ALACO DISPATCHES: Re-empowered Rouhani still faces struggle to woo investors

ALACO DISPATCHES: Re-empowered Rouhani still faces struggle to woo investors
Iran’s entrenched power structure means that President Hassan Rouhani is unlikely to be able to persuade the hardliners to change their ways.
By Tom Laub of Alaco May 26, 2017

Western investors will have been encouraged by the re-election of reform-minded Hassan Rouhani as Iran’s president, but Iran’s powerful hardline forces will likely frustrate efforts to make the country more attractive for foreign investment.

Rouhani’s clear victory over conservative rival Ebrahim Raisi is widely seen as public backing for his competent management of the economy and engagement with the West following the 2015 nuclear deal. Although investors have been slow in coming, oil exports have surged, enabling Rouhani to point to significant economic progress. In the year to March 2017 Iran’s GDP grew by around 6.5%, its current account surplus rose to around 6% of GDP over the same period, and inflation has tumbled from a 2013 high of 45% to 7%.  

During his re-election campaign Rouhani sought to appeal to voters by pledging to lift remaining US sanctions, step up anti-corruption efforts. and increase trade. He secured 57% of the vote, 6 percentage points more than his share in 2013, by urging the electorate to choose “the path of interaction with the world, away from extremes”.

The message appealed to Iranians keen to put the impoverishment of international isolation behind them. Yet even with his considerable popular mandate, it seems that Rouhani is unlikely to dislodge the main barriers to foreign investment, central to the country’s future prosperity.

One of investors’ principal concerns in advance of last week’s elections was that a victory for Raisi would encourage conservative hardliners to undermine the nuclear agreement, which they argue has failed to deliver the economic windfall Rouhani promised. But while fears about the demise of the accord may have been allayed for now, the president will find it hard to fulfil his campaign pledges to lift American sanctions.

This is because one of their main targets is the country’s arch-conservatives, the Iranian Revolutionary Guards Corps (IRGC), the elite and dominant branch of the security forces, which exerts considerable influence over the economy.

The US measures coupled with uncertainty about American sanctions policy on Iran have meant that Western investment has been thin on the ground since the removal of nuclear-related measures 18 months ago. There have been a few exceptions, notably deals with Airbus, Boeing and French car producers.

Investor nervousness is understandable. The risk of breaching US sanctions – which include measures linked to human rights violations, ballistic missiles and fomenting regional instability – are a big deterrent. In March a $1.2bn fine was imposed on the Chinese telecommunications group ZTE for exporting US-produced components to Iran and North Korea. 

Iran’s entrenched power structure means that Rouhani is unlikely to be able to persuade the hardliners to change their ways, in particular the IRGC’s support for insurgents in Syria, Lebanon and Yemen. The president and parliament, dominated by reformist and moderate conservative allies, have some scope to introduce economic reforms, which may include plans to restructure the banking and tax system and improve the business environment.  But the conservatives, led by the Supreme Leader Ali Khamenei, determine security policy, as they control the police and the army.

During his trip to the Middle East last week, American President Donald Trump engaged in anti-Iran rhetoric and emphasised the US alliances with Israel and Saudi Arabia, both sworn enemies of Tehran.  If Trump continues in this vein it will likely encourage the IRGC to maintain, if not bolster, support for allies in the region.  

At the same time, the hardliners will likely resist attempts by Rouhani to introduce greater transparency into the Iranian economy in order attract investors. Many are put off by the high levels of corruption – much of it linked to the IRGC – and the risk of partnering with companies that may have connections with sanctioned IRGC entities or individuals.  Under former Iranian President Mahmoud Ahmadinejad, the Revolutionary Guards became the largest commercial power in the country and now control up to 50% of the economy together with other conservative elements linked to the Supreme Leader.

These forces have little interest in the arrival of Western companies, which would present unwelcome competition, or in having their business affairs placed under greater scrutiny. Rouhani attacked corruption in the IRGC and allied elements in Iran’s conservative-controlled judiciary during his re-election campaign. But it seems he cannot do much to curb their excesses and economic influence. 

So while Rouhani’s election may have averted the re-imposition of nuclear-related sanctions, the significant limitations on his power means that he will struggle to tackle the issues that have deterred foreign investment.

Tom Laub is an analyst at Alaco.  Alaco Dispatches is the business intelligence consultancy’s take on events and developments shaping the CIS region.