Institutional reform and private sector legitimacy key to reducing instability risk in Iran
Anti-government protests that erupted in Iran on 28 December 2017 appear to have ended. However, the resentment that caused them will persist: discontent with government corruption and mismanagement, and the failure of the nuclear deal (Joint Comprehensive Plan of Action or JCPOA) to benefit a vast section of the population despite the country’s 12.5 percent growth rate. Protests and instability could erupt again if key structural issues are not addressed and economic growth does not trickle down to most Iranians over the medium-term of 5-10 years.
Since the JCPOA came into effect in January 2016, Iran has only seen modest benefits and the living standard of most Iranians has not improved. Iranian President Hassan Rouhani won two terms (second and most recent in May 2017) on a platform of economic growth, promising low unemployment and inflation levels.
However, Rouhani’s pledge will be difficult to deliver unless Iran combats internal dynamics such as reducing the role of Iran’s Revolutionary Guards Corp (IRGC) and resolving its internal governance issues before re-entering the global market. If these issues are not addressed, it will be difficult to attract high levels of foreign investment and improve the standard of living of most Iranians.
Iran is not yet business-friendly
One of the biggest obstacles Iran now faces is reforming its institutions and ensuring that they conform to international standards to attract foreign investment. For Iran, it implies that the country must fix its flawed governance system and reform its institutions to connect them to the outside world. Iran is working to establish rules and regulations to bring its institutions in line with international standards to participate in the international economy.
Locked out of most global markets for over a decade, the country’s regulatory environment was lax in comparison to international norms and standards. Iran is currently ranked 124th among 190 economies on the World Bank’s 2018 Doing Business Index because of excessive red tape involved in establishing a business in Iran.
Iran’s financial sector remains weak. Credit institutions are not regulated; many are illegal and some charge exorbitant interest rates. Further the problem with Iran’s banking sector is also particularly acute; many banks are sanctioned globally, monetary reserves in individual banks are low, and non-performing loans are high. The Central Bank of Iran is in the process of ensuring that banks are compliant to international standards in line with the International Financial Reporting Standards and has also imposed rules on lenders to improve performance on capital assets in line with Basel Committee Standards, but the process is slow.
Iran must reduce the role of the IRGC in key economic sectors
President Rouhani faces the challenging task of reigning in the IRGC’s influence on Iran’s economy. Through a network of companies owned or affiliated to the IRGC, the para military organization has stakes in almost every sector in the economy including construction and heavy industries, banking, insurance, trading, food, telecommunications, hospitality, and entertainment. The private sector only comprises 20 percent of Iran’s economy. Since the nuclear pact was implemented, contracts were also granted to companies where IRGC has a direct or indirect stake.
Since 2016, Rouhani has intensified privatization efforts to reduce IRGC influence from key economic sectors including telecommunications, construction and automotive. During the same year, Rouhani declined to award construction contracts to and cancelled the sale of a telecommunications company to IRGC affiliates.
The IRGC has a stake in almost every sector of the economy through a highly-sophisticated ownership web across various companies. They either circumvented, ignored, challenged, or resisted the government’s efforts to reign its interests entirely. Even if Rouhani succeeds in untangling these complicated relationships, he could end up pushing the IRGC’s business interests further underground making it difficult to decipher their involvement in Iran’s economy. For Rouhani to be successful in reducing IRGC influence from the economy, he requires the full support of Supreme Leader Ayatollah Ali Khamenei to reign in the IRGC.
Businesses are right to remain skeptical
Foreign businesses are skeptical of engaging with Iran because of their exposure to the United States, which continues to sanction IRGC affiliated entities. Barclays and the Royal Bank of Scotland have both declined to process payments to Iranian entities on behalf of its customers.
Currently, the US Department of Treasury’s Specially Designated Nationals and Blocked Persons List (SDN) restricts business with persons or entities on its lists and in businesses where these persons or entities directly or indirectly have at least 50 percent stake. It is highly likely that the United States could reduce this stake, presenting more challenges to foreign businesses and increasing problems for Rouhani and his ability to deliver high economic growth.
Meanwhile, the Financial Action Task Force, the body in charge of monitoring and countering money laundering and terrorist financing, continues to advise countries to exercise caution while engaging in businesses with Iranian entities.
All these challenges increase pressure on foreign businesses and complicate their efforts to re-enter the Iranian market.
