Is Iran soon back in the world market?
Based upon a Euler Economic Research (Euler Hermes is a company of German Allianz Group) by the authors Irène Herlea, Junior Economist, Daniela Ordóñez, Economist, Andrew Atkinson, Senior Economist, and Ludovic Subran, Chief Economist, TextileFuture presents to you the major results of their feature entitled “Iran: Back in the game?”
Many parties are interested to be among the first ones to re-enter this promising market after the signing of the nuclear agreement. Others who are engaged already in Iran hope that the sanctions will be lifted soon as they wish to expand their business in Iran. This is why we give you this insight on the most important key facts and figures on this “new” market and from a reliable source.
The basic data
An introduction to recent developments
Iran’s economy moved out of recession in 2014, so a modest improvement was discernible prior to the recent nuclear/sanctions deal. Further momentum is expected, with +2% growth in 2015 and +3.5 % in 2016 (or +4 % if sanctions are lifted). However, growth will remain below the pre-sanction annual average of +5 %.
Lifting international sanctions will have a marked impact on trade, with exports and imports both potentially increasing by +20 % in 2016 and imports increasing by a further +13 % in 2017. There will be opportunities for exporters into Iranian metal, machinery and equipment, automotives and food markets. Initially, European exporters will benefit the most, although current market leaders (the UAE and China) will also make gains.
For local industries, sanctions relief will result in marked changes in the energy, automotives, construction and retail sectors, with increasing market dynamism but also tougher global competition.
The post-sanctions period will be challenging. Substantial investment in infrastructure and industry is required at a time when foreign exchange and credit risks will increase and social and political expectations require management. Increasing annual GDP growth to more than 5% for a protracted period will require structural changes.
If sanctions are lifted
If the agreement reached on July 14 between Iran and the P5+1 is fully ratified, some sanctions imposed on Iran by the U.S., the European Union and the UN will be removed in 2016. In return, Iran will decelerate its nuclear programme.
Just as the tightening of sanctions in 2011 led to a 2-year recession, the easing of sanctions will have a positive impact on the Iranian economy as it will allow a return of the country to the global financial and energy markets. After +2 % forecast for GDP growth in 2015, we project real growth could accelerate to +4 % in 2016 and +4.2 % in 2017 if sanctions are lifted, but only +3.5 % in 2016 and +2.5 % in 2017 if sanctions continue to operate (Figure 1). Industrial activity will particularly benefit and could accelerate to + 5% per year by 2017 (against +2.9 % in 2015), while its annual growth will remain below +2 % if sanctions are not eased over that whole period.
Under this new environment, exports (especially oil) and imports are likely to soar, both expanding by close to +20 % in 2016, before decelerating slightly in 2017 to +11 % for exports and +13 % for imports. The net impact on external balances will therefore be limited, and Iran will continue to record large surpluses of above USD30 billion for merchandise trade and the current account surplus will remain equivalent to around +7% of GDP. Iran will therefore have a financial cushion to finance an economic recovery, especially as, following the removal of sanctions, Tehran will be able to access some of its currently frozen assets held overseas, which are estimated at USD50-150 billion. Moreover, the announcement of the framework agreement in April 2015 already led to an increase in global business interest, with some large companies seeking to position themselves to benefit from the new arrangement. Consequently, FDI inflows are likely to accelerate with the lifting of sanctions, reaching USD3.7 billion in 2017 (Fig. 2), benefiting especially the energy sector as Iran has the world’s largest natural gas reserves and the fourth largest oil reserves while oilfields and gas fields require significant amounts of investment and technical improvement after years of sanctions.
The winners are: Energy, Autos and Retail
Sector No. 1: Energy – The lifting of sanctions will automatically unlock Iran’s oil sector (25% of
GDP), allowing the country to increase its oil production by 600000 barrels/day in 2016 as a result of destocking (partly from oil supplies already stored on sea-going tankers), and returning to its pre-sanctions production level of 4.1 million barrels/day as soon as 2017 (Figure 3).
Iran’s contribution to global oil output will also recover, reaching 5 % in 2017. This will generate further downward pressure on oil prices, although international markets have already partially priced in re-entry of Iran into mainstream oil and gas markets. It is likely that Iran will seek to regain its pre-sanctions traditional markets: Japan (19% of Iranian exports of oil in 2006), Italy (7%), Spain (6%) and Taiwan (5%). If that is the case, then countries such as Saudi Arabia and, particularly, Russia will face severe market competition.
