Foreign companies, foreign governments, and Iranians expected to see improvements to Iran’s investment climate after implementing a nuclear deal and sanctions relief in the country. But peruse some of the recent headlines about Iran, and you might wonder whether the market’s potential was overstated. The economy still hasn’t received a boost from sanctions relief, and many big banks that left the country have not returned. This slow pace of change has left many senior leaders at multinational companies frustrated and doubtful about Iran’s potential. However, despite a weakened economy, political tensions, market uncertainty, and the lingering effects of sanctions, Iran remains an important opportunity for multinationals in emerging markets.
Compared to most oil-rich countries in the Middle East, Iran has a diversified economy, its tourism sector is on the verge of a major windfall, and threats to its political stability are in decline. The country’s urbanized and large middle class has maintained a strong preference for foreign-made products despite restrictions due toU.S. sanctions and a fragile economy. Senior executives should not lose perspective on the enormous opportunities in Iran, but they must be prepared to navigate some serious challenges.
U.S. sanctions, which were initially enacted in 1979 and strengthened in subsequent years, resulted in many U.S. and European companies restricting their presence in Iran or exiting the market altogether — and they continue to dampen foreign direct investment prospects in 2016. Many sanctions banning financial, trade, and business transactions remain in place, due to concern over Iran’s human rights record, terrorism, conventional weapons, and ballistic missiles program, which means that most U.S. companies can’t do business there. This dynamic will persist in the foreseeable future. (There are some exemptions for humanitarian-designated sectors, such as agriculture, food products, health care, and civil aviation.)
For non-U.S.-based companies, many relevant U.S. sanctions have been suspended, and most national– and EU-level restrictions were eliminated after the nuclear deal in January. Within weeks there was $50 billion in business deals involving foreign companies, including the Airbus agreement (worth $25 billion) to sell 118 planes, andItaly’s state rail company’s $5 billion pact to develop the local rail network. However, remaining U.S. sanctions are delaying these projects being financed. Large European banks in particular are not ready to return to Iran even though they are permitted. Financial institutions remain anxious because of the $15 billion in fines banks have paid for sanctions violations over the last five years and the difficulty of avoiding theU.S. financial system for bank transactions related to Iran.
Iran’s economic woes go beyond sanctions. The country remains reliant on oil revenue, though sanctions have hastened economic diversification: 37.5% of government revenue was derived from energy in the first half of FY 16. This is far lower than rival oil exporters such as Iraq, Saudi Arabia, and Kuwait. However, oil prices have dropped more than 60% since the interim nuclear deal in November 2013. Thus Iran is collecting less oil revenue than anticipated two and a half years ago, limiting public spending. The situation is encouraging the government to raise revenue through other means, including new taxes and subsidy reform — good news for sustainable economic growth, but bad news for economic recovery in 2016. And alongside the country’s bad debt (some estimates say it is $40 billion), sanctions were commonly evaded through money laundering, which discouraged foreign banks from operating locally.
Some powerful Iranian institutions are highly suspicious of Western influence. This dynamic can stall important change (e.g., more competition to reduce consumer prices, sharing international best practices, technology transfer, public-private partnerships) needed to boost the economy’s health. And while President Hassan Rouhani’s allies gained significant ground in parliamentary elections, allowing more space to open Iran to foreign investment, new policies will be subject to review by Supreme Leader Ali Khamenei, who needs to manage the expectations of his own constituents (religious institutions, Revolutionary Guard, the low-income segment).
Even with these challenges there are foreign companies seizing the opportunity ahead of their competitors. While the oil and gas sector gets the most attention, Iran’s diversified economy is attracting companies across industries. In particular, consumer-oriented sectors are counting on Iran’s large (nearly 80 million), young(more than 60% under 30 years old), and urbanized (more than 70%) population to be loyal customers in the future.
For example, South Korea–based LG Electronics, which maintained an Iran presence despite sanctions, is in discussions to establish a manufacturing plant in Tehran that will produce more than 1.5 million refrigerators, televisions, and washing machines per year. French automaker Renault has taken advantage of sanctions relief,assembling nearly 15,000 cars between January and April, a sevenfold increase from the same period in 2015. And Danish pharmaceutical company Novo Nordisk is building on its Iran presence by doubling local staff to nearly 300 and investing $76 million in a new factory.
The country’s tourism sector attracted fewer than five million visitors in 2014 while neighboring Turkey attracted 39 million people. Given Iran’s top 10 ranking in the number of UNESCO world heritage cultural sites in the world, this is poised to change. Luxury hotel brand Melia is joining Accor and Rotana to open the country’s first international five-star hotel, the Gran Melia Ghoo.
Looking further into the future, Iran is a potential global trade hub. Already nearly 20% of oil trade passes through the Strait of Hormuz, the narrow waterway off Iran’s southern coast, which is the only sea route out of the Persian Gulf and one of the world’s most strategic transit points. Furthermore, the International North-South Transport Corridor will make Iran a key link in connecting India, Central Asia, and Russia, while Iran’s role as part of China’s new Silk Road (especially with rail links) could boost bilateral trade between those countries to up to $600 billion. There are lucrative export and investment opportunities elsewhere in the region, such as inAfghanistan, which is seeking to tap mineral wealth, and in emerging giants such as India, Pakistan, and Turkey, which need natural gas to fuel economic development.
How to Plan for Doing Business in Iran
Based on frequent conversations with Iran-focused multinational companies, there are five notable challenges that deserve immediate attention in order to reap the benefits of the Iranian market:
- Updating global compliance policies. A comprehensive compliance strategy is the essential bedrock for building and implementing a successful Iran plan. Companies need to confirm that their policies are compliant by consulting with an external sanctions lawyer.
- Overcoming a lack of market data. Companies looking to enter the market should identify and track leading macroeconomic indicators of specific customer segments. Focusing on data such as population growth, inflation, and GDP growth is a way to anticipate market developments.
- Finding the right local partners. While it is possible to set up a direct presence, using local distributors at first is strongly advised. The best way to identify new partners involves in-person due diligence. Companies are increasingly considering a “Dubai model,” in which they use local partners in the UAE to connect with distributors in Iran. Many foreign companies have already employed a similar approach through a “Turkish model,” involving partners based in Istanbul.
- Reclaiming brand equity. Customers may have distorted views of foreign goods that are in Iran illegally. Senior executives should be ready to trace the origins of and combat grey market trade and counterfeits of their products in Iran. Otherwise, companies risk facing challenges related to pricing, value, and positioning against competitors.
- Accessing foreign exchange. Often, local companies spend weeks waiting for access to foreign currency to import goods from their foreign partners. Without access to the U.S. financial system, this pressure will not ease in the near term. Moreover, this problem is likely to persist because Iran is unifying dual currency exchange rates while also seeking to protect local producers from volatility.
Iran presents an important opportunity for multinational companies that operate in emerging markets. But managing expectations about the country’s trajectory is crucial for building an effective strategy. A smart approach will find the sweet spot: advancing ahead of competitors while sidestepping first-mover mistakes that often plague companies in unfamiliar, rapidly changing, high-stakes business environments.