factors favour the president's candidacy. Iran's reformists are likely to back Mr Rouhani—as they did in 2013—and the president could be helped by divisions among the "principlists" (hardline conservatives), who have been critical of the nuclear agreement. Hamid­Reza Baqaee, the vice president for executive affairs under the previous president, Mahmoud Ahmadinejad, has already announced his intention to stand, although he could be blocked by the Guardian Council, which in 2013 declared Mr Ahmadinejad's chief of staff, Esfandiar Rahim Mashaei, ineligible to stand. Other principlists have established the Popular Front of Islamic Revolution Forces in an effort to agree on a single candidate, but they are struggling to find a sufficiently charismatic figure. Among the names suggested are Mohammad Bagher Ghalibaf, the mayor of Tehran who unsuccessfully ran for president in 2005 and 2013, and Ebrahim Raeisi, who last year was appointed to chair the powerful foundation that oversees the shrine of Imam Reza. The bellicose rhetoric directed at Iran by the US president, Donald Trump, has ruffled public opinion and, arguably, provides an opportunity for hardliners opposed to Mr Rouhani's diplomatic outreach strategy. Instead, however, they are concentrating not on international affairs but on excessive pay levels of technocrats linked to the government. A populist appeal based on economic equality helped Mr Ahmadinejad win in 2005 and would chime with the egalitarian values of the 1979 Islamic Revolution. It is worth noting that Iranian elections can be unpredictable; few analysts expected Mr Rouhani to win with 50.88% of the vote (in a field of six) in 2013. Impact on the forecast We expect Mr Rouhani to be victorious, lifted by the popularity of the nuclear deal and conservatives' failure to coalesce around a single, strong candidate. His victory would ensure continuity in Iran's international diplomacy, including upholding the nuclear agreement, and cautious economic reform. As a result, our political and international relations forecasts are unchanged.

Analysis February 13, 2017 Kuwait offers strategic dialogue between GCC and Iran Kuwait's foreign minister, Sheikh Sabah alKhaled alSabah, visited Iran on January 25th, aiming to begin a strategic dialogue between the six Gulf Co- operation Council (GCC) states and the Islamic Republic. This comes after a tense

