Iran Country Outlook

POLITICAL STABILITY: The EIU expects the two heads of the Iranian regime, the supreme leader (and ultimate religious and political authority), Ayatollah Ali Khamenei, and the hardline and confrontational president, Mahmoud Ahmadinejad, to retain their posts (although Mr Ahmadinejad will be required to step down at the end of his second term in 2013). However, the ties between the two will become increasingly frayed, as the supreme leader struggles to manage the political fallout from the actions and statements of the erratic and interventionist president. Equally, although the outpouring of dissent that followed the president’s disputed electoral victory in June 2009 has now largely been stemmed, the country remains highly polarised, and these tensions will periodically rise to the surface during the forecast period, especially in the run-up to the 2012 parliamentary election.

ELECTION WATCH: A parliamentary election is due in 2012, and the next presidential election is scheduled for 2013. These will no doubt be closely watched given the protests that followed the disputed presidential election of June 2009. However, keen to prevent another repetition of those protests, the organs of the state, in particular the Guardian Council (which is responsible for vetting candidates), will ensure that the parliamentary election passes off with as little disruption as possible–and with only minimal debate and competition. Nevertheless, the elections may be a trial of strength between several competing regime factions. There may be subtle pressure from Iran’s supreme leader to strengthen parliament as a counterweight to the presidency, with some of Mr Ahmadinejad’s political foes receiving a boost. The reformist Green Movement appears to have lost much of its momentum in the wake of the 2009 presidential election and small-scale social unrest early in 2011.

INTERNATIONAL RELATIONS: The US administration has since toned down its overtures to Iran and from 2010 has worked hard to strengthen UN sanctions against the Islamic Republic, introducing a fourth round in June 2010. In response, Iran’s approach has been to stress repeatedly its “rights” under the Nuclear Non-Proliferation Treaty, while seeking to win the sympathy of non-aligned countries. This tactic has enjoyed mixed success: Turkey and Brazil voted against the fourth round of sanctions, but China and Russia supported the resolution. We expect Iran’s courting of non-aligned states to yield ever-decreasing returns over the forecast period, as Iran struggles to match the economic and diplomatic clout of the major powers.

POLICY TRENDS: With Western companies increasingly avoiding Iran because of the tightening of sanctions and pressure from their governments, the second-term Ahmadinejad government will instead attempt to source much-needed investment (especially into its hydrocarbons sector) from Asia. However, with South Korea and Japan also imposing their own sanctions on the country, Iran’s list of potential investment partners is diminishing, although China is likely to maintain a strong interest in its hydrocarbons sector. These trends will only reinforce the government’s penchant for economic self-sufficiency, which will lead to increased pressure on domestic banks to provide greater project finance, including by finding buyers for bonds issued by Iranian energy firms. However, with the fiscal position weakening and the government’s tendency to favour local over foreign firms where possible, especially in the energy and petrochemical sectors, Iran’s oil production capacity target of 5.3m barrels/day (b/d) by 2015, up from around 3.6m b/d at present, will not be met. If the nuclear dispute were to worsen markedly–leading to an eventual embargo on Iranian oil exports or a drastic decline in Iranian output, or worse, military action–the impact on economic policymaking and domestic industry would be severe.

ECONOMIC GROWTH: Iranian real GDP growth is likely to remain modest (and far below potential) over theforecast period, with subsidy cuts introduced late last year taking their toll. Although the subsidy reductions had been trailed in advance, the unexpected scale of the changes is likely to depress private consumption (the largest single component of GDP) in the first half of the forecast period especially, despite compensatory cash handouts by the state. Exacerbating this situation, industry is also likely to be hard hit, although it is earmarked to receive 30% of the savings accrued by the government in compensation. Real GDP growth, having recovered to 2.9% in 2010/11, will slip to just 2% in 2011/12, before slowly recovering over the remainder of the forecast period (as the impact of the subsidy cuts begins to fade).

INFLATION: The removal of subsidies has led to a sharp increase in fuel, electricity and flour prices. However, the impact will be minimised by the fact that the availability of such heavily subsidised items was probably restricted in any case. Inflation had reached 19.7% year on year in the Iranian month of Farvardin (ending April 21st), and we still expect a sharp increase in consumer price growth this year, to an average of over 20% (compared with an average of 10.1% in 2010). With the phased removal of subsidies planned to occur over almost the entirety of the forecastperiod, we expect inflation to average 16.3% in 2012-14, but to fall back in 2015 following the completion of the subsidy-reduction programme.

EXCHANGE RATES: We expect Bank Markazi (the central bank) to continue to try to maintain tight control over the exchange rate, with the objective of managing a gradual depreciation. This effort faced a stiff challenge in the second quarter of 2011, as a wide differential opened up between the official rate and the parallel market rate. The central bank responded with a snap devaluation on June 8th, which was reversed over the next few weeks, mainly as a result of the central bank’s readiness to pump foreign reserves into the market. The devaluation (and subsequent revaluation), indicates that Bank Markazi is willing to use a number of instruments it has at its disposal to support the local currency. However, the central bank has also indicated that some of the depreciation reflects fundamentals. Consequently, we project that the official rate will fall from an average of IR10,254:US$1 in 2010 to IR11,992:US$1 in 2015.

EXTERNAL SECTOR: With oil production stagnant and non-oil exports dampened because of sanctions, we estimate that the trade surplus stayed level in 2010/11, at around US$26bn. We expect the trade surplus to narrow markedly over the forecast period, declining to US$14.6bn in 2015/16. However, Iran’s external position will benefit from high oil prices in the first few years of the forecast period. The non-merchandise deficit is expected to remain relatively steady. The stagnant import bill is likely to suppress growth in services debits, and income debits should be depressed by reduced foreign participation in the Iranian economy. We expect the current-account surplus to narrow from an estimated US$31bn (6.5% of GDP) in 2011/12 to US$5.3bn in 2015/16, largely reflecting the country’s deteriorating trade position.

SOURCE: Country Outlook