DAVA Mercantile Digest no. 1 by Ion Josan, Senior Expert & Founder
During the first term of President Hassan Rouhani, Iran has struggled to improve its severed ties with the world. Understanding the huge shortcomings of being isolated from the global markets, Iran has tried to work on an agreement with the West. The efforts made in this direction by President Rouhani and his Foreign Minister, Javad Zarif, were met with willingness to compromise by the US and the EU.
The signing of the JCPOA is seen as a huge success by the Rouhani cabinet who tries to reinvigorate a struggling economy. Even though after the election of President Trump the JCPOA was heavily put into question, the EU has given strong signs that it will stick to the agreement. The participation of Frederica Mogherini in the ceremony of inauguration of President Rouhani is a clear sign that the EU is open to cooperate with Iran. European countries have new trade (and investment) agreements with Iran and European tourists now visit Iran in great numbers.
Overall, Iran is in a favorable situation and it has to make the most of it. However, there are also some challenges that Iran has to address. The structure of the Iranian economy is complicated and inadequate for a steady and healthy growth. This puts a lot of pressure on the Iranian society, especially on the young who want a more substantial change in the country.
In this paper, I will try to analyze the basic factors that can prevent an accelerated development of the Iranian economy after the JCPOA agreement.
The Banking System
One of the biggest problems in establishing a favorable environment for foreign investments is the banking system. Iranian banks have failed for a long period to adopt international standards. Even today the process of complying with the international system is slow-paced. Nevertheless, the Central Bank of Iran has made it mandatory for all Iranian banks to adopt an international accounting system based on the International Financial Reporting Standards (IFRS). This measure has had a huge impact on changing the old habits of a system accustomed with “creative accounting” that allowed them to cover up losses and non-performing loans. The Iranian bankers have now to face reality and become more efficient and transparent.
Another major shortcoming of the Iranian banking system was the failure to fully adopt the international standards of anti-money laundering and combating the financing of terrorism (AML/CFT) regulations. In June 2016, the Financial Action Task Force (FATF) welcomed Iran’s high-level political commitment to address its AML/CFT deficiencies. The FATF is monitoring progress in the implementation of the Action Plan. These measures are highly important for creating a credible and predictable environment for investments.
Unlicensed credit institutions are also creating an unpredictable banking system. Often affiliated with figures of the state (mostly with the IRGC), these institutions circumvent the Iranian banking laws, being an unfair competitors for the official banks. The Iranian economist Mousa Ghaninejad believes that they “are disrupting the whole financial sector as banks feel obliged to raise their interest rates on deposits to compete with these institutions, which mean their profits go down and have to borrow more from the central bank.” These aspects make many experts believe that without a profound reform of the system a banking crisis is looming in Iran.
Rouhani will have to tackle all these sensitive issues in his new term. If he prevails, he will give the Iranian economy the chance to better integrate into the world market. This will allow Iran to access more easily foreign investments that are so needed in an economy that lacks credit. So far, no leading international bank is ready to deal with any Iran-related businesses, but Rouhani seems committed to change this reality.
The ‘Private’ Sector
During the last 10 years the Iranian state (driven by circumstantial challenges), transferred an important part of its ownership to companies of a would-be private sector. In fact, the state transferred huge parts of its ownership to pseudo-private businesses who thrived because of state protection.
It is hard to evaluate the exact numbers of these companies, but it is clear that they represent a huge part of the Iranian economy. The transfer of shares towards this pseudo-private sector was made with the blessing of the Supreme Leader; in 2006 he stated that 80 percent of the public sector should be privatized. As a result, refineries, banks, petrochemical, steel, aluminum, shipping, telecommunications and insurance companies were “privatized”. The biggest deal was the sale of the state telecom company in 2009, when a consortium believed to be affiliated to the Revolutionary Guards bought a 50 percent plus one share stake for $7.8bn.