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 22 period in which Saudi Arabia and Iran have accused each other of meddling in regional conflicts across the Middle East, and backed opposing sides in the ongoing civil wars in Syria and Yemen. Tensions between Iran and Saudi Arabia are unlikely to subside, particularly with the US—a key Saudi ally—espousing increasingly hardline rhetoric against Iran. Instead, the foreign minister's visit highlights possible foreign policy divisions within the GCC. The foreign minister delivered a written message from the emir, Sheikh Sabah al Ahmed al Jaber al Sabah, to the Iranian president, Hasan Rouhani, that sought to establish the "basis for dialogue" between the GCC and Iran. The Iranian foreign minister, Mohammad Javad Zarif, responded positively to the meeting and the letter and stated on February 7th that Iran was ready for dialogue and that 'we should aim together for a future that looks different'. A time of heightened tensions The Kuwait-led attempt at a thaw in the relationship between the GCC and Iran comes after a year in which tensions between Saudi Arabia and Iran escalated to their most confrontational level for nearly three decades. Saudi Arabia cut diplomatic relations with Iran in January 2016 after protesters stormed the Saudi embassy in Iran following the execution of Sheikh Nimr al Nimr, a prominent Saudi Shia cleric. Ongoing conflicts in Yemen and Syria have also pitted Saudi and Iranian-backed groups directly against each other, while Saudi and GCC officials have additionally accused Iran of fomenting instability in Bahrain, frozen political and financial ties to Lebanon, and designated an Iranian-backed Lebanese Shia group, Hizbullah, a terrorist organisation in a multifaceted effort to pressure Iran across the Middle East. Taken together, these actions amounted to the most serious spike in Gulf tensions since the Iran-Iraq war of the 1980s. With bilateral relations between Saudi Arabia and Iran at such a low ebb, it is surprising that some GCC members have expressed a willingness to explore the parameters of a dialogue with Iran. Sheikh Sabah's letter and the subsequent follow- up by Kuwait's foreign minister may reflect a pragmatic acknowledgement that GCC states have gained relatively little from the stand-off with Iran. Saudi Arabia and Qatar have been outmanoeuvred in Syria by regime forces backed by Iran and Russia, and have little to show for their four years of support for Sunni Islamist rebel forces. In Yemen, the Saudi and Emirati-led coalition has become bogged down in a campaign that offers meagre prospects of a decisive political or military outcome. Moreover, the search for a common GCC position on Iran has remained elusive, with Kuwait, Qatar, and Oman favouring a more neutral approach that contrasts sharply with the hawkishness in Bahrain and Saudi Arabia, while within the UAE Dubai falls into the former and Abu Dhabi into the latter camp. The main obstacles remain Although initial responses to the Kuwaiti initiative have been positive in tone, there are several key issues that will continue to impede any thawing in relations. One is the degree of buy-in from Saudi leaders, given the depth of their involvement in Yemen. In particular, there is pressure on the deputy crown prince Mohammed bin Salman al Saud to deliver a successful outcome to a war he remains so closely associated with. It will be difficult for Mohammed bin Salman to support any policy that implies a loss of face on an issue that he and other Saudi leaders have played up so heavily over the past year. Moreover, the Saudi border remains threatened by the Iranian-backed Houthi rebels, who have fired a number of missiles at Saudi military bases. Under the direction of Mohammed bin Salman, Saudi regional policy has become far more assertive and the struggle with Iran has increasingly resembled a zero-sum game where one side's gain is another's loss. This view is compounded by the mutual mistrust between the two nations and the dominance Iran has achieved in Syria, particularly after the recent fall of rebel-held east Aleppo. The uncertainty surrounding the new US president, Donald Trump, and his approach to the Middle East also provides a further backdrop of unpredictability.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 23 Early signs indicate that the Trump administration intends to take aim simultaneously at Islamist organisations such as the Muslim Brotherhood and Iran. The rhetoric towards Iran has been particularly incendiary, while the introduction of further economic sanctions seems probable. This is likely to be accompanied by enhanced security guarantees and arms sales to Saudi Arabia, Bahrain, and the UAE as the administration looks set to boost the main anti-Iranian elements in the GCC and buttress efforts to deny the perceived spread of Iranian influence in Yemen and Bahrain. As a result, any rapprochement with Iran may be rendered moot either by direct US action against Iran or by the intensification of US assistance to selected security partners in the Gulf, which would further undermine prospects for GCC cohesion on critical issues, particularly if Qatar becomes caught in the crosshairs of any US action against the Muslim Brotherhood and its regional supporters. Even without the US, Saudi Arabia remains the dominant force in the GCC, and its battle for regional supremacy with Iran will therefore continue to constrain any diplomatic overtures from elsewhere in the GCC. Nevertheless, Sheikh Sabah's mission emphasises the differences in foreign policy objectives within the GCC. As a result of the lack of notable success for Saudi-led coalition in Yemen, cracks are likely to emerge in the alliance.

February 17, 2017 Iran's president seeks better relations with Gulf neighbours The visit of Iran's president, Hassan Rouhani, to Oman and Kuwait on February 15th seems to have had both a political and economic aim. On the one hand, Mr Rouhani will be concerned that the belligerence of the US administration of Donald Trump will encourage intransigence among the Gulf Arab countries— with which Iran already has frosty relations—and thus will be hoping to undercut any potential uptick in hostility. On the other, he will be hoping that Iran's economic opening, and the potential posed by its enormous gas reserves, may be sufficient to lure some of the Gulf states into more friendly relations with Iran. Mr Rouhani was paying his first visit since being elected in 2013 to Oman, which has been the Gulf state closest to Iran and which played a discreet intermediatory role between Iran and the US leading up to the 2015 nuclear agreement. Mr Rouhani's visit to Kuwait, where he met the emir, Sheikh Sabah al Ahmed al Sabah, was more unexpected, although it followed a trip to Tehran in January by Kuwait's foreign minister, Sheikh Sabah Khaled al Sabah. The foreign minister reportedly passed on a joint demand from the six state Gulf Co­operation Council (GCC) that Iran settle territorial disputes with the UAE over islands in the Gulf—namely, the Tunbs islands and Abu Musa, which were seized by Iran in 1971 —and scale down its relationships with various factions in the Arab world (a reference to the Lebanese Shia political/guerrilla group, Hizbullah, among others). Kuwait maintained diplomatic relations with Iran (although it did downgrade ties) when Saudi Arabia, followed by the UAE, broke off ties in January 2016 after demonstrators stormed its Tehran embassy in protest at Saudi Arabia's execution of a leading Saudi Shia cleric, Nimr al Nimr. Shared economic interests Although the Kuwaiti foreign minister's demands will have fallen on deaf ears—Iran has shown no inclination to abandon its allies across the region, nor withdraw from the disputed islands—there are several economic incentives for co­operation between Iran and the GCC. Notably, several of the Gulf states and Iran worked together to achieve the OPEC agreement on limiting output in December, when the Saudis accepted that Iran could increase production back to levels before draconian US and EU sanctions came into force in 2012. If oil prices continue to rise, co- operation between Saudi Arabia and Iran (supported by Russia) could see a further cut in production later this year—an outcome clearly in the interests of both Iran

