FDI and Business Environment in Iran

Shanda Consult Ltd, September 19, 2018

Despite its challenges, Iran is an interesting country to invest in with lots of opportunities and market chances locally and in the region. There are many areas in services and production that are far from saturation. Especially smaller foreign investors continue profitable operations in Iran.
Foreign Direct Investment into Iran is now effected by the US‘ withdrawal from the Nuclear Agreement. The US reinstated its sanctions and will put in action additional sanctions starting 5 November 2018.
Foreign Direct Investment (FDI) is not only affected by the new uncertainty, but also by the sometimes-challenging business environment in Iran.

The 4th International Conference on Entrepreneurship in Tehran, ICE 2018

The Faculty for Entrepreneurship of the University of Tehran organised its 4th International Conference on Entrepreneurship on 4th and 5th of September 2018. The Managing Director of Shanda Consult was kindly invited to lecture about “Foreign Direct Investment and Business Environment” in Iran. The following is an abstract of this lecture.

Foreign Direct Investment into Iran

The economy of Iran in general and Iranian businesses, in particular, have struggled from the international sanctions for long years. Necessary raw materials and spare parts for many industries could not be imported, leading to deficiencies in many sectors and affecting not only further development but also creating safety issues in transport systems (old and badly maintained planes, railway systems and wagons, the car industry etc.)

The “good in the bad” was that Iran had to focus on own resources, research and development and education. Some industries benefited from this situation and are today working with high technology and efficiently. The pharmaceutical industry and Nano-technology, in general, are just two examples. High-tech producers can be found in many regions of Iran, not only in Yazd, where a very advanced high-tech industrial zone has been established decades ago.

Foreign Direct Investment influx into Iran continued during the years of international sanctions on a low level, reaching its peak in 2011.

Foreign Direct Investment into Iran mainly focuses on the following sectors: polymer and chemicals, steel, trade, motor vehicles, mining, plastic and medical devices.

The Nuclear Agreement, correctly the “Joint Comprehensive Plan of Action” (JCPOA) was signed on 14 July 2015 between the Iran, the US, the UK, France, China, Russia and Germany. The agreed lifted of sanctions was implemented on 16 January 2016.

Business people and company representatives mainly from Europe but also from many other countries started to visit Iran, mostly in form of organised business delegations, to identify business and investment opportunities. As the above graphic shows, it (naturally) took a while until Foreign Direct Investment into Iran picked again. Globally operating companies were the first to enter Iran with investments.

However, the lack of clarity regarding its stance towards the implementation of lifted sanctions by the US, despite being signatory of the Joint Comprehensive Plan of Action (JCPOA), plus the continuation of the US’ own sanctions and consequently US penalties applied to some banks and companies, made many companies from Europe and other countries refraining from investing in Iran.

Today, those foreign companies from Western countries that invested in Iran are working to fulfil their obligations from current investment contracts but refrain from signing new contracts for already negotiated and planned investments.

This situation leaves Iran as a market and a destination for investments to mainly Russian and Chinese companies, which are rapidly gaining ground in Iran and establishing strongholds, leading to more influence – economically and politically – in the Islamic Republic of Iran. With the withdrawal of the US from the nuclear agreement and with the lack of successfully established banking facilities between Iran and Europe, the Western world is losing influence in Iran – a fact that contradicts the actual goals of the Western world.

Foreign Direct Investment into Iran and into Turkey

The Islamic Republic of Iran and the Republic of Turkey are quite similar in many aspects. The population of both countries has about the same size. Culture, traditions and habits are quite similar, to the extent of similar figures of speech. About 40 % of the Iranian population are Azeri, easing communication between people from the two countries. Both countries are relatively powerful and are striving for more influence in the region. The development of the two countries and their economy and markets is quite comparable as well.

Business Environment in Iran, the PESTLE factors

There are of course many ways and angles to evaluate a prospective investment market, and methods of evaluation need to be formulated as per a specific investor’s needs and industry.

The PESTLE factors are on way to analyse and to evaluate a market. PESTLE is the abbreviation of Political, Economic, Social, Technological, Legal and Environmental factors that influence or may influence an investment and its success.

