Iran: The Mideast's Model Economy?

Not long ago, it was a basket case. But now growth is strong as oil prices soar and Tehran eases restrictions

Running one of Iran's largest Internet service providers is close to a 24-hour job for Abdollah Fateh, who has to hustle to keep customers happy while prying more phone lines from the government. But recently a haggard-looking Fateh, who is Pars Online's managing director, took time out for a meal at Monsoon, a popular Chinese restaurant in Tehran. Fateh, 31, grew up in Boston but moved back to Iran in 1995. Haggard or not, he doesn't regret leaving comfortable America one bit. "I can make a difference here," he says.

Fateh has certainly made a splash. The Pars Online logo is as commonly seen around Tehran as the late revolutionary leader Ayatollah Ruhollah Khomeini's scowling visage. Pars Online's business has grown tenfold in the last three years, to an estimated 120,000 customers. Fateh and his partner, Madjid Emami, are far from the only Iranian entrepreneurs who have found a sweet spot at home. The Tehran Stock Exchange rewarded investors with 130% gains for the year ended in March and continues to climb, while businesses ranging from autos to information technology are booming. "You can double [your business] here every year," says Mojdeh Abedi, a 32-year-old Iranian woman who five years ago abandoned a legal career in Paris to manage a budding food additives business in Tehran.

It's one of the strangest paradoxes in the Mideast. One goal of the U.S. invasion of Iraq was to turn Baghdad into a model regional economy. But could it be that Iran, a charter member of George W. Bush's axis of evil, will wind up filling that role?

It's a distinct possibility. Siamak Namazi, managing director of Tehran-based business consultants Atieh Bahar, ticks off several factors that could lead to a sustained growth spurt in Iran if the country's leaders play their cards right. To start with, Iran has the region's largest market, with a population of 69 million. High oil prices are providing Iran with substantial revenues (chart), and the country has massive gas reserves to tap for industrial projects.

PRAGMATIC CONSERVATIVES. Until now, Iran has been starved for goods, outside capital, and technology, thanks in part to U.S. sanctions. To date, foreign investment has been minimal -- only about $2 billion per year recently. But local entrepreneurs say that big regional groups, which have grown wary of putting money into the U.S., are starting to check out Iran. "We are in the best position in 40 years; the only comparable economy is China. If we could solve our political and social problems we could have double-digit growth," says Saeed Laylaz, an economist and vice-president for marketing at Iran Khodro Diesel, the truck arm of Iran's largest vehicle maker.

The country has racked up growth in the 5% range for four years running, thanks to high oil revenues, abundant rainfall, and a gradual easing of the choking economic restrictions ushered in by the 1979 revolution. Not long ago, Iran was a bona fide basket case struggling to pay its debts. Now its external accounts are under control, with the trade balance in surplus and substantial hard currency reserves of $35 billion. The government is also raising money internally by privatizing shipping, auto, and other assets.

It's true that democracy took a beating in the February Parliamentary elections, thanks to the disqualification of reformist candidates and other strong-arm tactics. But the business community is pleased that a new group of pragmatic conservatives took power in the Majlis. These conservatives include a number of business types and entrepreneurs who are far more focused on economic issues than the curmudgeonly clerics, and they want to hold on to power by delivering on the economy. "The right wing wants to repair its image by producing visible, tangible changes," says Namazi.

The focus on economics by these politicians comes as a surprise and relief to many Iranians, who feared a curtailment of social liberties. Women in North Tehran, where the elite live and work, are still walking around with their hair poking out from under scarves, and single men say they can take their girlfriends out riding in the moonlight without fear of being pulled over for a grilling by the police. "Unlike what most people expected, there have been no major changes on social issues," says Amir Mohebian, a member of the board of editors of Resalat, the leading conservative newspaper. "Those who won a majority in Parliament are moderate conservatives."

