Construction: Minimal Upside To A Bearish Outlook
BMI View: Our bearish real industry growth forecast for the Iranian construction sector remains unchanged at - 3% year-on-year in 2013. We base this downbeat outlook on: a staggering inflation; intensified pressure on Iranian finances following US and EU energy sanctions; and a business environment that remains opaque and difficult to penetrate. We expect this pattern to continue in the short term (at least until Iranian elections in June 2013), after which we anticipate a gradual easing and an average annual growth of 2.7% between 2017 and 2022. Presently China and Russia are, by and large, the only two countries with a continued international presence within the Iranian construction sector, and we see few opportunities for any outside players in the short to medium term.
Any predictions concerning the Iranian market are highly volatile based on any single event's dramatic effect on the country and its economy. However, on the back of a continued stalemate in Western-Iranian negotiations (though recent nuclear talks in Kazakhstan did produce some positive sentiment) our bearish outlook for Iran this quarter remains unaltered. We do not anticipate any significant political change prior to the Iranian elections in June 2013, nor do we see any major break-through in bilateral talks until then.
The elections will likely see the conservative candidate seize the helm of government, which could staunch Iran's position towards the West. However, the latter would also bring a less fractured and more homogenous coalition together, which in turn would represent a more united and coherent negotiation partner. Hence, though the risks will increase in the aftermath of the elections, they do not necessarily weigh to the down-side.
Inflation in Iran climbed during 2012, and we anticipate it to linger around a staggering 20% between 2013 and 2017 (25% for 2013). Hence, despite significant nominal growth, we expect 2013 year-on-year (y-o-y) real construction growth to come in at a low -3%.
With US and European energy sanctions now firmly in place - preventing any foreign financial institutions from transacting with Iran's Central Bank (though again there appears to have been some 'softening' to previous demands during the last nuclear talk in Kazakhstan), coupled with an oil embargo and an end to London as an insurance provider - we continue to see severe disruptions to an industry already suffering from underinvestment.
In fact, according to the US Department of Energy, oil production has fallen to its lowest level since the aftermath of the Iran-Iraq war 20 years ago. Hence, with oil accounting for half of Iran's government revenues, and 80% of the country's exports, the wave of sanctions continues to dog the economy at large, contributing to the country's weak construction sector.
|Tough Years Ahead|
|Construction Industry Value (US$bn), Real Growth (%)|
A Draught On Investors
Iran's business environment remains opaque and difficult to penetrate for any outside investors. China and Russia are, by and large, the only two countries with a continued international presence. Both countries have vested interests in Iran, most significantly in terms of commodities trade, and have therefore contributed in funding major related infrastructure projects in the past. However, we have noted setbacks in the relationship with China when it pulled out of the US$4.7bn development of phase 11 of the South Pars gas field, as well as the US$2bn, 1,500MW, hydro-dam project in Bakhtiari. As a result we now question the viability of the planned US$1.5bn Iran to Pakistan pipeline, which is unlikely to be built without significant Chinese backing.
That said, China - with a total of US$30bn-worth of bilateral trade - has invested heavily in both roads and railways. In October 2011, the Chinese government made an offer to build a US$2bn freight rail line - a modern day silk route - in Iran, according to Engineering News-Record. The line would allow the continuous rail transport of goods from China, through the Middle East, all the way to Europe.
Likewise, the North-South Rail Corridor, an ambitious project to create a freight-rail link between Europe, via Russia and Azerbaijan, through Iran and eventually linking to India and Southeast Asia, took a step forward in October 2012 with the unveiling of a cooperation agreement between transport ministry representatives from Russia, Azerbaijan and Iran. It is hoped the rail line will carry around 20 million tonnes of cargo a year, and improve transport links across Eurasia. Furthermore, a new railway linking the eastern regions of Iran to Afghanistan is set to open in early 2013 according to Abdolarbi Sediqi, the head of Afghanistan's railway organisation.
We are also seeing progress on the US$450mn Iran to Iraq gas transmission pipeline. At the time of writing 25% is reportedly built, with the remaining 75% expected for completion in July 2013. However, we do question the viability of the project under the current state of sanctions, and likely political pressure from the US.
A Negative ForecastHowever, despite these developments Iran has amassed a hefty US$40bn backlog of incomplete projects, and the fact that there are now few markets prepared to accommodate Iranian output (Iranian crude has continued to fall across major markets in Asia, with China picking up some of the slack- most likely at a hefty discount) means that there is little incentive to invest in Iran's upstream sector, and related infrastructure.
Hence, though Iran may possess 9% of the world's proven oil reserves, a lack of new developments and foreign expertise has left the country heavily reliant on existing and ageing infrastructure, with few opportunities for any international construction players to invest in necessary upgrades.
Furthermore, politically the country is still in a fundamentally unchanged position, as the anti-government opposition remains suppressed in a violent manner whilst tensions continue to grow between the theocratic arms of the Iranian state and President Mahmoud Ahmadinejad.
All these factors combined have lead BMI to maintain its bearish outlook for Iran's construction industry over the short to medium term. We expect to see a stagnation of construction industry growth up until 2016, where after we see a potential of gradual easing of downward pressure and an annual average real growth of 2.7% between 2017 and 2022.
Risks To An Already Bearish Outlook
However, we must again reiterate that estimated growth is based on our core scenario displayed above. Hence, with respect to the currently volatile political landscape a slight change to any variable could have far reaching implications for our outlook for the country and its construction sector.
The only upside potential might come in the form of political change. The dire economic situation could eventually turn those most loyal to the regime against them. Though a full blown revolution is unlikely, we could see a change in political direction. An establishment more open to negotiation could result in a partial lifting of sanctions and a "return to normal". This scenario poses an upside risk to our forecast outlook.
That said, the risks currently weigh heavy to the downside. Further hardship and isolation due to continued sanctions could eventually result in a gradual depletion of foreign reserves. The effect of which would be an economic nosedive leading to rationing of goods, and the country's construction sector coming to a complete halt.
Then, the outcomes of war with the West could explode and scatter in any direction. The repercussion of such conflict would be detrimental. The already fragile economy would reverse drastically and so would any of its sub sectors, including construction.
Still, despite a great deal of uncertainty we retain our 2013 construction industry forecast of -3% y-o-y. We do not expect any drastic changes in the short-term. As shown above, any predictions concerning the Iranian construction sector are highly volatile.