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 24 and Saudi Arabia. Besides oil, Mr Rouhani's trip to Oman also highlighted the shared opportunities posed by Iran's enormous gas reserves. In 2013 Oman and Iran signed an agreement to pipe Iranian gas to Oman. The Iranian oil minister, Bijan Namdar Zanganeh, recently put the cost of a pipeline circumventing Qatari waters at US$1.2bn. The line is due to come on stream by 2020, with half of the 28m cu metres/day of supply being consumed by Oman, and the remainder turned into liquefied natural gas and exported on Iran's behalf. Oman is also planning to develop Duqm port to benefit from Iran's re-emergence into global markets. Iran has also recently reiterated that it wants to restart talks with Kuwait and other littoral states over supplying gas. Increasing gas exports is a major priority for Iran, which despite holding 18.2% of the world's gas reserves, in 2015 produced only 5.4% of global output (of which 99% was consumed domestically). Tensions between Iran and the GCC will persist Although Mr Rouhani's visit highlighted genuine intentions on both sides to explore possibilities for improving relations, tensions will persist. Saudi Arabia is committed to supporting rebels in Syria against the regime of Bashar al Assad, who continues to receive military support from Iran (as well as Hizbullah), and this rivalry has also spilled over into Lebanese politics. Saudi Arabia is more directly involved —especially with its air force—in the Yemeni civil war, where it accuses Iran of backing Houthi rebels against the ousted Yemeni president, Abd Rabbuh Mansour Hadi. An informal understanding between Iran and Saudi Arabia is probably more likely in Yemen than in Syria. During his visit to the Gulf, Iran's president called for a truce in Yemen (as well as, more generally, a better understanding between Shia and Sunni Muslims), and any deal with Saudi Arabia could potentially involve Iran scaling down support for the Houthis (although this has arguably always been exaggerated). Iran's involvement in Syria is, however, more overt and the positions of Saudi Arabia and Iran over the future of Mr Assad are probably insurmountable. Nevertheless, even here, the edge may be taken off the Syrian conflict as it settles into more or less stable zones, controlled by different factions. In Lebanon, Iran and Saudi Arabia both welcomed an agreement in October that saw the Hizbullah-allied Christian leader, Michel Aoun, take over as president and the Saudi-backed Sunni leader, Saad Hariri, as prime minister. Arms build-up raises chance of flashpoint The importance of attaining a working relationship between Iran and its Gulf neighbours is underlined by the region's position as a globally significant flashpoint, combining both insecurity (including war and terrorism) and oil—around 35% of the world's seaborne oil passes through the Strait of Hormuz between Iran and the UAE and Oman. In addition, Iran has a stated goal to increase defence spending by 2021 from 2% to 5% of the annual budget, with an emphasis on missiles, drones and cyber warfare—although its spending will remain well short of that of the GCC. (Saudi Arabia spends around five times as much as Iran.) Meanwhile, the US Fifth Fleet based in Bahrain has 40 warships, including nuclear- powered aircraft carriers. Saudi Arabia has been the US's biggest arms buyer since 2009, while the UK established a new base in Bahrain in 2016 and added to its presence in Oman. However, the extent of the Western presence raises the potential for an incident with Iranian forces, and in turn the risk of escalation—in January, for example, the destroyer USS Mahan fired warning shots at several small Iranian vessels that were approaching the ship. Unsurprisingly, it is thus arguably in everyone's interests to cool the diplomatic temperature across the region, given the volatile mixture of oil, religion and armaments. However, the militant rhetoric of Mr Trump and his administration's officials is arguably only adding to the friction, raising the risk of miscalculation—

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 25 and undermining Mr Rouhani's long-standing goal of reintegrating Iran into the global community. As a consequence, he, arguably even more than his Gulf hosts, will be hoping for a positive outcome to his Gulf tour.

