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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 2 Political stability 4 Election watch 4 International relations 5 Policy trends 5 Fiscal policy 6 Monetary policy 6 International assumptions 7 Economic growth 7 Inflation 8 Exchange rates 8 External sector 8 Forecast summary

Data and charts 9 Annual data and forecast 10 Quarterly data 11 Monthly data 12 Annual trends charts 13 Monthly trends charts 14 Comparative economic indicators

Summary 14 Basic data 16 Political structure

Recent analysis Politics 19 Forecast updates 23 Analysis Economy 29 Forecast updates 33 Analysis

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

Highlights Editor: Mohamed Abdelmeguid Forecast Closing Date: May 23, 2017 Outlook for 2017-21 Political stability under the reformist president, Hassan Rouhani, who secured a second presidential term in the May election, will be weakened by polarisation between his camp and his conservative opponents. Despite the 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. We expect Iran's fiscal account to record modest (but widening) deficits in 2017 21 as a ramping­up of capital spending is partly offset by rising oil revenue on the back of higher prices (compared with 2015 16) 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. The official rial rate will weaken markedly in 2018, in line with the government's (delayed) plan to merge it with the market rate. The pace of depreciation will then slow, with the rial averaging IR46,821: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 Mr Rouhani was re-elected by a big margin in the presidential election held on May 19th. The president will use his second term to advance his policy agenda based on economic liberalisation and social reform. On May 17th the US administration renewed sanctions relief for Iran. The move reflects an understanding that, given opposition from the major powers in Europe and Asia, the US will not be able (unilaterally) to reimpose the international sanctions against Iran that were lifted following the nuclear deal. Iran has resumed crude oil supplies to the regime of the Syrian president, Bashar al Assad. The development is an indication of how invested Iran is in the regime's survival, given that Syria has yet to pay for previous Iranian supplies. More than 2,000 computers in Iran have been infected by the global outbreak of WannaCry—malware that targets Microsoft Windows operating systems and locks files until a ransom is paid to hackers using digital Bitcoins. Farid Dehdilani, an international adviser at Iran's state-run Privatisation Organisation, has said that his country attracted US$3.6bn in foreign direct investment in fiscal year 2016/17, which ended on March 30th. This is well below the government's target of US$15bn in annual inflows.

Outlook for 2017-21 Political stability The Economist Intelligence Unit expects the moderately reformist president, Hassan Rouhani, to continue with gradual economic liberalisation and social reform in his second presidential term, which he secured in the election held on May 19th. Having gained partial sanctions relief for Iran in 2015, with the signing of the Joint

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 3 Comprehensive Plan of Action (JCPOA) with world powers. Mr Rouhani has deepened his support base among younger and middle-income Iranians aspiring for greater domestic freedom and economic integration with the outside world. The deal is undoubtedly a positive factor for the economy over the long term, although the effect of the agreement on the wider public has yet to trickle down to young Iranians, who will continue to grapple with limited employment opportunities and stagnant real wages, at least in the early years of the forecast period. In addition, there is resistance among vested interests—especially religious foundations and the Islamic Revolutionary Guards Corps (IRGC)—to the present government's notion of increasing competition and transparency as part of fostering a more vibrant private sector. Nonetheless, Mr Rouhani will benefit from the fractious nature of the hardline conservative camp. Mr Rouhani's reformist drive and diplomatic outreach will be threatened both by resistance among hardliners in Iran and by the US presidency of Donald Trump, whose administration is adopting a far more confrontational approach towards Iran than that of his predecessor, Barack Obama. Although Mr Trump has recently renewed sanctions relief for Iran, he has simultaneously agreed to boost the defence capabilities of the country's main rivals in the region—chiefly Saudi Arabia— through major arms deals. (In February Mr Trump also imposed new sanctions on Iran, after the latter conducted missile tests, which the US contends represented a violation of UN Security Council resolutions.) This US stance will encourage Mr Rouhani's opponents in Iran, who fear that the JCPOA might lead to 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 negative approach 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 following Mr Trump's inauguration will result in increased pressure from Iranian hardliners to withdraw from the JCPOA. Nonetheless, we expect Ayatollah Khamenei to stick with the JCPOA, reflecting a desire not to jeopardise rising investment from abroad and a calculation that Iran has an opportunity to isolate the US from other world powers (which are likely to remain committed to the agreement). In any case, the hardliners will continue to interfere in daily decision­making, 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 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. However, the identity of Ayatollah Khamenei's potential successor remains uncertain, with the orientation of the Assembly of Experts—which selects the supreme leader—also unclear; although reformists performed strongly in the February Assembly of Experts 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 90), and so Ayatollah Khamenei's successor will almost certainly come from the next generation.

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 4 Election watch The next legislative election will take place in 2020, followed by a presidential poll in 2021. In both cases, the position of reformists will be tested by the ability of Mr Rouhani to tackle unemployment successfully and improve living standards for low- and middle-income Iranians in the coming years. In contrast, conservative hardliners are likely to campaign strongly on populist economic platforms to boost their chances of electoral success in the future. However, we expect the reformists' agenda for gradual reform to prevail over the populist appeal of their conservative opponents (as demonstrated most recently in the May 19th presidential vote). There will also be increased fighting between reformists and conservative hard liners over the succession of the ailing supreme leader, Ayatollah Khamenei. The main rival to Mr Rouhani in the May presidential vote was Ebrahim Raeisi, a hardline conservative and chair of the foundation that manages the Imam Reza shrine in Mashhad. The elevation of Mr Raeisi to such a prominent public post is widely interpreted as evidence that he is being groomed to succeed Ayatollah Khamenei. Despite his defeat in the presidential election, Mr Raeisi (or another conservative hardliner) is likely to win the backing of important security and religious establishments in Iran for the unelected post of supreme leader.

International relations Iran's foreign policy priorities will remain focused on cementing the diplomatic gains it achieved after the lifting of nuclear-related sanctions in the face of a more hostile US administration. Further, a US cruise missile strike on a Syrian airbase in early April is also likely to heighten tensions between Iran and the US—particularly if Iran decides to respond by stepping up its military assistance to the regime of Bashar al Assad in Syria. Consequently, Mr Rouhani will be wary of adopting a dovish stance in the face of a more confrontational US administration, as well as strong pressure from hardliners within Iran. He will therefore occasionally adopt more hawkish positions—as seen in a series of tit­for­tat retaliatory measures against the US in recent months, in response to new sanctions imposed by that country. Seeking to counter increased US and Gulf Arab assistance to the anti- Assad rebels in Syria, Iran resumed crude oil supplies to the regime of the Syrian president in late May, while Iranian-backed militias continue to fight alongside his troops across the country. Nonetheless, given opposition from the major powers in Europe and Asia, we do not believe that the US would be able to reimpose the international sanctions against Iran that were lifted following the JCPOA, 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). As a result, we expect that Mr Rouhani's diplomatic approach and moderate image, combined with Iran's obvious economic appeal, will continue to attract 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. Mutual distrust and differing positions on the wars in Yemen and Syria will keep Iranian ties with Saudi Arabia, in particular, frosty, and will ensure that both sides remain closely involved in both conflicts. 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 June 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 to attract 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 cumber some approval 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. 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 influential groups, notably the IRGC and the bonyads (politically powerful Islamic "charities" that run large business conglomerates), 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 Macroeconomic stabilisation was the main economic theme of Mr Rouhani's first four years in the presidency (2013-17). Now, faced with heightened expectations among the electorate, Mr Rouhani may need to prioritise economic growth over fiscal discipline, with the aim of creating employment opportunities for young Iranians. This is a central assumption in our fiscal balance forecast, which envisages larger fiscal deficits in the coming years on the back of greater government spending on capital projects. However, the shortfall will remain manageable, as indicated by government spending plans laid out in the budget for fiscal year 2017/18 (March 21st-March 20th), which envisage a real spending increase of less than 2%; the deficit should therefore remain relatively modest in 2017/18, at 2.3% of GDP. We expect the focus of spending cuts to shift steadily from investment (capital spending was almost two-thirds below budget in the first nine months of 2016/17) to the current 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 3% of GDP a year in 2018/19 2021/22. In response, the government will seek to strengthen non­oil revenue, including by further increasing 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 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 June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 6 Monetary policy Reflecting a sharp slowdown in inflation in 2016, which pushed up real interest rates (known locally as "profit rates"), Bank Markazi (the central bank) has shifted towards a more expansionary monetary stance. In a bid to support the economic recovery, the authorities have cut bank reserve requirements from 13% to 10% and stepped up the pressure on banks to increase their lending to small and medium- sized enterprises. Nonetheless, with inflation set to rise again in 2017 (and US rates also on an upward trajectory), the scope for further near-term monetary relaxation is limited. Instead, the ongoing pick-up in economic growth in the final two years of the forecast period will afford the central bank an opportunity to lift the key policy rates again, to bring inflation under control.

