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Country Report

Iran

Generated on May 23rd 2016

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

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© 2016 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. ISSN 2047-5020

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 2016-20 3 Political stability 4 Election watch 4 International relations 5 Policy trends 6 Fiscal policy 6 Monetary policy 7 International assumptions 7 Economic growth 8 Inflation 8 Exchange rates 8 External sector 9 Forecast summary

Data and charts 10 Annual data and forecast 11 Quarterly data 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 18 Forecast updates 24 Analysis Economy 28 Forecast updates Analysis

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 2

Highlights Editor: Robert Powell Forecast Closing Date: May 13, 2016 Outlook for 2016-20 Internal politics will become increasingly polarised as the president, Hassan Rowhani, seeks to exploit the international nuclear deal and the strong showing of his supporters in the elections to eclipse the country's hardliners. We expect Mr Rowhani to win re-election in the presidential election scheduled for 2017, assisted by the economic gains engendered by the nuclear deal and divisions among his hardline conservative opponents. With the economy struggling under the burden of low oil prices, the govern ment will energetically seek to leverage the lifting of sanctions to stimulate inward investment, with a focus on the oil and gas sector and infrastructure. We forecast that Iran will record the fastest growth in the Middle East and North Africa in 2016 20, at an average of around 5%, as the lifting of sanctions boosts trade and investment. We have lowered Iran's inflation forecast, in line with a fall in price growth in the first quarter of 2016. We now expect inflation to decline to 9.2% in 2016, rising to an average of 11.5% in 2017-20 as demand-pull inflation increases. We expect the official exchange rate to continue to weaken against the US dollar. Nevertheless, the nuclear deal should boost confidence in the rial and help to narrow the gap between the official and weaker market rates. After a short-lived fillip in 2016-17, as oil exports are boosted following the lifting of sanctions, we forecast that the current account will slip into deficit in 2018-20 as imports are driven up by pent-up demand and rising investment. Review In keeping with the results of the first round of the parliamentary election, reformists and moderates had a strong showing in the run-off. Moderates now hold some 125 seats in the new 290-seat parliament, with the rest split between hardliners and independents. Differences between Iran's supreme leader, Ayatollah Ali Khamenei, and the president over economic policy have re emerged, in the wake of speeches from Ayatollah Khamenei extolling the virtues of a "resistance economy". Data from Bank Markazi (the central bank) have revealed the extent to which the economy was struggling in late 2015, with manufacturing, construction, trade and bank finance all painting a moribund picture of economic activity. Data from Bank Markazi have indicated that the fiscal deficit in the first ten months of 2015/16 (March 21st-January 20th) rose from IR126trn (US$4.4bn) in the same period of 2014/15 to over IR160trn as oil prices plummeted. According to the central bank, year­on­year inflation fell to 8.3% in March— its lowest level since June 2010—as food costs continued to decline.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 3 Outlook for 2016-20 Political stability Internal Iranian politics will become increasingly polarised. The president, Hassan Rowhani, will seek to build on the strong showing of centrists in parliamentary and Assembly of Experts (AoE) elections in February and April to build a consensus in favour of social and economic reform. In particular, with an eye on the 2017 presidential election, Mr Rowhani will seek to leverage the implementation in January of the Joint Comprehensive Plan of Action (JCPOA)—the international agreement reached in July 2015 over Iran's nuclear programme—in order to tackle vested interests, combat corruption and draw in much-needed foreign investment. However, hardliners, fearful that Iran's reintegration into the global community might precede broader political and civil change, will respond by cracking down on moderates and attempting to neuter Mr Rowhani's government and his parliamentary allies. Amid this in-fighting, the position of the supreme leader, Ayatollah Ali Khamenei, will be crucial in maintaining stability and preventing an outbreak of general disorder. In this regard, he will seek to strike a balance between the two sides: generally supporting the JCPOA and economic liberalisation, while maintaining an uncompromising approach towards social and political reform and the US. However, such an uneasy balance will prove difficult to maintain. In particular, the continued capricious interventions of the unelected Guardian Council (a vetting body dominated by hardliners) will prove a continual source of irritation for the president and his pro-business cabinet. This situation will be exacerbated by the extra-judicial interventions of the Islamic Revolutionary Guards Corps (IRGC) in the country's political and economic spheres, and the residual dominance of vested business interests. As a result, political and social reform will remain largely stifled, and economic liberalisation will proceed inconsistently. Amid these political machinations, the future of Ayatollah Khamenei could come under greater scrutiny. His position is guaranteed by the theological doctrine of velayat e faqih (the rule of the supreme Islamic jurisprudent), but his ability to maintain a degree of stability between the country's myriad political factions would weaken if speculation over his health were to revive; the 77 year old supreme leader underwent prostate cancer surgery in September 2014. As a consequence, the issue of succession will loom larger in 2016-20. However, the identity of Ayatollah Khamenei's potential successor remains unclear at this time. Hardliners on the Guardian Council managed to exclude most reformist candidates from participating in the election for the AoE, which in turn selects the supreme leader. Nonetheless, even with this interference, a number of leading conservatives (including the AoE's chairman, Mohammad Yazdi) failed to win re-election, while Mr Rowhani and his reformist ally, Akbar Hashemi Rafsanjani, topped the poll in the election in Tehran. The upcoming internal poll to select a replacement for Ayatollah Yazdi will give an indication of the relative power of different factions in the Assembly, but it is worth noting that hardliners can still call on supportive state actors, such as the state press (and, potentially, the IRGC), to influence the selection of a sympathetic replacement. In addition, despite the obvious public show of support in the election for the government's diplomatic outreach, Mr Rowhani will need to garner an uptick in the economy to cement these gains—a tough task amid the current oil­price slump—or he will risk a loss of authority and an opportunistic counter-coup by hardliners.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 4 Election watch The second round of the parliamentary election—which took place on April 29th for the 69 seats (out of 290 in total) where no candidate won more than 25% of the vote initially—largely mirrored the results of the first round in February, with reformists and centrists performing strongly. Although the lack of organised political parties undermines coalition cohesiveness, the "List of Hope" coalition—comprising reformers and pragmatic conservatives—won around 125 seats in the new parliament, with hardliners having a much-reduced 84 and independents holding the remainder. As a result, the next parliament is set to be more supportive of the president and the nuclear agreement reached last July. Nevertheless, the Rowhani administration will still have to court independent members of parliament (MPs) in order to push through legislation, and, given the loose nature of the List of Hope coalition, there is a risk that it could split because of divisions over policy or personality—such as the choice of the next Majlis speaker. The next major election will be for the presidency, scheduled for June 2017. The Economist Intelligence Unit expects Mr Rowhani to run and win, boosted by the expected economic gains garnered from the nuclear deal. Although hardline conservatives are likely to offer stiff resistance, their weakened position in parliament and the AoE, exacerbated by internal divisions, will undermine their position. One possible unifying figure for hardliners would be the popular head of the IRGC's Quds Force, Qasem Soleimani (should he choose to enter politics). However, even in this instance, Mr Soleimani's public backing for the current parliamentary speaker, Ali Larijani (who supported the JCPOA), in the February election may make him unsuitable for some conservatives.

International relations In the near term, Iran's foreign policy priorities will be rooted in garnering max imum diplomatic and economic gain from the implementation of the JCPOA in January, and the concomitant lifting of US and EU sanctions. Mr Rowhani was quick to capitalise on the lifting of sanctions; he embarked on a visit to Italy and France, where he agreed business deals worth US$55bn, and has hosted major business delegations from South Korea and India, among others. However, despite the dramatic thaw in Iran's ties with the EU and the election of a more centrist Iranian parliament, we do not expect the JCPOA to lead to a marked transformation in relations between Iran and the US. Although the US has praised Iran's compliance with the JCPOA's requirements and agreed a prisoner swap, in January it introduced a range of new sanctions over recent Iranian ballistic-missile tests. Adding to the tension, more recently Iran has reacted furiously to a US Supreme Court ruling to block US$2bn of Iranian assets held in the US (to compensate US families of victims of attacks attributed to Iran), threatening to sue at the International Court of Justice. The persistence of US sanctions will also hamper any US corporate investment into Iran. Iran's ties with its regional peers—notably Saudi Arabia—will, if anything, be even more severely strained, given mutual distrust, Arab fears of Iran's nuclear programme and differing positions on the wars in Yemen and Syria. In this latter regard, the deepening regional rivalry between Iran and Saudi Arabia will prevent the former from emulating the partial drawdown of Russian forces in Syria. Both Russia and Iran have militarily backed the regime of Bashar al Assad, but the maintenance of a close ally in Damascus is critical for Iran's development of its long- standing Lebanese proxy, Hizbullah, and Iran is more heavily invested than Russia in the Syrian regime (via oil deliveries and loans). Meanwhile, a military clash between Israel and Iran over the latter's nuclear programme still looks improbable but cannot be ruled out entirely. Iran is unlikely to reduce support for groups that can exert pressure on Israel, such as Hamas in Palestine or Hizbullah in Lebanon.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 5 Policy trends With the economy struggling under the burden of low oil prices, the govern ment will seek energetically to leverage the lifting of sanctions to stimulate inward investment, with a focus on the oil and gas sector (given its importance to the fiscal and external balances) and infrastructure. The drive to draw in new investment will be accompanied by a stepping-up of privatisation efforts; Mr Rowhani stated in early March that the country's large automotive sector should be "completely privatised". However, such a push will also probably have to be accompanied by efforts to update the 2002 Foreign Investment Promotion and Protection Act. This overhaul of business regulation has already made significant progress in the oil sector, via the launch of a new "integrated petroleum contract", which is of a longer duration than its predecessor and gives companies an incentive to maximise production and profits. In addition, Iran is also seeking to revive build-operate- transfer contracts for infrastructure projects, including a new deepwater port in Sistan-Baluchistan province. However, accommodating the myriad business networks of a range of interest groups, notably the bonyads (politically powerful Islamic "charities" that run large business conglomerates) and the IRGC, could prove difficult. The IRGC's business interests, including notably its engineering arm, Khatam al Anbiya, benefited from the absence of international rivals during the sanctions era, and in some instances will seek to undermine the operations of foreign firms (including via the arbitrary arrest of foreign businesspeople). This defiance will be buttressed by the supreme leader's continued advocacy of a "resistance economy"—a vague term, but rooted in a commitment to self-sufficiency and protecting the economic role of state bodies. With a raft of residual US sanctions also hindering global financial transactions with Iran, we thus believe that the government's goal of attracting US$30bn-50bn a year of inward investment (including US$100bn in hydrocarbons investment by 2021) will prove overoptimistic.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 6 Fiscal policy We expect Iran's fiscal account to remain in deficit throughout 2016-20 as persistently weak oil prices and increasing capital expenditure offset rising oil exports. In response to the low oil price, the budget for fiscal year 2016/17 (March 21st-March 20th) envisages a small cut in overall spending in real terms. Further cuts beyond those originally envisaged are now on the agenda, with the outgoing parliament in April passing a bill to cancel cash handouts (introduced in 2010 to offset the impact of fuel and electricity price rises) to households earning more than US$11,500 annually—a move that will save around US$3.3bn annually. Although this will be partly offset by an increase to the defence budget, we expect improved fiscal discipline and surging oil export volumes to cause the deficit to decline in 2016/17, to 2.8% of GDP, compared with an estimated 3.5% of GDP shortfall in 2015/16. The easing of sanctions under the JCPOA will provide a short-lived fiscal windfall, in the form of the export of crude stored offshore in tankers, and the repatriation of money (estimated by the central bank, Bank Markazi, at US$32bn) frozen abroad owing to sanctions (although the bulk of this is expected to be used to buttress Bank Markazi's foreign reserves). Mr Rowhani has pledged to utilise this extra revenue to upgrade infrastructure, and investment spending will increase rapidly. As a result, after narrowing in the first two years of the forecast period, the fiscal deficit is forecast to rise slowly from 2018/19, averaging 3.6% of GDP a year in 2018 20. In response, the govern ment will seek to strengthen non­oil revenue, including moves to further raise sales taxes and improve tax compliance. Although the government has begun the process of garnering a sovereign credit rating from the major international rating agencies, we expect it to continue to rely on domestic banks in order to finance its fiscal shortfalls. Nevertheless, it is worth noting that Iran's forecast fiscal deficits are relatively modest compared with other regional oil exporters, reflecting the progress it made during sanctions to lessen its reliance on oil revenue. Notably, oil income is projected to equal just 25% of total revenue in Iran's 2016/17 budget, compared with an average of 70-90% among the Gulf Arab states.

