Rouhani's Election Bodes Well For Growth
BMI View: We project Iran's economy to contract by 2.0% and then grow 2.8% in real terms in 2013 and 2014, respectively, compared to our previous forecasts of 2.3% contraction in 2013 and 2.4% growth in 2014. The victory of moderate cleric Hassan Rouhani in Presidential elections in June bodes well for the outlook, and we expect economic growth to accelerate significantly over the medium term.
We forecast Iran's economy to contract by 2.0% in real terms in 2013 and return to growth of 2.8% in 2014. We revised our forecasts up from a 2.3% contraction in 2013 and growth of 2.4% in 2014, mainly as a result of the victory of moderate cleric Hassan Rouhani in Presidential elections on June 14. While improvements to the economy will be modest over the short term, Rouhani's victory bodes well for the country's medium-term macroeconomic outlook.
|Still In Negative Territory|
|Iran - Components of GDP (IRRtr) & Real GDP Growth|
Private Consumption Outlook
Iranians' purchasing power has been eroding steadily over recent quarters. According to official data, consumer price inflation reached 34.0% in June, with unemployment standing at approximately 13.0%. According to unofficial figures, however, inflation exceeded 40.0%, and the joblessness rate stood at about 20.0% in the same month. We do not expect inflation and unemployment to decline significantly over the coming quarters. For one, although Rouhani will adopt a more conciliatory stance with the West, sanctions will remain in place. Indeed, the US unveiled new sanctions in June, including penalties on anyone facilitating "significant" transactions in the Iranian rial or holding significant amounts of the currency outside Iran. In addition, structural weaknesses in the economy, including a weak private sector and an opaque business environment, will ensure that unemployment remains elevated.
That said, Rouhani's election will lead to modest improvements in macroeconomic conditions over the coming months. Importantly, the rial gained approximately 12.0% in the weeks following Rouhani's victory, with the unit trading at IRR32,000/US$ in black market transactions on June 24, compared to IRR36,000/US$ before the election. Although the currency will remain weak over the coming months, improved confidence on the country's economic trajectory will ensure that a rapid drop in the value of the unit is unlikely in H213, which will contribute to a stabilisation of prices. Moreover, Rouhani pledged to undertake a series of the reform to the economy, including introducing tighter controls over the growing money supply and increasing the independency of the Central Bank of Iran from government's interference. It remains to be seen if the new government will be able to implement such reforms, and we do not expect immediate direct effects on the economy. That said, such pledges will increase confidence and a sense of stability among private businesses and consumers, which is likely to trigger an increase in consumer demand. We forecast private consumption increasing by 0.3% and 1.0% in 2013 and 2014, respectively, from our previous forecasts of a 0.1% contraction in 2012 and 0.7% growth in 2014.
Government Spending Outlook
We project Iran's budget deficit coming in at 7.4% and 6.1% of GDP in FY2013/14 (fiscal year beginning on March 21 2013) and FY 2014/15, respectively. With total revenues remaining low as a result of falling oil exports, Rouhani will seek to undertake a tighter fiscal policy compared to outgoing President Mahmoud Ahmadinejad - who oversaw one of the loosest fiscal policies in the history of the Islamic Republic - and this year's budget will be contractionary. As a result, government spending will remain subdued, which we forecast to increase by 2.0% and 3.0% in 2013 and 2014, respectively.
Fixed Investment Outlook
We retain a broadly bearish outlook for the Iranian construction sector in 2013. While we expect business confidence to improve ( see above), a challenging macroeconomic environment and international sanctions will continue weighing on the industry's growth prospects over the next 12 months ( see 'Infrastructure & Construction - Q3 2013', June 6). That said, Rouhani's victory bodes well for growth in fixed capital formation over the medium term. In line with the general objective of engaging the private sector, Rouhani repeatedly mentioned his plan to implement the "Law for the Continuous Improvement of the Business Environment," which calls for the complete overhaul of all business-related regulations. The law, which had already been passed by the Iranian parliament, was not implemented by the outgoing administration. That said, we are confident that the legislation will be implemented more effectively over the coming years, which will allow the country's private sector to operate more freely as outdated regulations are removed. In addition, under a scenario whereby sanctions are eased over the coming years, foreign direct investment inflows would increase significantly, resulting in stronger growth rates for fixed investment. We forecast the segment to expand by 0.3% in 2013 and 2.5% in 2014, from our previous forecasts of a 1.0% decline this year and a 3.2% increase next year.
|In A Soft Patch|
|Iran - Exports & Imports|
Iran's external position will remain precarious in 2013. We see total exports declining by 22.0% in 2013 before returning to growth of 10.0% in 2014, mostly as a result of fluctuations in oil exports - which accounted for 85.0% of total exports in 2010. According to the International Energy Agency, oil production declined by 18.8% y-o-y to 2.68mn bbl/day in May. China - Iran's largest export market for crude - bought 2.36mn tonnes of Iranian crude oil in May, a 49.5% m-o-m increase. However, this was likely due to the timings of cargo arrivals and how they were counted, as China's two main importers - Sinopec Corp and Zhuhai Zhenrong - do not usually vary their term crude imports widely month-to-month. Conversely India, Iran's second largest customer, cut Iranian crude imports 12.2% y-o-y in the same month, and South Korea reduced imports by 8.3% y-o-y. Given that the United States renewed in early June waivers on sanctions for China and other Asian countries in exchange for their reducing purchases of crude from Iran, we expect crude production and exports from the Islamic Republic to continue declining this year.
|Set To Rebound Over The Medium Term|
|Iran - Oil Exports|
As a result of continued weakness in the value of the rial and international sanctions on Iran's financial industry, total imports have fallen significantly over the past few quarters, a trend which we expect to continue going forward. We forecast total imports declining by 19.0% in 2013, only partially offsetting the corresponding fall in exports, and increasing 9.0% in 2014.
|Decline To Continue This Year|
|Iran - Oil Production, Million Barrels per Day (LHS), % chg y-o-y|
We forecast real GDP growth averaging 3.2% over the 2013-17 period, from our previous forecasts of 2.4%. Prospects for improving foreign relations and our view that macroeconomic management will improve bode well for the outlook, while base effects will ensure that oil production and exports return to positive territory from 2014 onward. In addition, we see risks lying mainly to the upside. Under a scenario whereby sanctions are lifted as a result of a rapprochement between Tehran and the West over the Islamic Republic's nuclear programme, we would expect economic growth to accelerate sharply over the coming years.