International assumptions 2016 2017 2018 2019 2020 2021 Economic growth (%) US GDP 1.6 2.0 2.1 1.0 2.0 2.0 OECD GDP 1.7 1.9 1.7 1.3 1.7 1.9 World GDP 2.3 2.6 2.4 2.1 2.5 2.7 World trade 2.0 3.0 2.7 2.3 3.1 3.3 Inflation indicators (% unless otherwise indicated) US CPI 1.3 2.5 2.1 1.3 1.7 1.9 OECD CPI 1.0 2.3 1.9 1.6 1.9 1.9 Manufactures (measured in US$) -1.8 0.7 2.5 6.1 4.1 4.7 Oil (Brent; US$/b) 44.0 54.2 55.1 54.8 60.0 63.8 Non-oil commodities (measured in US$) -3.0 6.8 0.2 -1.6 -1.4 2.2 Financial variables US$ 3-month commercial paper rate (av; %) 0.5 1.0 1.5 0.8 0.2 0.5 Exchange rate IR:US$, official rate (av) 30,915 32,770 36,964 40,291 43,555 46,821 Exchange rate US$:€ (av) 1.11 1.07 1.08 1.11 1.13 1.15

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 7 Economic growth Iranian growth is set to surpass that of most of the Middle East region during the forecast period, lifted initially by further increases in oil exports and sub sequently by an upturn in inward investment. Although the Trump presidency could theoretically jeopardise such investment, we expect that Iran's continued adherence to the JCPOA should keep EU, Russian, Indian, Chinese and South Korean firms engaged. As a result, we maintain our outlook for a gradual increase in economic growth rates (relative to the first four years under Mr Rouhani), driven by investments in infrastructure, which will provide 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; output at the South Pars field is already set to rise sharply in 2017 following the inauguration of phases 17 21. 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 an economic "hard landing" in China (and an accompanying drop in oil prices). We expect the oil sector to contribute positively to real GDP growth over the forecast period. Despite the oil production cut agreed by OPEC in November 2016, Iran managed to secure consent to increase its production; we there fore expect Iran's oil output to rise slightly to 3.86m barrels/day (b/d) in 2017/18. Although the pace of production growth is set to slow (compared to 2016), given the age of the country's major fields and our expectation that the OPEC cut agreement will remain in place throughout 2017, Iran's 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 2.1 4.9 6.1 5.8 6.3 6.4 Government consumption -0.4 4.0 5.2 5.0 5.4 5.8 Gross fixed investment 5.0 9.7 11.1 7.0 7.1 7.7 Exports of goods & services 18.0 9.5 6.2 5.6 6.0 6.6 Imports of goods & services 15.9 15.0 11.9 8.0 8.6 9.7 Domestic demand 2.2 5.3 6.5 5.4 5.9 6.3 Agriculture 1.0 2.0 1.7 1.5 1.2 1.3 Industry 5.1 6.9 5.6 4.3 4.5 5.0 Services -0.7 4.7 6.7 6.3 7.0 7.2 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts.

Inflation Having declined to single digits in 2016, because of easing trade bottlenecks and lower foodstuff costs, inflation is expected to accelerate once more in 2017, to an average of 12.7%. The increase largely reflects, among other things, a rebound in food prices. Inflation will edge up further in 2018, to 13.5%, as a weakening of the official rate of the rial (on the back of the planned abolition of the current dual exchange­rate system) pushes up import costs. Subsequently, and notwith standing a small dip in consumer price growth in 2019 (reflecting renewed commodity price weakness), we expect inflation to average 11.3% in 2019 21, as the impact of a more stable exchange rate is offset by rising demand-pull inflation.

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 8 Exchange rates The market exchange rate of the Iranian rial plunged in late December 2016, to IR41,500:US$1 (from around IR36,500:US$1 in November), amid speculation surrounding new US sanctions and uncertainty relating to plans to end the rial's current dual exchange rate. Bank Markazi has since succeeded in stabilising the currency market (helped by partial sanctions relief), partly through an injection of additional liquidity but also through its decision to delay the unification of the official and open-market exchange rates (originally due to take place on March 20th) until February 2018. The postponement reflects the central bank's view that a strengthening in correspondent banking relations is first needed. However, the phasing-out of the dual exchange rate in 2018 will result in a sharper slide in the rial in that year, to an average of IR36,964:US$1. As inflation then stabilises and inward investment picks up, we expect the pace of depreciation to ease, with the average rate of the rial reaching IR46,821: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 2.8% of GDP in 2017 21.

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) 40,452 48,041 49,435 52,142 56,949 58,619 Consumer price inflation (av) 8.6c 12.7 13.5 11.5 11.1 11.3 Consumer price inflation (end-period) 9.2c 13.1 12.5 11.3 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) -2.7 -2.3 -2.3 -2.8 -3.2 -3.5 Exports of goods fob (US$ bn) 81.6 93.8 98.8 104.7 113.5 119.7 Imports of goods fob (US$ bn) 60.5 70.5 79.3 85.8 94.3 104.5 Current-account balance (US$ bn) 17.6 17.6 12.6 10.8 11.5 7.2 Current-account balance (% of GDP) 4.3 3.9 2.7 2.1 2.1 1.2 External debt (end-period; US$ bn) 8.1 10.4 12.2 13.6 15.5 17.8 Exchange rate IR:US$ (av) 30,915c 32,770 36,964 40,291 43,555 46,821 Exchange rate IR:US$ (end-period) 32,376c 34,031 39,247 42,051 45,315 48,581 Exchange rate IR:¥100 (av) 28,425c 28,925 33,479 39,023 43,479 46,821 Exchange rate IR:€ (end­period) 34,128c 36,754 42,976 47,097 51,659 56,840 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual.

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 9 Data and charts Annual data and forecast

2012a 2013a 2014a 2015a 2016b 2017c 2018c GDP Nominal GDP (US$ m) 603,012 539,468 443,958 393,436 409,541 452,628 474,317 Nominal GDP (IR trn) 7,342 9,934 11,517 11,414 12,661 14,833 17,533 Real GDP growth (%) -5.6 -1.9 4.3 -1.3 4.6 5.4 5.9 Expenditure on GDP (% real change) Private consumption -1.9 -1.0 3.1 -5.6 2.1 4.9 6.1 Government consumption -8.5 1.6 2.7 10.0 -0.4 4.0 5.2 Gross fixed investment -21.9 -6.9 3.5 -5.9 5.0 9.7 11.1 Exports of goods & services -20.5 0.0 12.0 -2.8 18.0 9.5 6.2 Imports of goods & services -23.1 -18.7 -5.7 -16.7 15.9 15.0 11.9 Origin of GDP (% real change) Agriculture 3.7 4.7 3.8 8.2 1.0 2.0 1.7 Industry -20.5 -5.1 4.9 2.6 5.1 6.9 5.6 Services 1.1 -1.5 2.4 0.8 -0.7 4.7 6.7 Population and income Population (m) 76.2 77.2 78.1 79.1b 80.0 80.9 81.8 GDP per head (US$ at PPP) 17,307 17,484 18,150 17,890b 18,744 19,993 21,425 Recorded unemployment (av; %) 12.2 10.4 10.3b 10.5b 10.7 10.0 9.7 Fiscal indicators (% of GDP) Public-sector revenue 13.6 13.4 14.0 15.7 18.7 18.3 17.9 Public-sector expenditure 14.2 14.3 15.1 17.5 21.4 20.6 20.3 Public-sector balance -0.6 -0.9 -1.1 -1.7 -2.7 -2.3 -2.3 Net public debt 10.7 9.7 9.9 12.3 14.3 15.1 15.7 Prices and financial indicators Exchange rate IR:US$ (av) 12,176 18,414 25,942 29,011 30,915a 32,770 36,964 Exchange rate IR:US$ (end-period) 12,260 24,774 27,138 30,130 32,376a 34,031 39,247 Consumer price inflation (av; %) 26.0 39.3 17.2 13.7 8.6a 12.7 13.5 Stock of money M1 (% change) 26.7 10.5 7.1 0.2 33.0a 14.0 13.0 Stock of money M2 (% change) 32.0 28.1 34.8 24.6 28.1a 25.3 18.3 Lending interest rate (av; %) 11.0 11.0 14.0 14.2 13.0 13.0 12.5 Current account (US$ m) Trade balance 28,562 29,326 18,061 12,178 21,106 23,237 19,543 Goods: exports fob 97,296 92,910 88,976 64,597 81,650 93,770 98,823 Goods: imports fob -68,734 -63,584 -70,915 -52,419 -60,544 -70,534 -79,280 Services balance -7,360 -6,820 -6,878 -4,472 -5,814 -7,575 -8,809 Income balance 1,649 2,034 1,845 764 1,779 1,536 1,469 Current transfers balance 509 565 543 547 492 448 399 Current-account balance 23,362 25,105 13,571 9,016 17,563 17,646 12,601 External debt (US$ m) Debt stock 7,406 7,006 5,441 6,321 8,097 10,428 12,179 Debt service paid 601 439 501 820 905 947 1,275 Principal repayments 446 396 463 742 802 821 1,125 Interest 155 43 38 79 103 126 150 International reserves (US$ m) Total international reserves 104,650b 107,950b 111,029b 115,994b 133,701 132,551 142,551 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. Source: IMF, International Financial Statistics.

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 10 Quarterly data 2015 2016 2017 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Central government finance (IR

bn)a Revenue 293,200452,600416,400 635,000 255,500 580,900 n/a n/a Expenditure 359,590478,600436,000 709,700 370,200 703,100 n/a n/a Balance -66,390 -26,000 -19,600 -74,700 -114,700 -122,200 n/a n/a Output GDP at constant 2004/05 prices (IR bn) n/a n/a n/a n/a n/a n/a n/a n/a GDP at constant 2004/05 prices (% n/a n/a n/a n/a n/a n/a n/a n/a change, year on year) Prices Consumer prices (2011=100) 222.3 224.9 229.1 233.5 238.3 245.1 250.1 258.5 Consumer prices (% change, year on 16.3 12.8 10.1 8.9 7.2 9.0 9.2 10.7 year) Wholesale prices, general (2000=100) n/a n/a n/a n/a n/a n/a n/a n/a Wholesale prices, general (% change, n/a n/a n/a n/a n/a n/a n/a n/a year on year) Financial indicators Exchange rate IR:US$ (av) 28,641 29,754 30,014 30,195 30,404 31,113 31,948 n/a Exchange rate IR:US$ (end-period) 29,319 29,956 30,130 30,260 30,700 31,460 32,37632,422 M1 (end-period; IR trn)b 1123.701180.201158.10 1367.00 1364.40 1480.30 1540.70 n/a M1 (% change, year on year) -2.0 -1.7 0.2 13.2 21.4 25.4 33.0 n/a M2 (end-period; IR trn)b 8166.608727.509251.7010172.8010595.0011227.1011848.60 n/a M2 (% change, year on year) 22.7 23.5 24.6 30.0 29.7 28.6 28.1 n/a Sectoral trends Crude oil production (m barrels/day) 2.87 2.89 3.16 3.59 3.65 3.78 3.79 3.75 Crude oil prices (US$/barrel) OPEC basket 59.89 48.35 39.71 30.14 42.39 43.00 47.52 52.03 Iranian Heavy n/a n/a n/a n/a n/a n/a n/a n/a Balance of payments (US$ m)a Exports fob 17,680 15,936 16,768 14,213 18,905 19,239 n/a n/a Oil & gas 10,633 9,432 7,028 6,476 11,640 13,167 n/a n/a Imports fob 12,902 13,171 12,510 13,836 12,383 15,112 n/a n/a Trade balance 4,778 2,764 4,259 377 6,522 4,127 n/a n/a Current-account balance 3,947 2,189 3,817 -937 5,231 3,459 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 June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 11 Monthly data Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exchange rate IR:US$ (av) 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 2017 32,367 32,386 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Exchange rate IR:US$ (end-period) 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 2017 32,366 32,403 32,422 32,293 n/a n/a n/a n/a n/a n/a n/a n/a M1 (% change, year on year) 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 26.3 32.0 2017 26.9 22.6 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a M2 (% change, year on year) 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 26.4 32.0 2017 26.9 22.6 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Deposit rate (av; %) 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 12.8 12.8 2017 12.7 12.7 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Lending rate (end-period; %) 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 18.0 18.0 2017 18.0 18.0 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Consumer prices (av; % change, year on year) 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 2017 9.6 10.6 11.9 12.6 11.8 n/a n/a n/a n/a n/a n/a n/a Sources: IMF, International Financial Statistics; Haver Analytics.