Monetary policy Bank Markazi will seek to maintain greater exchange-rate stability and concurrently lock in lower inflation. However, this drive will be strained by growing pressure on the central bank to revive the economy, in the wake of weak oil prices and fiscal cutbacks. On balance, with inflation comfortably within the central bank's 10% target, we expect some monetary easing in 2016 17 (in March, for example, it lowered interest rates on business loans), although it will proceed gradually as it assesses the impact of the rolling-back of sanctions. Subsequently, rates should level off as a small recovery in inflation is offset by a weakening once again of the oil price.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 7 International assumptions 2015 2016 2017 2018 2019 2020 Economic growth (%) US GDP 2.4 2.0 2.3 2.3 1.0 2.1 OECD GDP 2.0 1.7 1.9 2.0 1.4 1.9 World GDP 2.4 2.3 2.6 2.7 2.3 2.6 World trade 2.6 2.9 3.6 3.7 2.8 3.4 Inflation indicators (% unless otherwise indicated) US CPI 0.1 1.4 2.0 2.3 1.3 1.7 OECD CPI 0.5 1.1 1.8 2.0 1.6 1.8 Manufactures (measured in US$) -4.8 -0.8 2.7 3.8 4.3 3.9 Oil (Brent; US$/b) 52.4 40.2 55.5 67.5 62.8 61.8 Non-oil commodities (measured in US$) -17.3 -7.2 6.4 9.7 -2.4 -0.6 Financial variables US$ 3-month commercial paper rate (av; %) 0.2 0.6 1.4 2.1 2.3 2.0 Exchange rate IR:US$, official rate (av) 29,011 31,187 33,059 34,877 38,016 41,095 Exchange rate US$:€ (av) 1.11 1.10 1.09 1.11 1.15 1.18

Economic growth We expect Iran to record the fastest growth in the Middle East and North Africa in 2016 20. After declining to an estimated 0.9% in 2015/16 in the wake of the oil­price slump, real GDP growth is forecast to surge to an annual average of 4.9% in 2016/17- 2017/18 as the lifting of international sanctions boosts trade and investment. In the near term, we expect crude oil exports, which had been roughly halved by sanctions, to make gains of around 700,000 barrels/day by the end of 2016. There will be further increases in 2017 20, but the size of these will depend in part on whether Iran can entice technologically advanced international companies to invest in the sector. Investment in Iran's relatively underexploited natural gas reserves, in particular, could increase dramatically. Although low oil prices will preclude a government windfall in the near term, a sharp uptick in inward investment, notably into the country's infrastructure, led by EU and Chinese firms, will provide a host of knock-on opportunities for the private sector. With renewed momentum in the economy and rising state spending from 2017/18, private consumption will also strengthen (as will import growth). Overall, given Iran's hydrocarbons wealth, demographics and economic diversity, the comprehensive nuclear deal could herald a return to trend real GDP growth rates of around 5%. However, growth will remain below potential, given the challenging business environment and continued soft oil prices (which will prevent any post- sanctions budget giveaways). Economic growth % 2015a 2016b 2017b 2018b 2019b 2020b GDP 0.9 4.5 5.4 5.2 5.1 5.5 Private consumption 0.8 2.6 5.2 6.1 5.8 6.3 Government consumption -2.2 -0.4 4.0 5.2 5.0 5.4 Gross fixed investment 1.3 6.3 10.1 7.5 7.0 6.7 Exports of goods & services 8.0 17.5 9.5 6.1 5.5 6.0 Imports of goods & services 7.1 15.5 15.0 10.0 8.0 8.6 Domestic demand 0.3 3.1 5.9 5.9 5.6 5.9 Agriculture 0.5 1.0 2.0 1.0 1.5 1.2 Industry 2.4 4.6 5.9 5.4 4.4 4.6 Services -1.8 0.5 5.5 5.6 6.0 6.5 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 8 Inflation We have lowered our forecast for Iranian inflation, in line with consumer price data showing that consumer price growth fell to 8.9% year on year in the first quarter of 2016, down from 13.7% in 2015, led by falls in food and beverage costs. This decline will be supported by the onset of sanctions relief, which will ease bottlenecks and moderate services costs on imports (notably insurance). However, as global commodity prices recover from 2017, we expect inflation to rise once more, to around 11.5% in 2017-18 (reinforced by a less helpful base effect). Consumer price growth is subsequently forecast to remain relatively stable in 2019-20, as a combination of resumed commodity price weakness from 2019 and a more stable exchange rate is largely offset by rising demand-pull inflation.

Exchange rates Bank Markazi introduced a new official exchange rate of around IR25,000:US$1 in July 2013—a significant devaluation from IR12,260:US$1. The rate has since weakened gradually, with the official rate now closer to the unofficial market rate of around IR35,000:US$1, to which most Iranians have access. We expect this gap to narrow further as the official rate continues to weaken against the US dollar and as the lifting of sanctions and subsequent uptick in inward investment boosts confidence in the rial. The central bank's ability to manage the exchange rate should improve as it gains access to foreign reserves currently stuck abroad.

External sector We expect Iran's current account largely to track oil prices, although it will be given a short-lived boost in 2016 as oil export volumes surge following the lifting of sanctions. Nevertheless, even with a rapidly growing import bill (on the back of years of pent-up demand, when sanctions led to the imposition of import controls), we expect the trade account to remain in surplus, buttressed by rising non-oil exports, including petrochemicals, automotive and textiles. 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 income debits. Although the impact of this will be partly offset by rising tourism earnings, we forecast that the current account will slip into deficit in 2018—its first such shortfall since 1998—and will remain in the red for the rest of the forecast period.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 9 Forecast summary Forecast summary (% unless otherwise indicated) 2015a 2016b 2017b 2018b 2019b 2020b Real GDP growth 0.9 4.5 5.4 5.2 5.1 5.5 Crude oil production ('000 b/d) 2,905 3,356 3,433 3,536 3,628 3,809 Oil exports (US$ m) 41,213 46,320 59,980 67,911 67,066 72,769 Consumer price inflation (av) 13.7c 9.2 11.2 11.7 11.5 11.5 Consumer price inflation (end-period) 9.4c 10.2 11.5 11.6 11.5 12.0 1-year deposit rate (end-period) 16.0 13.6 13.0 13.0 12.5 13.0 Official net budget balance (% of GDP) -3.5 -2.8 -2.7 -3.1 -3.7 -3.9 Exports of goods fob (US$ bn) 75.6 83.5 101.2 112.4 114.5 123.8 Imports of goods fob (US$ bn) 67.7 77.2 91.9 103.3 111.8 121.9 Current-account balance (US$ bn) 1.8 0.4 0.4 -1.3 -8.8 -8.7 Current-account balance (% of GDP) 0.4 0.1 0.1 -0.2 -1.6 -1.4 External debt (end-period; US$ bn) 5.5 6.4 8.5 10.5 11.7 13.0 Exchange rate IR:US$ (av) 29,011c 31,187 33,059 34,877 38,016 41,095 Exchange rate IR:US$ (end-period) 30,130c 33,032 35,537 37,986 41,125 44,204 Exchange rate IR:¥100 (av) 23,973c 27,746 29,497 30,621 33,792 37,064 Exchange rate IR:€ (end­period) 32,803c 36,005 39,091 42,734 48,116 52,603 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Official reported income. d Includes payments into the National Development Fund as revenue.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 10 Data and charts Annual data and forecast