PESTLE – Political Factors in Iran

- Influence of government and local administrations
Influence of the Government and local administrations can be unexpected and sudden. Clashing interests of various interest groups of an economy that is largely in the hands of the Government and semi-governmental bodies may lead to sudden legal changes or the reluctance to proceed with licenses and permits.
A positive aspect in Iran is that governmental bodies, including ministries and ministers, and local administrations generally apply an open-door policy and are willing to meet. Generally spoken, officials are eager to improve things.

- Fiscal policy of the government
The fiscal policy of the Government does, of course, take into consideration the international political and economic factors that influence the country’s situation. The market mechanisms of Iran need to be improved to international standards. This may lead to relatively sudden changes in the fiscal policy. Underdeveloped fiscal and market instruments are in the process of modernisation, the country is really working hard on this. However, this also leads to unforeseeable changes, more frequently than in “settled” countries.

- Tariffs
Tariffs, for example custom duties or feed-in tariffs in the energy sector, may change often (custom duties) or may be not satisfying (feed-in tariffs in the energy sector in local currency under current inflation). Tariffs for custom duties are often used ad hoc as an instrument to regulate markets, aiming protection for local producers.
There are price caps for some products to ensure affordable prices for the poorer segments of society. One example are milk retail prices, which are set by the government at a level that leaves milk production of diaries almost without profit, forcing them to concentrate on other products such as yoghurt and cheese.

- Protection of local market
As a yet developing country, protection of local producers is indeed appropriate. However, personal influence and ties may lead to sudden protectionist measures which may hit an investment.
On the other hand, protectionist measures may be for the benefit of a foreign investor’s enterprise as well.

- Steadiness and reliability of political decisions/implementation
Iran has a complicated structure of political management, including several centres of political power that may follow opposite interests and may generate changing coalition of power centres, which in return may lead to short-lived decisions and even to the non-implementation of decisions.

PESTLE – Economic Factors in Iran

- Performance of the economy
The performance of economy is an important factor that determines income and level of consumption, willingness to invest, employment rates and more.
The economy of Iran is currently affected by the uncertainty deriving from international policies, high inflation and weak fiscal policies. Basic consumer goods continue performing well, services and goods not directly addressing consumers may perform as well, due to ambitious programmes of the government.
Exports to countries of the region enjoy an increasing performance.

- Inflation
The rate of EUR/IRR was around 42.000 in January 2017. Today, the official rate is around 55.000, while the free market ranges between 120.000 and 140.000. The large spread between official and free market rates indicates a weak fiscal policy, artificially backed official rates and important lack of trust in the current economy.
High inflation makes market and price projections difficult, increases production cost in an unforeseeable manner and reduces consumers’ purchase power.

- Interest rates
Interest rates currently (September 2018) range at 12 – 15 %, while deposit interest rates are at 16 – 18 %. Islamic Treasury Bonds are offered at a rate of 28 %, weakening banks’ competitiveness. The high interest rates do not suggest investment financing through banks. However, interest rates may be favourable for businesses that are mainly depending on free market rates in sales but on official rates in procurement (high inputs from imports).

- Competition
As Iran is not very well developed yet, there is generally no saturation in the market. Declining purchase power increases competition on the market, though. Large companies that belong to the governmental or semi-governmental sector may sometimes choose unfair ways to control raising competitors.

- Demand and supply
Demand is currently affected by unfavourable market indicators (inflation, decreasing purchase power, economic uncertainty), while supply is marked by increasing difficulties in imports, and sometimes monopolistic positions and attitudes of local manufacturers/suppliers. Good planning and wise decisions are required to ensure uninterrupted supply.

- Purchase power
As mentioned above, the purchase power of consumers is weakening, due to high inflation, increasing unemployment and high interest rates.
The purchase power of the wealthier part of the population, however, is still enough to satisfy the construction and operation of new luxury shopping centres.

PESTLE – Social Factors in Iran

- Demographics & Population size
Iran’s population is slightly over 80 million at the moment and expected to raise above 100 million in 2050. The population of Iran is widely distributed over the large country, with Tehran being the largest centre of population, counting for more than 16 % of the entire population of Iran. The urban population of Iran, 74 % of the total population, is concentrated on Tehran, Mashad, Isfahan, Tabriz, Karaj (Alborz) and Shiraz.
More than 98 % of the population are Muslims, with Shia Muslims being the largest group (90 %).
Iran is a large country with a large population, making it an interesting market for FMCG.