Sector No. 2: Automotive – The removal of sanctions will consolidate Iran as one of the key markets in the region for the automotive sector.
Indeed, despite international sanctions, Iran was one of the top 20 passenger car producers worldwide in 2014, with over 900000 units, and it was the largest market in the region in terms of sales, with more than 1.1 million new units registered last year, markedly above Turkey and Saudi Arabia (around 600,000). The number of registrations could go back to the pre-sanctions level of 1.4 million units in 2016 and even reach 1.6 million in 2017. In addition, local car production will increase by around +15 % per year, reaching 1.32 million units in 2017 (figure 4).
Sector No. 3: Retail & Consumer Goods – Classified as an upper-middle income country with more than 77 million inhabitants, the domestic market for consumer goods presents potential following the lifting of sanctions. Although the sector remains dominated by small traditional retailers, malls and supermarkets are currently developing, mainly in urban areas. In general, the country presents a significant “new” market for consumer-related products.
Incremental economic activity as sanctions are lifted – in particular, additional private consumption and investment needs – will support import growth, which we estimate could increase by some +USD 20 billion over 2015-17. Specifically, we estimate that Iranian purchases of machinery and equipment will rise by more than +USD 4 billion from now until 2017, representing more than 20 % of total imports. Consumer-oriented markets are particularly promising, with additional imports of manufactured articles estimated at +USD 3.1 billion, of road vehicles +USD 2.7billion and of electronic devices +USD 1.7 billion over the period. Additionally, the renewal of the local automotive industry will support imports of iron and steel and of parts and components, which could increase by +USD 2.5 billion and +USD1.2 billion, respectively (Figure 5).
In terms of trade partners, European countries are likely to be the big winners driven by additional exports of machinery and equipment, automotives and agro-food. Germany appears to be particularly well positioned and will see its exports to Iran grow by close to +USD 2 billion over 2015-17. Export gains of France could be +USD 1.3 billion, of Italy +USD 0.9 billion and of the U.K. +USD 0.6 billion. The U.S., which currently accounts for less than 1 % of Iranian imports, will see its exports multiply fivefold, with total export gains slightly above +USD500 million in 2015-17. The structure of these sales will shift from agro-food and chemicals towards higher value-added goods (machinery, manufactures and electronic devices).
Current key partners focused on higher-value added exports will also be big winners: the United Arab Emirates, which currently accounts for almost 30 % of Iranian imports, will benefit from Iran’s economic boost in the two coming years as it will continue to act as a re-export platform for foreign products to enter the country. It will see its exports increase by USD 2.1 billion over 2015-17; China will see its export gains reach USD 1.8 billion over the period, mainly driven by iron and steel, machinery, electronic devices and automobiles; and South Korean export gains, which could reach USD 1 billion, will be driven by cars and machinery, especially as the country will be a key partner for Iran in developing its construction sector.
Turkey and Russia may lose market share to European competitors. After slowing in 2016, their exports to Iran could even decrease in 2017 (Figure 6) notably items in the fuels, chemicals, textiles and agro-food sectors.
Former and current key-partners (except Turkey and Russia) of Iran will benefit from the economic regeneration of the lifting of sanctions in 2016-17. However, the outlook is more uncertain for the medium-term. While Japan and European partners will want to recover lost market share, the U.S. will try to become a new major supplier in key sectors. For their part, China, the UAE and South Korea will fight to keep market share they acquired since 2006 (Figure 7). It is likely to be competitive in all markets.
The country’s significant potential – difficult to achieve in the short term
Risk No. 1: Currency and financing. The effectiveness of the financial system deteriorated under international sanctions. Non-performing loans are around 13 % of total loans (the exact figure is probably even higher) and the banking system is largely state-operated. Moreover, major international banks will be wary of dealing with Iran until there is clarity in relation to sanctions; since 2009 banks have been fined around USD 14 billion after rulings that they evaded sanctions. Until Iran has free access to global payment systems corporates will find it problematic to conduct business with the country. International traders and investors will want to see reduced exchange rate volatility and rationalization of the current system of official and free market rates for the rial (IRR). Currently, the Central Bank’s reference rate is around USD 1:IRR 29000 and the free-market rate USD 1:IRR 33000. Currency risks stem from a high inflation rate, low interest rates in relation to trade partners and competitors and continuing political and diplomatic uncertainties. However, still large FX Foreign Currency reserves provide some support, and Euler Hermes expects the Rial will end 2015 at around USD33700 and end 2016 at USD34750. (Figure 8)
Risk No. 2: Political and geo-political pressures. Domestic expectations are now high and will be a challenge for the Iranian government to meet, even partially, in the short term. Moreover, elections in February 2016 (Majlis al-Shoura – parliamentary – and Assembly of Experts) and June 2017 (presidential) provide scope for slowing in policy implementation or even abrupt reversals. Much also depends on the progress of sanctions relief in the U.S. and responses by regional actors, including Israel and Saudi Arabia. Ongoing conflicts in Iraq, Syria and Yemen also pose contagion risks.