2011a 2012a 2013a 2014a 2015b 2016c 2017c GDP Nominal GDP (US$ m) 592,038 587,209 511,621 425,326 410,844 427,045 475,321 Nominal GDP (IR trn) 6,285 7,150 9,421 11,034 11,919 13,318 15,713 Real GDP growth (%) 3.7 -6.6 -1.9 4.3 0.9 4.5 5.4 Expenditure on GDP (% real change) Private consumption 4.2 -1.7 -1.0 3.1 0.8 2.6 5.2 Government consumption -3.4 -7.2 1.6 2.7 -2.2 -0.4 4.0 Gross fixed investment 3.5 -23.8 -6.9 3.5 1.3 6.3 10.1 Exports of goods & services -0.3 -20.5 0.0 12.0 8.0 17.5 9.5 Imports of goods & services -9.4 -23.1 -18.7 -5.7 7.1 15.5 15.0 Origin of GDP (% real change) Agriculture -0.1 3.7 4.7 3.8 0.5 1.0 2.0 Industry 2.6 -18.3 -4.7 4.9 2.4 4.6 5.9 Services 5.8 1.1 -1.5 2.4 -1.8 0.5 5.5 Population and income Population (m) 75.2 76.2 77.2 78.1 79.1 80.0 80.9 GDP per head (US$ at PPP) 17,949 16,846 16,554 17,302 17,426 18,328 19,416 Recorded unemployment (av; %) 12.3 12.2 10.4 10.3b 10.5 10.7 10.0 Fiscal indicators (% of GDP) Public-sector revenue 17.7 13.9 14.1 14.6 13.3 13.4 13.5 Public-sector expenditure 18.6 14.6 15.0 15.8 16.8 16.3 16.2 Public-sector balance -0.8 -0.6 -0.9 -1.2 -3.5 -2.8 -2.7 Net public debt 13.2b 11.0b 10.3b 10.3b 13.2 14.9 15.8 Prices and financial indicators Exchange rate IR:US$ (av) 10,616 12,176 18,414 25,942 29,011a 31,187 33,059 Exchange rate IR:US$ (end-period) 11,165 12,260 24,774 27,138 30,130a 33,032 35,537 Consumer prices (av; %) 20.6 26.0 39.3 17.2 13.7a 9.2 11.2 Stock of money M1 (% change) 19.5 26.7 10.5 7.1 0.2a 6.5 10.5 Stock of money M2 (% change) 20.3 32.0 28.1 34.8 24.6a 25.3 25.2 Lending interest rate (av; %) 11.0 11.0 11.0 14.0 14.2 13.8 13.5 Current account (US$ m) Trade balance 67,779 28,559 31,969 21,392 7,865 6,240 9,313 Goods: exports fob 145,806 97,271 93,124 86,471 75,613 83,471 101,219 Goods: imports fob -78,027 -68,712 -61,155 -65,079 -67,747 -77,232 -91,906 Services balance -9,771 -7,306 -7,137 -6,985 -7,031 -8,063 -10,652 Income balance 93 1,661 1,066 943 427 1,709 1,273 Current transfers balance 406 510 541 511 526 505 485 Current-account balance 58,507 23,423 26,440 15,861 1,788 391 419 External debt (US$ m) Debt stock 17,344 7,406 7,006 5,495 5,463 6,364 8,548 Debt service paid 1,649 601 439 506 715 687 739 Principal repayments 1,389 446 396 468 608 575 611 Interest 260 155 43 39 107 126 142 International reserves (US$ m) Total international reserves 92,450b 104,650b 107,950b 108,950b 89,950 115,450 114,300 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. Source: IMF, International Financial Statistics.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 11 Quarterly data 2014 2015 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Central government finance (IR bn)a Revenue 532,785298,793470,086381,254458,646293,200452,600 n/a Expenditure 529,405332,339466,196448,529490,753359,590478,600 n/a Balance 13,291 -47,733 4,664 -64,462 -32,107 -66,390 -26,000 n/a Output GDP at constant 2004/05 prices (IR bn) 513,066476,486551,285515,989531,939 n/a n/a n/a GDP at constant 2004/05 prices (% change, -2.2 3.2 4.7 5.7 3.7 n/a n/a n/a year on year) Prices Consumer prices (2011=100) 184.8 191.1 199.4 208.1 214.4 222.3 224.9 229.1 Consumer prices (% change, year on year) 23.6 16.2 14.6 15.5 16.0 16.3 12.8 10.1 Financial indicators Exchange rate IR:US$ (av) 24,930 25,548 26,482 26,809 27,637 28,641 29,75430,014 Exchange rate IR:US$ (end-period) 25,444 25,651 26,668 27,138 28,085 29,319 29,95630,130 M1 (end-period; IR trn)b 1 1 1 1 1 1 1 1 M1 (% change, year on year) 5.2 7.1 9.0 7.1 1.0 -2.0 -1.7 0.2 M2 (end-period; IR trn)b 6 7 7 7 8 8 9 9 M2 (% change, year on year) 38.8 40.7 39.5 34.8 22.3 22.7 23.5 24.6 Sectoral trends Crude oil production (m barrels/day) 2.81 2.83 2.83 2.85 2.82 2.82 2.85 2.89 Crude oil prices (US$/barrel) OPEC basket 104.70 105.90 100.80 73.40 50.30 59.89 48.26 41.88 Balance of payments (US$ m)a Exports fob 25,979 24,688 24,040 19,561 17,386 17,680 n/a n/a Oil & gas 18,257 17,594 16,037 12,104 9,461 10,633 n/a n/a Imports fob 18,289 14,632 16,285 14,594 16,685 12,902 n/a n/a Trade balance 7,600 10,056 7,755 4,968 701 4,778 n/a n/a Current-account balance 5,900 8,625 7,090 4,223 -1,008 3,947 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.

Monthly data Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exchange rate IR:US$ (av) 2014 24,821 24,883 25,085 25,499 25,534 25,611 26,303 26,505 26,635 26,688 26,777 26,958 2015 27,372 27,600 27,939 28,256 28,562 29,106 29,509 29,798 29,956 29,954 29,974 30,113 2016 30,173 30,186 30,225 n/a n/a n/a n/a n/a n/a n/a n/a n/a Exchange rate IR:US$ (end-period) 2014 24,866 24,898 25,444 25,403 25,580 25,651 26,303 26,601 26,668 26,706 26,816 27,138 2015 27,530 27,708 28,085 28,241 28,829 29,319 29,600 29,958 29,956 29,960 30,086 30,130 2016 30,183 30,197 30,260 n/a n/a n/a n/a n/a n/a n/a n/a n/a Deposit rate (av; %) 2014 14.8 14.7 14.9 14.8 14.8 14.7 14.7 14.7 16.9 16.9 16.9 16.9 2015 16.9 16.9 17.5 17.5 17.7 17.7 16.4 16.4 16.4 n/a n/a n/a 2016 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Lending rate (end-period; %) 2014 11.0 11.0 11.0 11.0 11.0 11.0 14.0 14.0 14.0 14.0 14.0 14.0 2015 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 14.2 n/a n/a n/a 2016 n/a n/a 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) 2014 28.8 22.8 19.7 17.4 16.6 14.6 14.6 14.7 14.4 14.6 15.1 16.7 2015 15.7 16.2 16.2 16.5 16.2 16.2 14.2 12.6 11.7 10.8 10.1 9.4 2016 9.6 8.9 8.3 7.4 n/a n/a n/a n/a n/a n/a n/a n/a Sources: IMF, International Financial Statistics; Haver Analytics.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 12 Annual trends charts

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 13 Monthly trends charts

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 14 Comparative economic indicators

Basic data Total area 163.6m ha Population 73.6m (2010, Statistical Centre of Iran) Towns with populations in excess of 500,000 Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 15

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

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

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 17 President, elected by universal suffrage for a four-year term for a maximum of two terms. Hassan Rowhani was elected as president in June 2013 and took office in August 2013 Executive The post of prime minister was abolished in 1989. The current cabinet was approved by the Majlis in August 2013 Main political trends Parliamentary factions are loose. The new Majlis is dominated by the United Fundamentalist Front and the Stability of Islamic Revolution Front, both conservative groups close to the supreme leader Key ministers President: Hassan Rowhani Head of presidential office: Mohammed Nahavadian Commerce & industries & mines: Mohammed Reza Nematzadeh Culture & Islamic guidance: Ali Jannati Defence: Hossein Dehqan Economy & finance: Ali Tayebnia Education: Ali Ashgar Fani 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 May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 18 Recent analysis

Generated on May 23rd 2016 The following articles were published on our website in the period between our previous forecast and this one, and serve here as a review of the developments that shaped our outlook. Politics Forecast updates April 1, 2016: International relations Western powers criticise Iran missile tests Event In late March a joint letter by the governments of the US, Britain, France and Germany levelled charges against Iran of defying the terms of UN Security Council Resolution 2231, which was passed after the conclusion of the July 2015 nuclear deal. Analysis The joint letter came in response to recent ballistic missile tests conducted by Iran on March 8th. The letter warned that the tests were "in defiance of" the UN resolution, but stopped short of accusing Iran of violating the terms of the July nuclear deal that it signed with Western powers. In response, Iran has defended testing the Qadr H, Qadr F and Qiam missiles, during large­scale exercises, and maintains that Resolution 2231 "calls" on—rather than "requires"—the country to refrain for up to eight years from any activity, including test launches of missiles with the capability of delivering nuclear weapons. Iran also claims that the missiles tested are not designed to carry nuclear weapons, and has long resisted efforts by the US and Europe to include the missile programme as part of negotiations over its nuclear activities. A speech by the supreme leader, Ayatollah Ali Khamenei, on March 30th made clear the continued importance that Iran attaches to missile tests. In contrast to earlier conciliatory remarks from Akbar Hashemi Rafsanjani—a veteran politician close to the president, Hassan Rowhani—Ayatollah Khamenei stressed that "these are times of both missiles and negotiations". International sanctions on Iran were lifted in January, allowing the country a chance to return gradually to the fold of the international community. Nevertheless, in a reminder that the US stands ready to act unilaterally, the US Treasury Department blacklisted two Iranian companies—Shahid Nuri Industries and Shahid Movahed Industries—on March 24th, for supporting Iran's missile program. In any case, although this disagreement highlights a continued mistrust between Iran and the Western powers, it is unlikely to undermine the July nuclear deal. The latter specifies that UN sanctions can only be re-imposed if Iran violates the agreed restrictions on its atomic work. Moreover, Iran will benefit from the diplomatic backing by Russia and China, both of whom are likely to veto any new UN sanctions on the country. Impact on the forecast The recent developments are in line with our view that, despite the conclusion of the nuclear deal, we do not expect it to lead to a dramatic transformation in relations between Iran and the US in the short term. Our forecast remains unchanged.