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 12 Annual trends charts

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

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 14 Comparative economic indicators

Basic data Total area 163.6m ha Population 73.6m (2010, Statistical Centre of Iran)

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 15 Towns with populations in excess of 500,000 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; IR30,915:US$1 (2016 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: 2020 (legislative); 2021 (presidential) The supreme leader (rahbar) Ayatollah Ali Khamenei Head of state

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 17 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 subsequently won a second four-year term in the May 2017 election 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 June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 18 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.

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 19 Politics Forecast updates May 15, 2017: International relations Inaugural Belt and Road Forum held in Beijing Event On May 14th the Chinese president, Xi Jinping, addressed the inaugural Belt and Road Forum (BRF) for International Co-operation in the capital, Beijing. Analysis The hosting of the high-profile event underlines China's seriousness about its push to deepen regional trade and investment links. The forum is meant to represent a scaling up of China's diplomatic trade initiative, known as the Silk Road Economic Belt and 21st Century Maritime Silk Road (Belt and Road Initiative, BRI, formerly called One Belt, One Road). Launched by Mr Xi in 2013, the project aims to integrate and develop countries economically along ancient trading routes linking China with the world, mainly through building physical infrastructure. In his speech, Mr Xi called it "the project of the century". Mr Xi promised additional loans and grants of around Rmb540bn (US$77.1bn) for the initiative at the BRF. The China-based Silk Road Fund, set up in 2014 with capital of US$40bn, will receive Rmb100bn for renminbi-denominated lending, while China's major policy banks, China Development Bank and Export-Import Bank of China, will provide the equivalent of Rmb250bn and Rmb130bn, respectively, in financing to projects across BRI countries over an unspecified timeline. Mr Xi also said that Rmb60bn in aid would be provided for "livelihood projects" included in the BRI. Besides financing, announcements at the BRF showed that China is looking to build some governance architecture around BRI. It will set up a mechanism to facilitate high-level co-ordination, as well as dedicated centres for finance and economics development, construction promotion and multilateral development financing collaboration. These steps will only partially ease international concerns about the transparency of the initiative. Separately, several bilateral trade and investment deals were signed on the sidelines of the BRF. To date, the BRI has been more rhetoric than action, but the high-level political support on display at the BRF suggests that the Chinese government will push the initiative aggressively. There are significant risks, given often unstable operating environments in the more than 60 countries in the BRI and the likelihood of low returns on several projects. However, Mr Xi's government has clearly decided that the potential benefits of the scheme—geopolitical as well as economic—are worth bearing. This promises a significant boost in the financing available for infrastructure development across the region. Impact on the forecast We will be adjusting our forecasts to assume a faster pace of BRI implementation. Nevertheless, political tensions between China and its neighbours will persist.

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May 17, 2017: Election watch Ghalibaf withdraws from presidential race Event The mayor of Tehran, Mohammad Bagher Ghalibaf, has announced his withdrawal from the upcoming May 19th presidential race. Analysis The withdrawal of Mr Ghalibaf will help consolidate the "principlist" (hardline conservative) vote in the May election and could diminish the chances of the centrist, incumbent president, Hassan Rouhani, of winning a second term. Mr Ghalibaf's statement on his withdrawal called for "the unity of conservative camp and asked his supporters to back Ebrahim Raeisi. The latter was appointed only last year by the supreme leader, Ayatollah Ali Khamenei, to chair the foundation managing the Imam Reza shrine in Mashhad and poses the biggest challenge to Mr Rouhani in the presidential race. Having two main candidates has strengthened the principlist message, and although there are three others left in the race—including, at least for now, Mr Rouhani's first vice­president, Eshaq Jahangiri—the election now boils down to a relatively clear choice. Mr Rouhani has promised continued international engagement—based partly on the 2015 nuclear agreement with world powers, attracting foreign investment and developing a vibrant domestic private sector. Meanwhile, Mr Raeisi has promised to triple cash payments to poorer Iranians and create 6m jobs. He has also criticised the high pay enjoyed by technocrats linked to Mr Rouhani's government and promoted resistance (against international pressure on Iran's nuclear programme) and self-sufficiency. In any case, Mr Ghalibaf's withdrawal comes just days before the May 19th vote, with polling, although unreliable, suggesting that Mr Rouhani leads his main challengers. Support for Mr Rouhani from the former reformist president Mohammed Khatami, and more recently from Mehdi Karroubi—one of the Green Movement leaders under house arrest since the social unrest of 2009—will boost middle­class support for the incumbent president. In contrast, Mr Raeisi's populism may appeal to poorer Iranians disappointed by limited economic progress since the 2015 nuclear agreement—recorded unemployment is 12%—and as chair of the foundation managing the Imam Reza shrine he can tap into clerical networks and others linked to the Revolutionary Guards. Impact on the forecast Mr Ghalibaf's withdrawal strengthens that position of Mr Raeisi in the upcoming vote. However, we retain our forecast that Mr Rouhani will win the election, helped by the popularity of the 2015 nuclear deal and endorsement from other influential reformist figures.

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May 22, 2017: Political stability Rouhani comfortably wins presidential election Event The incumbent president, Hassan Rouhani, was re-elected for a second term in the May 19th presidential election. Analysis Mr Rouhani won with 57% of votes cast, sweeping aside three challengers. The re election will enable him to continue his efforts to introduce economic reform, attract foreign investment and improve Iran's relations with the outside world. Mr Rouhani's arguments for cautious change prevailed over the populist appeal of his opponents—especially Ebrahim Raeisi, the hardline conservative and chair of the foundation managing the Imam Reza shrine in Mashhad—arguing for bigger handouts and subsidies for poorer Iranians. In his first term, Mr Rouhani enjoyed better relations with both the supreme leader, Ayatollah Ali Khamenei, and parliament than his two immediate predecessors, the reformist Mohammed Khatami and the hardline Mahmoud Ahmadinejad. He will now use his second term to take forward economic reforms designed to strengthen central bank independence, tighten fiscal and monetary control, boost a private sector undermined by both international sanctions and past government policies, and create a regulatory environment more attractive to would be foreign investors. Nonetheless, Mr Rouhani will continue to face powerful opponents, including clerics suspicious of his international outreach and vested interests like religious foundations and the Islamic Revolutionary Guards Corps. Internationally, the president faces a more activist Saudi foreign policy—including in Yemen and Syria, and an unprecedented arms build up by his Gulf Arab neighbours. Coinciding with his election victory, the US president, Donald Trump, has signed a US$350bn, ten year arms agreement during his visit to Saudi Arabia. In contrast to the US's approach towards Iran, the warm welcome for Mr Rouhani's re election from Federica Mogherini, the EU's high representative for foreign affairs and security policy, reflects Europe's commitment to the 2015 nuclear deal. Russia and China are also committed to the deal, and are wary of US attempts to criticise Iran for its ballistic missile programme—which they judge does not violate UN resolution 2231. In any case, despite Mr Rouhani's re election, US sanctions and uncertainly over Mr Trump's policy towards Iran will all contribute to the wariness of international companies, including energy majors, as they consider whether to go ahead with proposed investments. Impact on the forecast We had forecast Mr Rouhani re-election and therefore our political and economic forecasts will remain unchanged. We continue to expect gradual economic liberalisation in Iran, although vested interests in the state bureaucracy and the religious establishment will work to undermine Mr Rouhani's efforts on social and political reform.

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May 24, 2017: International relations US extends Iran sanctions waivers Event On May 17th the Trump administration renewed sanctions relief for Iran. Analysis The Trump administration's extension of the waiving of certain sanctions— including those on third-party oil purchases through Bank Markazi (the central bank)—against Iranian institutions maintains the US's adherence to the 2015 nuclear agreement between Iran and world powers (which led to a lifting of UN sanctions) while the administration continues a review of Iran policy. However, coinciding with the extension of waivers on Iran, the US president, Donald Trump, travelled to Saudi Arabia—Iran's main regional rival—where he signed a historic ten year weapons deal, worth US$350bn, aimed at boosting the kingdom's defence capabilities. Mr Trump has struggled for a coherent approach after heavily criticising the 2015 nuclear deal during his election campaign. His secretary of state, Rex Tillerson, recently confirmed Iran's compliance with the deal, but the administration's review is also looking at ways to counter Iranian (military) influence in the region. All the other nuclear deal signatories—Russia, China, the UK, France and Germany, as well as Iran—want to maintain the agreement, whose success depends on separating the nuclear programme from other issues. The US argues that Iran's ballistic-missile programme contravenes UN Resolution 2231, but Iran, China and Russia have clearly rejected this on the grounds that the missiles tested by Iran are not designed to carry nuclear warheads. The US State Department has also issued a report criticising Iran over human rights, an argument that carries little weight internationally, both because it is regarded as "interference" and because the US does not apply similar penalties on its allies, including Saudi Arabia and Israel. In any case, although the US cannot on its own tear up the multilateral nuclear agreement, uncertainties over policy are deterring would-be investors from Iran. In December the US granted a waiver for a US aircraft maker, Boeing, to sell 80 passenger aircraft to Iran Air for US$16.6bn, but many companies are pausing before acting on Memorandums of Understanding. In what is in effect a test case, France's Total has said that it will decide this summer whether to go ahead with a US$2bn project for phase 11 of Iran's massive South Pars gasfield. Impact on the forecast The recent developments support our international relations forecast that, given opposition from the major powers in Europe and Asia, the US will not be able to reimpose the international sanctions against Iran that were lifted following the nuclear deal. Our forecast therefore remains unchanged.

