wiiw Opinion Corner: What are the consequences of the Iranian sanctions relief?

International economic and financial sanctions against Iran were significantly relieved. wiiw Expert Mahdi Ghodsi assesses the possible consequences of the country’s comeback.

It may mean the beginning of a new era of diplomatic ties between Iran and the West, which will lead to a new economic environment for Iran, giving hope for a better and more peaceful Middle East. Since initiating the Joint Comprehensive Plan of Action (JCPOA) on 14 July 2015 in Vienna, Iran has already been establishing tighter economic relationships with the West, in particular with the EU. During the last couple of months, the Austrian president visited Iran as the first of the EU heads of states, accompanied by a team of more than 300 delegates including 130 delegates from Austrian companies, according to the Iranian media. The Czech Republic, Denmark, Finland, Germany, Poland, Slovakia, Slovenia and Spain are among the EU Member States sending economic teams to Iran. This was an ambitious start marking the beginning of new era of the relationship between the EU and Iran.

Assessing the impact of sanctions

After the Islamic Revolution in 1979, Iran became an isolated economy lacking foreign direct investment (FDI). In spite of efforts during the presidency of former president Rafsanjani to attract FDI for building up the post-war economy, foreign investors did not consider Iran a secure and stable environment for their projects. The oil and gas, transport and vehicle industries, and the mining sectors had been the branches of the economy attracting FDI. However, investors left the Iranian industry after the imposition of the sanctions hurting them heavily. Moreover, the sanctions against these major industries reduced their capacities as production was lacking intermediates (e.g. spare parts, tools and devices) and could not be maintained.

Increasing Iran’s attractiveness for FDI

Recently, Iranian officials have announced their desire for Iran to again become an attractive place for FDI after the abolishment of the sanctions. Ali Tayebnia, Iran’s Minister of Economic Affairs and Finance, recently indicated that Iran economy needs USD 45 billion FDI, a quarter of which is needed in the next Iranian calendar year starting from March 20, 2016.  However, despite manifold opportunities for investment, which are to enhance the Iranian capacities and technology in the manufacturing industries, Iran still needs to achieve more stability in its economy, e.g. by reducing two-digit inflation that erupted during the past years, in addition to offering tax credits and loan plans.

After the Iran nuclear deal framework had been announced in Lausanne, Switzerland, on 2 April 2015, the Iranian Oil Minister Bijan Zanganeh reiterated that Iran would increase its oil exports after the easing of sanctions by 500,000 barrels per day (bpd) (1), which could potentially lead to a further downward pressure on oil prices. Before reaching the Iran nuclear deal, amid the two-week negotiation marathon, oil prices had already been gradually dropping by a few percentages. Despite the lack of maintenance in petroleum exploitation due to the sanctions, Iran still has the capacity to increase its exports to more than 4 million bpd.

Unfreezing international assets

The easing of the sanctions will additionally release an estimated USD 107 billion of Iranian assets overseas, of which USD 29 billion may be released immediately (2).These new flows of income and assets could bring an extraordinary opportunity for Iran to develop its economy.

Iran’s macroeconomic homework

Appropriate management of the economy and putting safeguards against corruption will be the necessary conditions enhancing growth after the removal of sanctions. The achievements of reducing inflation from 40% to 15.5% and bringing back the economy to positive growth from a previously 6% recession during the first two years of Rouhani’s presidency already indicate a better economic management. By the end of the current Iranian calendar year, the economy is expected to reach 3% growth. However, this development is accompanied by monetary tightening in order to bring down inflation to a one-digit figure in the next Iranian calendar year. This strategy should prepare the economy to reach sustainable growth, providing a stable environment which is attractive for foreign investors.

Financial flows and institutions

In 2008, total EU exports to Iran stood at USD 15.8 billion (at their peak). On 23 March 2012, the EU implemented the EU Council Regulation No. 267/2012 regarding Iran’s nuclear programmes, which tightened previous sanctions and embargoes and targeted the central bank of Iran and other financial institutions. Consequently, all Iranian banks were disconnected from SWIFT transactions, which severely paralysed Iranian international trade, and in 2012 and 2013, EU exports to Iran dropped dramatically to USD 9 and USD 7 billion, respectively. Austrian total exports to Iran were at their peak level in 2009 with USD 0.44 billion, but dropped by more than 50% to USD 0.21 billion in 2013.

Despite the strict regulations and sanctions, total trade to Iran has never been halted completely. Iran has employed its overseas delegates to reroute trade through the United Arab Emirates (UAE), China, India and Turkey. This however increased trade costs. Particularly imports to Iran became more expensive, which – due to a lack of currency reserves and frozen international assets – resulted in a devaluation of the Iranian Rial by more than 200%.

Import structures

The depreciated currency, the absence of manufacturing maintenance by the pre-sanction Western partners, and economic mismanagement led to economic stagnation in Iran, characterised by increasing unemployment and high inflation. As a result the economy could no longer satisfy consumers’ demand. Therefore, import structures became more consumer-oriented. In 2007, the share of consumption goods in total exports to Iran (f.o.b.) was 12%; by 2014 that share had gradually increased to 22%. Intermediates and capital goods imports were losing shares, as the sanctions hit those most. Thus, agricultural and low-tech (3) manufacturing exports to Iran significantly gained in importance. Low-tech exports to Iran, at USD 6.7 billion (13% of total exports) in 2008, increased to USD 13.3 billion (24% of total exports to Iran) in 2014. On the other hand, medium-low-tech and medium-high-tech exports to Iran shrank dramatically during this period. These sectors are mostly related to intermediate inputs of Iranian industries such as petroleum. Moreover, the lack of intermediate inputs resulted in stagnation of many other industries as well, such as the pharmaceutical and the automotive industries. Consequently, Iran was obliged to import high-tech manufacturing products such as medicines and pharmaceuticals, yet through rerouting as mentioned above.

