Iran's economic strengths come back into focus

Iran is expected this week to confirm when it will sign the Additional Protocol of the Nuclear Non Proliferation Treaty. This marks a remarkable turnaround from a month ago where it seemed that Iran could ignore an October 31st deadline imposed by the International Atomic Energy Agency (IAEA) and be subject to UN economic and political sanctions. Iran's disclosure of documents last week detailing its nuclear programme has lifted a major political risk that had been overhanging the country.

Uncertainties remain. Iran's declaration needs to be verified by the IAEA as being comprehensive and comments over the weekend highlight that some senior Iranian officials remain uncomfortable with some of the IAEA's demands. Nonetheless the progress has been positive and the agreement with the IAEA is an important step forward. It also potentially removes a major obstacle to foreign investment. Several large deals, particularly in the oil and gas sector, had been postponed and these should now be revived. Indeed a positive response from the IAEA at its next board meeting on November 20th would allow attention to shift to Iran's economic position, rather than its political one, and the strong performance of the economy in 2003.

The non-oil sector is booming and the dominant oil sector (it accounts for close to 50% of government revenues and 80% of export earnings) is benefiting from the twin effects of increased output and high international crude oil prices. We now expect real GDP growth to reach around 6% in the current Iranian year ending March 2004. Although below the 6.8% growth reported by Bank Markazi for the year ended March 2003, this is well above recent trend growth.

Non-oil sector activity is once again driving the economy. Iran's non-oil sector has benefited tremendously from the gradual easing in import restrictions (imposed to protect foreign exchange reserves and allow Iran to meet external debt obligations in the 1990s) that has accompanied the steady build up in foreign exchange reserves since 2000. Combined with exceptionally low interest rates and increased liquidity, industrial and manufacturing activity has soared. Services are also booming. The Tehran stock exchange is on a roll. Share prices have rocketed and market capitalisation has gone through the roof. The outlook for non-oil sector activity remains positive with non-oil GDP expected to build on last year's strong performance (7.5% in the year ended March 2003). There are suggestions that some import restrictions may be re-imposed if oil revenues slump, but if so they will be limited.

Currently the near term outlook for oil is reasonably encouraging. Supply disruptions and low inventory levels suggest prices will remain firm through the northern-hemisphere winter months. The big test is likely to be Q2 2004, when seasonally oil demand traditionally softens. Oil market fundamentals imply that OPEC members, including Iran, will need to cut production to defend the cartel's target price band. Iranian crude output has been running at an average 3.7mn barrels a day (mbd) so far this year, 7.5% up on average output in 2002.

Annual growth has averaged 6% since 1999 but further economic reforms are needed if Iran's economy is to reach its full potential. Efforts to diversify the economy away from oil and gas need to be accelerated, trade liberalisation enhanced and the role of the state in the economy scaled back. The IAEA's approval on November 20th would lift a major geopolitical risk surrounding Iran and should help support the reform process.


Gill James is Standard Chartered's Chief Economist for the Middle East and South Asia. Daniel Hanna is the Regional Economist for the Middle East.