IRAN, THE LAST GREAT UNEXPLORED MARKET?

The lifting of economic sanctions on Iran would generate export potential in the machinery, chemicals and transportation sectors.

Iran’s large and educated population generates high demand for consumer goods, telecommunications and finance.

Risks in a resumption of trade relations are the violation of sanctions during the transition, the possible reinstatement of sanctions, and the absence of credit information on Iranian companies.

Iran, the last great unexplored market?

The announcement a few weeks ago of a framework agreement to curtail Iran’s nuclear weapons program has sparked speculation about the possible lifting of sanctions should a deal be reached by the end of June. Iran could be the last untapped frontier market offering billions of dollars in potential through the restoration of international trade with the Middle East’s second largest economy. However, there is no guarantee of a long-term solution and the transition will be long and complicated. Therefore, the recommendation is patience and caution for companies interested in restarting trade relations with Iran.

Many hurdles remain to be overcome before a final agreement is reached at the end of June. A key issue is establishing when and how sanctions will be lifted. Iran is demanding an immediate lifting while the United States and the European Union envisage a gradual removal as Iran complies with its obligations. It is also necessary to determine the consequences if Iran breaches any point of the agreement: will sanctions be reinstated immediately or will Iran be given some leeway? The negotiations are fraught with uncertainty, but the consequences of Iran re-entering the global economy and changing the balance of power in the Middle East are so far-reaching that it is worth analyzing the opportunities and risks.

Potential opportunities

Cut off from world trade due to tightening sanctions over the past few years, trade with Iran could create tens of billions of dollars worth of business for local and foreign companies. The Iranian economy could open up to gradual but substantial inflows of foreign investment. Iranian industry is currently operating at only 60% to 70% of capacity, handicapped by outdated technology and an unstable economy due to sanctions. This deal would immediately boost the country’s economy and the economic benefits would also spread across the Persian Gulf, especially in Dubai and Oman, where Western companies could set up shop to resume business relations with Iran.

Iran is a significant exporter of oil and natural gas but, compared to the rest of the Middle East, its potential for diversification is vast. Agriculture and tourism are potential growth sectors, and the race to modernize the country would also generate large-scale investment in infrastructure. Prior to the establishment of EU sanctions in 2012, machinery and transport equipment, as well as chemicals, were the main exports to Iran. Our Economic Research Service expects these sectors to be faster-growing for Western companies returning to the country.

Iran’s consumer market is nearly 80 million people, most of them well-educated and highly skilled. Consumer purchasing power is high, with high demand for Western products, especially consumer electronics, durable goods and services, telecommunications and finance. In addition, household leverage is currently low due to the absence of credit cards and foreign banking activity. Prior to sanctions, Iran’s stability and large consumer market made it one of the most attractive economies in the Middle East.

During the first years of the century, the growth of exports from the euro zone to Iran showed a trend comparable to that of the United Arab Emirates or Saudi Arabia, the region’s two main export destinations. As was evident in trade relations with Iranian companies before the latest round of sanctions, Iran has a particularly strong payment performance. The credit lines of companies selling their products and services to Iranian companies covered by our insurance amounted to 272 million euros in 2005. However, 2006 was a turning point when the UN Security Council imposed the first trade sanctions, which were intensified, especially in 2010.

The country’s natural resource reserves are among the largest in the world. Iran’s oil exports to the West would help maintain low oil prices, prolonging the economic boost that lower oil prices have provided to American and European companies.

Potential risks

Speculation and uncertainty prevail in the deal talks and, should the deal be reached, there are risks that those interested in doing business in Iran should be aware of. With sanctions, some Iranian companies across all industrial sectors have established large domestic market shares in the absence of foreign competition. These companies will have very little time to adapt and increase their international competitiveness.

The new competition resulting from Iran’s entry into the world market would also affect other Gulf states. For example, Iranian oil exports to the West would directly hurt Saudi Arabia’s exports during a year of unprecedented deficits due to falling oil prices. Also, Arab stock markets are in the process of reform, so the developed Tehran Stock Exchange would compete for foreign capital.

If sanctions are lifted, entry into the Iranian market will need to be undertaken with extreme caution. Patience will need to be maintained during the transition phase while the complex web of international sanctions is unraveled, as exporters and investors could face penalties for non-compliance with sanctions during this period. Also, sanctions unrelated to Iranian nuclear weaponry will remain in place.

As in the past, if Iran does not comply with its nuclear and transparency obligations, sanctions will be reintroduced immediately, which could result in billions of dollars in fines imposed for sanctions violations and the reinstatement of banking restrictions, suspending international payments to and from Iran, making it impossible to collect from Iranian companies, even if they are committed to repaying their debt.

There is great uncertainty about Iran’s economy. Since the state has been under sanctions, virtually no trade relations have been established. In terms of investment, although the Iranian economy is legally prepared for foreign investment, the system has not been evaluated during the sanctions era. In terms of creditworthiness, regulation and available financial information is scarce, especially in the SME segment, making the identification of potential buyers a daunting task for Western exporters.

Overall, despite the major challenges in reaching a definitive agreement, our Economic Research Service sees great potential in restoring trade with Iran. Historically, it is a large consumer market with high demand for Western products and strong payment morale. However, given the uncertainty about the final agreement, about compliance and the paucity of information about the Iranian market, caution and patience are advised when exploring trade and investment opportunities.

Original source: Crédito y Caución and Aral ITS.