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April 13, 2016: Political stability Former Green Movement leader pleads for public trial Event The former speaker of parliament and one of the leaders of the Green Movement, Mehdi Karroubi, has written an open letter to the Iranian president, Hassan Rowhani, asking for the president to ask "the despotic regime" to grant him a public trial so that he could show who is "honourable" and who is "dishonourable". Analysis Mr Karroubi has been under house arrest since 2011, having taken a leading role in the popular protests that followed the disputed victory of Mahmoud Ahmadinejad in the 2009 presidential election. In his letter, the former speaker of parliament and veteran of the 1979 revolution, who himself ran in the elections in 2005 and 2009, said that he would produce evidence that both elections were rigged by "certain sections of the Revolutionary Guards, the Basij and the intelligence ministry". Mr Karroubi's letter demonstrates that he has not retreated from the positions he expressed against the establishment after 2009. His letter is part of a long tradition of dissident letter writing against the establishment in Iran, following similar letters by a political activist and former interior minister, Ali-Asghar Haj Seyed Javadi, in 1981, by the country's first post-revolution prime minister, Mehdi Bazargan, in 1988, and by a leading cleric and human rights activist, Ayatollah Hossein Ali Montazeri, in 1989. It is highly unlikely that Mr Karroubi (78), his fellow reformist presidential contender, Mir-Hossein Mousavi (73), or the latter's wife, Zahra Rahnavard (70), will be granted public trials. Ayatollah Khamenei has personally accused them of sedition for calling people to the streets in 2009 to protest the re-election of Mr Ahmadinejad, a result which the supreme leader explicitly backed. Equally, much effort has been expended by Iran's elites to repair the fractures within the establishment that emerged following the 2009 election. Holding a public trial or releasing the ailing revolutionaries would risk mobilising their dormant base and be likely to provoke a severe backlash by the security apparatus. Impact on the forecast Despite Mr Rowhani in the past raising the possibility of releasing the Green Movement leaders, it is more likely that the president, who is generally viewed as a cautious reformer, will avoid inciting a stand-off with hardliners by directly responding to Mr Karroubi's letter. Instead we expect Mr Rowhani to focus his political capital on utilising the favourable outcome of the recent elections to push through his economic reform programme, with a focus on drawing in foreign investment.

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April 18, 2016: International relations Doha talks over oil output freeze collapse Event Talks held in Doha on April 17th between non­OPEC and OPEC members— including Saudi Arabia but excluding Iran—failed to agree an output freeze. Analysis The scuppering of the widely expected production freeze reflects significant tensions between the de facto leader of the oil cartel, Saudi Arabia, and regional rival, Iran, with neither country prepared to set aside political differences for the sake of higher oil prices. Saudi insistence that Iran be party to any production curbs —a position that Iran steadfastly refused to countenance as it seeks to rebuild market share post­sanctions—surprised senior OPEC delegates in the Qatari capital, given that the kingdom's petroleum and ministerial resources minister, Ali al Naimi, had helped formulate the first draft of the freeze agreement. Iran's non-participation in any output freeze had long been anticipated (and it had not even dispatched a representative to Doha). Significantly, Saudi Arabia's refusal to relinquish market share to Iran is indicative of the influence of the powerful deputy crown prince, Mohammed bin Salman al Saud, who said prior to the meeting that the kingdom would not sign up without Iran. The collapse of the output freeze proposal led to a 3.9% fall in the price of dated Brent to US$41.42/barrel in the early hours of trading on April 18th. Although the fall is noteworthy, the new oil price is still well above its level in mid-January when it bottomed out at below US$30/b. In the immediate term, a disorderly drop in oil prices has been prevented, partly owing to a two-thirds cut in Kuwaiti crude production as the country's oil workers started industrial action on April 17th. Meanwhile, although Iran would have preferred a freeze in Saudi output in order to give additional support to a higher oil price floor, it is more focused on regaining market share to realise the benefits of the lifting of sanctions in January. Its exports, at an estimated 1.6m barrels/day (b/d) in March, are still more than 500,000 b/d down from the pre-sanctions levels in mid-2012. Impact on the forecast Tense political ties between Saudi Arabia and Iran will continue to limit any scope for an oil output freeze. As a result we expect Saudi Arabia to maintain its output at record levels, and Iran to increase its production as they both compete for market share. This will preclude broader OPEC agreement on production levels, and our oil market outlook is therefore unchanged.

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April 27, 2016: Election watch Iran prepares for second round of parliamentary election Event The second round of Iran's parliamentary election, for the 69 seats (out of 290 in total) where the result was indecisive in the first round on February 26th, is due to take place on April 29th. Analysis All the 69 seats (where no candidate won more than 25% of the vote in the first round) are outside metropolitan Tehran—where a coalition supportive of the president, Hassan Rowhani, won all 30 seats in February. The contest will be primarily between two broad lists, one backing Mr Rowhani and the other supporting his conservative "principlist" opponents, who have been especially critical of the nuclear agreement forged with world powers last year. The election has seen the active return to Iranian politics of the reformists, who were largely excluded from formal politics (and in some cases imprisoned) following the 2009 unrest after the disputed presidential election that brought Mahmoud Ahmadinejad to power. The reformists have followed a more practical approach than in the past, firstly by agreeing an electoral list with pragmatic conservatives such as the former president Akbar Hashemi Rafsanjani and Mr Rowhani himself, and secondly by calling on supporters to vote tactically, voting, for instance, for "moderate principlists" against hardline rivals. Mr Rowhani needs parliamentary support for a programme of economic reform, including phasing out expensive subsidies and making the business climate more welcoming for foreign investors. Among the challenges he faces are managing those who feel threatened by reform, including vested interests linked to religious foundations or the Islamic Revolutionary Guards Corps. At the same time, continuing US sanctions, especially those that restrict Iran's access to the US dollar, may strengthen critics of the nuclear agreement. Mr Rowhani will also be aware that most Iranians have thus far failed to notice any material benefit from the agreement, which could at the very least depress the turnout. Impact on the forecast Despite some public misgivings about Iran's continued weak economic performance, we expect moderate candidates to emulate their allies' impressive performance in the first round of the election. Such an outcome is likely to strengthen the position of the Rowhani administration, and in turn reinforces our forecast that the government will make progress in strengthening the business climate and drawing in foreign investment.

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May 2, 2016: Election watch Run-off election opens new political phase Event In keeping with the results of the first round of the parliamentary election, reformists and moderates had a strong showing in the run­off election—which took place on April 29th for the 69 seats (out of 290 in total) where no candidate won more than 25% of the vote initially. Analysis According to state media, centrists and reformists will hold a total of 122 seats in the new parliament, with hardliners having a much-reduced 84 and independents holding the remainder. Responding to the election, the president, Hassan Rowhani, focused on the fact that a record number of women were returned to parliament (indeed, for the first time, there were more women than clerics elected). The electoral run-off opens a new phase in Iranian politics, ahead of the presidential election due in 2017. The new parliament that will convene on May 20th will be more supportive of the president than the outgoing one, but the president will continue to face challenges from conservative critics. The main contested area will be the economy as the government works to introduce reform to bolster the private sector, attract foreign investment and improve the fiscal outlook. Overall, improvement is likely, but the government will need to woo independent MPs—probably via the time­honoured method of promising development projects in their constituencies—in order to gain the passage of his reform programme. Mr Rowhani's critics, however, sense vulnerabilities to exploit. This is likely to centre on an appeal to poorer Iranians based on populist egalitarianism. Turnout in poorer areas of Tehran in February was low—overall turnout was 50% in the capital, compared with 62% nationally—reflecting a sense that last year's nuclear deal has brought no tangible benefits, with inequality and poverty having increased under the administration. Arguably, the increasing numbers of morality police in Tehran—who check Islamic dress codes—may also be a way for conservative elements to appeal to poorer citizens who resent better-off Tehranis flaunting their wealth. Mr Rowhani favours easing social restrictions and needs to satisfy middle-class supporters, but will be wary of social-media campaigns against hijab that could excite their expectations. Impact on the forecast The success of moderates in the second round of the elections reinforces our forecast that Mr Rowhani will face a more supportive parliament than its predecessor. We expect him to leverage this advantage to expedite economic reform; however, social and political reform will continue to be strongly resisted by hardline conservative elements, hindering progress.

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May 3, 2016: International relations Iran to sue US over terrorist compensation case Event Iran has reacted furiously to a US Supreme Court ruling to block around US$2bn of Iranian assets held in the US, threatening to sue at the International Court of Justice (ICJ) for what it says is a "naked violation of international law". Analysis On April 20th the US Supreme Court ruled that around US$2bn of Iranian state funds—held at a Citibank account in New York under now­lifted US sanctions on Iran's nuclear programme—would be made available as compensation to US families of victims of attacks attributed to Iran. Foremost among these was the bombing of a US marine corps barracks in Beirut in 1983, at the height of the Lebanese civil war, in which 241 US marines were killed. The attack itself was by the Lebanese Hizbullah group, but the plaintiffs cited Iran's material support for the group in their claim. Iran denies responsibility for the bombing. In response to the court's decision, Iran's foreign minister, Mohammed Javad Zarif, wrote a letter of protest to the UN secretary­general, Ban Ki moon, on April 29th asserting that Iran "reserves the right to take appropriate lawful … countermeasures". He also countered that the US should pay overdue compensation for its "hostile" policies against Iran, including its backing of the Iraqi dictator, Saddam Hussein, during the Iran­Iraq war (1980 88) and for shooting down an Iranian airliner in 1988. In terms of its legal response, on April 25th Iran said that it would pursue a claim against the US through the ICJ. However, the US has previously rejected the ICJ's jurisdiction after losing a landmark case to Nicaragua in 1986 over American intervention in that country. The fight over the US$2bn is less to do with money and more to do with whose version of history prevails. US appropriation of Iranian state funds to pay US victims strengthens its own narrative of Iran as a sponsor of terrorism overseas. Iran, however, paints the US as the paramount source of instability overseas, and views the appropriation of its assets as not only wrong but hypocritical. Impact on the forecast The appropriation of the Iranian state funds reinforces our forecast that, despite the nuclear deal implemented in January, normalisation of relations between the two historical foes is highly unlikely, given mutual mistrust, the maintenance of unilateral US sanctions and opposing policies in the Middle East.