We might think that these pseudo-private institutions are all linked to the Revolutionary Guards or the Bonyads. According to Kevan Harris the “bonyads and the IRGC have a burgeoning presence in the economy” but the roles of other institutions, such as large pension funds belonging to Iran’s “non-governmental” sector, are equally important. Beside this we also have to mention the Setad, that is a foundation created by Imam Khomeini in order to manage and sell properties abandoned in the chaotic years after the 1979 Islamic Revolution. In time, this institution (led by the Supreme Leader) became one of the most important organizations in Iran. According to Reuters, Setad’s holdings of real estate, corporate stakes and other assets total around $95 billion.
In an economy dominated by such pseudo-private companies, it is hard for the state to be an impartial player. People involved in politics will always try to gain privileges from the state for companies that are closer to their circle of interests.
According to the Iranian Financial Tribune, about 60% of Iran’s economy does not pay taxes, including 40% that are exempted from tax and 20% that evade tax payment, so that tax evasion is estimated at 300 trillion rials ($7.7 billion) annually. These figures should be alarming for the Rouhani cabinet. As long as the subterranean economy remains so powerful, huge amounts of money that could be invested in education, health or infrastructure remain out of reach. The Iranian economic system is obscure even for many Iranians. The intricate networks of ownership and the preferential rules they sometimes enjoy make any foreign investment endeavor in Iran risky.
Reuters reports that from nearly 110 agreements worth at least $80 billion that have been struck since the JCPOA agreement in July 2015, 90 have been with companies owned or controlled by Iranian state entities. As I have shown here, this is not surprising at all. The most lucrative businesses in Iran have direct or indirect ties with the state. You do not have big private companies (100% private) with whom to make huge deals. After the signing of the JCPOA, most of the foreign companies ready to invest in Iran were economic giants able to negotiate directly with the state.
Unemployment is one of the key issues in Iran with 27 percent of the youth struggling to find a job. Iran is a young nation, with 35 percent of its population between the ages of 15 and 29, one of the highest shares in the world. In fact, besides being the most active group of the society, the youth also has the numbers to make a difference in the elections.
The economy has to create more opportunities for them. In this moment, the Iranian state is creating a limited amount of new jobs. Still having a huge part of the economy dependent on petroleum and gas, Iran has to become more inventive in developing other economical braches.
During the sanctions period, a joint venture between the South African telecom company MTN and the Germany-based company Rocket Internet has been launching startups in Iran, setting up Iranian versions of eBay (Mozando), Amazon (Bamilo), and even Uber (Taxi Yaab). The diversity of the startup companies has since steadily increased so that companies such as Takhfifahn (local version of Groupon), Digikala, (Iranian version of Amazon), ZarinPal, (the equivalent of Paypal) and Zoraq (Iranian Expedia) have spread. Nevertheless, it has to be seen how much of the youth can be employed by such companies. The startup industry has to rely on a minority of highly skilled youngsters in a period when Iran is facing a severe brain drain. In these conditions, the development of these startups might not have a huge impact on employment at all.
One solution to adjust youth unemployment might come from the car industry, where over 700,000 people are working. Companies such as Peugeot, Renault and Citroën are building cars in Iran. One of the problems of this industry is low standards of quality, but this issue might be improved by employing young engineering students eager to make a difference. Nevertheless, for this to happen, the mentality of the employer has to change so that it accepts innovative ideas more easily.
A huge challenge will also be to improve the numbers for women unemployment (44%). Local culture generally sees women in the role of mother, not that of a career-driven person. However, in recent years things have changed. Population growth in Iran has drastically dropped, reaching 1.24%, and the divorce rate has exceeded 20 percent. More Iranian women today are single and childless so they have to rely more on themselves than on their family.
However, some see in the recent fertility decline in Iran an excellent opportunity for a more equilibrated society and a permanent transition to an economic system that rewards human capital. As the pressure of demographic growth decreases, the state can invest the oil revenues in education and increase the value of its human capital.
I have tried to analyze here in a very concise manner some of the most basic factors that can have a negative impact on the growth of the Iranian economy. The topic discussed is without doubt a complex phenomenon that requires a nuanced and detailed study. Nevertheless, in some cases a sketchier approach is needed to have a short overview of the problem.
DAVA Mercantile Digest No. 1, August 2017 (also see in .pdf format)