New Cebr forecasts show clear imminent boost to Iranian development, but challenges remain

 

• After two years of deep recession in 2012 and 2013, and a year of rebound in 2014, Cebr expects growth to gradually stabilise in Iran at around the 2.5% mark throughout our forecast horizon to 2020.
• The main driver for growth will be the lifting of economic sanctions by the UN that have been in place since 2006.
• This should help Iran move away from being a ‘pariah’ of the global economy and become more integrated through trade and investment.
• However, we maintain that there are many hurdles to this process and forecast the benefits to start feeding through more slowly than widely expected.
• The oil sector is a clear candidate for driving forward the Iranian economy, given the country’s claim to the fourth-highest level of reserves worldwide.
• The country further benefits from strong demographics and high literacy rates which should help develop other industries such as tourism and services.
• However, structural challenges remain: Iran’s economy still fares relatively badly on global governance and ease of doing business indicators. This means that even as Iran returns to the global economic community it will take a while before investors regard it as truly ‘open for business.’
• Moreover, geopolitical factors could hinder Iran’s integration in the regional and global economy despite clear economic incentives for this to happen.

 

New forecasts by the Centre for Economics and Business Research (Cebr) show that after a slight blip of GDP contraction[1] in 2015, Iran is expected to return to recovery with growth gradually accelerating throughout our forecast horizon. The pace of output expansion when accounting for inflation is expected to stand at around 2.5% through the next five years. This is on the cautious side of global economic forecasters. The IMF for example expects Iran’s GDP to keep expanding at almost double the pace throughout the same period.

 

This means that even by 2020, the level of GDP when measured in current US$ will be $80 bn lower than the recent multi-year peak of 2012. This compares with a roughly $30 bn gap on the IMF’s forecasts.

 

Figure 1: 2010-2020: A lost decade?

Level of Gross Domestic Product, measured in current US $ bn

Source: International Monetary Fund, Cebr forecasts

Cebr’s cautiousness mainly derives from the uncertainty around the pace of adopting the terms of the sanction relief agreement – this has continued to underwhelm expectations for faster adoption. Our baseline forecast assumes that we will have to wait until mid-2016 before any real impact on the economy is visible. Moreover, even once the impact of lifting sanctions feeds through, Iran’s outward-looking industries could take even longer to respond.

 

Danae Kyriakopoulou, Cebr Senior Economist and editor of Cebr’s ‘Global Prospects’, recalls from her recent visit to Iran:

 

“There is a general enthusiasm around the country about the prospect of sanctions being lifted, especially among the young people. But the tourism industry has taken a big hit from many years of economic isolation and it will take a long time for it to recover. Some things are easy to fix quickly – soft infrastructure and logistics for example. I was positively surprised to experience that passport control at Tehran’s Imam Khomeini airport lasted a swift few minutes – it shows that the desire to open up and welcome visitors really is there.

 

Other things will take a longer time to adjust: From Tehran to Esfahan and from Yazd to Shiraz, traditional ‘bazaaris’ once selling handicrafts, carpets, and saffron – the sort of goods tourists are usually after – have now been replaced by shops selling cheap ‘made in China’ household goods and clothes to cater to the domestic consumer.”

 

Economic indicators analysed by Cebr seem to confirm these observations and highlight further structural challenges. The World Bank’s ‘Ease of Doing Business Index’ for example points to Iran being one of the most troublesome economies regionally and globally in this regard:

 

Figure 2: Score on World Bank’s ‘Ease of Doing Business Index’

Source: World Bank, ICAEW/Cebr Middle East Economic Insight Q4 2015

Other governance indicators also show Iran performing badly. It scores particularly poorly when it comes to Regulatory Quality and Accountability ranking in the bottom-5% worldwide.

 

Figure 3: Iran’s percentile rank in World Bank’s Worldwide Governance Indicators 2014 (0 is worst, 100 is best)

Source: World Bank Worldwide Governance Indicators, Cebr analysis

 

“The informal character of the economy and the complicated currency system (with tomans and rials as simultaneous units of account) make transactions unnecessarily difficult for the foreign visitor. Moreover, the hyperinflated currency also poses practical inconveniences, such as having to carry a big pack of bank notes around just to get by for the day. The lifting of sanctions should partly help alleviate this issue through enabling the use of foreign credit cards, but this will also take time”, Kyriakopoulou continued.

 

On the bright side, the economic fundamentals are strong. Our research, drawing on data from the United Nations Populations Estimates, points to Iran as poised to enjoy strong growth in the size of its labour force in the medium term. Specifically, we forecast an increase of 65% between 2015 and 2045. This is due to a combination of demographic and sociological reasons.

 

On the demographic side, the United Nations Population Division expects the population of Iran to continue expanding over the medium term. The size of the working age population (those aged 15-64) is expected to increase from around 56.4 million in 2015 to 62.8 million in 2045. Perhaps more importantly, the participation of working-age individuals in the labour force is expected to rise, especially among women. According to the World Bank’s latest World Development Indicators from 2013, only around 17.6% of working-age Persian women participate in the labour force. This compares to 23% for the Middle East & North Africa region on average, and 40.7% compared to the average in lower and middle income countries. The equivalent rate for Persian men stood at 76.7% in the same year. This presents a clear opportunity for Iran’s labour market.