Economy Forecast updates February 13, 2017: Economic growth Total signals caution on investment in Iran Event A French supermajor, Total, has cautioned that its final investment decision on developing Phase 11 of the giant South Pars gasfield in the Gulf is dependent on the US administration maintaining its commitment to the Joint Comprehensive Plan of Action (JCPOA, the international deal over Iran's nuclear programme). Analysis The comments by the chief executive of Total, Patrick Pouyanne, highlight broader business uncertainty over the intentions of the US administration. Mr Pouyanne suggested that executive orders signed by the former president, Barack Obama, needed to be renewed to ensure that the company is exempt from possible US sanctions. Some close to the administration of Donald Trump have proposed renegotiating the JCPOA, and the president has also introduced new sanctions following Iranian missile tests. Yet Mr Pouyanne posed a simple choice for Mr Trump: either renew by April and May the waivers—allowing Total to proceed—or prove that Iran has breached the deal and "tear [it] up", in which case the company would not be able to work in Iran. Broader uncertainty about sanctions and Iran's business environment have contributed to the decision by most Western oil majors—including BP (UK), Chevron and ExxonMobil (both US)—to avoid Iran. In addition, Royal Dutch Shell (Netherlands UK) has not yet commented on the future of its preliminary agreement in December to work on the South Azadegan and Yadavaran oilfields and the Kish gasfield. Schlumberger, a Dutch energy services company, Norway's DNO and Austria's OMV have also signed Memorandums of Understanding (MoUs) to operate in Iran. In addition, Iran has signed seven MoUs with Russian companies, including Lukoil and Gazprom. Iran's energy firms are making their own progress in developing Iran's hydrocarbons reserves. Notably, the oil minister, Bijan Namdar Zangeneh, recently said that South Pars output had risen to 500 cu metres/day, and that the inauguration of phases 17 21 (being led by the Pars Oil and Gas Company, a subsidiary of the state­ owned National Iranian Gas Company) was expected before the end of the Iranian year (March 21st), with these phases set to produce an additional 150m cu metres/day. He added that Iran is targeting US$130bn in foreign investment for oil and gas development by 2021, prioritising increased recovery in existing (and older) fields. Impact on the forecast Mr Trump's actions will hamper but not stymie Iran. We thus still expect inward investment to increase markedly over our 2017 21 forecast period, but will continue to monitor the actions of the US administration closely.

February 22, 2017: Fiscal policy outlook

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 26 Fiscal deficit continues to widen Event According to the latest data from Bank Markazi (the central bank), the fiscal deficit widened to IR269trn (US$8.7bn; or 2.4% of GDP on an annualised basis) in the first nine months of 2016/17 (March 21st-December 20th). This was sharply up from IR191trn in the same period of 2015/16 but broadly in line with the nine-month budgeted figure of IR263trn. Analysis The deterioration in the fiscal account continues to be driven by the underperformance of oil revenue and the failure of tax revenue to hit its (perhaps overoptimistic) growth targets. However, the oil revenue outturn—which fell from IR453trn in the first nine months of 2015/16 to IR422trn in the same period of 2016/17 —is artificially low; in December the president, Hassan Rouhani, revealed that the government has continued to deposit "20% of its petrodollars" into the National Development Fund (akin to a sovereign wealth fund). If these deposits were included in the revenue outturn, we estimate that the actual deficit would have come in at a far lower IR185trn (below the comparative nine month period of 2015/16).