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May 26, 2017: International relations Gulf disputes spill over into Egypt Event The Egyptian authorities have launched a crackdown on opposition political figures and sections of the media. Analysis The arrests of politicians and the blocking of news websites appear to be related to renewed tensions in the Gulf between Saudi Arabia and the UAE on one side and Qatar on the other. Among the political figures to have been arrested is Khaled Ali, a lawyer who stood for president in the 2014 election and who has played a prominent role in legal challenges to the government conferring sovereignty over two Red Sea islands to Saudi Arabia. Mr Ali has been ordered to appear in court to face charges of public indecency. This is thought to relate to public gestures he made after a court ruling in favour of his challenge to the islands deal. In October 2016 Saudi Arabia suspended fuel supplies in what was widely interpreted as a sign of displeasure with the legal obstructions in Egypt to the islands deal. However, relations have improved since the start of 2017 as the Egyptian parliament has sought to push the agreement through. Meanwhile, relations among the Gulf states have soured after Qatari media reported statements attributed to the country's ruler, Sheikh Tamim bin Hamad al Thani, criticising the US president, Donald Trump, for his hostile remarks towards Iran during a recent official visit to Saudi Arabia. The Egyptian government was also incensed by the statement's alleged support for Islamists. The Qatari government claimed that the ruler's statements had been put out by hackers, but this explanation was ridiculed by authorities in Egypt, Saudi Arabia and the UAE—all of whom have placed restrictions on Qatari news outlets. Meanwhile, the Egyptian authorities may have also exploited the recent developments as an opportunity to silence domestic opposition to the government. Following the Saudi and UAE actions, media reports said that about 20 news websites in Egypt had been blocked—including the Qatari government­owned Al Jazeera. Impact on the forecast We had already highlighted that divergent views on regional conflicts mean that sporadic rifts will continue to erupt between Qatar on the one hand and fellow Gulf Arab states and Egypt on the other. We expect the Qatari authorities to act swiftly to mend fences with Saudi Arabia and the UAE (with no guarantee that cordial ties in the future will last), although relations with Egypt will remain tense throughout the forecast period. Our forecast remains unchanged.

Analysis May 18, 2017 Progress and next steps for China's Belt and Road Initiative An ambitious blueprint for the region, China has championed its Belt and Road Initiative (BRI) as a vehicle for Chinese-led integration and development. To date, the project has been long on rhetoric and short on implementation, with related economic activity showing little sign of a step change. That will change in the coming years, but The Economist Intelligence Unit still believes that several implementation obstacles mean that the project is likely to fall short of its grand

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 24 ambitions. On May 14th–15th, with 29 heads of state in attendance, China convened the inaugural Belt and Road Forum (BRF) for International Co-operation to promote its flagship diplomatic trade initiative. The BRI (previously known as "One Belt, One Road"), a loosely defined framework comprising China and over 60 countries, is composed of an overland "Silk Road Economic Belt" linking China to Europe via Central Asia and the Middle East, alongside a "21st Century Maritime Silk Road" connecting China to Europe via South-east Asia, South Asia and East Africa. Chinese state media have invoked poetic parallels between the BRI and the ancient Silk Road, when the Ming dynasty was at the centre of world trade and commerce. The Chinese president and chief champion of the project, Xi Jinping, has presented the BRI as an antidote to rising global protectionism, labelling it "the project of the century". Limited trade impact, deficit risk Despite high-level Chinese support for the BRI, the economic impact of the project has been muted to date. Since Mr Xi first proposed the BRI in 2013, we discern no dramatic shift in the make-up of China's global trade relations. In terms of merchandise trade, two-way flows between China and the 65 countries that the Chinese government has identified as belonging to the BRI have remained fairly constant. In 2016 two-way trade reached US$962.6bn, accounting for 25.8% of China's external trade. This number has remained largely stable in the years since 2013, when the BRI was first announced, hovering around 25%. In the first quarter of 2017 this proportion rose to 26.7%. China's exports to BRI countries have performed better than imports. The BRI countries' share of the value of Chinese exports stood at 27.9% in 2016, compared with 25.8% in 2013. They did not grow strongly over that period—by only 1.8% a year on average in 2014–16—but have held up better than China's exports to other parts of the world. Imports from BRI countries comprised 23% of China's inbound shipments in 2016, a slide from 24.1% in 2013—they declined by an annual average of 7.5% in 2014–16.

The slippage in the proportion of China's imports from BRI countries reflects softer Chinese demand for commodities and lower global prices for such items. Exports from BRI countries, which are mainly developing economies, are dominated by natural resources, but growth in Chinese domestic investment is slowing steadily. Future Chinese demand will be driven more by the needs of households and advanced manufacturing; however, the consumer goods and capital equipment they seek will generally be exported by developed economies not within the BRI.

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 25 For Chinese exports, the rising share heading to the BRI region may confirm suspicions that the initiative is designed to help to export China's industrial overcapacity. Rising demand in fast-growing developing economies clearly presents opportunities for Chinese metals, building materials and construction equipment firms, particularly in the light of weaker domestic activity in such sectors. Chinese firms engaged in BRI projects will also lean heavily on local suppliers. As such, there is a risk that the already-large goods trade surplus China maintains with the BRI region could rise significantly. In 2016 China had an accumulated trade surplus of US$231.8bn with the BRI countries (by comparison, China's surplus with the US ran to US$250.7bn). A failure to lower the surplus could eventually compromise the viability of the BRI, as it will stoke political and economic concerns. China appears sensitive to the issue and has pledged to host an "import trade expo" for BRI countries looking to export to the country in 2018. Investment has underwhelmed Promises of Chinese investment may help to offset concerns about the trade deficit. On this front, there has been a more telling step change since the BRI was launched in 2013. China's total overseas direct investment (ODI) in BRI countries accelerated to US$21.4bn in 2015, up strongly from US$13.6bn in 2014 and US$12.6bn in 2013. It is worth nothing that partial data on ODI from 2016 show a 2% decline in non- financial ODI across the BRI. Nevertheless, there is also less here than there appears on the face of it. Over 60% of Chinese ODI flows to BRI countries in 2013–15 were directed to Association of South-East Asian Nations (ASEAN) countries, with Singapore attracting by far the largest share. That investment is unlikely to be related to the core infrastructure- development purpose of the BRI, and will have more to do with the attractions of the Singaporean business environment. Moreover, the share of overall Chinese ODI flows heading to the BRI region has actually fallen in recent years. We estimate that these flows amounted to 10.2% of China's total ODI in 2016, compared with 14.7% in 2015 and 11% in 2014. There have been much stronger rises in Chinese investment in developed markets in North America and Europe over the same period, with Chinese firms acquiring brands and technology in a bid to raise their competitiveness and invest in perceived safe assets, notably property. Caution about investment in the BRI region is understandable. Operating environments in many of the countries are challenging. Chinese banks are already facing a rise in non-performing loans tied to their domestic lending; they may not want to risk a further deterioration in their balance sheets by lending to firms investing in the BRI region. Similar concerns pertain to loans to BRI country governments with high-risk sovereign profiles. The receptiveness of host countries to Chinese ODI may have also been a factor in constraining investment. China-backed overseas infrastructure projects have proved politically controversial in several countries, especially if they rely largely on Chinese subcontractors and labour. In Kazakhstan, the government was forced to abandon plans in 2016 to allow increased foreign involvement in the agricultural sector following nationalist protests, which appeared to be motivated by fears that the reforms would allow Chinese investors to acquire agricultural land. Concessional lending has accelerated In contrast to weak trade and investment figures, there has been a meaningful rise in contracted projects involving Chinese firms in BRI countries. Most of these projects are supported by Chinese concessional loans financed by the Export-Import Bank of China (China EXIM Bank). Such loans offer discounted financing in return for negotiated benefits, such as guarantees on project tenders or importing Chinese labour and capital. Loans may also be granted as part of resource swaps or sovereign guarantees.

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Turnover from completed contracted projects signed in 2016 between China and BRI countries grew by 9.7% to US$75.9bn, according to the Chinese Ministry of Commerce. Contracts in BRI countries account for almost 50% of China's total turnover in overseas contracting projects. The pipeline also appears strong: the value of newly signed foreign contracting projects in BRI countries rose by 36%, to US$126bn, in 2016.

