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Iran could be next big thing for frontier market investors

PUBLISHED : Thursday, 23 July, 2015, 9:54am
UPDATED : Thursday, 23 July, 2015, 9:54am

Every so often, an investment opportunity appears which seems too good to be true.

Whether Iran, the second-largest economy in the Middle East after Saudi Arabia, will end up in this category is likely to be the subject of intense debate among foreign investors following last week’s historic agreement between Tehran and six world powers to lift economic sanctions against the country in return for curbing Iran’s nuclear programme.

Investment banks are already churning out research reports looking at the economic and financial market implications of dismantling an unprecedentedly harsh sanctions regime that stretches back nearly a decade and whose restrictions covering Iran’s energy, financial and transport sectors are set to be lifted in the first-half of next year.

Provided Iran starts scaling back its nuclear enrichment activities in the coming months and demonstrates that it is complying with the list of stringent curbs outlined in the agreement, the “largest and most important economy still closed to institutional investors” could attract US$1 billion of inflows into its stock market within a year of sanctions ending, according to a report by Renaissance Capital (RenCap).

There is no question that Iran holds significant appeal.

The country’s 78 million population is roughly the size of Turkey’s, its $400 billion economy is larger than Thailand’s and South Africa’s, while its oil reserves are the world’s fourth-largest and almost as big as Canada’s, according to RenCap.

The bank believes that in the “first phase” of the liberalisation and opening-up of Iran ‘s economy - which it believes will last until the end of 2016 -“experienced EM [emerging market] and frontier [market] investors will arrive to discover what we believe will be a substantial opportunity.”

Much larger, more sophisticated and more diversified than other closed economies, notably North Korea, Iran (which grew 4 per cent last year despite the punitive effects of the sanctions regime and whose balance of payments position is quite strong unlike many other frontier and emerging markets) could become an earlier version of post-communist Russia whose economic reform and liberalisation efforts in the mid-1990s attracted significant interest on the part of foreign investors.

Iran’s oil sector is likely to be the main beneficiary of the lifting of sanctions.

Iran has a strong incentive to adhere to the terms of the nuclear accord in order to significantly ramp up its oil production. According to RenCap, Iran could boost its production by 750,000 barrels a day to 4.4 million next year, helping lift its exports from last year’s 1.6 million barrels a day to 2.4 million next year, potentially increasing the European share of Iran’s oil exports from 2 per cent to the 17 per cent level just before the country’s oil trade was sanctioned in 2011.

Just as importantly, the reintegration of Iran’s banking and insurance industries into the international financial system - including the SWIFT system of international banking payments - and the removal of sanctions against the Iranian central bank could help unfreeze some $100 billion in foreign assets, boosting trade and investment and underpinning the economic recovery.

This is the optimistic scenario.

Unfortunately there are many question marks regarding the political viability of the nuclear accord and, crucially, the willingness of a hard-line Islamic regime to open up Iran’s economy to foreign investment.

While there is a growing reformist opposition in Iran - which to some extent includes the country’s centrist president, Hassan Rouhani, who convinced the regime to make the necessary concessions in order for the deal to be signed - the county’s supreme leader and ultimate decision maker, Ayatollah Ali Khamenei, has pledged to maintain Iran’s long-standing anti-US and anti-Israel policies.

Iran’s domestic politics and, crucially, the regime’s strong control over the economy could dissuade foreign investors - particularly Western ones - from putting money into the country.

RenCap believes the “second phase” of the liberalisation of Iran’s economy in 2017-18 will be one in which investors are forced to come to terms with “the pitfalls of investing in a country with entrenched vested interests, from the clergy to the Revolutionary Guard.”

The jury is still out as to whether Iran becomes a modern-day Russia in which the Islamic regime opposes major economic and political reforms and retains ownership of strategic sectors of the economy, or, alternatively, a version of Turkey in 2002-07 when the ruling neo-Islamist party, Justice and Development (AK), undertook major economic and financial sector reforms.

For now, however, all eyes will be on whether Tehran lives up to its commitments under the agreement.

 

Nicholas Spiro is managing director of Spiro Sovereign Strategy