Queen s Global Markets A PREMIER UNDERGRADUATE THINK-TANK

Queen s Global Markets A PREMIER UNDERGRADUATE THINK-TANK Post Nuclear Sanction Iran Outlook for growth in one of the region s largest economies Jeremy Brock Alex Aleksic Conner Rakhit Katie Russell Linna Li October 4, 2016

Queen s Global Markets A PREMIER UNDERGRADUATE THINK-TANK 1 Background of Iran s Economy & Sanctions 2 Military & Political Ambitions 3 Human Rights and Standard of Living 4 Future Economic Drivers & Outlook

% Growth A Brief History: 1960-2016 Iran Before and After Sanctions 30 20 1990: The agriculture sector continues to decline and economic hardship in the countryside forces many to move to different cities/countries. 2016: Oil & Gas sanctions are lifted and Iran can once again deal in international markets adding to the downward pressure on oil prices. 10 0-10 -20 1960/61: Iranian Central Bank was established and an Economic Stabilization Program was implemented and backed by the IMF. 1979: Iranian Revolution happens and the US imposes economic sanctions on the nation. 1980: The Iran-Iraq War commenced; leading to decimation of the country s economic and social conditions. 2008: Oil & Gas became the largest industry in Iran and amounted to 55% of Government revenue in 08; which was greater than tax revenue. -30 Sources: Iran News Real GDP Growth QGM 3

Sanctions Global Isolation of a Nation Reasons for Sanctions The reasons for the sanctions are rooted from the illicit activities regarding the Iranian Revolution, nuclear program and terrorist financing. The Iranian Revolutionary Guards Corps established by the Islamic Republic of Iran was accused of training and funding terrorist organizations in surrounding regions. There were allegations that Iran was not declaring all its nuclear activities to the International Atomic Energy Board of Governors and was not complying to the UN Security Council s safeguard agreement. Economic Sanctions United States of America: Imposed a total economic embargo on Iran that suspended Iranian imports, dealing with Iranian financial institutions and largely targeted the Iranian Oil & Gas industry. Japan: Banned investment in Iran s Oil & Gas industry and reduced its 10% oil dependency on Iran (Japan was the second largest customer of Iranian oil) India: Enacted a ban on the export of any item that could be used in Iran s nuclear program. Military Sanctions UN Resolution 1737: Suspended the supply of nuclear materials and technologies. Also froze nuclear assets related to Iran s Nuclear program. Iran failed to meet the requirements of the International Atomic Energy Agency Board of Governors. UN Resolution 1747: Imposed an arms embargo and expanded the freeze on Iranian assets. UN Resolution 1929: Banned Iran from dealing ballistic missiles and tightened the arms embargo. Sources: Source: UN QGM 4

Implications of The 1979 Revolution Sanctions, War and Hardship Prior to Sanctions During Sanctions After Sanctions Before 1979 1979 2016 After 2016 Iran s economy was traditionally focused on Agriculture and Manufacturing. Industrialization of the nation in the 1960s led to opportunities for growth in the private sector and foreign investment. In the 1970s the Oil & Gas industry was rapidly expanding with the rally of global oil prices. Immediately after the Iranian Revolution, Iraqi forces informally invade Iran commencing the Iran-Iraq War. The Economic Cooperation Organization was founded in Tehran in 1985 with the objective of promoting trade and investment opportunities amongst developing countries in Eurasia. During the sanction period, Iran was importing majority of its food; causing economic hardship in rural areas and diminishing the Agriculture industry. Oil sanctions were lifted meaning Iran, a founding OPEC member, can once again deal in international markets. Two of Iran s largest banks that were blacklisted for financing a ballistic-missile program are no longer under sanction and will play a critical role in funding the country s international trade. The lift of crippling sanctions on Iran has opened the gates to one of the world s last great emerging markets for international trade and investment. Sources: Source: BBC, World World Bank; Bank, Reuters Reuters QGM 5

Iran s Military Affiliations Compelled by Rivalry A Force for Shia Islam Iran is the major political and militant force in the Middle East that represents Shia Islam Resulted in military alliances with Syria, Lebanon, Iraq and Yemen, where Iran s military force is used to protect and represent Shia communities Fierce rivalry with Saudi Arabia, a Sunni state Russia the Ally Iran and Russia are allies in the Syrian war, supporting the current dictator, Bashar Al-Assad Share military intelligence and co-develop military planning Iran uses alliance to challenge the West and regional powers World Shia Population by Country Iran Pakistan India Iraq Rivalry with Saudi Arabia Iran constantly seeks military dominance to challenge Saudi Arabia s militant power As a result of the nuclear deal, Iran continues to seek new military advancements that demonstrate its power in the region Sources: Business Insider, Insider; New York Times, Times; Pew Research Center