Risk No. 3: Structural reforms. In the World
Bank’s Doing Business survey 2015, Iran is ranked 130 out of 189 countries assessed for the overall ease of doing business in an economy.
Strikingly, Iran appears to be lagging behind other Middle East countries. Therefore business regulations and protection require changes to inject more confidence. Additionally, unemployment remains high (around 11%), mainly among young people, and investment needs to be attracted to labour- and not just capital-intensive sectors. Without domestic structural reforms to boost investor and consumer confidence, business and human capital flight may increase as Iran opens up. (Figure 9)
Some textile aspects
TextileFuture adds some facts on Iran’s textile and clothing sector. ran’s textile and apparel imports registered a record high of USD 1.3 billion during the first nine months of the current year, which started March 21,2014, and according to data provided by the Islamic Republic of Iran Customs Administration (IRICA). The textile imports amounted to USD 300 million during this period, up by 20 percent compared with last year.
The high level of textile imports is particularly alarming as the provided data indicates only imports through legal channels and does not account for the large amount of smuggled clothes and apparels entering the country through illegal trade.
The growth in textile and apparel imports also implies that weaving factories have been running below their full capacities for various reasons, which would in turn lead to lower demand for yarns and threads, affecting the spinning industry, as a report by Persian daily Ta’adol suggests.
The statistical data provided by the ministry of industry, mine and trade confirms that the volume of yarn production fell during the first nine months of the current year. According to reports, Polyester filament yarn and cotton yarn production dropped by 11.5 % and 6 % respectively during this period.
The IRICA data also shows that the import of various types of yarn fibres – the raw material used in textile industry— dropped by 15 % during this period, further denoting decline in textile production activities.
As experts point out, the lower production rates in the spinning and weaving industries would in turn translate into increased production costs in garment manufacturing industries, thereby reducing the competitiveness of Iranian products in the domestic and international markets.
Meanwhile, the import of textile machineries worth USD 250 million during the nine-month period is a light at the end of the tunnel, indicating that the Iranian businesspeople are willing to expand their investments in the textile industry.
Textile manufacturers have been calling on the government to levy higher tariffs on textile and apparel imports. The Turkish Textile and Garment Exhibition held in Tehran at the beginning of February 2015 led to new rounds of criticism by domestic manufacturers and pushed authorities to reschedule the Turkish exhibition to coincide with The Iranian Apparel Exhibition.
This is while the head of research and development in Iran’s Clothing Association, Mohammad-Javad Sedghamiz insists that increasing import tariffs would not result in reduced imports as most of the foreign apparels currently flood the country through illicit trade.
“More than 70 % of the foreign clothes flow to the domestic markets through large-scale and organized smuggling, partly due to the high import tariffs. Therefore, reducing the import tariffs, as in the case of the preferential trade agreement (PTA) with Turkey, is in the best interest of Iranian manufacturers as it would lead to less smuggling,” he said, referring to the PTA signed between Iran and Turkey in January 2014.
Former head of Import Affairs Department of IRICA, Nasser Ebrahimi believes holding the Turkish textile and garment exhibition in Tehran was an “unfair” decision made by authorities, “at a time when the domestic textile sector is faced with numerous difficulties and skilled workers are losing their jobs.”
He suggested several solutions to help the domestic textile industry “combat the surge of textile and clothes imported illegally from China and Turkey,” including the easing the formalities for release of raw materials from the customs warehouses in a bid to bring down the production costs by reducing the delay, shipment and storage costs; to establish organisations with support from the ministry of industry, mine and trade, dedicated to improving the quality and design of Iranian products based on expert knowledge; engaging in joint ventures with the owners of foreign brands to establish production units in Iran licensed under the name of the parent company, but strictly banning their products if they do not accept the terms and conditions; using the national media to encourage the use of domestic products to curb unemployment and poverty; taking initiatives to revive the export of Iranian products through a process of continuous planning and reinforcing the textile sector.