Just look at the platform of the group that did best in the election, known as Abadgaran, or The Coalition for the Development of Islamic Iran. The group's document calls for "respect for privacy" and "empowerment of women," and pledges to reduce "government intervention in the economy." The only firm requirement seems to be that the religious leader, Ayatollah Ali Khamenei, remain the top authority.

Business leaders think that a conservative majority in Parliament and the likely election of a conservative President next year could end the gridlock between the Majlis and the conservative-dominated Guardian Council, which has blocked so much reformist legislation. The business community also figures that the conservatives will be under pressure to improve standards of living. The government will want to deliver such goodies as more mobile-phone capacity to slash the exorbitant $1,000 per subscription price for service charged on the black market. A mobile deal was recently signed with a group led by Turkcell (TKC ).

Business circles in Tehran are even buzzing with hopes that the victorious conservatives will try to shore up their position by ending the nation's seemingly endless standoff with the U.S. Such a move would be popular, and there is a certain logic to the notion that just as the tough-talking President Richard M. Nixon was able to break the American logjam with China, only Iran's conservatives can safely cut a deal with the Great Satan. But it's hard to say if the two sides can figure out a way to overcome a quarter-century of ill will. The most recent point of contention: Iran's tussle with the U.S. and the international community over its nuclear program. While the deal brokered by Britain, France, and Germany last fall between Iran and the International Atomic Energy Agency to allow enhanced inspections of Iran's nuclear assets has eased tensions, it hasn't ended the imbroglio.

SHARING U.S. INTERESTS. Despite the nuclear tensions, the optimists point out that the U.S. and Iran share plenty of regional interests. Iran despised both the Taliban in Afghanistan and Iraq's strongman, Saddam Hussein, and applauded the toppling of both. Since then, the Iranian government has encouraged local businesses to supply both countries with goods that range from fuel to cement. While some Iranian factions may be contributing to the turmoil in Iraq, the mainstream wants calm to return to its neighbor in order to hasten the departure of U.S. troops. The Iranians reckon that once the Americans go, a Shiite-led government friendly to the Islamic Republic will come to power. In an interview with BusinessWeek, Iranian Vice-President Mohamed Ali Abtahi poured scorn on the rebel Iraqi cleric Moqtada al-Sadr. Sadr's troublemaking "is providing the Americans with a reason to stay" in Iraq, the vice-president said.

`THE INK NEVER DRIES'. Tehran also has plenty to work on at home. The economy needs more reform. Billions go each year to subsidies on everything from wheat to imported gasoline. Exports of non-oil products are anemic, and trade barriers allow money-losing plants to remain in operation. Government ministries and religious charities called bonyads control an estimated 50% or more of economic activity. Economic policy is still laid down in laboriously negotiated five-year plans. Even when the government turns business units over to private hands -- as in last year's sale of $1.3 billion in state assets -- it often retains big stakes through pension funds or other public arms.

Private investors, while officially welcome, face a daunting series of hurdles. The foreign business community in Tehran is fond of saying that "the ink on the contract never dries." Nowhere is that expression more true than in the crucial oil industry, where Iran has been driving such tough bargains that few international companies want to sign up. Haunted by its colonial experience with the British, Iran bars deals that give foreign companies rights to oil. Oil companies can participate in Iran only under turnkey, fixed-return arrangements called buybacks.

Iran is paying a price for these policies. It has barely found enough investment for the oil industry to stem the long decline in output that began after the 1979 revolution. There have been no major discoveries since the late 1970s, industry sources say. Iran is also losing out to Qatar, which is working the giant natural gas field that the two countries share at a far greater pace than the Iranians. Still, the lure of Iran's fields, which produce close to 4 million barrels a day and have the world's second-largest natural gas reserves, remains. Both Royal Dutch/Shell Group (RD ) and Total (TOT ) are negotiating for massive liquefied-natural gas projects, and Total and BP PLC (BP ) remain interested in an oil field called Bangestan.