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May 4, 2016: International relations South Korean president makes landmark visit to Tehran Event South Korea's president, Park Geun­hye, has completed a three day visit to Iran focused on exploring economic opportunities beneficial for both countries. Analysis The visit comes despite continuing problems caused by Iran's limited access to US dollars owing to the maintenance of unilateral US sanctions. The two countries have long been major trading partners, although a tightening of international sanctions saw bilateral trade decline from around US$17bn in 2011 to US$6.4bn in 2015 according to the World Bank. South Korea has increased its imports of Iranian crude oil since the Iranian nuclear agreement came into effect in January. Figures reported in the South Korean media indicate that imports of Iranian oil (including condensates) rose to 22.85m barrels in the first quarter of 2016, up sharply from 10m barrels in the same period of 2015. Iran's oil imports are bought by two South Korean refiners, SK Innovation and Hyundai Oilbank. Both sides have alluded to ongoing problems in making payments but stress optimism that these will soon be overcome. The visit was cordial, with the South Korean president arriving in a green, red and white outfit, reflecting the colours of Iran's flag, and both sides expressing respect for the way the other sought to protect its culture in today's globalised world. Significantly, Park Geun hye met Ayatollah Ali Khamenei, despite it being rare for the supreme leader to meet non Muslim heads of state. Park Geun-hye emphasised in her keynote speech the opportunities for South Korean companies in Iran in energy, hydroelectric dams, airports and harbours, and stressed Iran's interest in accessing South Korea's advanced information technology. South Korean officials revealed that 31 purchasing deals, worth US$537m, had been agreed during the visit, with provisional agreements worth up to a further US$37bn. Park Geun-hye's visit comes shortly after the visit to Tehran of Italy's president, Matteo Renzi, in April. On May 2nd, in an indication of the scale of outside interest in Iran's economic potential, Valiollah Afkhamirad, the head of Iran's Trade Promotion Organisation, revealed that the number of foreign trade delegations tripled over the past Iranian year (March 21st 2015-March 20th 2016), with 64 trade delegations and officials from 28 countries visiting the country. Impact on the forecast The visit to Tehran by South Korea's president reinforces our forecast that the Iranian government will seek to leverage the lifting of sanctions to expedite urgently needed inward investment into the country.

Economy Forecast updates April 6, 2016: Fiscal policy outlook Fiscal deficit rises modestly in first ten months of 2015/16 Event

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 25 New official data from Bank Markazi (Iran's central bank) have indicated that the fiscal deficit in the first ten months of 2015/16 (March 21st-January 20th) rose from IR126trn (around US$4.4bn at 2015 exchange rates) in the same period of 2014/15 to over IR160trn. Analysis The widening of the fiscal deficit was primarily driven by a fall in crude oil and condensate revenue, which was down by 10.6% over the period. However, in reality, the drop-off in hydrocarbons revenue was relatively modest, given that the average price of oil in the first ten months of 2015/16 was 47% below its level over the same period of 2014/15. This fairly small dip in income reflected the fact that oil export volumes continued to rise over the past year, initially led by condensates (which were not restricted by EU and US sanctions), but subsequent to the implementation of the international nuclear deal in January, by crude oil as well. In early April the Iranian official press reported that the country's oil exports, including condensates, have now reached 2m barrels/day (b/d)—some 650,000 b/d above their level at the start of the year, according to our estimates.

Fiscal account (IR bn; Mar 21st-Jan 20th) 2013/14 2014/15 2015/16 % changea Total non-oil revenue 504,222 724,899 798,851 10.2 Tax revenue 359,893 540,136 581,549 7.7 Other revenue (excl privatisation proceeds) 144,329 184,763 217,302 17.6 Oil revenue 417,374 529,620 473,371 -10.6 Total revenue (incl others) 923,801 1,256,711 1,363,675 8.5 Current spending 897,535 1,134,743 1,289,337 13.6 Development spending 100,923 242,985 204,208 -16.0 Other spending 8,592 5,075 30,262 496.3 Total spending 1,007,050 1,382,803 1,523,807 10.2 Balance -83,249 -126,092 -160,132 27.0 a 2015/16 compared with 2014/15. Sources: Bank Markazi; The Economist Intelligence Unit. Nevertheless, the overall weakness in the oil price is being compounded currently by slower growth in non-oil revenue. This in large part reflects the weakness of the local economy (which, among other things, contributed to a sharp slowdown in corporation and import tax receipts), as well as the ending of the temporary benefits accrued from the rise in the rate of value-added tax from 6% to 9% in recent years. In response, the government has managed to introduce a considerable measure of austerity, with total current spending up by 13.6% year on year over the first ten months of 2015/16—broadly in line with inflation over the period—and less politically sensitive development spending cut by 16%. As a consequence, we estimate that the fiscal deficit came in at a relatively modest IR160trn for the first ten months of 2015/16, compared with the government's much larger targeted budget shortfall of IR251trn. Impact on the forecast The deficit figure for the first ten months of 2015/16 is modest, compared with our own estimate for the year of IR417trn (3.5% of GDP). However, it is worth noting that interim Iranian fiscal data are often incomplete and inconsistent, and we will await full-year outturn figures before adjusting our own forecasts.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 26

April 13, 2016: Policy trends Italy and Iran sign raft of new investment deals Event On April 12th Italy's prime minister, Matteo Renzi, and the Iranian president, Hassan Rowhani, attending a signing ceremony in Tehran designed to strengthen bilateral economic ties between the two countries. Analysis The signing of seven trade agreements builds on the earlier visit by Mr Rowhani to Italy in late January, during which €17bn (US$19bn) in memoranda of understanding (MoUs) were signed. Similar to that earlier visit, the latest deals were focused on infrastructure and energy. Among the most high-profile on this occasion is a deal involving Italy's state railways company, Ferrovie dello Stato, to build two high-speed rail lines in Iran, and a potentially far-reaching agreement between Italy's Enel and the National Iranian Gas Export Company that could presage the export of Iranian natural gas to Italy. Although smaller, a separate deal between Italy's Saipem (which had already signed MoUs in January regarding refineries and natural gas pipelines) and privately owned Razavi Oil and Gas Development Company to develop the onshore Toos gasfield marks a major step forward in the re-engagement of international oil companies in Iran's hydrocarbons sector. However, of more significance was the news that Cassa Depositi e Prestiti, Italy's state financing agency, and Sace, Italy's export credit agency, will provide €4bn in credit lines and export guarantees to back the deals, as well as a separate €800m in financing for Italian small and medium-sized firms doing business in Iran. Mr Rowhani's investment drive has been hindered by the maintenance of unilateral US financial sanctions on Iran (even after international sanctions were lifted in January), which have deterred foreign banks from re-engaging in Iran. However, with the two Italian agencies providing credit lines via three Iranian private banks, Pasargad Bank, Parsian Bank and Saman Bank, the way should be clear at least for some Italian firms to recommence operations in Iran. Prior to the ramping-up of EU and US sanctions in 2012, Italy and Iran had enjoyed close trade ties. The two countries' bilateral trade totalled US$9.6bn in 2011, according to the World Bank, with Italy a particularly major market for Iranian oil exports. However, this trade dropped to less than US$2.2bn in 2014, following the EU ban on importing Iranian crude and petroleum products. Impact on the forecast The latest trade deals with Italy reinforce our forecast that the Rowhani administration will seek to capitalise on the lifting of sanctions to draw in much- needed foreign investment and, in turn, boost economic growth.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 27

April 20, 2016: Policy trends Iran and India to tighten economic co-operation Event The Iranian and Indian oil ministers met in Tehran in mid-April to discuss energy exports to India on favourable terms. Analysis Iran's exports of oil to India have increased in recent months as the two countries, whose relations were impeded for years by international sanctions, have continued discussions over deepening co-operation, particularly in energy. The oil ministers' meetings in the Iranian capital showed that both sides are seeking favourable terms, meaning negotiations over a complex set of agreements are likely to progress. Bijan Namdar Zanganeh, Iran's oil minister, has said that Iran has been exporting about 350,000 barrels/day (b/d) of crude oil to India in recent months, although Iranian media reports gave a significantly higher figure of 510,000 b/d for March, up from 190,000 b/d in December. Regardless, the increase is a result of easing sanctions in January, months after the signing of a nuclear agreement with world powers. However, discussions also centred on US$6.5bn owed by Indian refiners to Iran for oil supplies, suggesting Iran's problems in accessing the US dollar are continuing. The two oil ministers also looked at the US$5bn development of the Farzad B gasfield, linked to the Binaloud oilfield, where Indian firms have been involved in exploration since 2000. A consortium led by India's ONGC Videsh is thought to be in a leading position to develop a field, with over 12.5trn cu ft of recoverable gas. Talks have also focused on projects linked to Chabahar, the deepwater port India is due to develop in Iran's eastern province of Sistan-Baluchistan. Although the port can offer a trading gateway to central Asia, India is also interested in developing facilities for importing Iranian gas either by establishing a liquefied natural gas (LNG) plant or through a seabed pipeline. Multi-billion-dollar investment (US$20bn has been quoted in addition to the cost of developing the port), including petrochemical and fertiliser plants, means that India will capitalise on the potential of Iran's unsaturated hydrocarbons market, seeking concurrently to secure favourable contractual terms. Impact on the forecast The interest of foreign firms in Iran's energy sector and negotiations over boosting Iranian fuel exports to India confirm our forecast that Iranian oil exports (excluding condensates) will rise by some 700,000 b/d in 2016.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 28

April 27, 2016: Inflation Inflation continues to decline Event According to the latest data from Bank Markazi (the central bank), year-on-year inflation fell to 8.3% in March (down from 8.9% in February)—its lowest level since June 2010. The decline in the quarterly rate is even more marked, with year-on-year inflation slipping to 8.9% in the first three months of 2016, down from 10.1% in the last quarter of 2015 and the lowest quarterly rate since the second quarter of 2006. Analysis The decline in price growth has continued to be led by sharp falls in inflation in the food and beverages category (which has the second-biggest weighting in the Iranian consumer price index), with the category increasing by 3.5% year on year, compared with 5.3% in December. The housing, water and electricity category (which has the heaviest weighting in the category) has also softened, although inflation in this category remains relatively high at 10.7% year on year (reflecting the impact of subsidy cuts and rising rental costs). Intriguingly, further subsidy cuts beyond those envisaged are now on the agenda. However, in this instance the outgoing parliament has passed a bill to cancel cash handouts (first introduced in 2010 to offset the impact of major hikes in fuel and electricity prices) to those households earnings more than IR350m (US$11,500) a year—a move that will save the government around US$3.3bn a year, and will add to the disinflationary trend.

