The Tehran Stock Exchange continued its post-sanctions surge through March when the Iran fiscal year ends, up 20% since January, as market capitalization topped $100 billion and daily trading volume quintupled to $500 million.
Domestic retail investor sentiment, with foreign participation still under 1% of the market, was buoyed by parliamentary election results where candidates backing President Rouhani’s economic reform agenda, focused on bank cleanup and international opening, prevailed. However the rally may lose steam in the coming months, with GDP growth still near recession at just over 0.5% through December, and the lingering US ban on dollar access and financial institution engagement stifling global transactions despite Iran’s reconnection to the SWIFT payments network.
The Supreme Leader Imam Khamenei blasted Washington for “bad faith” as the Treasury Department promised to clarify permitted relationships pending expiry of formal boycott legislation at year-end, while central bank representatives accused the Obama administration of fostering European and Asian bank “Iranphobia” with the undiluted threat of denied US system entry.
Oil price rebound critical
Agriculture was the only positive category in the latest output figures, with industry and services remaining in decline, and the official 4% forecast for the 2016-17 fiscal year will depend heavily on oil export and price rebound as OPEC suppliers try to devise a joint strategy. Inflation will stay above 10% and not reach single digits until the medium term, as the central bank again lowered the benchmark Islamic “return” rate from 20% to 18% in March as monetary stimulus.
Fiscal room is limited on a 2% of GDP deficit with costly consumer food and fuel subsidies despite rollbacks under the previous administration. The outgoing legislature, dominated by conservatives, voted to eliminate transfers nominally as a budget discipline move, but also to increase political pressure on President Rouhani and his allies who prefer slower spending cuts coupled with higher tax collection through better VAT enforcement.
In external accounts, the current account is in minor surplus and foreign debt is negligible at less than 20% of GDP, but the two-tier currency system endures with a 20% gap between the formal and market rates at 30,000 and 35,000 rial to the dollar, respectively. The authorities have pledged unification later this year, but the IMF’s December Article IV report cited previous unmet deadlines, and the level of actual foreign reserves for backing the change, often put in the $100 billion range, is still uncertain as billions of dollars released from frozen accounts go to pay past international contractor debt.
The tightly-controlled banking sector, with ailing state-owned giants in charge of most of the $400 billion asset total, is in the first stage of urgent rehabilitation regularly stressed by the President’s economic team. Capital adequacy is around half of Iran’s Middle East neighbors and follows dated Basel I standards, according to the IMF.
Bad loans tally higher?
Reported bad loans by local classification rules are 15% of portfolios, but stricter enforcement ordered by the presiding Money and Credit Council could well double the tally and drive the overall rescue cost toward $50 billion. Banks have also been told to divest property holdings seized in recent years after individual and corporate borrower defaults, but auctions have few buyers with depressed real estate values.
The new parliament will consider consolidation and modernization laws, including stronger independent regulation and the possibility of a single bad asset disposal agency, as well as updated anti-money laundering and terror funding provisions that can satisfy US and international objections.
Despite Iranian banks’ domestic crisis and outside residual penalties, mid-tier European banks from Belgium and Germany, and Asian policy and commercial ones from China, India, Japan, and Korea have re-engaged tentatively. China’s ICBC has applied for a local license in Tehran and the Kish Island free trade zone, and Iranian counterparts plan operations in Beijing, Hong Kong, and Shanghai.
But SWIFT reintegration mandates transactions at the unfavorable formal exchange rate which exacerbates overarching issues of counterparty creditworthiness and US violations risk, and stock market enthusiasm will likely again be muffled by Tehran’s self- inflicted and Washington’s self-absorbed policy inertia.
Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.