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Iran Update: Assessing the Current Market Environment Dr Iran update: Assessing the current market environment Dr. Vedat Mizrahi 21 March 2017 © 2017 ÜNLÜ & Co | Özel ve gizlidir 1 Table of Contents Section Page I. Political scene a year after the nuclear agreement 03 II. State of the Iranian economy and foreign direct investment 07 III. Appendix 15 I. Political scene a year after the nuclear agreement Will the Nuclear Deal with Iran begin to unravel? 3 Renewed external uncertainty → Uncertainties on how the Trump Administration will handle the Iran Nuclear Deal → On one hand, President Trump has been harshly critical of the deal, which he called “the worst deal I have ever seen negotiated.” → On the other hand, the U.S. has limited options outside the deal. The status quo is no longer available; UN and EU sanctions have been limited and are unlikely to be re‐imposed. → It would be hard for the U.S. to restore the level of economic pressure on Iran that persuaded Iran to negotiate in the first place. Russia, with whom the Trump Administration has promised to work more closely, will certainly encourage the U.S. to stay within the deal. → The U.S. and Iran will continue to test each other → Iran has continued a series of ballistic missile tests, which U.S. officials believe to be a violation of the terms of the Joint Comprehensive Plan of Action (JCPOA). → The U.S. has responded by imposing new sanctions on 25 individuals and entities involved in the ballistic missile program, some of whom are based in China, the UAE and Lebanon after Iran carried out a missile test on 29 January 2017. → These new sanctions are symbolic and their impact is limited. Most of the Iranian entities and individuals being targeted do not have US assets that can be frozen. New sanctions may not be enforced 4 New sanctions by the US will not be effective without the participation of Europe, China and Russia → There is substantial pressure in Congress for tighter non‐nuclear sanctions on Iran → The new US administration may reinstate UN sanctions by invoking the “snapback” provisions in the Iran deal, but this would be very risky. → Other UN members (particularly the EU, China, and Russia) might not enforce the sanctions, and Iran would almost certainly take the opportunity to walk away from its obligations under the deal. → For the EU, the nuclear deal is considered the best alternative to either a war between Iran and Israel, or an Iranian nuclear bomb. The EU would only agree on new sanctions if Iran fails to comply with the nuclear deal. → A friendly US‐Russia relationship could mitigate the risk of an escalation in tensions between Iran and the United States, given that the Russians could act as a mediator. → If the nuclear deal is undermined it would strengthen the position of hardliners, including the elite Revolutionary Guard, and damage Rouhani’s prospects of being reelected in May → Such an outcome would make the regional conflicts more entrenched and raise the risk of war with Israel. → Recently, the Iranian Parliament has asked the government to resume enrichment of uranium if the US tries to renegotiate the nuclear deal. → Ultimately, the new US administration may find the deal hard to unwind. Power struggle in Iran 5 The political scene in Iran is polarized → Iran prepares for Presidential Elections in May 2017 → The power struggle between pro‐reform forces and regime hardliners (including the Revolutionary Guard, the Judiciary and Conservative Clerics) is expected to intensify → Current President Rouhani is seeking to be re‐elected → The death of Rafsanjani (the former President, and a key ally of Rouhani) may complicate the current power struggle → A period of more radical foreign policy may be in the cards → Hardliners are yet to decide on their consensus Presidential candidate → Rouhani is being critized for failing to promote domestic investment following the lifting of economic sanctions in early 2016 → Nonetheless, Rouhani is in a strong position to be re‐elected for a second four‐year term as he has managed to unite reformist and moderate conservative fractions to support his economic reform agenda II. State of the Iranian economy and foreign direct investment Foreign banks still cautious 7 US maintains economic pressure on Iran → International banks are still cautious about doing business in Iran, → US dollar clearing restrictions have not been lifted and continue to pose a major challenge for global banks to re‐establish correspondent banking relations → This in turn restricts access to corpoate trade and primary sanctions remain in place → In addition to maintaining a broad domestic trade embargo prohibiting most transactions between US individuals and Iranian entities, the US also retained sanctions on Iranian entities connected to terrorism financing, human rights abuses and the ballistic missile program., → Foreign firms may be subject to US secondary sanctions for facilitating financial transactions with designated Iranian institutions. → ...in part because the US still retains extensive sanctions against Iran → The US Department of Treasury took some action in Fall 2016 to alleviate foreign bank concerns by issuing guidance that US banks can do dollar trades with Iran, provided that they do not pass through a US institution. → However, following the elections in the US, there is strong support in the Congress and in the new Administration for maintaining economic pressure on Iran. → In late 2016, the Congress passed a 10‐year extension of the Iran Sanctions Act, which provided the framework for secondary sanctions. Limited progress in economic reforms 8 Risks to the outlook beyond near‐term are significant → Structural economic reforms are necessary to achieve sustained growth and to reduce the unemployment rate → Business environment needs to be improved in additionto maintaining political stability and better relations with the international community → The country suffers from large infrastructure deficiencies: Its oil fields have been crippled as sanctions kept needed equipment and machinery out of the country → The energy sector alone requires at least USD100bn in the next five years to make up for the under‐investment in the past decade → Business discrimination, legal uncertainties and widespread corruption hinder a strong recovery in investment → Iran ranks 76th out of 138 by the World Economic Forum (WEF) in terms of competitiveness → Some priority measures that could address these challenges include streamlining business regulations and an affirmation of investor rights. → Financial market development and labor market efficiency are other areas that need to be tackled. → International trade integration would complement the reforms in boosting lagging productivity. Banking system is fragile 9 Iranian banking sector needs to consolidate and to be recapitalised → Fragile domestic banking system, continued difficulties in reconnecting to the global financial system and hurdles to reform the regulatory system have held back major long‐term commitments to invest → Continued public payment arrears, related‐party lending and poor management of the banking system has weakened the balance sheets of the banks → Iranian banks need large capital injection, management restructuring and governance improvements → Poor management and sanctions over the past few years have led to a sharp increase in non‐performing loans (NPLs), which reached 12% of total loans in 2016, well above the GCC average of 3% → The capital adequacy ratio has continued to deteriorate from 8.5% in 2012 to slightly less than 6% in 2016 → Profitability remains constrained by the high cost of funding → High NPLs and tight cash‐flows in the financial and corporate sectors continue to undermine domestic investment → Iranian bankers are also frustrated at the slow progress in finding European banks to handle international payments for them → In July 2016, the Central Bank of Iran cut the lending rate following private banks move to lower the one‐year deposit rate from 18% to 15% → Further cuts in the lending rates are unlikely given the high NPLs and the recent up‐tick in the CPI inflation rate to 9.6% in January 2017. IMF Report on Iran 10 IMF concludes 2016 Article IV Consultation with the Islamic Republic of Iran on 27 February → In its recent report, IMF emphasizes the importance of → Maintaining prudent economic policies and building buffers → Strengthening the financial sector through → Enhanced supervision of distressed banks → Asset quality review to identify viable banks that warrant recapitalisation → Advancing reforms to lessen Iran’s reliance on oil, while using oil revenues to fund bank recapitalisation → Develop private sector → Implement a medium‐term fiscal framework to underpin their commitment to prudent fiscal policy → IMF welcomes recent steps to → Strengthen the AML/CFT framework → Introduction of IFRS reporting in banks → Audit and securitization of government arrears → Underscores the authorities’ commitment to unify the exchange rate and shift to a managed float by early 2018 → IMF projects GDP growth to stabilise at 4.5% in the medium‐term as the recovery broadens → Real GDP growth is expected to reach 6.6% in 2016/17 and to ease to 3.3% in 2017/18 as oil production remains at the OPEC target Business Activity Overview 11 Automotive → The production line of a newly formed joint venture between Volkswagen and the Iranian automotive company Mammut Khodro will be launched by the end of the current Iranian fiscal year that ends in March 2017. → The first CVT transmission‐manufacturing factory named 'Qova Moharekeh Punch Powertrain Iran' was inaugurated in Zanjan (northwestern Iran), in a partnership deal between the Belgian firm, Punch Powertrain and the Industrial Development and Renovation Organization (IDRO). The project will be executed in three phases. In the first phase Punch Powertrain will invest USD27.5mn in the plant. → Scania has signed an agreement in principle with the Iranian province of Isfahan and Shahr‐e Atiyeh Investment Company on the delivery of 1,350 buses for public transport for Isfahan and four other Iranian cities.
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