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Iran: Middle East’s sleeping giant awakens

After decades of isolation, the Islamic republic emerges from the shadow, offering investors plenty of opportunities to take part in its economic transformation.

The lifting of most international sanctions on Iran early this year has given the Islamic state a chance to finally flex its financial muscles. With market capitalisation currently at around US$120 billion, the Tehran Stock Exchange (TSE) could be a potential goldmine for investors, but experts agree that there are still stumbling blocks that Iran has to overcome before it can reach its full potential.

Speaking at FundForum Middle East held in Dubai on Monday (21 November), Homan Harandian, CEO of Griffon Capital Cayman, underscored the attractiveness of the Iranian market to investors.

“Since the start of 2016, 27 IPOs have been launched. There are more than 500 publicly listed companies and average daily volume stands at about US$150 million ,” he said. “And despite the size and diversification of the Iranian economy, the market trades at a massive discount to MSCI frontiers, with average PE ratio close to 6.5%, yet average daily yields is around 11%-12%.”

Like most countries in the Middle East and North Africa (MENA) region, Iran’s economy is often associated with the oil and gas sector. However, according to Harandian, oil only accounts for between 15% and 20% of the GDP, while the services industry represents the lion’s share, at 60%.

Clemente Cappello, CIO of Sturgeon Capital, agreed, adding that his company started looking at the Iranian market three years ago and has found it to be one of the most diverse, liquid and sophisticated markets among the “new Silk Road” economies.

“The regulations, depository infrastructure and brokers are advanced. But I think the biggest that Iran has over any other markets is the fact that foreign capital is 10 basis points – that’s where the opportunity lies,” he said.

However, both admitted that while the country may be teeming with opportunities, it is a difficult market for foreign investors to access.

Barriers to growth

Conor Griffin, Analyst at The Economic Intelligence Unit, said Iran’s macroeconomic fundamentals are strong, with average real GDP growth projected at 5% over the next five years – even outperforming MENA’s major economies such as Saudi Arabia, Turkey, Egypt and the UAE.

“We’re quite bullish on Iran. But the flip side is, it has the potential to grow at 8% to 9%,” he said. What’s preventing Iran from growing faster can be attributed to two main reasons, according to Griffin: one is the chronic lack of domestic liquidity, and another is limited foreign investment.

“Even though interest rates have gone down, which helped reduce inflation, they are still relatively very high. So if you’re a domestic investor looking to get a new project off the ground, for example a hotel, you have to put up a lot of cash and the high interest rates can be a tall order,” he said.

Harandian noted that interest rates in the country stands at between 15% and 16%.

With oil prices losing more than 70% of its value in the past 24 months, the government also faces a liquidity squeeze. To address this, more foreign capital has to enter the market to fund new infrastructure and development projects.

However, there are also unique challenges to attracting foreign capital into Iran, according to Stephen Newby, Partner at Herbert Smith Freehills.

“The US primary sanctions regime remains in place following the JCPOA implementation day . This means sanctions still apply to US nationals, US citizens, green-card holders and people who are in the US but are not necessarily Americans,” he explained.

Those people cannot invest in Iran unless they have a specific license. Newby cited as an example the recent decision by the US Treasury Department to give Boeing approval to sell passenger jets to Iran.

“Outside of the US , non-US persons are no longer subject to secondary sanctions. They are permitted to invest, subject to restrictions on dealing with specifically designated nationals of Iran,” Newby added.

Investors looking to invest directly or indirectly have to be wary of the so-called “naughty list”, which also include specific sectors, such as military- and telecom-related operations.

Areas of investment

Currently there are only four foreign fund vehicles with access to Iran, according to Harandian. But while the market may be restrictive at the moment, opportunities await for foreign investors who are set up to park their cash in the country.

“Because of the sanctions, Iran’s middle class has shrunk, so consumer finance is becoming an interesting play for funds like us. The IT sector, not necessarily telecom, is another area we like,” he said, adding that Iran is the world’s largest exporter of cement, with around 20 million tonnes of export capacity.

Meanwhile, Cappello advises investors to look at bonds with a three-to-five-year duration, where he claims they can lock in more than 20% yield.

“In addition, Iran has a export potential with labour that is highly educated and very cheap. Watch out for industrial companies that have invested in machinery and have the potential to export to regional markets,” he said.

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