Fiscal account (IR trn unless otherwise indicated; Mar 21st-Dec 20th) 2015/16 2016/17 2016/17 Outturn Budget Outturn % changea Total non-oil revenue 707.3 1,190.0 885.2 25.2 Tax revenue 508.0 785.1 655.0 28.9 Other revenue (excl privatisation proceeds) 199.4 404.9 230.3 15.5 Oil revenue 452.8 563.4 421.9 -6.8 Total revenue (incl others) 1,160.1 1,753.4 1,307.1 12.7 Current spending 1,110.5 1,616.4 1,400.2 26.1 Development spending 203.7 434.7 158.3 -22.3 Other spending 38.7 - - - Total spending 1,352.9 2,051.1 1,558.5 15.2 Balance -190.8 -263.2 -268.9 40.9 a Between the 2015/16 outturn and the 2016/17 outturn. Source: Bank Markazi. Perhaps more worrying is the underperformance of tax revenue, which, at IR655trn, was some 16.6% below budget (although still 28.9% above the 2015/16 outturn). This would seem to reflect weak domestic demand, as demonstrated by the below- budget performance of import tax receipts (which were more than 40% lower than the budgeted projection over the first nine months of the year) and value-added tax (VAT) revenue (22.7% below its budget target). In response, the government has stuck with its previous practice of holding down spending; development expenditure in particular was depressed—22% below the 2015/16 outturn and almost two thirds below budget. However, such a practice has long-term implications for the economy's productivity, given the negative consequences for the country's infrastructure. With this in mind, the government is looking to step up foreign involvement in development projects, with Iran's sixth five year plan, covering 2016 21, targeting annual foreign financing of US$30bn (probably primarily in the form of bilateral soft loans). Impact on the forecast We currently estimate a fiscal deficit in 2016/17 of IR348trn (2.5% of GDP), which is in line with the latest nine month outturn, with the shortfall expected to narrow

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 27 slightly to 2.1% of GDP in 2017/18 as revenue strengthens in line with improved economic growth and higher oil prices. Our forecast is thus unchanged.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 28

February 24, 2017: Inflation Inflation picks up Event According to the latest data from Bank Markazi (the central bank), consumer price growth picked up to 9.6% year on year in January (and was 0.8% month on month) —its highest level since the same month a year earlier. Analysis The increase in consumer price growth was once again led by rising foodstuffs costs, and in particular bread and cereal prices, which were up by 9.8% and 17.8% respectively (compared with 9% and 17.1% in December). In contrast, back in May foodstuffs inflation was below 2%. The sharp uptick in wheat and bread prices has not been fully explained, and comes despite a reported good wheat harvest. However, the government has over the past year imposed protectionist measures to shield its wheat farmers from imports, measures that have, among other things, contributed to a shortage of high-gluten wheat. In late January, perhaps with an eye on rising living costs, the government announced a cut in import tariffs on rice (whose cost has risen by some 30% over the past year), as well as meat, bananas, butter and pulses.

The latest inflation figure is especially significant as it accompanies the slump in the rial that occurred at the turn of the year, when concerns about possible new US sanctions and the upcoming ending of the preferential exchange rate for priority importers led to a short-lived plunge in the local currency. As a consequence of the depreciation, import costs will have increased—a factor that will become increasingly evident in the coming months, as the higher costs for suppliers feed through into the price of goods in shops. Of more significance, however, will be the implementation of the unification of the exchange rate, which is scheduled to occur at the end of the Iranian year (March 20th), and the government may seek to introduce some price controls in an effort to ameliorate the impact. Nonetheless, combined with recovering global commodity prices (and a budgeted increase in tobacco taxes), we expect price growth to return to double figures shortly. Impact on the forecast The pick-up in inflation in January chimes with our expectation that average consumer price growth will reach 10.8% this year, with the increase accelerating from April. Our forecast is thus unchanged.