 

Looking ahead, we expect the participation rate to rise significantly over the medium term, both for men and especially so for women. Not only is Iran modernising and developing welfare-state attributes that encourage female participation in the labour force, but literacy rates have risen tremendously across the generation, meaning that today’s Persian women are more ready to join the labour force due to developments in the education system. Data from the United Nations (UNESCO) show literacy rates in the population of those aged between 15 and 24 at 98%. This is more than three times as high as the literacy rate for those aged 65 and older, at 26%. Enrolment in tertiary education has been gradually increasing throughout the new millennium, as shown in Figure 4 below. And Iran’s cabinet has the highest number of US college alumni serving in any foreign government cabinet in the world, according to Reza Aslan, a creative writing professor at the University of California at Riverside. SCImago, a Spanish firm that monitors academic journals, expects Iran’s scientific output to have become the world’s fourth-largest by 2018, ranking just behind China, the US, and the UK, and ahead of Germany and Japan[2].

 

Figure 4: Enrolment in tertiary education, percent of population enrolled in relevant age category

Source: World Bank, Cebr analysis

The combination of these demographic and sociological factors is expected to help Iran’s workforce increase by 65% over the coming 40 years, as shown in Figure 4. Men will continue to account for the lion’s share of the labour force but it is among women that the fastest growth rate is expected to be seen. In fact, we expect the level of Persian women in Iran’s labour force to more than triple in that period, from 5.4 million to 19.7 million.

 

Figure 5: Labour force split by gender, millions

Source: United Nations Population Estimates, World Bank World Development Indicators, Cebr analysis

 

“Iran is a very young nation – it is something one notices immediately when travelling around the country. And it is not only about quantity, but also quality. The literacy rates of the youth compared to that of older generations are miles apart. Young Persians also have an enthusiasm to engage with foreigners and practise their English – they are very eager for the sanctions to be lifted.

 

Another encouraging sign is the trend of “re-migration” among ex-pats. Second and sometimes third-generation Persians who typically grew up in London, Paris, or the United States after their families left the country following the revolution, are now starting to return to the homeland to set up their own businesses or take over the family businesses. The affluent neighbourhoods of Elahieh and Zafaraniyeh in North Tehran seem to be booming.” – Kyriakopoulou noted further.

 

The advertising industry is a particularly interesting proxy indicator for the health of the services sector and the development of a consumer-based economy. “One of the most surprising things about Tehran is the level of advertising one sees in its underground transport system. Much like in London, there are advertisements of consumer goods everywhere, from the elevators to the ticket machines and from the platform area to the screens in the carriages themselves”, noted Kyriakopoulou.

 

Encouragingly, the dynamism and the process of modernisation of the economy extends beyond the narrow shores of the capital. This in big part thanks to the wide use of digital technology, which has spread Western entertainment forms, social networks, beauty ideals, and even gender roles to the most remote parts of the country. Even though Iran gets second-last place in Freedom House’s ‘Freedom of the Net’ index after China[3], this does not seem to match the reality as experienced on the ground. Websites such as Facebook, Twitter, or news sources that are officially banned are in fact widely used through the technology of virtual private network (VPN) systems. This is only set to strengthen with the lifting of the sanctions and there is great room for catch-up in internet usage. Freedom House estimates level of internet penetration in the country at around 39%.

 

But while the economic and demographic fundamentals seem to be strong, we believe it is important to account for non-economic factors when forecasting the long-term impact of the lifting of sanctions on the Iranian economy.

 

Naturally, one would expect the optimism around the opportunities for the country’s future to have taken off in the surrounding region. To an extent, this is already the observed reality in some of Iran’s neighbours, particularly in Dubai. Our analysis through google trends and internet page archives of job search engines suggests that there is an increasing interest from Dubai-based companies to hire Farsi speakers. But other economies that are more politically dependent on Saudi Arabia may not behave in the same way.

 

Nina Skero, Cebr Economist and contributor to the report, recalls from her recent visit to Bahrain: “The geopolitical environment of the region raises doubts over how willing Iran’s immediate neighbours will be to engage in trade even if the economic logic points in that direction. For nations such as Bahrain or the UAE, the economic cost of alienating themselves from Saudi Arabia – a country whose relations with Iran have traditionally been strained – may simply outweigh the economic benefit of engaging with Iran.”

 

“Additionally, not all levels of sanctions against Iran will be lifted. For example, the US will maintain sanctions relating to the country’s involvement with terrorism and human rights violations. This means that many firms will still have only a limited capacity to work with the country and even some of the parties that could work with Iran may find the rules vague and confusing and therefore decide it is overly risky to explore economic opportunities”, Skero continued.

 

In terms of the oil market in particular, at the end of 2015 oil prices remains at a multi-year and there is little reason to believe that 2016 will see a substantial pick up.  As a part of the strategy to defend its market share against high-cost rivals OPEC has refused to support the oil price by cutting production. Although Saudi Arabia has somewhat reversed its rhetoric on the matter at the December OPEC meeting it is very likely that it will not get other oil producers on board until at least the end of next year. Given that Iran’s very substantial oil reserves may soon make it onto the global market, the supply side price pressures are expected to persist. A slump in global trade and slowing growth in China mean that demand will also be relatively weak. However, as global growth picks up in outer forecast years demand for oil may increase thereby somewhat pushing up prices.

 

[1] This refers to nominal GDP measured in US $. In real terms GDP measured in rials is expected to have grown by 0.9% this year.

[2] Source: http://www.scimagolab.com/blog/wp-content/uploads/2012/04/forecasting-excercise.pdf

[3] Source: https://freedomhouse.org/report/freedom-net/2015/iran

 

For media enquiries on this story, please contact:

Danae Kyriakopoulou, dkyriakopoulou@cebr.com    020 7324 2878 and 07812540030

 

NOTE: Cebr’s Annual World Economic League Table, containing more detailed forecasts around the prospects of the world economy, will be released on Boxing Day (26/12/2015).