The Iranian trade structure was mainly suffering from its pre-sanctions EU partners’ exits. Total EU imports from Iran amounted to USD 24.1 billion in 2011 (before the financial sanctions), but dropped to USD 7.2 and USD 1 billion in 2012 and 2013, respectively. 94% to 98% of the EU imports from Iran were intermediates imports until 2012, with 83% to 93% of total EU imports from Iran constituting mining and quarrying products such as petroleum and steel. According to COMTRADE data, EU imports of intermediates from Iran shrank from USD 23.6 billion in 2011 to USD 0.6 and USD 1.1 billion in 2013 and 2014, respectively.

Trade relations with Austria

Austria ranked 12th among the largest exporters to Iran in the years 2007 and 2011, and 19th in 2014. While in 1996 more than 3% of Austrian extra-EU exports went to the Iranian market, this share fell gradually but continuously to less than 1.7% and 1% in 2009 and 2014, respectively.

Before the EU sanctions against Iran intensified in 2012, the majority of Austrian exports to Iran had comprised capital and intermediate goods with shares of around 40% and 50% in total exports, respectively. Before 2005, a major share of Austrian high-tech products exported to Iran consisted of radios, TV sets and communication equipment. Shifting to more domestic production of these high-tech equipment and diversion to Chinese imports reduced the share of Iranian imports of these products from Austria. Instead, pharmaceuticals (medicine), medical and optical equipment became the major high-tech imports from Austria: Since 2011, 73% to 84% of Austrian high-tech exports to Iran comprise pharmaceuticals. Austria thus became a dominant supplier of medicine to Iran during the time of severe sanctions. However, it is important to note that a big portion of pharmaceuticals in Iran was imported through Chinese and Indian channels with lower products quality.

What to expect?

According to Iran’s Central Bank Governor, Valiolah Seif, the newly released funds after the sanctions removal will be used for necessary and primary goods imports. Hence, a higher inflow of consumption goods to Iran is expected in the short run to balance the market and counteract inflationary pressures. This is being accompanied by tighter monetary policies that have raised conservatives’ concerns as a bad strategy for recovering from the recession. However, the Iranian government’s economic strategies are expected to be effective in the longer run as these are not mainly focused on the demand side but mostly on the supply side.

In an interview in May 2015 (4) Governor Seif reported that Iran would elaborate strategies to channel the released funds in order to accelerate the development in key sectors. This will become easier in a few days, when the Iranian banking system will be reconnected to the SWIFT system and the foreign branches of its banks will restart activities. In addition to the oil and gas industries – traditionally in the focus of economic plans – tourism and IT will be new sectors addressed by the development strategies, says Seif. Consecutive EU Member States’ meetings with Iranian representatives, and already signed cooperative contracts with European companies (5), point towards new inflows of investment and capital goods to Iran. These contracts are expected to lead to investment and technology transfers to Iran. The majority of contracts are related to the expansion of infrastructure, such as the enlargement of airports in Tehran and major cities, high-speed electrical railway connections between Tehran and major cities, as well as metro establishments and enlargements. Thus, all these contracts will provide a new environment to attract FDI and inflows of capital goods in the near future. It can therefore be expected that trade volumes with Iran will again reach levels comparable to those before the start of intensified sanctions in 2009. Furthermore, the new relationship between Iran and the West – a unique opportunity after the Islamic Revolution in 1979 – is hoped to change the structure of trade towards more capital- and high-tech-intensive products, enabling quick economic recovery and a sustainable growth path.

Iran has not yet liberalised its trade in order to protect its domestic industries, e.g. with tariffs up to above 100% on imported automobiles. Nevertheless, Iran has been an observer government to join the World Trade Organisation (WTO), and in 2005 its working party was established, but the chairman has not yet been elected. Despite Iran’s memorandum to the WTO on its foreign regime in 2009 and 2011, Iran’s accession to the WTO was opposed by major stakeholders in the WTO such as the United States, due to the disputes over Iran’s nuclear programmes. Now, after implementation of the JCPOA, Iran’s accession to the WTO is expected in the near future. Following the WTO commitments, Iran will then no longer be able to protect its domestic industries easily. Therefore, in order to be able to compete in a liberalised market, Iran still needs to develop its industries with the help of various technology transfers and investment strategies. In fact, the investment partnerships that have been intensively negotiated recently can be identified as one of the key strategies not only to revive the domestic industries but also to keep them competitive after the accession to the WTO.


References:

(1)http://www.bloomberg.com/news/articles/2015-08-02/iran-s-oil-minister-says-output-to-rise-one-week-after-sanctions.

(2) For further information on assets refer to: S. Devarajan and L. Mottaghi (2015), ‘Economic Implications of Lifting Sanctions on Iran’, Middle East and North Africa Quarterly Economic Brief, (July), World Bank, Washington DC.

(3) OECD definition of technology intensity of industries: http://www.oecd.org/sti/ind/48350231.pdf

(4) Financial Times: http://www.ft.com/intl/cms/s/2/b4addeb4-f975-11e4-ae65-00144feab7de.html#axzz3xpJtbpGS

(5) Total S.A., OMV, Eni, Siemens, Airbus, Daimler AG, and PSA Peugeot Citroën are among the largest European companies meeting with Iranian delegates.

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