IRAN

It has been said that the relative isolation of Iran's economy from the rest of the world should have protected the country from the negative impact of the global financial crisis. But as the crisis has pushed down oil prices, due to the diminishing demand caused by the financial meltdown, the crisis does effect Iran's position. Iran is just too depended from its oil revenues to keep the country running.

Since World War II oil revenues have started flowing in and it became Iran's main source of foreign exchange and government revenues. At that time, the economy was still primarily backward, agrarian, feudalistic, and rural. By the time of the revolution, there had been enough interaction between the Iranian economy and the rest of the world to create a ratchet effect.

Iran's government has been criticized and held responsible for its credit deterioration, because of its policies, depriving the country of foreign investments. In addition to this, the UN Security Council imposed sanctions on Iran and it is therefore not regarded as investment friendly. A recent example of this is German's decision to reduce federal export credit guarantees for domestic companies wanting to do business in Iran, following criticism from the US and Israel.

As one of the biggest oil producing countries, Iran has become increasingly dependent on oil earnings since the 2005 election of the president Ahmadi-Nejad. Therefore, if the existing condition persists, it is broadly expected that the government will encounter huge budget deficits in the near future. In order for the government to cope with these budget deficits, there will be no other way but to borrow from the Central Bank, which will result in an increase in the money supply and hence increase inflation even further. The Central Bank of Iran claims there is $25bn in the fund, but analysts are doubting whether this figure is not much lower.

The deputy Central Bank governor for economic affairs Ramin Pashaeifam quoted that Iran needed oil prices to average $60 per barrel till March, the end of the current Iranian year, to avoid big economic problems. Iran's government however, is still insisting on continuing to offer credits and loans to applicants. Iran's economy is already suffering from overspending and exploitation of natural resources.

At this moment Iran does not seem to change its populist policies. Yet again Iran's supreme leader Ayatollah Ali Khamenei has ordered that 20 per cent of oil and gas revenues should in future be set aside for a new investment fund, in order to give the ability to the government to use this income to fund its populist initiatives.

Mr Ahmadi-Nejad's opponents accuse him of ignoring the current development plan which was drawn up under the previous reformist government and increasing the budget dependence on oil to as much as 70 per cent. However, they doubt that any government will be able to dramatically decrease dependence on petrodollars by 2015. Iran has nothing else but oil to sell. Only recently, China National Petroleum Corporation (CNPC), parent of China's largest oil and gas producer Petro China, signed a $1,75 bn agreement with National Iranian Oil Company on the development of Iran's North Azadegan oilfield. Located in Iran's western province of Khuzestan, the North Azadegan oilfield is one of the biggest oilfields in the world. It has an estimated oil reserve of 6 billion barrels and can produce 75,000 barrels per day during the upcoming 25 years.

A continuing base inflation, coupled with additional inflation due to any future budget deficits because of significantly lower oil profits in a recessionary environment, will compel economic stagflation to become practically imminent. Stagflation is an economic situation in which inflation and economic stagnation occur simultaneously. High inflation of around 30 per cent and youth unemployment of around 20 per cent are fuelling public criticism of the government for its inability to tackle people's daily economic problems.

In addition to low oil prices, making any economic recovery difficult for Iran and despite last year's political statements of releasing the US dollar for any of its oil transfers, Iran did the same as Russia and other Arab countries of the Persian Gulf by having its currency pegged to the US dollar. It would have been prudent for Iranian policymakers to either allow the Rial to float freely against other currencies or at least devaluate it against the US dollar, or to accept euros as payment. Iran will have difficulties to reduce inflation by increasing the interest rate, because its Rial is connected to the US dollar. Iran will have to follow the policy of the Federal Reserve Bank of New York to keep the exchange rate within its margins.

With collapsing oil prices, it will threaten the Iranian government's ability to restore the economy and maintain popular support ahead of next June's presidential election, therefore the present government should be worried for the election to come.

The oil minister of Iran claims to stick to the agreed production cuts which should drive up oil prices. He also claims that enough reserves have been saved to make local investments and to meet immediate needs. There is also the deal with China's Sinopec to develop the Yadavaran oil field and other gas agreements, such as with Malasia's SKS. The oil minister of Iran further claims that Iran's barter deals, even for petrol imports, is only a tiny proportion of total trade and that Iran has found many ways to limit the impact of financial sanctions. Iran does not lack the confidence to cope with the financial crises, but Iranian companies, however, are finding it increasingly difficult to secure lines of credit as banking sanctions imposed are taking its toll. Some Iranian officials even admit that sanctions are having an impact. With confidence only, Iran will not stay afloat and it may well be that, instead of becoming a new emerging market, it will be a new defaulting country that will only survive by asking for an international debt-restructuring scheme. Only a change in political attitude from the Iranian government and the international community could avoid Iran from the way to bankruptcy.

As such, creditors holding Iran claims better react now, before everybody does, and can always contact us for further information and a free of charge advice how to collect in the soonest way possible their outstanding dues.

For background Iran Emerging Market see HERE