Iran: Investment outlook improves as 2017 election approaches

27 Oct 2016

Iran: Investment outlook improves as 2017 election...

Recent US clarifications on sanctions against Iran have improved the climate for foreign investors, but uncertainty remains over extensive due diligence requirements and the consequences of the 8 November US presidential vote for Washington’s Iran policy.

Although President Hassan Rouhani has acknowledged the need for further reforms to improve the investment climate, factional politics threatens progress and will accelerate in the run-up to Iran’s May 2017 presidential election.

Based on current indicators and historical precedent, Rouhani is widely expected to run and secure a second term. However, divisions within his moderate-reformist coalition and concerns over the economy could leave him vulnerable should his opponents rally around a formidable challenger. 

Under pressure from its European partners and Iran, the US Treasury Department provided further guidance on Iran-related sanctions on 7 October. European businesses and governments, alongside Iranian officials, had argued that the lack of certainty around remaining US sanctions were a major impediment to doing business in Iran even after the lifting of nuclear-related sanctions in January as part of the implementation of the landmark 2015 nuclear deal. The latest guidance affords Iran greater access to the US financial system by allowing foreign companies to process Iran-related transactions in US dollars. Although long-standing US sanctions bar most American companies from Iran-related transactions, many foreign companies had also been deterred by the sanctions due to fears of penalties for trading in US dollars even if they avoided American banks. The new guidelines also permit non-US companies to do business with Iranian entities so long as they are not on remaining US sanctions lists, even if those entities are minority-owned or controlled by a person or entity subject to sanctions.

The latest US guidance is positive for foreign investors, but notable internal and external challenges to greater foreign investment will remain. For example, the US Treasury failed to outline specific minimum due diligence steps companies should to take to limit their future sanctions liabilities. The US maintains an extensive network of sanctions on Iran and opaque ownership arrangements can make it difficult to determine ultimate beneficial ownership. Beyond remaining US sanctions, and the threat of the reapplication of nuclear-related sanctions under the so-called snap-back mechanism, regional instability and Iran’s foreign policy – which has left it isolated in the region – may also reinforce caution among investors. Further uncertainty comes from the coming presidential transition in the US, with prospects for President Obama’s successor to adopt a tougher stance towards Iran’s perceived destabilising activities in the Middle East.

Further reforms needed to increase foreign investment 

Domestically, further reforms are necessary to sustain or increase the current uptrend in foreign direct investment benefitting Iran. According to data from the Financial Times, FDI in Iran increased to 22 projects with an estimated capital expenditure of USD 3.49 bn in the first three months of 2016 compared to nine projects and total expenditure of USD 2.4 bn in all of 2015. Iran has attracted investment in a range of sectors, including automotive, transport and tourism, but the level is well below the USD 30-50 bn in annual FDI that Iranian officials said they were targeting when sanctions were first lifted in January. Widespread corruption, inadequate transparency requirements, close ties between various business entities and the security services, and dual exchange rates are among the remaining impediments to investment in Iran. In October, the IMF noted that economic conditions in Iran were “improving substantially” and credited the government with pursuing ambitious reforms to support growth. However, in a statement following a staff visit, the IMF warned that consolidating these gains required further government action, including an overhaul of the financial sector to increase transparency and strengthen regulatory oversight.

Additionally, recent episodes of factional infighting highlight the ongoing political obstacles to reforms considered necessary to improve the domestic climate for investment. Opposition from hardline lawmakers delayed the approval of new contracts for foreign investors in the oil and gas industry by several months, creating uncertainty in a key sector. The final contracts were approved by a parliamentary panel in September, but the dispute demonstrated that Rouhani, a centrist, will be forced to make concessions to his political opponents even though his moderate-reformist allies made notable gains in the February parliamentary vote. Hardliners have also opposed reforms designed to bring Iran into compliance with the Financial Action Task Force (FATF), an inter-governmental financial transparency body whose restrictions are a major barrier to Iran’s reintegration with the global financial system. Some opposition to the FATF is driven by suspicion of foreign and especially Western influence, but there is also a clear desire among powerful entities such as the Revolutionary Guards to protect their extensive economic interests.

Factional infighting is anticipated to intensify as the May 2017 presidential election approaches. Polling has shown a sharp drop in public support for the nuclear deal amid perceptions that Rouhani’s policies have failed to deliver promised benefits. In a widely cited June public opinion survey conducted by the University of Maryland’s Centre for International Security Studies, 59 percent of Iranians described the economic situation as bad and 74 percent felt that living conditions had failed to improve despite the deal. Hardliners have exploited this sentiment, challenging the president on economic and culture issues while seeking to undermine his agenda with provocative actions like ballistic missile tests and the arrests of dual nationals. While Rouhani can point to some improving indicators such as declining levels of inflation, restoring confidence in the country’s economic prospects will ultimately rest heavily on his ability to mitigate the perceived threat from sanctions to investors that are otherwise attracted to commercial opportunities in Iran.

Rouhani favoured but vulnerable in 2017

Rouhani’s overall popularity, and the precedent for incumbents to secure second terms, make it likely that he will be re-elected. Moreover, the president’s opponents have yet to coalesce around a single candidate and are confronted with their own divisions between hardliners, or Principlists, and more moderate conservatives. However, evolving political and economic dynamics could still weaken Rouhani’s standing in the coming months, especially if conservative factions are able to unite around a popular candidate able to exploit widespread economic discontent. In September, the semi-official Iranian Labour News Agency reported that Elias Naderan, an economist who has levelled a populist critique of Rouhani over his failure to grow the economy and tackle inequality, could become a possible challenger. A conservative victory and subsequent uncertainty over Iranian economic and foreign policy could dent the positive trajectory for FDI in Iran, which is otherwise likely to accelerate as a result of the latest US sanctions guidance. 

Poor economic conditions have historically led to lower voter turnout, which has traditionally hurt moderate politicians like Rouhani most. Turnout among Rouhani’s base of support could be further weakened by tensions within his moderate-reformist coalition over a lack of progress on divisive issues such as human rights and the release of jailed reformist politicians. As evidenced by the Guardian Council’s mass disqualification of moderate and reformist candidates in January ahead of the parliament vote, conservative opponents of Rouhani in powerful institutions, including the courts, security services and media, could seek to undermine his popularity in a bid to damage his prospects for re-election. The scale of a Rouhani victory will also shape his ability to make policy, with a narrow victory in 2017 likely to encourage greater political challenges by his rivals, and a stronger showing affording him a larger mandate to pursue his reformist agenda.




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