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 29

February 27, 2017: Fiscal policy outlook Parliament approves issuance of US$4.5bn in bonds Event As part of the budget approval process, on February 25th the Majlis (parliament) passed a law allowing the Ministry of Oil to issue up to US$4.5bn of bonds, in both foreign and local currencies, in 2017/18 (ending March 20th 2018). Analysis The bonds will be issued for two purposes: first, some US$3bn will be used to repay debts to both local and international companies (which will have been amassed during the years of sanctions), with a further US$1.5bn to be used to help finance new projects. However, a slew of uncertainties surround the bonds' issuance. Even though the government began the process of garnering a sovereign credit rating from the major international rating agencies last year, foreign financing institutions will be wary of investing in Iranian paper, given the risk of running foul of US sanctions. Equally, Iran would need to decide on which currency to float any bonds in—local currency will not be popular, given its periodic volatility, but US restrictions ban Iran from using the US dollar. Nonetheless, given its relatively small fiscal deficits and tiny external debt stock (worth a mere 1.5% of GDP in 2015), Iran would probably get a relatively solid credit rating, albeit one below investment grade (The Economist Intelligence Unit's Country Risk Service rates Iranian sovereign credit risk at BB). In addition, in the case of the borrowing connected to oil investments, foreign investors might be reassured as the returns on the bonds could be connected to future hydrocarbons revenue from these developments. Adding to the complications, if foreign demand is insufficient, the oil ministry could well struggle to source enough demand locally. Notably, in the first five months of 2016/17, the government failed to find sufficient buyers for its state bonds, with just US$610m of bonds purchased out of a total US$1.47bn on offer. And there remains the risk that the Council of Guardians (a vetting body) could block the bonds, given that its final approval is required for the budget's passage. Partially with this in mind, if the bonds go ahead, we would expect them primarily to be in the form of Islamic bonds (sukuk). Impact on the forecast We are not including the proposed bond offering in our forecasts, given the raft of uncertainties associated with it. However, if it goes ahead, it could prompt further bond issuance on the international debt markets, and we would raise Iran's external debt forecasts as a result.

Analysis February 15, 2017: 5-year summary EIU Global Forecast February 2017 The initial market reaction to Donald Trump's election as US president and the Republican party maintaining control of both houses of Congress was to price in a reflation of the US economy on the basis of tax cuts, spending on infrastructure and deregulation. This fuelled a rally in US equities to new record levels, pushed up bond yields and bid up the dollar. The initial exuberance has abated since the start of 2017. US equities have paused for breath. US bond yields have fallen back, although, at around 2.4% for ten-year bonds, they remain much higher than the level of around 1.8% just before the election. The dollar has given back part—and, against some currencies, all—of the gains that it made in the last two months of

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 30 2016. The Economist Intelligence Unit remains sceptical about the reflation story. The US economy is now running close to capacity. Fiscal stimulus could push up inflation, but, in that case, the US Federal Reserve (Fed, the central bank) would raise the policy interest rate more quickly, curbing any gains in output. Moreover, small- government Republicans will oppose a big public-spending programme on infrastructure unless it is fiscally neutral. We therefore maintain our US growth forecast of 2.3% in 2017. There are upside risks to this forecast. But there are also downside risks, and these are potentially large: for example, if the US were to raise tariffs on Chinese imports, which could set off a trade war between the world's two largest economies. Our forecast assumes that the Trump administration will adopt some protectionist measures but that these will be targeted at specific sectors and will not seriously undermine relations with China. A Republican proposal for a corporate tax reform including a border adjustment tax would have huge implications for the world economy as well as for the dollar. But such a complex proposal would attract much opposition from large importers, and we expect that Congress would fail to pass such contentious legislation. Mr Trump's election victory was part of a broader trend in Western democracies. Like the UK's decision to leave the EU and the rejection of a referendum on parliamentary reform in Italy in December, it saw voters rebel against an establishment that they perceived to be pursuing the wrong course. Some of these political changes were the culmination of a long-term decline of popular trust in government institutions and political parties. They also signify unhappiness with stagnant incomes. Above all, they demonstrate that society's marginalised and forgotten voters are demanding a voice—and if the mainstream parties will not provide it, they will look elsewhere. Of particular significance in the coming months is the presidential election in France. The election is a two-step process. The two candidates with the most votes in the first round then face a run-off. Marine Le Pen of the far-right Front national (FN) will almost certainly reach the run­off, where she will face either François Fillon of Les Républicains or Emmanuel Macron, a former economy minister running as an independent. Mr Fillon had emerged as the favourite but his standing has diminished following allegations that he misused public money. Although Ms Le Pen has succeeded in dragging FN into the political mainstream, we believe that either Mr Fillon, if he stands, or Mr Macron would attract sufficient support from the centre ground to keep her from power. Ms Le Pen is ambivalent about France's membership of the EU and would favour France withdrawing from European economic and monetary union (EMU), factors that have contributed to a pronounced widening of spreads between French and German bonds. Were she to win—we put her chances at 40%—a period of turbulence in global financial markets would be in prospect. The surge in US bond yields since November was a continuation of an already established trend that was amplified by Mr Trump's election victory. Bond yields in the US and other developed markets bottomed-out in mid-2016 and have been on an upward trend since, possibly signalling the end of a three-decade-long bull market in government bonds. The rise in bond yields has coincided with an increase in inflation in the developed world, in part but not wholly related to the recovery of oil prices from the lows plumbed in early 2016. We forecast global inflation of 4.3% in 2017, the highest rate since 2011. Although bond yields touched bottom in mid-2016 and are now on a rising trend, we expect them to remain low by historical standards. Similarly, policy rates will remain very low. We expect only a further 100-basis-point increase in US policy rates in the current cycle, and we expect policy rates to remain at zero in both the euro zone and Japan in 2017 21. These forecasts would create a reasonably benign interest­rate environment for emerging-market borrowers (notably corporates) with hard- currency debts to refinance. But payment stresses could arise from other sources, for example a renewed surge in the dollar or a new downturn in commodity prices

