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Analysis
Iran votes for openness

Iran votes for openness

Reformist victory highlights economic opportunities

by Danae Kyriakopoulou in London

Tue 23 May 2017

For a few hours after winning Iran’s presidential election, Hassan Rouhani could be forgiven for thinking his task might be easier this time around compared with when he first won the post in 2013.

The 2013 election took place against the backdrop of eight years of economic weakness linked to growing international isolation under former President Mahmoud Ahmadinejad. Rouhani’s ‘prudence and hope’ platform signalled Iran’s desire for a break with the status quo. Throughout the campaign, he proclaimed himself as a moderate reformist who could return the country to normalcy through stabilising the economy, modernisation, and reviving Iran’s ties to the global economy and international diplomacy.

Since 2013, the state of the economy has greatly improved. GDP grew by 7.4% between March-September 2016 and the International Monetary Fund expects growth to stabilise at around 4.5% over the medium term. Inflation – traditionally a significant burden on the Iranian economy – has fallen to single-digit levels from over 40% at the beginning of Rouhani’s first term.

This transformation was due in great part to Rouhani’s judicious policy approach, which involved a combination of prudent monetary and fiscal policy and extensive structural reforms to modernise the economy. These included the requirement for large listed companies and all banks, insurance companies, and other financial institutions (whether listed or not) to comply with International Financial Reporting Standards from March 2016. This was extended to all listed companies in March of this year.

Rouhani’s reforms were part of a bigger picture, with economic recovery also supported by good fortune and a positive international environment. Under the leadership of President Barack Obama and Vice-President Joe Biden, the US adopted an unprecedentedly positive attitude towards Iran. This culminated in the signing of a nuclear deal in summer 2015 in which the P5+1 (the permanent members of the United Nations Security Council – the US, UK, Russia, France and China, plus Germany) and the European Union agreed to a gradual lifting of economic sanctions in exchange for Iran lowering its uranium enrichment capacity.

With Donald Trump delivering his clearest message on his attitude towards Iran, that deal may now be at risk. In the headline address of his first foreign trip as president, he signalled a rejection of his predecessor’s policies. Speaking in Saudi Arabia only hours after Rouhani’s victory was announced, Trump isolated Iran as being ‘responsible for so much instability’. This contrasted with the many European leaders (and even some Gulf policy-makers) who congratulated Rouhani.

Iran’s economic fundamentals are encouraging. Often described as the last great emerging market, it has a young and well educated population of around 80m, though some resources are underutilised. Women’s participation in the labour force is low, at 16%. However, Iran has more women engineers than the US, and women’s participation in the labour force is expected to increase gradually.

Natural resource wealth further improves Iran’s economic potential. It has the second largest oil reserves in the world and the fourth largest gas reserves. As with many other Middle Eastern economies, this has been a mixed blessing. While Iran’s economy is more diversified than other resource-dependent economies, it is still too dependent on oil. The swing in its economic fortunes to growth of 7.4% between March-September 2016 from recession in 2012-13 was due largely to increased oil production. Its export levels increased to 3m b/d in March 2017, a level not seen since the 1979 Islamic revolution. But the non-oil sector of the economy has struggled. Between March-September 2016 , growth in the non-oil sector averaged just 0.9%.

This combination of strong fundamentals, resource wealth and prospects for greater openness points towards increasing levels of inward foreign direct investment. That said, Iran still lacks a well-functioning banking sector to absorb such flows. Following the nuclear deal, Iran has attracted only $3bn in FDI, compared with the government’s expectation of $50bn. Reforms like expanding the central bank’s regulatory powers and the application of the Financial Action Task Force standards against money laundering should take priority. These changes will be difficult to implement politically, but the overwhelming benefits of a well-functioning banking sector to provide liquidity to the economy cannot be ignored.

Danae Kyriakopoulou is Chief Economist at OMFIF.

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