Regional Military Ambitions A Desire for Dominance Percent of GDP Exporting the Revolution Iran currently engages in regional conflicts to support the Shia communities and remove or destabilize Sunni-led governments Connections to Terrorism Military supports Shia terrorist groups as part of exporting their revolution to the rest of the Middle East Terrorist groups that Iran supports include: Hezbollah, Hamas, and the Taliban The US State Department annual survey of global terrorism concluded that Iran is the greatest supporter of terrorism o The report stated Iran provided: financial support, training and equipment to terrorist groups around the world Military Spending Despite nuclear deal, Iran continues to invest heavily in its Subtopic military budget 2016/17 Military Budget includes at 90% increase in military spending compared to next year o o 7 6 5 4 3 2 1 $11.3 billion USD for armed forces $5 billion USD for military projects at the discretion of armed forces Iranian Military Expenditure (% of GDP) 0 1988 1993 1998 2003 2008 2013 Year Sources: New York Times, Times; The World Bank, Bank; US State Department, Department; The Independent

Basel AMX Index Score Corruption Ingrained in Iranian Institutions Financial Institutions and the Military Basel AMX Index ranks Iran first for the risk of money laundering and financing of terrorist organizations Financial institutions are controlled by Iran s Revolutionary Guard Corps (IRGC) IMF warns that Iran s use of embezzlement and moneylaundering significantly impedes its economic growth Political and Economic Corruption Lack transparent government Judicial and political system are controlled by the office of the Supreme Leader, Ali Khamenei Transparency International ranks Iran 136 out of 175 countries for level of corruption Index for High Risk of Corruption Transparency International Percentile Rankings 10 9 8 7 6 5 4 3 2 1 0 Iran Lebanon Yemen Algeria United Arab Emirates Country 25% 20% 15% 10% 5% 0% Control of Corruption Rule of Law Voice and Accountability Sources: Basel AMX, AMX; Transparency International, International; IMF

Standard of Living in Iran How were Iranians impacted by the sanctions? Key Statistics High Consumer Price Index (CPI) inflation seen, with a peak in 2012 of 45.1% falling to 12.6% in January 2016 Poverty fallen to 9% in 2013 compared to 15% in 2009, in part because of subsidies changed to direct cash transfers Education is fairly universal with 87% of the population being literate and the school life expectancy being 15 years for males and females - 48.2% of undergraduates are females, almost 15% lower than in 2007 Unemployment at 11.7% with youth unemployment closer to 30% 60.0% GDP Growth and CPI 45.0% 30.0% 15.0% CPI Inflation GDP Growth 0.0% -15.0% Source: World Bank; CIA World Factbook

Rising Unemployment Can Iran stem the tide? Youth Unemployment Young Dependency Ratio The labour market is small at 37% of people actively engaged This is much smaller for women, at only 18% of women engaged in the labour market Youth unemployment is becoming serious issue with major social impacts, at 26.1% 60% of the population is below 30yrs old and the youth dependency ratio is 33.1% in 2015 100% 80% 60% 40% 20% Youth Unemployment Rate A Demographic Dividend 32% 29% 26% 23% 20% Females have especially difficult time entering the workforce because of social stigma To take advantage of Iran s demographic dividend, structural and cultural changes are needed Increased privatization could increased FDI because of transparent partners, and have positive effects on employment Investing in programs to ensure proper skills can be acquired by youth can help integrate them into the market Cultural barriers need to be broken down to allow women fair access to the job market Source: Source(s): World <Insert Bank; Here> Trading Economics; United Nations; Nasseri

Gender Inequality Progress made on gender equality since 1979 Timeline 1979 Iran Revolution Focus on consolidation of Islamic Republic Period of domestic turmoil, political violence, economic austerity, and international isolation Role of women was based in religion 1988 General Plan of the System of Education in the Islamic Republic of Iran Eliminating discrimination Women participating in education as policy makers Strengthening political and social insight of girls through education 1993 First Economic, Social, Cultural Development Plan of the Islamic Republic Improving education for women Increasing participation in cultural, social, economic, educational affairs 2003 Third Development Plan Reduce gender gaps in STEM fields Teach management skills to increase women in decision making roles Creating employment opportunities Source: UNESCO

Gender Inequality Current Situations Gender Gap Index 2015 Attention Being Drawn to Gender Inequality Rank 141 (out of 145 countries) Score 0.580 (0.00 = inequality 1.00 = equality) We have no patriarchy nor matriarchy in Islam, what we have is a meritocracy. Rouhani - President Hassan Educational Attainment 2015 Economic and Political Participation 2015 Tertiary Education (%) Ministerial Positions Secondary Education (%) Primary Education (%) Literacy Rate (%) 0 20 40 60 80 100 Parliamentary Positions Professional and Technical Workers Legislators, Senior Officials, Managers 0% 20% 40% 60% 80% 100% Male Female Female Male Source: World Economic Forum