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 31 related to a fall-off in Chinese demand. Developed world The US economy is in good shape, buoyed by rapid employment growth, rising wages and strong consumer spending. Business investment is also turning a corner, helped by the recovery in oil prices. But without a boost to productivity or a broad improvement in the global economy, economic growth of around 2% is the new normal for the US. We forecast average real GDP growth of 2.2% in 2017 18, before a business cycle recession in 2019. We forecast that Europe's muted recovery will be consolidated over the forecast period, although political risk will remain high. For Japan we forecast growth averaging just 0.7% a year in 2017 21. Emerging markets On the assumption that Mr Trump makes only modest adjustments to US trade policy, the outlook for emerging markets in 2017 is reasonable, with growth quickening to 4.5% from 4% in 2016. Brazil and Russia, the third- and fourth-largest emerging economies, will both emerge from lengthy recessions. Overall, emerging markets will benefit from the upturn in commodity prices. Furthermore, as mentioned above, we expect financing conditions to remain relatively benign, albeit subject to occasional episodes of volatility. In 2016 China grew by 6.7%, in line with the official target, despite persistent inefficiencies in the state sector and recessionary conditions in the industrial north- east. However, this was achieved at the cost of a further increase in indebtedness, accompanied by a property bubble in some cities. The build-up in debt, particularly in the corporate sector, is unsustainable, and we think that once the president, Xi Jinping, has consolidated his power at a party conference in the autumn, he will sanction policies to rein in credit. Firms in the construction and real-estate sectors will be hit hardest. As a result of these policies, we forecast that growth will slow sharply in 2018, to 4.2%, from 6.2% in 2017. With China losing momentum, India will be Asia's fastest-growing large economy in 2017 21, expanding at an average annual rate of 7.6%. However, the economy is also going through a painful period. A lending spree has saddled state-owned banks with bad loans and created excess capacity in heavy industry. Meanwhile, a currency reform announced in late 2016 has proven extremely disruptive, causing a severe cash shortage during the wedding, harvest, festival and tourist seasons. We expect GDP growth in fiscal years 2016/17 2017/18 (April­March) to average just 6.8%. The mishandling of the reform raises concerns about the quality of the policymaking led by the pro-business prime minister, Narendra Modi. Brazil's emergence from a two-year recession will help to lift aggregate growth in Latin America back into positive territory in 2017. But Brazilian growth will be meagre, at just 0.5%, and we downgraded our GDP forecast for Mexico to 0.9% following Mr Trump's election. Although social and economic ties between the US and most Latin American countries will remain strong, the risk of a deterioration in relations under the Trump administration will be high. The policies pursued by the president-elect in areas such as trade and migration will have an important bearing, although our forecasts assume that Mr Trump will not follow through on some of his more radical campaign pledges, such as walking away from the North American Free-Trade Agreement (NAFTA) if he fails to get a better deal. Despite the OPEC supply deal, oil prices will remain too low to enable a significant revival in the oil-dependent economies of the Middle East and North Africa (MENA). These are continuing to cut spending, which in turn is depressing private consumption. The most vibrant economy in MENA in 2017 21 will be Iran, which will experience a post-sanctions revival, enabling it to contribute more to regional growth than Saudi Arabia, Israel or the UAE. Following a dismal performance in 2016—when we estimate that Sub­Saharan Africa's rate of economic growth fell to just 1.1%, the lowest pace of expansion for at least 20 years—growth will pick up in