The government's pervasive role in the economy also provides numerous opportunities for corruption -- from tax assessors accepting the common gift of gold coins to insiders taking payoffs on big contracts. Entrepreneurs say that, if anything, the demands for baksheesh are becoming more endemic. "There is no way we could smoothly run our business without paying bribes," says Nazila Noebashari, chief executive of Traf Co., a freight-forwarding firm.

The obstacles are enormous -- which makes it all the more remarkable that the private sector is gradually gaining traction. Banking licenses have been issued to private firms, corporate taxes have been cut to 25%, and trade has been liberalized. "They are reforming slowly, on a microlevel," says Fareed Mohamedi, chief economist of Washington-based consultants PFC Energy and a longtime student of the Iranian economy. "What they need now is the dropping of sanctions so that all sorts of investors can move in without feeling a cloud hanging over them."

Among the encouraging tales is the saga of Parviz Aghili, a veteran of the U.S. banking industry who struggled for years to persuade the Iranian authorities to grant him a license for a privately owned bank. Aghili finally got the green light in late 2001, and now he seems almost overwhelmed by the demand for his Karafarin Bank's services. The bank's assets have soared to $400 million, and it has received the imprimatur of a $10 million World Bank loan. Following an initial public offering last year, the company's share price has more than tripled. You would think that Aghili would be ecstatic, but instead he's worried that his new investors will eventually be disappointed. "These people expect high returns," he explains.

Aghili wants the government to lock in reforms before oil prices drop, depriving the government of the cash flow that subsidizes the economy. One primary reform would be to dismantle the trade barriers that largely block out foreign competition. Restrictions on auto imports, for instance, has led to tremendous growth in the Iranian auto industry, which this year will produce about one million passenger cars, compared with 12,000 in 1989. "There is no doubt about it; we have been working in a closed market for years," says Ahmad Ghalehbani, president of Saipa Corp., Iran's second-largest vehicle producer, whose plants outside Tehran will churn out 265,000 Kia, Citroën (PEUGY ), and Nissan (NSANY ) vehicles this year.

Companies like Saipa are making a game effort at improving productivity, as its workers will tell you. "Not long ago, 37 people produced 10 cars a day. Now we do it with 16 people," complains Mehdi Kushesh Safa, a 26-year-old assembly line employee. Yet business leaders worry that they won't be able to stay in operation as pressures from the global economy grow.

The government's strategy appears to rely on an ever-so-gradual opening to the outside world. According to Ghalehbani, tariffs on autos will ease from 220% last year to 140% this year to 100% next. In the same vein, it now looks like foreign banks may be able to open branches in Iran, perhaps in 2006. But the Tehran regime is unlikely to risk increasing unemployment, which is officially 15% and probably higher.

BUDDING CAPITALISTS. The pace may be slow, but the ship appears headed in the right direction. Policymakers keep pushing the privatization of state companies to improve efficiency and limit the scope of baksheesh. "Our studies show that economic corruption has had a [negative] impact on investment in Iran," says Davood Danesh-Jafari, an economics professor and recently elected parliamentarian. "By reducing the government's role in the economy, there will be less opportunity for corruption."

The drive to privatize provides ample fodder for the stock exchange, as IPOs like auto maker Saipa come to market. The galleries of the Tehran Stock Exchange are packed with investors every day. Some, like 42-year-old Shahab Mousavi, an engineer, have quit their jobs to trade full-time. "I am very satisfied," he says. "Sometimes I make 100%, sometimes 200%. What I like is that I can cash in anytime I want."

Hussein Abdoh Tabrizi, Secretary General of the exchange, thinks it's important to encourage these budding capitalists by providing trading floors in other cities so that the public can get a feel for investing. He is trying to find a way to allow foreign investors to participate -- perhaps through separate share classes.

And Tabrizi is working to stamp out insider trading and other imperfections. He concedes that the privatizations are incomplete, since government or religious entities often hang on to stakes. "But as long as we can separate government managers from these assets, it doesn't matter," he says. If you take the long view, he's probably right.

By Stanley Reed, with Babak Pirouz, in Tehran

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