Iran Commercial Banking Report Q3 2007

Boosted by government spending, real growth should reach 5.3% this year, though will continue to decelerate over the forecast period, as macro mismanagement and political uncertainty take their toll on the economy. According to our calculations, real expansion reached 5.7% in 2006/07 (Iranian year 1385), thanks to robust consumption growth and slowing but still high gross fixed capital formation. The local Iranian Fars news agency reports that the Central Bank of Iran (Bank Markazi) and Economy Ministry have estimated 2006 growth at 5.8%, with the oil sector leading the way with 9%, agricultural sector 7%, services 6.3% and the mines and industries sector with 4.5% growth. We will review our figures once official data has been released. As has been noted in the latest IMF country report, economic priorities have shifted away from structural reforms under President Mahmoud Ahmadinejad's government since his election in 2005, towards addressing social welfare and inequality. The president's promises to share the oil wealth with the masses has meant a widening of the budget deficit, despite rising oil receipts, thanks to high global energy prices. At the same time, investment has continued to dry up, owing to the president's unfriendly stance towards business and the ongoing unilateral financial squeeze imposed by the US. Against this backdrop, we do not see a significant improvement in Iran's economic fortunes under the current administration.

Economic growth in Iran is increasingly being powered by highly expansionary fiscal policy, which has boosted private consumption but at the cost of sustainable job-creating development and double-digit inflation. While the Minister of Labour and Social Affairs has put unemployment in 2006/07 at 11.1%, unofficial estimates place it much higher, particularly amongst the young which make up the vast majority of the population. Nor is a privatisation drive announced by the Ayatollah Ali Khamenei likely to encourage private-sector activity in an environment where the state dominates over 80% of the economy and economic policy remains arbitrary. Even under the former reformist, more business-friendly administration, only 30% of the US$2.5bn worth of state assets offered was sold. Many state-owned companies are inefficient and in debt, and the private sector lacks the capital to invest.

The Commercial Banking Sector Despite erratic political leadership in Iran, the country's commercial banking sector has always met its commitments in a straightforward and reliable manner and has as such maintained a good reputation within the international financial community.

Mounting tensions over the country's nuclear programme are, however, placing pressures on international banks to cease doing business in Iran and with Iran's banks. This is likely to increase the pressure on Iran's domestic banks. According to the latest press reports, over 40 major international banks and financial institutions have either cut off or cut back business with Iran's government and private sector, as a result of a campaign launched by the US Treasury and State departments in September 2006.

Tehran's ability to finance petroleum industry projects and pay for imports has been severely limited by this economic squeeze. According to US officials, the financial institutions cutting back business ties are primarily in Europe and Asia. These institutions include: UBS, London-based HSBC Holdings and Standard Chartered, as well as Commerzbank of Germany.

The press has also reported that the UN sanctioned a resolution, which calls for a freeze on Bank Sepah, Iran's fifth-largest state-owned bank, on March 26 2006. In January this year, Washington barred US banks from doing business with Sepah because of what the Bush administration said was the institution's connections with Iran's missile programme. The decision effectively stopped Sepah from carrying out dollar transactions. However, the latest sanction by the UN will have a more significant impact on Bank Sepah. Bank Sepah's wholly-owned subsidiary Bank Sepah International claims it has 'relationships in over 45 countries worldwide', as well as offices in London, Paris, Frankfurt and Rome. European Union (EU) countries have resisted taking action against Sepah; however, in response to the UN resolution, the Bank of Italy Governor Mario Draghi took over the management of the Rome branch of Bank Sepah in April.

Total assets of US$258.8bn rank the banking sector in Iran as among the largest in the region. On the other hand, deposits are comparatively low at US$117.7bn.

In short, there are at present real risks for the commercial banking sector in Iran. The economy is overly dependent on oil revenues and is very exposed to any fall in prices. The political uncertainty and the economic sanctions being placed on Iran are also likely to increase the risk to the economic environment.