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 32 2017, with an improved performance in each of the region's three largest economies, South Africa, Nigeria and Angola. This reflects our expectation that prices for exported commodities will rise and weather conditions will be more clement. Taken together, the outlook for developed economies and emerging markets means that we expect global economic growth to pick up to 2.5% in 2017, from an estimated 2.2% in 2016. Growth will be soft in 2018 and 2019 as the slowdown in China and a business-cycle recession in the US hit demand. As both economies recover, this will lift global growth to 2.6% in 2020 21. Exchange rates Although yield differentials will favour the dollar in 2017 18, we believe that much of this is already priced in to the foreign-exchange market, which leaves the dollar vulnerable to any disappointment on growth, not to mention possible shocks emanating from erratic policymaking under the Trump administration in areas such as trade and migration. Over the medium term we maintain the view that the dollar will weaken moderately against the euro and the yen, as we expect the Fed to ease monetary policy in 2019 in response to recessionary conditions, taking the policy rate back near the zero lower bound. Still-accommodative monetary policies in the G3 and firmer commodity prices should support emerging-market currencies in 2017 but conditions will become more challenging in 2018 19 as Chinese growth slows sharply. Commodities Compliance on the OPEC deal in November to trim oil production by 1.2m barrels/day for six months was estimated at 90% in January. This will help the global market to move into a small deficit in 2017. But in the light of a quicker than expected recovery in US shale oil output, we have shaded down oil price forecasts for 2017 19 but leave forecasts for 2020 21 unchanged. We have raised our 2017 price forecast for industrial raw materials.

World economy: Forecast summary 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Real GDP growth

(%) World (PPP* 3.4 3.4 3.5 3.3 2.9 3.4 3.2 2.9 3.5 3.6 exchange rates) World (market 2.3 2.4 2.6 2.7 2.2 2.5 2.4 2.1 2.6 2.6 exchange rates) US 2.2 1.7 2.4 2.6 1.6 2.3 2.1 1.1 2.0 2.0 Euro area -0.8 -0.2 1.2 2.0 1.7 1.5 1.5 1.4 1.5 1.4 Europe 0.2 0.8 1.8 1.9 1.7 1.6 1.6 1.6 1.8 1.8 China 7.9 7.8 7.3 6.9 6.7 6.2 4.2 4.3 5.2 4.8 Asia and 4.4 4.6 4.1 4.2 4.0 4.0 3.2 3.3 3.7 3.8 Australasia Latin America 3.0 2.8 1.3 0.2 -0.7 1.1 2.0 1.9 2.8 2.9 Middle East & 3.9 2.1 2.6 2.6 2.4 2.6 3.5 3.0 3.7 3.8 Africa Sub-Saharan 4.1 4.7 4.5 2.9 1.1 2.5 3.4 2.9 3.1 3.7 Africa World inflation (%; 4.0 3.8 3.6 3.2 3.8 4.3 3.8 3.0 3.1 3.0 av) World trade 3.5 3.9 4.3 2.8 1.6 2.6 2.7 2.0 2.9 3.1 growth (%) Commodities Oil (US$/barrel; 112.0 108.9 98.9 52.4 44.0 56.0 60.0 59.9 61.3 64.0 Brent)

Country Report March 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 33 Industrial raw materials (US$; % -19.4 -6.8 -5.1 -15.2 -1.9 14.6 -4.9 -3.6 -1.7 3.4 change) Food, feedstuffs & beverages (US$; % -3.5 -7.4 -5.2 -18.7 -3.5 3.1 1.7 0.7 -1.7 1.5 change) Exchange rates

(av) ¥:US$ 79.81 97.56 105.86 121.02 108.76 116.14 105.90 100.48 100.18 99.88 US$:€ 1.29 1.33 1.33 1.11 1.11 1.06 1.07 1.11 1.13 1.15 *PPP=purchasing power parity Source: The Economist Intelligence Unit.

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