Returning To Growth In 2014

BMI View: We project Iran's economy to expand by 2.8% and 3.4% in real terms in 2014 and 2015, respectively, from our estimate of a 3.5% contraction in 2013. Improving relations with the West and better macroeconomic management, coupled with low base effects, will lead to an improved outlook for exports and increased business and consumer confidence. That said, the macroeconomic outlook will remain highly susceptible by developments in negotiations on the nuclear programme.

We forecast Iran's economy to expand by 2.8% and 3.4% in real terms in 2014 and 2015, respectively, from our estimate of a 3.5% contraction in 2013. Iran and the 5+1 powers (the United States, Russia, China, France, Britain and Germany) clinched an interim deal on the Islamic Republic's nuclear programme on November 24, including gains of approximately US$7bn in sanctions relief ( see 'Interim Nuclear Deal: Key Implications', November 25 2013). This will result in an improved outlook for exports, as well as increased confidence among investors and consumers. In addition, we see macroeconomic management improving significantly during the presidency of Hassan Rouhani, which will lead to a gradual decline of price pressures over the coming years. We see private consumption and fixed investment as the major drivers of growth in 2014 and 2015.

Private Consumption Outlook

Private Consumption And Fixed Investment Driving Growth
Iran - Components of GDP (IRRtrn) & Real GDP Growth

BMI View: We project Iran's economy to expand by 2.8% and 3.4% in real terms in 2014 and 2015, respectively, from our estimate of a 3.5% contraction in 2013. Improving relations with the West and better macroeconomic management, coupled with low base effects, will lead to an improved outlook for exports and increased business and consumer confidence. That said, the macroeconomic outlook will remain highly susceptible by developments in negotiations on the nuclear programme.

We forecast Iran's economy to expand by 2.8% and 3.4% in real terms in 2014 and 2015, respectively, from our estimate of a 3.5% contraction in 2013. Iran and the 5+1 powers (the United States, Russia, China, France, Britain and Germany) clinched an interim deal on the Islamic Republic's nuclear programme on November 24, including gains of approximately US$7bn in sanctions relief ( see 'Interim Nuclear Deal: Key Implications', November 25 2013). This will result in an improved outlook for exports, as well as increased confidence among investors and consumers. In addition, we see macroeconomic management improving significantly during the presidency of Hassan Rouhani, which will lead to a gradual decline of price pressures over the coming years. We see private consumption and fixed investment as the major drivers of growth in 2014 and 2015.

Private Consumption And Fixed Investment Driving Growth
Iran - Components of GDP (IRRtrn) & Real GDP Growth

Private Consumption Outlook

We project private consumption to increase by 4.0% in 2014 and 5.0% in 2015, compared to our estimate of 3.0% growth in 2013. A combination of high base effects, improving macroeconomic conditions and the government's efforts to tackle inflation will ensure that consumer price index inflation (CPI) gradually declines over the coming quarters. We forecast the headline inflation print to average 26.0% in FY2014/15 (fiscal year running from 21 March 2014 - 20 March 2015), from our projection of 35.0% in FY2013/14. In addition, improving relations with the West and Rouhani's pledge for macroeconomic reform will contribute to increasing investors' and consumers' confidence.

Inflationary Environment Improving Gradually
Iran - Components Of CPI, % chg y-o-y

This is not to say, however, that private consumption growth will accelerate drastically over the coming quarters. We expect fiscal policy to be contractionary in FY2014/15 ( see below), and we do not expect private sector activity to increase at a rapid pace as long as the outcome of nuclear talks remains uncertain. This will ensure that unemployment levels - which currently stands around the 20% level according to unofficial estimates - will remain relatively elevated for the foreseeable future.

Government Spending Outlook

The government will undertake a relatively contractionary fiscal policy in FY2014/15, as the administration seeks to trim an elevated budget deficit. That said, we do not expect cuts in areas such as healthcare, public services and education to be too radical, as Tehran seeks to maintain public support to its rule. We project government consumption increasing by 1.5% and 3.0% in 2014 and 2015, respectively.

Fixed Investment Outlook

Growth in gross fixed capital formation has been significantly hampered by international sanctions, an opaque business environment and a challenging macroeconomic picture over the past few years. The improving macroeconomic environment and renewed business confidence will in our view contribute to an uptick in investment over the coming quarters, and our Infrastructure and Construction research team sees real growth in the construction industry returning to positive territory as a result. Recent developments have also seen renewed interest by foreign in the Iranian market. As an illustration, German pharmaceutical major Merck said on December 31 2013 that it is considering partnering an Iranian drugmakers to manufacture drugs in the country, while Finland-based Outotec, which provides technologies and services for the metal and mineral processing industries, revealed interest to invest in Iran's iron-ore and pelletising development projects on December 27.

That said, a measure of caution is to be warranted. For one, we do not expect a significant uptick in foreign investment until a longer-term agreement on the nuclear programme is found. Moreover, the continuation of banking and hydrocarbon sanctions will limit investment by domestic companies. We forecast fixed investment expanding by 5.0% in 2014 and 6.0% in 2015, respectively.

Recovering Gradually
Iran - Hydrocarbon Exports

Net Exports

Iran's external position will remain weak over the coming quarters. We see total exports declining by 1.0% in 2014 and 2.0% in 2015, compared to our estimate of a 11.0% decline in 2013. Much of the improvement will result from improving oil exports - which accounted for 85.0% of total exports in 2010.

According to the International Energy Agency, oil production increased by 0.4% y-o-y to 2.71mn bbl/day in November 2013, having declined an average of 11.7% y-o-y over the first 11 months of 2013. The recent interim deal on nuclear sanctions offers a measure of optimism whereby several international companies are reportedly discussing with Iranian officials a potential return of investments should the sanctions be relieved. In addition, we note that the deal could provide an easing of the ban on European shipping insurance for Iranian oil, which would result in a slight increase of oil exports from Iran to major customers like India and South Korea to at least the level permitted under current the sanctions regime. That said, we remain cautious about the prospects for Iranian energy exports in 2014, given that a significant easing of oil sanctions would only come as part of a broader, final settlement, which would in our view be at a minimum 6-12 months away.

Oil Production On The Mend
Iran, Oil Production, Million Barrels per Day (LHS), % chg y-o-y

The fall in value of the rial and international sanctions have resulted in a sizeable decline in total imports over the past few quarters. Although the value of the rial will remain volatile over the coming quarters ( see 'IRR: Nuclear Talks Triggering Volatility In 2014', December 11 2013), a gradual appreciation in the open market coupled with an uptick in economic activity will lead to a return to import growth in 2014, which will offset the improvement in the outlook for exports. We forecast total imports expanding by 5.0% in 2014 and 6.0% in 2015, from our estimate of a 10.0% contraction in 2013.

Risks To Outlook

The macroeconomic outlook will remain highly susceptible by developments in negotiations with the West on the country's nuclear programme over the coming years. We see three potential scenarios in negotiations. One sees talks continuing without key developments over the next 24 months, another a major breakthrough within 6 to twelve months, and a third a breakdown in talks within the same time frame (see 'US - Iran Talks: Three Scenarios', October 1). Should the second or third scenario play out, this could prompt us to significantly revise our forecasts.

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Sector: Country Risk
Geography: Iran
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