With fiscal austerity thus remaining on the agenda and inflation seemingly heading lower, attention will increasingly turn to the central bank to provide some monetary stimulus for the economy. Although Bank Markazi has been relatively cautious thus far, it appears that it is willing to act; in October 2015 the central bank reduced commercial banks' reserve requirement and interest rates and in March it lowered bank deposit rates from 20% to 18% and the "profit rate" (akin to an interest rate) for business loans from 21% to 20%. We expect further rate cuts in 2017, although, wary of the impact of weak oil prices on the Iranian rial, Bank Markazi will be careful about substantially easing its monetary stance. Impact on the forecast We are currently expecting average inflation to decline to 10.8% in 2016, from 13.7% in 2015. However, we are likely to reduce this figure to closer to 9.5% in our next forecast, in line with the latest first-quarter consumer price data.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 29 Analysis April 4, 2016 Panama Papers: Impacts will be widespread, but uneven The impacts of the Mossack Fonseca leak will vary considerably, but The Economist Intelligence Unit expects significant political fallout. This will largely affect countries that are already politically fragile, or facing institutional challenges. Significant emerging markets may face renewed political uncertainty as a result. Russia, and other large authoritarian states, will not be heavily affected. The Kremlin will dismiss the allegations as politically motivated. The number of resignations directly linked to the leak may be limited. However, the revelations will help to undermine establishment parties. There is a possibility of some indirect impacts on the Brexit debate. Papers seen by the International Consortium of Investigative Journalists (ICIJ), a US-based non-profit organisation, have revealed alleged financial impropriety involving public figures from a large number of countries. There will be significant political fallout from these revelations, with more information expected to be revealed shortly from the leak at the Panama-based law firm Mossack Fonseca. It will take some time before the full implications are clear; more than 11m documents from Mossack Fonseca's database have been leaked. In many cases, the information revealed may not show that leaders have broken laws. But the revelations of wealth accrued while in public office, and the hypocrisy of storing this offshore in order to avoid domestic taxes, will put pressure on politicians named in the leak. We expect six main areas of impact from the information that has been released so far. These are set out below. Overall, we expect the political impact on flawed democracies, hybrid regimes and weak states to be more substantive than that in either full democracies or authoritarian regimes linked to the allegations. For those governments that are already facing significant political challenges, the allegations have the potential to be serious. For others, they are likely to be manageable; indeed, we expect most of the impacts of the leaks to be indirect. The potential impacts are as follows: i) Some leaders might be forced from office It is possible that some serving political leaders may be forced from office as a direct consequence of the Panama leaks. Iceland's prime minister, Sigmundur Gunnlaugsson, is the likeliest candidate. Mr Gunnlaugsson, who has been accused of impropriety involving an investment vehicle, Wintris, leads a coalition government of the centrist Progressive Party and the centre-right Independence Party (IP). Bjarni Benediktsson, the finance minister and leader of the IP, is also implicated in the leak. A vote of no confidence on April 4th would trigger new elections in which the Pirate Party (PIR) could secure the largest share of the vote. ii) Political risks will increase in a number of fragile economies The leaders of several politically fragile states are implicated in the allegations, among which Ukraine and Pakistan stand out. It is alleged that the Ukrainian president, Petro Poroshenko, sought to avoid domestic taxation on the sale of his assets in Roshen, the country's largest confectioner. This is damaging both because of the implication of trying to evade taxes in a time of war and fiscal strain, and because it smacks of the "old" corrupt politics that Mr Poroshenko came to office

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 30 promising to tackle. More critical is the timing; local media have made much of the juxtaposition of the president approving the details of the offshore restructuring plan and the Ilovaisk incident—the turning point in the war in the south east, in which large numbers of Ukrainian volunteer forces were killed or captured by pro Russian forces. The accusation may do significant damage to the president's patriotic credentials, weakening further his popular support, and probably exacerbating an already serious government crisis. We do not expect him to be removed from office, but the allegations complicate an already fragile domestic environment, where policymakers are focused on managing the departure of the prime minister, Arseny Yatsenyuk. In Pakistan, it is alleged that the prime minister, Nawaz Sharif, concealed ownership of a number of assets revealed in the disclosures, notably including London property held in the name of family members. The Sharif family has long faced corruption allegations, albeit unproven. This will limit the political fallout from the new revelations. Still, opposition politicians will use the new claims to put pressure on the government (possibly in the form of public protests) and urge the country's anti-corruption agency and electoral commission to take action against the family. We do not expect any change of government as a result. iii) Government legitimacy may be undermined in key emerging markets There are a number of allegations affecting leaders in large emerging markets, notably Argentina's new president, Mauricio Macri. Mr Macri has come to office on a reform platform with a commitment to fight corruption. His reformist and anti- corruption credentials are likely to be damaged by the allegations, and there may be an impact on the speed and effectiveness of the reform agenda in Argentina as a result. The context for other major emerging markets is challenging, with impeachment proceedings under way in both Brazil and South Africa, where large corruption scandals affecting political and business leaders are already being investigated. We have recently changed our forecast on Brazil and expect the president, Dilma Rousseff, to fail to see out her term. In South Africa, Jacob Zuma's presidency is already looking increasingly shaky. The Constitutional Court ruled on March 31st that South Africa's president had breached the constitution in relation to the use of state resources to fund improvements to his private Nkandla homestead. Any suggestion of involvement from policymakers in either country could worsen existing political instability. iv) Another source of volatility in the Brexit debate The Panama allegations that have surfaced thus far have little direct impact on the UK, and they do not alter our forecast that the UK will vote to remain in the EU in the referendum on June 23rd. However, coming in the wake of significant domestic disruptions—a chaotic 2016 budget and a senior resignation from government—the leaks again highlight the inauspicious backdrop against which the electorate will be voting on June 23rd. Our Brexit call rests in part on an assessment that despite being elevated at present, anti­establishment sentiment in the UK—a country with a broadly conservative political culture—is too inchoate to swing the referendum in favour of those campaigning to leave the EU. Nevertheless, we acknowledge the potential cumulative impact—for example on turnout, which could be crucial to the result—of developments that may intensify discontent with the political status quo. We will therefore be monitoring the reception of the Panama leaks in the UK carefully. And if the leaks lead to any allegations with a more direct focus on senior figures in the UK or the EU, we will review our assessment of their impact on the EU referendum result. v) Political populists and non-traditional parties

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 31 are well placed to benefit The leak comes at a time when establishment political parties are under stress in a number of regions—notably Europe. The critique offered by populist parties of the radical left and right, that the political mainstream is corrupt, is likely to be bolstered by the allegations. This will have resonance in countries such as Italy and Spain (a member of the Spanish royal family has been specifically identified by the ICIJ). The direct impact is unlikely to be large, but if the scandal continues to develop we would expect to see the indirect impact supporting gains for parties such as Italy's Five Star Movement and France's Front national. In Greece, allegations surrounding the previous New Democracy government could potentially complicate an already fraught political environment, where leaders are struggling to pull together a new deal with the IMF. vi) Pressure on offshore centres is likely to increase Pressure on offshore financial centres has been growing for some time, and we expect the leak to exacerbate this. States that in the past have relied on lax oversight and plausible deniability when it comes to the criminal misuse of their financial centres may be unable to resist calls for further reform. States likely to be affected vary by region. In Asia Pacific, states such as Samoa may be affected. The use of shell companies in jurisdictions such as Samoa has been identified by the Financial Action Task Force (FATF) as the major risk for money-laundering and the FATF stated in its 2015 mutual evaluation report that although there was "little firm evidence" of the proceeds of crime being laundered via Samoa, the lack of due diligence and the inability to detect the misuse of shell companies suggested abuse was likely. The Panama Papers will in Samoa and other jurisdictions provide to some degree the firm evidence that may hasten the improvement of standards. In Europe, we expect further political pressure on Cyprus. The revelations may offer the possibility, through a renewed urge for international co operation on financial regulation, that the usual pattern of jurisdiction shopping for money-laundering will be curtailed as countries generally improve regulatory compliance. Authoritarian governments better placed to respond Much of the commentary thus far has centred on allegations around the Russian president, Vladimir Putin. In practice however, we expect very little meaningful impact in Russia—or other large authoritarian states—from the allegations. Expectations around corruption in larger authoritarian states are, to a significant extent, already "in the price", and governments also have a greater ability to restrict information. In Russia, much of what has been leaked is in line with previous allegations that the government has largely ignored. We expect any political impacts to be de minimis, with the government simply not reporting the allegations directed against it and/or indicating that the claims reflect an ongoing hostile campaign from the West. Similarly, we expect any further allegations about senior Chinese officials to be dismissed, although there has been heightened political nervousness around criticism of senior leaders in recent months. Overall, it appears likely that the impacts of the allegations are likely to be greatest on weak states and flawed democracies that are already facing very significant institutional challenges, or countries where the political environment is already fragile. However, with further information likely to emerge, the full contours of the political impacts of the leak are not yet clear.