Data on contracted projects serve as a proxy for figures on concessional lending, which are sensitive and largely unavailable. Sporadic data from 2014 provided by China EXIM Bank shows outstanding concessional loans standing at Rmb252.2bn (US$41bn). We estimate that these loans expanded at an average rate of 20% a year in 2004–14, despite low rates of repayment. This has increased the level of risk in local investment projects, particularly in countries with poor economic management. Push coming, but may fall short of grand ambitions Although the above largely suggests that the BRI has been more rhetoric than action to date, there will clearly be a big push behind the programme in the coming years. Commitments at the BRF made by Mr Xi, where he outlined additional loans and grants of around Rmb540bn for the BRI, suggest that investment will be more forthcoming. In Pakistan alone, Chinese investment of around US$57bn has been promised in the China-Pakistan Economic Corridor. The BRI region is therefore promised a significant boost in the financing available for infrastructure development in the coming years. We think that these investments will underpin higher trade volumes between China and the region. Besides trade in relation to project work, the establishment of a more integrated infrastructure will help to stimulate crossborder flows by lowering costs and opening up new markets. In turn, stronger trade flows will underpin GDP growth and fiscal revenue creation. Despite being a promising initiative that we think is set to deliver regional economic benefits, we still believe that the BRI will fall short of its grand—although admittedly vague—aspirations. Issues relating to the trade deficit, credit risk and political tensions will complicate implementation. Ultimately, Mr Xi has pushed through the high-risk strategy because he sees both economic and political dividends for China. However, the perception that the project has a geopolitical dimension may ultimately make other countries hesitant to participate.

May 19, 2017 Syria slides towards de facto partition

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 27 The agreement reached in Astana, Kazakhstan, in early May between Russia, Iran and Turkey on the creation of four "de-escalation" zones was aimed ostensibly at reducing the overall levels of violence in Syria and opening the way for meaningful negotiations between the regime of the Syrian president, Bashar alAssad, and opposition groups on a political settlement. However, the deal also reflects the readiness of these three external actors to accept a de facto partition of Syria into spheres of influence, including zones where other outside forces, notably the US, Jordan and Iraq, could play roles in security and governance with local allies. The four de-escalation zones are a rebel-held area in the north-west corner of the country, comprising Idlib governorate and parts of Aleppo and Hama governorates; a small rebel-held enclave north of Homs; eastern Ghouta, on the fringes of Damascus; and a segment of Daraa governorate, along the border with Jordan. The co-sponsors have indicated that these zones will be spared bombardment, with the exception of areas controlled by al Qaida­affiliated groups or Islamic State (IS), and that the three external powers will act as guarantors of the de-escalation. Will it hold? The likelihood of the proposed de-escalation deal succeeding for a prolonged period appears slim. The opposition groups that attended the Astana talks have expressed major reservations about the plan, while Mr Assad has also not yet formally endorsed it—although he said in a television interview broadcast on May 11th that anti-jihadi groups should take advantage of the plan to drive al-Qaida- affiliated forces out of their areas and seek reconciliation with the government. This also highlights another issue with the Astana talks. Not only were al Qaida linked groups not invited to Astana but some, in particular Hayat Tahrir al Sham (HTS), are prominent in parts of the proposed de-escalation zones, meaning fighting will continue to some degree. Assad benefits For Mr Assad, this initiative provides an opportunity for him to consolidate his control over the country's main urban centres and the transport links between them, while strengthening his hand in the (extremely unlikely) bid to reassert state control over the entire country. Under the guise of the de-escalation plan, Mr Assad has made some small but significant gains on the ground. The process of transferring the population of the Al Waer district of Homs, the last remaining rebel-held area in the city, to Jarablus, a border town controlled by Turkish-backed rebel groups, has gathered pace. Government forces have also taken back the Qabun area abutting eastern Ghouta, exploiting a breach between the dominant faction, Jaish al Islam, and HTS over the former's participation in the Astana talks. Elsewhere, government forces have taken advantage of the lull on some fronts covered by the de-escalation plan by directing their energies to other areas. These include IS­held Deir al Zour, which is also being targeted by the Syrian Democratic Forces (SDF), a Kurdish-dominated, US-backed force that is putting pressure on IS in the north, around Raqqa, and in the southern Hasakah governorate, to the north- east of Deir al Zour. One of the concerns of the Syrian regime and its international allies, Russia and Iran, is the expansion of SDF/US zones of influence in northern and eastern Syria once the dominion of IS has been ended. These areas contain significant natural resources, including phosphate mines over which Iran has been granted a long-term lease, and Iran is thought to harbour ambitions to exert control over a land route linking its territory to the Mediterranean, via Iraq and eastern Syria. As a result, the area is likely to be the location of renewed fighting between rebel and regime forces once IS is territorially defeated—something we expect in late 2017 to early 2018—with international tensions escalating between the Russian­ Iranian axis, Turkey and the US. However, while the regime is using the offensives and local deals in Deir al Zour, Homs and the eastern Ghouta to try to extend its area of control, it is not yet clear whether Mr Assad has resolved to pursue a similar goal in the largest de-escalation

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 28 zone around Idlib, in the north-west. This zone serves a useful purpose in absorbing Syrians displaced from other areas as part of local deals. Mr Assad's remarks about reconciliation and rising up against jihadis suggest that he is probably pinning his hopes on conflict erupting between HTS and other rebel groups that could in turn open the way for a reassertion of regime control. Moreover, if HTS does start to exert greater control over the area, by confronting other rebel groups, it would work in Mr Assad's favour, given the international consensus against the al Qaida linked group. However, the local population predominantly remains strongly opposed to the regime, and it is therefore unlikely that Mr Assad, whose forces are relatively thinly spread, will bring the area back under his authority in the medium term. A de facto partition UN peace efforts remain stalled, with the future of Mr Assad proving a particular quagmire for negotiators and unlikely to produce a solution acceptable to all sides. In contrast, although any ceasefire is likely to remain fragile, the Astana talks have offered a more practical solution. The acknowledgement and designation of particular rebel areas highlights the most likely long-term outcome of the conflict: a de facto partition of the country. The north-eastern de-escalation zone around Idlib is likely to remain in rebel hands, and the southern de-escalation zone around Daraa has also held firm as a result of Jordanian and Western support to the rebel Free Syrian Army in the area, despite heavy regime bombardment. At the same time, the mainly Kurdish SDF has carved out a large zone of control in northern and eastern Syria, while the regime continues to cement its own control of the central west. Moreover, the Democratic Union Party (PYD), the principal Kurdish political force in the region, has set out its vision of what governance structures should be put in place in areas liberated from IS. This is based on the implementation of a federal system, for which the first step is the creation of elected local councils. The PYD has stated that it does not want to see a return to direct rule by the central Syrian state, but it has worked out security deals with Syrian regime forces in some areas, such as Manbij, that lie outside the territory considered to make up Rojava, or western Kurdistan. So, although the fighting will continue, particularly along the borders of these zones of control and in the areas vacated by IS, the country appears to be partitioning into Kurdish, rebel and regime-held mini-states, indicating a gradual end to the pre-war Syrian state.

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 29 Economy Forecast updates May 12, 2017: Economic growth Foreign direct investment still hindered by sanctions Event Farid Dehdilani, international adviser at Iran's state-run Privatisation Organisation, told the international press in May that his country attracted US$3.6bn in foreign direct investment (FDI) in the 2016 fiscal year—which ended on March 30th. Analysis This figure—although up from US$2bn in 2015—is well below government targets. The five year plan covering 2016 21 envisages an annual average of US$15bn in FDI. The easing of international sanctions after the 2015 nuclear agreement raised hopes of increased foreign investment, which Iran needs in order to shore up the availability of foreign exchange domestically. Government officials have recently made various claims about investment either targeted or due. Ali Kardor, managing director of the National Iranian Oil Company, said in early May that the second development phase of the South Pars gasfield— which is focused on technology transfer and improving recovery methods—would require US$30bn in financing. Similarly, the government hopes that Iran can attract US$10bn in foreign investment in petrochemicals in the coming years—based on comments by oil officials—and a further US$35bn to increase capacity from 62m tonnes/year (t/y) to 150m t/y by 2025. In the next five years, the government aims to court around US$185bn in foreign and domestic investment for upstream and downstream energy projects. Memorandums of understanding (MoUs) announced in 2016 by Russian companies —including Lukoil and Gazprom—and Asian firms for investment in energy and other sectors are more likely to go ahead than those signed by Western energy majors, who are wary of the hostility of the US government towards Iran. France's Total has said that it will decide this summer whether to proceed with a US$2bn project for phase 11 of South Pars (for which it heads a consortium including China National Petroleum Corporation and Petropars) as it awaits clarity by the Trump administration on Iran (and possibly the election results of the May 19th presidential poll). In a similar vein, most Western oil majors—including BP, Chevron and ExxonMobil —have not taken concrete steps to invest in Iran since the nuclear agreement. However, in December Shell signed a preliminary agreement for the South Azadegan and Yadavaran oilfields, and for the Kish gasfield. Norway's DNO, Austria's OMV and Schlumberger, an energy services company, have also signed MoUs. Impact on the forecast We may revise our estimate for inward direct investment in 2016 (currently US$3bn) upwards slightly to the US$3.6bn quoted by Mr Dehdilani. However, this is unlikely to have an impact on our forecast of average growth of 5.6% in 2017 21.

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May 25, 2017: Policy trends WannaCry ransomware hits Iran Event Media reports have said that more than 2,000 computers in Iran have been infected by the global outbreak of WannaCry—malware that targets Microsoft Windows operating systems and locks files until a ransom is paid to hackers using digital Bitcoins. Analysis The outbreak in Iran has been relatively limited compared with other countries— owing in part to the swift development of patches by Padvish (a local company) and another by Microsoft. Nonetheless, the incident has illustrated the country's use of outdated versions of Windows, which were targeted by criminals demanding a ransom. The ransom is initially set at the equivalent of US$300 but increases exponentially as time lapses. On May 15th the Iran Information Technology Organisation, a division of the Ministry of Telecommunications and Information Technology, claimed to have curbed the problem, and it has established hotlines for reporting new infections. However, there is no guarantee that the malware will not infect more computers in the future, not least because cyber-criminals are constantly evolving their methods to attack computer systems around the world. The main sectors targeted so far in Iran have been the Internet service providers, telecoms operators, hospitals and universities. Iran is one of around 100 countries that have been infected by the global cyber- attack, which was first launched on May 12th. The malware used is reportedly one of the most detrimental of its kind to date, given the scale of its reach worldwide (over 200,000 computers around the globe have been targeted). Colonel Hossein Ramezani, the chief of international and legal affairs within Iran national police, told state television that Windows users should take preventive measures to prevent WannaCry from spreading, including updating operating systems as a matter of priority. Although the problem appears no more severe in Iran than elsewhere, the authorities well remember the Stuxnet worm that targeted computing systems linked to the country's nuclear programme in 2010. The Iranian authorities accused the US and Israel of being behind the attack, although no concrete evidence of this was disclosed to the media. Impact on the forecast WannaCry has highlighted the vulnerability of Iran's information technology infrastructure, which could prove problematic to vital institutions—including banks that provide online services. However, future attacks of this nature are likely to prompt a further development of the domestic cyber-security system by the authorities and, as a result, our economic forecasts remain unchanged.