- Dominant cultural trends
Cultural trends can be various in Iran, forming a strong blend of Eastern and Western trends. While the younger generation and the wealthier part of the population looks westwards, the other parts of the population are well rooted in local and traditional culture and traditions. While the performance of female singers as well as the sale of their records are still prohibited, the number of concerts and cultural events not related to religion is apparently growing.
The number of cafés and chic restaurants is rapidly increasing, mainly fed by the wealthier that more and more open up, adopting a more Western life-style.

- Religious aspects
Religion plays an important role in Iran. Iran is an Islamic Republic by constitution. Many Iranians are not deeply religious, though. Yet, religious feasts and traditions play an important role for large parts of the society. Successfully investing and operating in Iran requires familiarity with and respect for the countries religious concerns, habits and traditions.
Iranian people are generally very tolerant towards people of other religions and issues based on the fact that a foreigner’s faith is different from their own faith will not come up under normal conditions.

PESTLE – Technological Factors in Iran

- Technological trends
As mentioned above, Iran has a surprising number of high-tech companies and high-tech is rapidly entering daily life. Technological trends in Iran are parallel with the world’s trends. There is a large number of more or less successful tech startups and Fintechs.

- Devices owned & Connectivity
The mobile phone penetration in Iran is 104 % (June 2017). 61,39 % of Iranian households enjoy access to the Internet, while 45 million Iranians are present on global social networks. Iran blocks access to certain domains (i.e. Facebook, Twitter, YouTube).
40,5 % of Internet users connect through GPRS, 28,6 % through dial-up connections, 22,7 % through optical fibre, 5,6 % through ADSL connections and 2,6 % through WiMax.
Broadband penetration is relatively low, the majority of broadband is provided by mobile phone operators.
The total length of fibre optic cable connections between cities is currently 64.205 km.
In terms of B2C e-commerce, Iran ranks on place 46 in 2017.

- Affinity
Technology affinity is high among the population under 35 years (53 % of the population). People above this age do not have a high technology affinity, living a more traditional life.

PESTLE – Legal Factors in Iran

- Legal framework
The Legal framework in Iran consists of elements based on French civil law and of Sharia-based Islamic law. The legal framework of Iran is complicated, sometimes contradictory and with many areas uncovered or only roughly covered. Iran is in the process of modernising its laws, a lot of efforts have to be paid yet.
It is of utmost importance for foreign investors to seek proper legal consulting from good lawyers, specialist in the area needed.

- Functionality of judicature
The functionality of judicature is not only questionable but uncertain and frustrating at times. Judgements regarding one and the same case may totally differ from court to court, each court seeming to compete for the superior authority of interpreting law.
There is a very good article about the “Life of the Law in the Islamic Republic of Iran” by Reza Banakar (professor at the Lund University) and Keyvan Ziaee (social researcher in Lund, Sweden).

- Freedom of capital movement
There are currently now restrictions on capital movement in Iran. The majority of banks in the world does not work with Iranian banks though, and this may create problems when repatriating dividends from Iran.

PESTLE – Environmental Factors in Iran

- Environmental legislation
The environmental legislation is in the phase of development, with the parliament trying to modernise environmental legislation in order to protect nature and national resources. Generally spoken, Iran is yet far from environmental protection, compared with other countries.

- Effect of own processes on environment
Depending on the industry an investor focuses on; related environment legislation needs to be studied and own processes to be analysed. There may be locally differing provisions which need to be adhered to.

- Existence of necessary facilities
As environmental protection has not much developed yet, one may face a lack of necessary facilities owned by the public, and this may require building own facilities.

Business Environment in Iran – Possible Main Issues

Iran is an interesting and, on the medium term, promising country to invest in. However, being a country in transition, investing in Iran may face some challenges, mainly:

International banking facilities (sanctions)
Monopolistic practices
Rent-seeking
Corruption
Weak economic indices
Government-run structure of the economy
Lack of proper infrastructures for investments
Lack of effective advertising

Conclusion

Despite its challenges, Iran is an interesting country to invest in with lots of opportunities and market chances locally and in the region. There are many areas in services and production that are far from saturation. Especially smaller foreign investors continue profitable operations in Iran.

The currently difficult situation for companies in Iran (inflation) provides plenty of very advantageous opportunity to buy existing facilities for a very low asking price.
Shanda Consult will be happy to share its Iran experiences and to assist interested (prospective) foreign investors through its well established and resilient local network. Please do not hesitate to contact us directly .


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