April 14, 2016 Ayatollah Khamenei extols the "resistance economy"

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 32 Differences between Iran's supreme leader, Ayatollah Ali Khamenei, and the president, Hassan Rowhani, over the direction of economic policy have reemerged into the public sphere, in the wake of a series of speeches from Ayatollah Khamenei extoling the virtues of a "resistance economy". The two men's approaches in large part result from the need to placate different constituencies, and can therefore probably be managed at this stage, but they also highlight the extent to which the continuing unilateral US sanctions are undermining Mr Rowhani's drive to "open up" Iran's economy to greater international investment. In a speech in the shrine city of Mashhad on March 20th for Nowruz (the Iranian New Year), Ayatollah Khamenei accused the US of failing to respect the terms of the July 2015 nuclear pact by not lifting its financial sanctions. As a result of the US's actions, the supreme leader suggested that Iran needed to maintain a "resistance economy" to "fight unemployment and recession, control inflation and confront the threats of enemies". Since Ayatollah Khamenei first used the term around 2010, "resistance economy" has assumed two related but distinct meanings: first, a general commitment to self sufficiency and domestic production; and second, protecting or developing the economic role of state bodies such as the Islamic Revolutionary Guards Corps (IRGC) and religious foundations. The term is flexible enough to imply an almost siege economy with low international trade, but could still include, as Mr Rowhani would like, a robust economy with a vibrant private sector that can compete internationally and attract foreign investment. Reflecting this definitional flexibility, back in 2014, Ayatollah Khamenei issued a decree calling for a "resistance economy" based on a diverse array of protectionist and liberal measures, including reduced imports, higher investment of energy revenue, financial reform, greater transparency and development of "knowledge- based" industries. The primary explanation for this multifaceted approach stemmed from the fact that the decree itself was actually drafted by the Expediency Council (which mediates between parliament and the Guardian Council, a powerful vetting body), which is chaired by Akbar Hashemi Rafsanjani, a former president and an ally of Mr Rowhani. As a result, the decree reflected pragmatic conservatives' desire to mould the "resistance economy" to their agenda, and thereby undermine opponents who want to defend the IRGC's vested economic interests or resist Mr Rowhani's wish for détente with the US. The IRGC and economic jihad However, sidelining the IRGC's business arms and other vested interests will prove challenging, given their deep roots. The "resistance economy" can be traced back to the term "economic jihad", which originated with the 1979 Islamic revolution, was expanded during the 1980 88 war with Iraq, and subsequently near­institutionalised during the immediate post war period when Mr Rafsanjani as president encouraged the IRGC into peacetime projects. The tightening of international sanctions later enhanced the IRGC's role, as its affiliated companies took over energy and infrastructure projects from international companies pulling out of Iran. The private sector was further weakened in 2005 13 by the economic policies pursued by the then president, Mahmoud Ahmadinejad, whose dirigiste and nationalist approach favoured his allies in the armed services and among his hardline backers. Besides a desire to protect their own privileges, Mr Rowhani's critics are wary of greater foreign involvement for more ideological reasons; some senior clerics are fearful of Western cultural influence undermining Islam, and there are those in groups like the Basij (a paramilitary volunteer organisation) who have been steeped in anti Western ideology. "Fundamentalists" are among the staunchest supporters of Ayatollah Khamenei, which means the leader has to acknowledge or placate their feelings and fears, as he was careful to do over the nuclear agreement with world powers.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 33 Economic outlook remains encouraging, but vulnerabilities remain Key to Mr Rowhani's drive to open the economy to greater foreign involvement is showing credible and positive results from the lifting of sanctions. In his Nowruz speech, Ayatollah Khamenei gave a mixed assessment of the government's economic performance, noting that "preliminary actions" had been successful in reducing inflation (which has now reached single figures, having being more than 40% when Mr Rowhani took office in 2013), but he maintained a relatively cautious (albeit patient) tone, saying: "I do not expect that these problems will be solved in a year". The challenge of reassuring the population at large is not made easier by the fact that most Iranians have not benefited from the easing of sanctions since the nuclear deal. In March a report from the Statistical Centre of Iran suggested that both inequality and poverty had increased in the Iranian year 2015/16 (ending on March 20th), which ended a four year decline in both. Unemployment in Iran is around 11% and youth unemployment is 25%, making job creation vital. With this in mind, in his own message for Nowruz, Mr Rowhani said that he was aiming for 5% real GDP growth in 2016/17 (close to our own forecast of 4.5%), and was "certain that with interaction with the world, we can move towards economic prosperity". Iranian politics, US pressures However, in managing expectations, the challenge for the Iranian leadership is further complicated by the US dragging its feet over financial sanctions. These restrictions include continued problems for Iranian companies gaining access to the dollar—a complex area but clearly one where Iran expected more progress under the nuclear agreement—and those measures related to the maintenance of US sanctions that were not part of the nuclear deal. The latter include the designation of some Iranian entities, including the IRGC, as "terrorist", a situation that worries potential foreign investors in Iran, as it is not always easy to discern exactly where the IRGC's influence ends (especially after Mr Ahmadinejad's privatisation programme's transfer of state-owned bodies to quasi-state operators including the IRGC). The mood music has also hardly been helped by the ongoing divisive US election campaign, with the supreme leader observing that candidates for the US presidency were competing to "vilify" Iran. Nevertheless, Mr Rowhani's position has no doubt been bolstered by the results from February's parliamentary election—which should result in a continuation or even improvement of the generally co operative relationship with parliament that the government has enjoyed since Mr Rowhani was elected in 2013—and he will hope to see more positive results from the run off elections on April 29th, when the remaining 64 of the 290 seats will be filled. The popular mandate he has built up from these successive election results should give him time to engineer an economic turnaround and enable him to resist the more protectionist tendencies of the supreme leader and his hardline allies. However, Mr Rowhani also faces a presidential election in 2017, when presumably he will seek a second term, and he will probably need to be able to point to a post sanctions economic dividend if he is to maintain his recent electoral run of successes.

April 20, 2016 EIU global forecast - Volatility will be a recurring theme The global economy has found a firmer footing after a rocky start to 2016. The opening weeks of the year were notable for dramatic falls in global stockmarkets, a renewed dip in the oil price and remarkable declines in sovereign bond yields: Japanese ten-year yields fell below zero for the first time ever in February. The downturn in sentiment was sparked by two factors: concerns about the strength of

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 34 Chinese demand and volatility caused by the start of a US monetary tightening cycle. Sentiment has since improved. The US has continued to post excellent job creation numbers and inflation is gradually rising. There are further signs that a cyclical upturn is under way in the Chinese property market, and even Europe was given something to cheer with the introduction of further monetary easing by the European Central Bank (ECB) to encourage banks to lend more to companies. In many emerging markets, local currencies have appreciated against the US dollar. These developments boosted market confidence, prompted a market rally and spurred higher commodity prices. However, volatility will remain the dominant theme of 2016, driven by global monetary policy divergence and the sustainability of Chinese growth in the light of that economy's build-up of debt. The developed world will remain dependent on central bank stimulus, and the outlook for emerging markets will not be helped by capital outflows, heightened geopolitical risk and the slowdown in China. Overall, The Economist Intelligence Unit expects global GDP growth to moderate slightly, from 2.4% in 2015 to 2.3% this year. Growth will accelerate to an annual average of 2.6% in 2017 18 as the outlook for emerging markets improves. The global economy will then slow once more, to 2.3% in 2019, when we expect the end of the US business cycle to result in a mild recession, before recovering to 2.6% in 2020. Developed world Among the most fundamental problems facing the global economy is the inability of the developed world to stimulate domestic demand. It is now clear that the financial crisis provided a structural break in the functioning of these economies, but the new rules of the game are still being learned. Trend levels of real GDP growth, consumer price inflation, interest rates and trade are all lower than in the pre-crisis period. The policy response has been to engage in unprecedented levels of monetary easing. We are pessimistic about the ability of the UK, Europe and Japan to lift their main policy interest rates from rock bottom in our forecast period (2016 20), and we expect the pace of monetary tightening by the Federal Reserve (Fed, the US central bank) to be pedestrian compared with previous cycles. Of the four, the US economy is in the best position. We believe that the long business cycle that began with the recovery from the financial crisis still has some way to run. This year is likely to be a soft one—with growth of around 2%, held down by contracting business investment in the energy sector and the strong dollar, which will dampen exports—but we expect growth to rise to an annual average of 2.3% in 2017 18, supported by stronger investment. Inflation will accelerate as the labour market tightens and commodity prices recover. The business cycle will turn in 2019 as higher interest rates curb private consumption, resulting in a short recession. Weaker US import demand will weigh on global growth in 2019, but we expect a swift recovery in 2020. In Europe, the ECB remains firmly in loosening mode. In March it reduced its deposit rate from 0.3% to 0.4%; increased the size of its quantitative easing (QE) asset purchases by €20bn (US$22bn) a month, added investment grade non­bank corporate debt to the QE programme; cut its policy rate to zero; and introduced more measures to encourage banks to lend. This was an aggressive package, but the euro failed to weaken against the dollar in response. The resilience of the euro will hamper the ECB's efforts to deliver inflation of 2%. Confidence in the euro zone will continue to be undermined by wider existential questions about its future, the rise of national opt-outs from region-wide policy and its failure to resolve the migrant crisis. In the UK, the high level of indebtedness and an ageing population will prevent the Bank of England (the central bank) from raising rates before mid 2020. The fate of Japan is what European governments are keen to avoid. Growth is lacklustre, pulled down by a shrinking workforce, a rising old-age dependency ratio and tight immigration controls. The Bank of Japan (BOJ) is pursuing unconventional