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May 25, 2017: External sector Iran renews deal to supply oil to Syrian regime Event Iran has resumed crude oil supplies to the regime of the Syrian president, Bashar al Assad. Analysis A tanker laden with Iranian crude was scheduled to dock at Syria's Banias terminal in late May, the first such supply since Iran ceased deliveries at the start of 2017 after a US$3.6bn line of credit had been used up. According to an unnamed Syrian oil sector official cited in local media reports, the resumption of supplies is part of an agreement to reactivate the credit line, although there has yet to be any formal announcement from either government. The official also said that if the previous arrangement were reinstated, Iran would dispatch two to three tankers per month, each carrying about 1m barrels of oil. The original credit line was agreed in July 2013, and it was used to finance the supply of about 70,000 barrels/day on average of crude oil delivered on Iranian tankers for processing in the Banias refinery. However, the Syrian prime minister, Imad Khamis, implied that the arrangement had come to end when he announced in January that the government had been obliged to secure its crude oil through commercial contracts with new suppliers as "friendly" countries were no longer prepared to sell oil on concessional credit terms. Given the crippling costs of the ongoing war effort and the severe drop off in regime-controlled oil production since the war began in 2011, the ability to import cheap oil from Iran using Iranian credit remains vital to the regime's survival. But with Iran wholly committed to sustaining the Assad regime in order to maintain its influence and interests in Syria, it is unlikely that financial support will be cut in the medium term, particularly with Iranian support paying off and the Assad regime currently in the ascendancy. Possibly in connection to the renewed credit, Iran has expressed interest in investing in Syria's hydrocarbons sector. On May 22nd the Iranian ambassador to Damascus, Jawad Torkabadi, held a meeting with the Syrian petroleum minister, Ali Ghanem, after which he announced that Iranian companies were ready to contribute to the development of Syria's oil sector. The government has also agreed to provide long-term leases to Iranian companies to work in Syria's phosphate mining sector. Impact on the forecast We had expected Iranian financial support to be reinstated, given how invested Iran is in the regime's survival, and our forecasts for ongoing financial and military support are therefore unchanged.

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May 25, 2017: Policy trends South Africa explores potential partners for oil refinery Event South Africa is considering a number of international partners—including Iran—for a planned oil refinery. Analysis South Africa is a net importer of fuels, and with imports set to reach one-third of the economy's domestic demand, the government is looking for a minority partner to build a new refining plant. Iran is among a list of potential candidates, which also includes Saudi Arabia and Nigeria. Indeed, ties between South Africa and Iran have strengthened under Jacob Zuma's presidency. For instance, South Africa resumed its dealings with Iran following the lifting of nuclear sanctions in early 2016, and signed a Memorandum of Understanding to co-operate closely on defence in early 2017. For its part, Iran would welcome the ability to gain a foothold in the refinery sector in South Africa, which is currently dominated by Western companies such as Royal Dutch Shell, BP and Total, all of which have usually been reluctant to source Iranian crude. Costs and capacity specifications for the new refinery have not yet been announced. A previous plan mooted in 2010 by PetroSA, the South African State Petroleum Company, and China's Sinopec, to build a refinery with the capacity to process 400,000 barrels/day was cancelled after the government rejected the project owing to the heavy cost (put at around US$10bn). Sinopec agreed to buy Chevron's local assets, including a Cape Town refinery, for US$900m in March. Impact on the forecast Our current policy forecast already incorporates rising demand for fuel in the medium and long term. However, the need for new refinery investment is questionable, especially after Sinopec's recent acquisition.

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May 26, 2017: Policy trends Qatar calls for co-ordination with Iran over gasfield Event Qatari officials have called for a joint technical committee to be set up with Iran, to co­ordinate offshore natural gas production in a shared field—known in Qatar as the North Field, and in Iran as South Pars. Analysis The call for a joint committee reflects renewed concern about rising Iranian production from its portion of the field. Until now, despite sharing the world's largest gasfield, neither side has officially co-operated in gas operations. That may be about to change, however. The joint committee would represent something of a reversal of natural gas production policy for Qatar, which has in the past significantly outpaced Iran's production rate and saw little need to co-ordinate production with Iran. Now, the Qatari government is taking a more measured approach to production to avoid depleting the reservoir—particularly given increased Iranian drilling in areas close to the Qatari maritime boundary. Iran's natural gas production capacity at South Pars is still well behind Qatar's. However, after repeated delays (caused in part by international sanctions on Iran), Iranian production is finally set to rise. In April, South Pars (development) phases 17, 18, 19, 20 and 21 were inaugurated. The largely untapped southern part of the field will be developed to produce 2bn cu ft/day of gas. Iranian officials predict that South Pars production could overtake Qatar's output from the North Field by as early as March 2018. This could potentially be a source of political tension in bilateral relations between the two states. However, in contrast to many of its Gulf Arab neighbours, Qatar boasts cordial ties with Iran, and the joint technical committee between the two countries should help to reduce any possible diplomatic conflict over offshore gas developments. Impact on the forecast We do not expect Iran to ramp up production to a level that can threaten Qatari natural gas output—not least because significant investment in the Iranian energy sector will be slow to arrive as a result of lingering US sanctions. Moreover, Qatar has recently lifted its moratorium on new gas export projects from North Field, which should mean gas exports rise towards the end of the forecast period. Our economic forecasts for both countries remain unchanged.

Analysis May 17, 2017 Iran struggles to shore up foreign investment Despite the easing of international sanctions since January 2016, foreign investment flows to Iran have only shown modest progress. According to Farid Dehdilani, an international adviser at Iran's state-run Privatisation Organisation, Iran attracted US$3.6bn in foreign direct investment (FDI) in the 2016/17 fiscal year—which ended on March 20th. This figure—although up from US$2bn in 2015/16—is well below the government target of an annual inflow of US$15bn in 201620. The disappointing outturn is the clearest indication yet that shoring up foreign investment in Iran will remain a long­term—rather than a short­term— objective for the government. The 2015 nuclear agreement between Iran and six world powers—the Joint Comprehensive Plan of Action (JCPOA)—and subsequent easing of international

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 34 sanctions encouraged the government's expectation of increased international investment. Iran's educated workforce, its population of around 80m and prime geographical location are all attractive features for international companies. Nowhere is investment in energy as potentially lucrative as in Iran, which has been slow to develop the world's largest combined hydrocarbons reserves. The country is home to 34trn cu metres of natural gas, close to 18% of the global total, and oil reserves of 159m barrels, which amounts to 9% of global reserves. Hostile Trump induces investor jitters As yet, hopes of substantial foreign direct investment inflows have not been fulfilled. Memorandums of understanding (MoUs) signed since the JCPOA have not borne fruit as would-be investors hesitate in the face of the hostility of the administration of Donald Trump in the US towards Iran. Most recently, in February the US introduced new sanctions listing 30 companies or individuals from China, North Korea and the United Arab Emirates for alleged links to Iran's ballistic missile programme. Despite Iran's adherence to the JCPOA, the Trump administration is reviewing possible further measures, including a stronger designation of the Islamic Revolutionary Guards Corps (IRGC) as a "terrorist" organisation, on the grounds of Iran's missile programme or its regional links to the Assad regime in Syria, Lebanon's Hizbullah, the Palestinian group Hamas and Houthi rebels in Yemen. Domestic financing options remain insufficient In addition, limited financing options through Iranian banks continue to poses challenges for investors. This is partly a reflection of the extent to which banking sector health has been affected by years of sanctions and exposure to the government's weak financial position. Lax spending under the previous administration of Mahmoud Ahmadinejad, who served as president from 2005 to 2013, has left the banking sector with a high level of non-performing loans (NPLs). The latter stood at around 15% of total loans in his final year in office, a high ratio even by regional standards. More positively, in November, the central bank put NPLs at 11%, a marked improvement that diminishes the risk of sector-wide instability in the current low oil price climate. With the aim of enhancing financing prospects for the private sector, the current president, Hassan Rouhani, has identified banking reform as an important pillar of a strategy to improve transparency and regulation. In July 2016 he endorsed a plan for more active management of the interbank system, bank rating based on performance, and closer supervision of beleaguered banks. The government is committed to improving oversight, increasing private banks' capital, reducing non- performing loans, and merging or dissolving ailing banks and credit institutions. Mr Rouhani has also claimed progress in diverting oil revenue into productive investment, which proved difficult for past presidents and governments when Iran laboured under broader international sanctions. Hoping to ring-fence funds for investment and emergency fiscal support, the government deposited 20% of its crude oil export proceedings in 2016/17 into the National Development Fund—akin to an oil stabilisation fund. Nonetheless, however successful the government can be in reforming the banking sector, domestic credit is likely to be insufficient for Iran's infrastructure investment needs, which will amount to hundreds of billions of US dollars in the coming years. European investors still risk-averse What available credit there is will mostly be channelled to the vital energy sector— which has significant potential for expansion. MoUs announced in 2016 by Russian companies, such as Lukoil and Gazprom, and Asian firms, including South Korea's Hyundai, SK E&C and Daelim, are more likely to go ahead than those signed by Western energy majors who are more wary of the Trump administration. Indeed, most Western oil majors—including BP, Chevron and ExxonMobil—have not taken concrete steps to invest in Iran since the nuclear agreement. However, Royal Dutch