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 35 measures, most recently a fee on some commercial bank holdings. The appreciation of the yen is a troublesome trend that it wishes to end, but the central bank appears to lack the tools to do so. The BOJ's QE programme probably has another year to run at its current volume before the central bank reduces the size of its purchases over another 12 month period. Emerging markets There has been a heightened sense of instability surrounding the Chinese economy in the past year, with the government unwisely intervening in stock and currency markets. This suggests that the authorities are finding the ongoing process of delivering a consumption- and services-driven economy hard to manage. The economy is growing at two speeds: the manufacturing sector, plagued by overcapacity and inefficiency, is struggling to expand at all, but the consumer- driven services sector is thriving. Recent policy measures suggest that the government is again prioritising short-term growth over rebalancing. As a result, we believe that the risk of China experiencing a hard landing at some point in the next five years is around 40%. (We define a hard landing as growth of 2 percentage points or more below that of the previous year.) There are many routes to such an outcome, including a house price crash and the state sector crowding out investment, but we are particularly concerned by the build-up of debt in the economy. Our GDP forecast includes a slowdown from 6.5% in 2016 to 4.3% in 2020. This view assumes that the government recognises that credit growth has become unsustainable and takes steps to curb it as early as late 2016. These measures will be stepped up in 2017 and will result in a notable slowing of loan issuance in 2018 20. In India lower oil prices have eased structural problems with high inflation and enabled looser monetary policy. Growth should remain steady, averaging 7.3% a year in 2016 20, but the measures that could see it reach double digits again—land acquisition reforms and a nationwide goods and services tax—will prove hard to legislate without an upper house majority. The malaise affecting Latin America will continue for a third year in 2016. The underperformance is being driven by Brazil, where GDP shrank by 3.8% in 2015 and is forecast to fall by the same amount in 2016. We have changed our political forecasts and now assume that the president, Dilma Rousseff, who faces impeachment, will be ousted in 2016 and a new, more orthodox, government will take office. This will be a catalyst for a moderate recovery in business confidence from record-low levels, brightening the outlook. But economic recovery will take some time to gain momentum because of the imperative of fiscal adjustments. Other than Brazil, even the better-performing countries, such as Peru and Colombia, are struggling with a downturn in the credit cycle. Venezuela faces a high risk of default. We assume a political transition that will see the president, Nicolás Maduro, leave office early, probably in 2017. Owing to the steep decline in oil prices, there is likely to be a restructuring of part of the debts of PDVSA, the state oil company, in 2016. The outlook for the Middle East and North Africa is uncertain and fraught with downside risk. In the wake of the Arab Spring in 2011 an intra-regional struggle has developed, pitting democrats against dictators, secularists against Islamists, Shia against Sunni and the jihadi Islamic State group against pretty much everyone else. The region's problems have increasingly spilled over its borders, exemplified by the flood of refugees into the EU and deteriorating relations between Iran and Saudi Arabia. In Syria we no longer expect the president, Bashar al Assad, to be toppled within the forecast period: instead, Russia (supported by an enlarged Iranian role) will seek to ensure a balance of power within Syria, stepping up its intervention at times when the regime appears particularly vulnerable and stepping back when it is at risk of overreach. Cheaper oil means that even countries with large sovereign wealth funds, such as Saudi Arabia, are cutting spending to contain budget deficits. Non-oil economies have received a boost and, combined with a stronger Iran, will enable regional GDP growth to accelerate from 1.9% in 2016 to 3.7% a year on

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 36 average in 2018 20. Sluggish growth in South Africa, Nigeria and Angola will continue to depress Sub- Saharan African growth. At 2.4 %, GDP growth this year will be the second-slowest rate this century. A less supportive external environment, including generally weak commodity prices, slower growth in China and much reduced international liquidity amid rising interest rates in the US, will continue to expose the structural flaws that plague many African economies. Growth will reach 4% only occasionally in the forecast period, a rate considered mediocre during periods of high commodity prices. By 2020 GDP per head at purchasing power parity exchange rates will have barely improved from its 2015 levels. Exchange rates The US dollar has weakened again, reflecting the Fed's admission that the pace of interest-rate rises will be slow. The weakening of the dollar has coincided with a rebound in commodity prices, which has supported commodity currencies. The euro is now trading close to the upper bound of the US$1.15:€1 to US$1.05:€1 range that has held for the past year. The ECB would like a weaker euro, given sluggish growth and persistent deflationary pressures. But with monetary policy already extremely accommodative, it is questionable whether any further easing will have much impact. We expect the dollar to rise against the yen in the rest of 2016. Like the euro, the yen is supported by a current-account surplus and a cheap valuation. These factors will contribute to a mild appreciation of the yen against the dollar in 2017 20. Commodities We do not expect crude oil prices to bounce back to pre 2014 levels in the next five years, as modest demand growth will fail to catch up with resilient supply. Despite a dip in US production in 2016, global crude supply will expand further, on the back of continued output growth from OPEC and, to a lesser extent, Russia. Combined with moderating demand growth, this points towards only a gradual increase in prices. Industrial metals prices will recover slowly in the remainder of the decade. An El Niño phenomenon has put some upward pressure on food prices, but stocks are generally very plentiful.

World economy: Forecast summary 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Real GDP growth (%) World (PPP* exchange rates) 4.0 3.3 3.3 3.4 3.1 3 3.5 3.6 3.2 3.5 World (market exchange 2.8 2.2 2.2 2.5 2.4 2.3 2.6 2.7 2.3 2.6 rates) US 1.6 2.2 1.5 2.4 2.4 2 2.3 2.3 1 2.1 Euro area 1.7 -0.8 -0.2 0.9 1.6 1.4 1.5 1.7 1.5 1.6 Europe 2.2 0 0.6 1.4 1.6 1.5 1.8 1.9 1.8 1.9 China 9.5 7.7 7.7 7.3 6.9 6.5 6.0 5.1 4.6 4.3 Asia and Australasia 4.2 4.4 4.4 4 4 4 3.8 3.7 3.5 3.6 Latin America 4.7 3.2 2.9 1.3 0.1 -0.4 1.9 2.9 2.9 3.2 Middle East & Africa 3.2 3.8 1.8 2.4 2.0 1.9 2.8 3.7 3.5 3.8 Sub-Saharan Africa 4.6 4.2 4.7 4.4 3.0 2.4 3.5 4.1 3.9 3.9 World inflation (%; av) 4.9 4.0 3.9 3.6 3.3 4 4.1 3.7 3.1 3.1 World trade growth (%) 7.1 3.4 3.8 3.6 2.6 2.9 3.6 3.7 2.8 3.4 Commodities Oil (US$/barrel; Brent) 110.9 112.0 108.9 98.9 52.4 40.2 55.5 67.5 62.8 61.8 Industrial raw materials - 21.7 -19.4 -6.8 -5.1 -7.7 8.2 7.5 -5.7 -1.7 (US$; % change) 15.2 Food, feedstuffs & - 30.0 -3.5 -7.4 -5.2 -6.8 5.2 11.2 -0.2 0.1 beverages (US$; % change) 18.7

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 37 Exchange rates (av) ¥:US$ 79.7 79.8 97.6 105.9 121 112.4 112.1 113.9 112.5 110.9 US$:€ 1.39 1.29 1.33 1.33 1.11 1.1 1.09 1.11 1.15 1.18 *PPP=purchasing power parity Source: The Economist Intelligence Unit.

May 10, 2016 Economy remains subdued in final quarter of 2015 New data published by Bank Markazi (Iran's central bank) in the quarterly Economic Trends have revealed the extent to which the economy was struggling in the third quarter of Iranian year 2015/16 (September 21st-December 20th 2015), immediately prior to the implementation of the nuclear deal in January and the accompanying lifting of nuclear-related sanctions. Manufacturing, construction, trade and bank finance all paint a moribund picture of economic activity, highlighting the overweening importance of the government's ongoing drive to draw in foreign investment and turn the economy around. For the third quarter in a row, Bank Markazi has failed to provide updated real GDP data, raising suspicions that the numbers are being deliberately concealed to avoid public scrutiny of the economy's weakness. However, there is still sufficient information available from Economic Trends at least to confirm that the economy is struggling. The manufacturing production index, for example, was down once again in the quarter, by 2.3% year on year (and 5.2% quarter on quarter). The index had experienced a brief uptick in the second quarter of the Iranian year, immediately following the signing of the nuclear deal, but it appears that this brief burst of optimism dissipated in the following quarter. The construction data were similarly downbeat, with private-sector investment in new building in urban areas down by 25%, year on year, and the number of new construction permits falling by 3.7% (although this is far slower than the rate of decline in previous quarters).

Manufacturing and construction remained in the doldrums The subdued manufacturing and construction data are in large part a reflection of the depressing impact on the overall economy of the persistently weak oil price and the government's concurrent fiscal austerity programme. However, it is also seemingly an indictment of the government's policy ineffectiveness: back in October 2015 the government announced plans to frontload IR75trn (US$2.5bn) in state development spending, but it appears that it is struggling to implement this pledge.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 Iran 38 Indeed, in the third quarter of 2015/16 government development spending was actually down by 9.7% year on year (to IR77.5trn). Meanwhile, although consumer spending figures are not available, a fall in the demand for cash—as demonstrated by a 14.4% year-on-year decline in the "currency with the public" category of narrow money, or M1—is highly indicative of lower spending levels. The weak economic backdrop is also reflected in the trade data, with the import bill for the quarter down by a substantial 29.1% compared with the same period a year earlier. Although this figure was in part exaggerated by lower global prices for foodstuffs and commodities over the period, the weight of imports (a proxy for volumes) was also down sharply, by almost 20%. This weak domestic demand will have been exacerbated by sluggish external demand, with non-oil exports rising by only 0.5% in volume terms (following four consecutive quarters of contraction). Banking sector continues to struggle The overall business climate is hardly being helped by the weak banking sector, which continues to be held back by large stocks of non-performing loans (NPLs) and state interference in lending decisions. As a consequence, bank lending to the private sector rose by just 8.1% in the third quarter (below the rate of inflation). Although the NPL ratio has at least now begun to decline, falling to 14.1% in the third quarter of 2015/16 (compared with a peak of 19.5% in the same quarter of 2013/14), it is clear that the sector remains far too weak to take advantage of the anticipated influx of foreign firms in the coming years. This shortcoming has particularly serious consequences given that the international banking sector remains extremely wary of doing business in Iran, in the face of continued US financial sanctions. Equally, although Iran's economic opening is undoubtedly drawing in significant foreign interest, thus far the vast bulk of economic agreements have been in the form of non-binding Memoranda of Understandings (MoUs). Turning these MoUs into actual contracts will require not just more clarity on residual US sanctions, but action by the Iranian government to reform its own investment climate, including tackling vested interests (such as the business arms of the Iranian Revolutionary Guards Corps) and providing greater legal certainty for businesses. However, as is clear, the administration under the president, Hassan Rowhani, remains far from achieving this goal—as demonstrated by the continued espousal of the "resistance economy" by the supreme leader, Ayatollah Ali Khamenei. Yet, as the raft of weak data in the latest Economic Trends shows, the economy is in urgent need of a post-sanctions windfall, or it risks seeing its current economic malaise deepen into an outright depression.

Country Report May 2016 www.eiu.com © Economist Intelligence Unit Limited 2016 (c) May 2016 The Economist Intelligence Unit Ltd. All rights reserved. Reproduced with permission of the copyright owner. No further reproduction is permitted.