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 35 Shell signed a preliminary agreement in December for the South Azadegan and Yadavaran oilfields, and for the Kish gasfield. Similarly, Norway's DNO, Austria's OMV and Schlumberger, a global energy services company, have also signed MoUs with Iranian entities. Indeed, European firms are delaying investment decisions in Iran as they watch Mr Trump's foreign policy evolve. France's Total has said it will decide in mid-2017 whether to proceed with a US$2bn gas project for Phase 11 of South Pars (for which it heads a consortium including China National Petroleum Corporation and Petropars), as it awaits a decision by the Trump administration on waivers. This will be a critical development, given the special importance of acquiring more advanced technology in converting natural gas into liquefied natural gas (LNG), the most flexible means of exporting the commodity. Meanwhile, the automotive sector is also likely to attract substantial foreign capital —owing to the large size of the Iranian market. For example, French carmakers Peugeot and Renault have already doubled sales in a sector accounting for 10% of Iran's GDP (second only to energy) and 4% of employment. By producing in Iran through joint ventures, the French manufacturers have avoided high import tariffs and taxes that could severely dent profits otherwise. Common challenges persist However, all companies face challenges both over Iran's relationship to the international financial system and in carrying out due diligence. In June 2016 the international Financial Action Task Force welcomed Iran's adoption of an action plan to address issues of money-laundering and "terrorism" and suspended actions against Iran for a 12-month period to monitor progress, but countries were required to apply enhanced due diligence in dealings with Iranian entities, nonetheless. Although the former secretary of state, John Kerry, made clear the US would not block international banks from dealings with Iran, they have held back as Iranian banks are not able to clear US dollars through New York or hold arrangements with US financial institutions. This challenge is compounded by fears that the US will maintain the designation of the IRGC as a terrorist organisation. Foreign companies carrying out due diligence in Iran already struggle in the face of complex ownership structures (including "public" ownership) and lack of transparency to decide whether would-be partners are linked to IRGC-owned companies. Taken together, despite the clear interest of foreign investors in Iran, there are numerous hurdles that will render the government's FDI targets for the coming years largely elusive.

May 18, 2017 EIU global forecast - Trump drives higher political risk Several months into 2017 the global economy looks more robust than it has been for some time. Two interest-rate rises in the past six months by the Federal Reserve (Fed, the US central bank), faster inflation in major economies, higher manufacturing purchasing managers' indices, a strong start to 2017 in China and falling unemployment rates in the developed world are all indicators of a likely acceleration in economic growth this year. The big concerns about the global economy in recent years—deflation, negative government bond yields and overly restrictive fiscal policies—have all become less apparent. Consequently, The Economist Intelligence Unit expects the world economy to expand by 2.6% in 2017, compared with a lacklustre 2.3% in 2016. There are, nevertheless, a number of caveats to this upbeat story. Global growth is not synchronised, reflecting the fact that the world's leading economies are at very different points of their business cycles. We consider China to be the furthest through its expansion phase: there is evidence of capacity constraints in some sectors, and the government is tightening monetary policy through a gradual

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 36 curbing of credit growth. In the US the Fed is increasing the pace of its interest-rate increases as inflation and wages accelerate and the labour market approaches full employment. The expansion in Europe is less well advanced. The regional economy is still firmly in recovery mode, with unemployment elevated and few signs of demand constraints. We believe that the European Central Bank is still about a year away from beginning to taper its quantitative easing programme. Deflation is still a cause for concern in Japan and, among emerging markets, Brazil and Russia are in the final throes of recession. This lack of synchronicity in the global economy will prevent a surge in economic growth or major upward pressure on commodity prices. However, the fact that growth in the global economy will accelerate at a time when interest rates are gradually increased and post-crisis stimulus is slowly withdrawn represents a milestone in the world economy's recovery from the financial crisis of a decade ago. Against this backdrop of a steadying global economy lies the highest level of political risk in years. At the centre of this is the administration of Donald Trump in the US. Mr Trump is an unpredictable, thin-skinned and impulsive leader. This makes him a difficult ally, both for Republicans at home and for allies abroad. It is also leading to a chaotic foreign policy, which, given the US's international reach, has consequences all around the globe. In recent weeks the US has bombed a Syrian government airfield; called for tighter economic sanctions on North Korea; watered down its condemnation of Chinese trade policy; and hosted Russian officials at the White House. It is hard to discern the outline of Mr Trump's "America First" foreign policy through the fog of these decisions. There is, however, enormous downside risk. Were the US to withdraw from the North American Free-Trade Agreement (NAFTA) or, worse, North Korea to launch intercontinental missiles under the impression that US military action was inevitable, the consequences for the global economy would be broad and severe. Mr Trump's election victory was part of a broader trend in Western democracies. Like the UK's decision to leave the EU and a referendum in Italy in which parliamentary reform was rejected, it saw voters rebel against the political establishment. Some of these political changes were the culmination of a long-term decline of popular trust in political parties and institutions. 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 this, they will look elsewhere. So far, 2017 has been a better year for the political mainstream than was 2016. A former Green leader, Alexander van den Bellen, saw off a nationalist, Norbert Hofer, in the Austrian presidential election in January. The populist Party for Freedom, led by Geert Wilders, performed poorly at the legislative elections in the Netherlands in March, and Emmanuel Macron defeated Marine Le Pen of Front national at the French presidential election in May. In the UK and Germany we expect far-right parties to win far fewer seats at elections later this year than implied by their poll ratings in mid-2016. These results suggest that the populist wave has crested. We are sceptical. Populists have been kept from power by electoral systems designed to be unfriendly towards them, by alliances built by the mainstream to keep them out and by the mainstream waking up to their threat and co-opting their policies. At the 2015 general election in the UK, the UK Independence Party (UKIP) won almost 13% of the vote but took just a single parliamentary seat. It will fare poorly in 2017, as the Conservative prime minister, Theresa May, is campaigning on the promise of delivering the very sort of departure from the EU that UKIP was advocating in 2015. Populist ideas will remain attractive while there is widespread anxiety about job security and living standards. Developed world The US economy is in relatively good shape, buoyed by rapid employment growth and rising wages. As has regularly been the case in recent years, the first quarter of

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 37 2017 was soft, but we expect stronger growth in the second half of the year. 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 2.1% 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. The economy will be constricted by a shrinking workforce, a rising old-age dependency ratio and tight immigration controls. Inflation will remain well short of the Bank of Japan's target of 2%. Emerging markets The outlook for emerging markets in 2017 is reasonable, with growth quickening to 4.4%, from an estimated 3.6% in 2016. Brazil and Russia, the third- and fourth-largest emerging economies, will both come out of lengthy recessions. Overall, emerging markets will benefit from the rise in commodity prices. Furthermore, 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 late in the year, he will sanction policies to rein in credit. Firms in the construction and real-estate sectors will be hit hardest. As a result, we forecast that growth will slow sharply in 2018, to 4.5%, from 6.6% 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 7.5%. However, the economy is also going through a painful period. A lending spree earlier this decade has saddled state-owned banks with bad loans. Combined with excess capacity in the steel industry, this will depress corporate lending and investment for some time yet. We expect GDP growth in fiscal years 2016/17 2017/18 (April­March) to average 7.2%, before growth accelerates as a major reform programme led by the pro-business prime minister, Narendra Modi, generates greater benefits, especially in infrastructure and policymaking. 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 forecast Mexican growth at only 1.6%, owing to a Trump-induced downturn. Although social and economic ties between the US and most Latin American countries will remain strong, the risk of weakening relations is high. The policies pursued by the president in areas such as trade and migration will be crucial, although our forecasts assume that Mr Trump's actions will largely fail to match his startling rhetoric. As the OPEC supply deal is failing to rebalance the market, 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 is enjoying a post-sanctions revival. The region will also remain the crucible for conflicts stoked by the geopolitical interests of global powers, which will stifle prospects for faster economic growth. Following a dismal performance in 2016—when we estimate that Sub­Saharan Africa's rate of economic growth fell to just 1%, the lowest pace of expansion for at least 20 years—growth will pick up in 2017. Prices for exported commodities will rise and weather conditions will be more clement. Exchange rates

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 38 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 further disappointing growth or policymaking by the Trump administration. In the medium term 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 a recession, taking the policy rate back near the zero lower bound. Emerging- market currencies will gain some support from higher interest rates compared with developed markets and stronger commodity prices, but conditions will become more challenging when Chinese growth slows sharply. Commodities In recent weeks it has become clear that the OPEC deal in November 2016 to cut oil production has failed to rebalance the market. US shale production has picked up and fully offset OPEC's reductions. We think that OPEC will extend its deal twice, until mid 2018, to prevent a wave of oil from coming back onto the market and pushing prices further down. We have revised our forecast for prices in 2017 18 downwards, and now expect an average price for dated Brent Blend of US$54.2/barrel in 2017 and US$55.1/b in 2018. We have again raised our 2017 price forecast for industrial raw materials, which we now expect to increase by 17.3% year on year.

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 3.0 3.4 3.2 3.0 3.5 3.6 exchange rates) World (market 2.3 2.4 2.6 2.7 2.2 2.6 2.4 2.1 2.6 2.7 exchange rates) US 2.2 1.7 2.4 2.6 1.6 2.2 2.1 1.0 2.0 2.0 Euro area -0.8 -0.2 1.2 2.0 1.7 1.6 1.5 1.4 1.5 1.5 Europe 0.2 0.8 1.8 1.9 1.7 1.7 1.6 1.6 1.8 1.8 China 7.9 7.8 7.3 6.9 6.7 6.6 4.5 4.6 5.2 4.9 Asia and 4.4 4.6 4.1 4.2 4.1 4.2 3.3 3.4 3.7 3.9 Australasia Latin America 3.0 2.8 1.3 0.2 -0.8 1.2 2.1 1.8 2.6 2.9 Middle East & 3.9 2.1 2.6 2.6 2.6 2.5 3.6 3.0 3.7 3.8 Africa Sub-Saharan 4.1 4.7 4.5 2.9 1.0 2.5 3.4 2.9 3.1 3.6 Africa World inflation (%; 4.0 3.8 3.6 3.2 3.8 4.5 3.9 3.3 3.1 3.0 av) World trade 3.6 4.0 4.2 2.8 1.9 2.9 2.7 2.2 3.0 3.3 growth (%) Commodities Oil (US$/barrel; 112.0 108.9 98.9 52.4 44.0 56.0 60.0 59.0 61.5 64.0 Brent) Industrial raw materials (US$; % -19.4 -6.8 -5.1 -15.2 -2.2 16.5 -4.5 -4.8 -1.7 2.9 change) Food, feedstuffs & beverages (US$; % -3.5 -7.4 -5.2 -18.7 -3.5 1.4 1.3 2.6 -1.4 1.5 change) Exchange rates

(av) ¥:US$ 79.81 97.56 105.86 121.02 108.76 114.45 105.92 100.48 100.18 99.88 US$:€ 1.29 1.33 1.33 1.11 1.11 1.06 1.07 1.11 1.13 1.15

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 39 *PPP=purchasing power parity Source: The Economist Intelligence Unit.

May 19, 2017 Saudi Arabia pushes for oil production cuts extension Saudi Arabia's energy minister, Khalid alFalih, has left little scope for doubt that the kingdom will soon push for an extension of a six-month production cuts agreement (which came into effect in January) that was reached between OPEC and non-OPEC producers in late 2016. In his address to the Asian Oil and Gas Conference in Kuala Lumpur on May 8th, Mr Falih said he was confident that the agreement, aimed at supporting oil prices, would be extended to the second half of the year—and possibly beyond. However, even if the deal is rolled over to the remainder of the year, there are considerable downside risks to oil prices, and the kingdom itself may have to shoulder more of the cuts burden. Saudi Arabia "is determined to do whatever it takes" to help reduce global stock levels significantly. These words were reaffirmed one week later, when, on May 15th, the Saudi energy minister and his Russian counterpart, Aleksandr Novak, met in Beijing to discuss a possible extension of the OPEC-led agreement to cut output by 1.8m barrels/day (b/d)—distributed as 1.2m b/d among OPEC members and 600,000 b/d shared between members outside the cartel—until March 2018. This is the programme of cuts that OPEC ministers will be asked to endorse at their upcoming meeting—largely on the same terms as the existing deal. Case for cuts extension boosted by recent fiscal outturn Helped by the partial recovery in oil prices since the announcement of the OPEC deal in November, the kingdom's fiscal revenue has increased. Based on quarterly fiscal outturn data released by the finance minister, oil revenue more than doubled to US$29.9bn in the first quarter of 2017, compared with the corresponding period of the previous year. The government exploited this positive outcome to minimise the risk of internal dissent; in April a royal decree returned "all allowances, financial benefits and bonuses to civil servants and military staff"—in effect reversing austerity measures that were introduced in September 2016. With this in mind, rolling over the production cuts to the remainder of the year seems logical, particularly if the government wishes to maintain high levels of current spending—although this will not negate the need for steep cuts to capital spending on infrastructure in order narrow the wide fiscal shortfall. (The deficit reached 12.2% of GDP in 2016 according to Economist Intelligence Unit estimates.) Moreover, the quarterly outturn suggests that the government may fall short of its own 2017 oil revenue target of US$128bn. Production cuts do not guarantee price increases The ministers' joint statement said that besides doing whatever it takes to curb global oil stock piles to the five-year average, they would commit to "stabilising the global oil market, reducing volatility, and ensuring the balancing of supply and demand in the near and long term". These are ambitious goals that even the considerable influence of Saudi Arabia and Russia cannot guarantee. Nonetheless, having the head of OPEC's largest producer and the largest non-OPEC member pre- announce the extended production-cutting deal sends a strong message that the recent bout of price weakness—driven by weaker demand and rising US supply— means there is no option left but to let it run on for a further six months. The challenges to the deal are growing, nonetheless, given the supply increases coming on stream and the absence of substantive demand growth. On the supply

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 40 side, we project that OPEC production will fall in 2017—owing to strong compliance by Saudi Arabia and other major producers—by 2.3% to 32.2m b/d. However, given the rising US shale rig count, non­OPEC production—with the notable exception of Russia and a few others—is forecast to rise, by 3.1% over the same period to 56.8m b/d, more than offsetting the impact of the OPEC cuts on total global crude supply. Meanwhile, demand growth is likely to remain sluggish in 2017—owing to weak global economic growth—and as a result, crude consumption will rise by a modest 1.4% (compared with 1.7% in 2016). Collectively, these factors will leave global stockpile levels unchanged at around 3m barrels in 2017, meaning that the overall impact of the production cuts on prices will be modest. Finally, there is an additional risk of weaker compliance if the cuts deal remains in place for long. This conclusion is borne out by recent data, with secondary sources suggesting that Algeria, the UAE and Iraq may have overstepped their respective quotas agreed in November. As a result, and in light to the considerable downside risks to global demand and rising US production, the kingdom may have to contend with the prospect of deeper cuts in order to accommodate for weaker compliance by other members, should OPEC agree to a renewal of the cuts agreement for another six months.

May 26, 2017 Another challenging four years ahead for Iran's economy The president, Hassan Rouhani, secured a second term in the May 19th presidential election, giving him another four years to continue his pursuit of domestic reform and reengagement with the global economy. In his post­election address, the president promised to stabilise the economy, improve foreign relations, allow greater access to information and endeavour to have the remaining sanctions on the country lifted. However, opposition to economic liberalisation from powerful interest groups (mostly linked to security and religious establishments) and the country's excessive reliance on the oil sector mean that the ultimate objective of sustainable economic growth in Iran will remain a long- rather than short-term objective. The May presidential poll was the first since Iran signed the July 2015 nuclear deal—known as the Joint Comprehensive Plan of Action (JCPOA)—with world powers. The election witnessed one of the highest turnouts in Iran's recent electoral history, reaching 73.1% of the 56.4m eligible voters in the country. This is remarkable given Mr Rouhani's disappointing performance on the economic front, particularly regarding unemployment, during his first term in office. Nonetheless, the high turnout reflected some understanding among young and middle-income Iranians that the fruits of Mr Rouhani's social and economic reformist approach will be seen over the long term. Mr Rouhani won a decisive victory, securing 23.5m (or 57.1%) of the 41.2m votes cast and soundly defeating his main opponent, Ebrahim Raeisi. The latter had the backing of hardliners and the powerful Islamic Revolutionary Guards Corps (IRGC), but trailed well behind Mr Rouhani with 15.7m votes—equivalent to around 38.3% of the total. Sanctions will continue to cripple the economy Macroeconomic stabilisation was the main economic theme of Mr Rouhani's first four years as president (2013 17). Arguably, his main achievement has been the decline of inflation from an annual average rate of nearly 40% in 2013 to under 10% by end 2016. This has also translated into greater stability of the rial, which appreciated in real terms in 2015 16. However, the president's quest for macroeconomic stability also came at a cost. Greater fiscal consolidation has weakened domestic demand, and real growth has remained sluggish (averaging an anaemic 1.4% a year in 2013 16, well below the annual average of 3.1% under his hardline predecessor, Mahmoud Ahmadinejad, in 2005 12). Importantly, growth continues to be unequal and largely driven by increases in oil production. The

Country Report June 2017 www.eiu.com © Economist Intelligence Unit Limited 2017 Iran 41 collective impact is stubbornly high youth unemployment—an unresolved legacy from the presidency of Mr Ahmadinejad. Now, faced with heightened expectations among the electorate, Mr Rouhani may need to prioritise economic growth over fiscal discipline, with the aim of creating employment opportunities for young Iranians. This is a central assumption in our fiscal balance forecast, which envisages larger—but manageable—fiscal deficits in the coming years on the back of greater government spending on capital projects. However, reaching high growth rates (sufficient to bring down unemployment) will not be an easy task. Indeed, the remaining US financial sanctions will impair Iran's ability to reboot its economy in the coming years. Despite Mr Rouhani saying that Iran would attract US$15bn a year of foreign direct investment (FDI) after signing up to the JCPOA, the economy attracted a meagre US$3.6bn in fiscal year 2016/17— which ended on March 20th. The structural reform process is likely to remain slow The key challenge facing domestic and foreign investors remains the entrenchment of sanctioned entities—such as the IRGC—in vital economic sectors. Courting foreign capital will therefore involve persuading the hardline-dominated judiciary and security authorities to soften their opposition to foreign capital and to shed some of their ownership in the various sectors. With this in mind, the biggest beneficiary of Mr Rouhani's economic liberalisation drive in the short term will continue to be the hydrocarbons sector, where some progress has been made on the business environment front. Business regulation has already made some progress in the oil sector via the launch of a new and potentially more rewarding integrated petroleum contract. However, hydrocarbons production is a capital intensive process, which will do little to generate sufficient employment opportunities. As a result, we expect the Iranian economy to labour under high unemployment rates for most of Mr Rouhani's second term. Furthermore, many sanctions not covered by the JCPOA remain in place, particularly US primary sanctions, most notable of which is the lack of access to the US financial system and to the use of US dollars for transactions, which significantly limits the ability of foreign corporates to conduct business in Iran. Corporates will continue to face a broad range of risks, at least in the early years of Mr Rouhani's second term, including a lack of investment protection schemes; delays to contracts; a complex and inefficient state bureaucracy; and inconsistent enforceability of business-related legislation (and rampant official corruption). The ability of his administration to overcome some or all of these obstacles will remain a challenge. Separately, Mr Rouhani must also deal with an unpredictable US administration, led by the president, Donald Trump. In particular, the Republican- controlled US Congress is unlikely to ease the unilateral sanctions that are frightening off foreign financial institutions and corporates. Thus far, with the exception of the oil sector—the mainstay of the Iranian economy —few sectors have shown signs of revival. Despite Mr Rouhani's clear intent to implement reform, and growing foreign investor interest in the Iranian market, domestic and external factors are likely to coalesce and sustain downside risks to economic growth—which we forecast will average around 5.5% in 2017 21.

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