Human Rights Issues Still a ways to go Freedom of Expression and Crime Almost 50 journalists and social media activists are behind bars - Extreme case of a poet who was punished with 99 lashes and 11 years imprisonment for insulting the sacred Over 270 internet cafés were closed in 2015 for fear that they would threaten social norms and values Bahai Community is particularly subjugated based solely on religion with 80 practitioners imprisoned just for practicing their beliefs Still impose death penalty and amputations Law of Qisas can not be overruled by the judiciary Population as of 2013 Adjusted Executions per Year Women s Rights Women s rights still lag behind first world states Parliament is 96.9% male In 8 months of 2015 there were 40,000 cases of women being pulled over for not having proper head covering while driving Legal marriage age is 13, or younger if the father consents Divorce has very strict rules to be granted, and domestic violence is not specifically criminalized Seat of Parliament Held by Women 450 400 350 300 250 200 150 100 50 0 2007 2008 2009 2010 2011 2012 2013 2014 Iran Saudi Arabia Iraq 30% 25% 20% 15% 10% 5% 0% Afghanistan Iran, Islamic Rep. Libya MENA Pakistan Source: Ssourcr: Economist, World Bank, 2016; United 2016, OPEC, Nations, 2016ource(s): <Insert Here>

Major Economic Drivers Where do Iran s Competitive Advantages Lie? % of GDP What Drives Iran s Economy About a third of Iran s economy is driven by oil and gas, small scale agriculture and a service sector. There is also a considerable government presence in the manufacturing and financial services sector 300.00 250.00 Major Contributors to GDP Achieving Economic Diversity Iran is still quite oil dependent; oil makes up a considerable amount of GDP but is not the only force driving economic growth. However, as Iran gains greater access to export markets there will be more incentive to increase oil production. Iran s relative efficiency and cheap production should force oil rents/gdp to rise 2015 Oil Rents as a % of GDP 200.00 150.00 100.00 50.00 0.00 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Oil Agriculture Construction Mining Manufacturing Services 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 25.6 Arab World (Average) 23.6 Iran, Islamic Rep. 38.7 33.3 10.8 Libya Nigeria Saudi Arabia Sources: IMF; The World Bank; Wall Street Journal Sources: The World Bank; Bloomberg

Global Producers Oil Cost per Barrel Sources: EIA; CIA; World Factbook QGM 18

Rising Oil Production Sanctions have allowed Iran to gain ground as dominant player in global oil markets Limited Production as a result of Sanctions Nuclear sanctions depressed Iran s access to International oil markets and forced Iran to cut production by over 25% High prices from 2012 2015 was a major benefit for other low cost producers in the region who experienced tremendous economic growth as a result of high prices Sources: IMF; The World Bank; Wall Street Journal Sources: Bloomberg; EIA; CIA; World Factbook

Foreign Direct Investment Removal of nuclear sanctions has increased flow of investments Record level Investment Foreign CAPEX The Q1 of 2016 Iran experienced record foreign direct investment growth The financial services sector has benefited the most from the lifting of sanctions There are still political and financial risks associated with investing in Iran The U.S. state department does still not allow American companies to invest in Iran Foreign Investment Projects 2016 E 2015 2014 2013 0 1000 2000 3000 4000 5000 Million of USD Jobs created by FDI 2016 E Q1 2016 2015 2015 2014 2014 2013 2013 0 5 10 15 20 25 30 35 40 45 0 1000 2000 3000 4000 5000 6000 Sources: IMF; The World Bank; Wall Street Journal Sources: Bloomberg; Financial Times; US Treasury Department

Percentage Risk What do the Next 5 Year have in Store? Economic growth will spike but will flatten off and become more moderate Immediate Growth Mitigating Risk and limited Future Growth Iran will see immediate spikes in GDP due to limited access to oil markets for the past 3 years Iranian energy minister, Bijan Namdar, has indicated Iran is planning to increase production above pre sanction levels to over 4 million barrels per day. This has shown a formal rejection of Iran s willingness to cooperate with a Saudi-led effort to curb oil production It is likely that Iran will see a spike in growth over the next 1-2 years from broader access to oil markets and eager investors who have been unable to enter the Iranian market until now We believe few investors will be willing to assume the additional risk Iranian investment brings 5 Year Projected GDP Estimated Hurdle Rates 500.00 400.00 300.00 200.00 100.00-2014 2015 2016E 2017E 2018E 2019E 2020E 45 40 35 30 25 20 15 10 5 0 Iran South Africa Lebanon Nigeria Sources: IMF; The World Bank; Wall Street Journal Sources: World Bank; ishares

Appendix 1: GDP and Oil Markets A $7 difference in the price of oil has a 3.5 billion USD affect on Iran s GDP Average Barrels/Day Iranian Oil Production Iran s Exports Sensitivity to Oil Prices 4500 4000 3500 3000 2500 2000 1500 1000 500 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 E Price/Barrel (USD) 2015 2016 2017E Addition to GDP 46.00 47.0120 60.7798 70.0748 23.0628 46.50 47.5230 61.4405 70.8365 23.3135 47.00 48.0340 62.1011 71.5981 23.5641 47.50 48.5450 62.7618 72.3598 23.8148 48.00 49.0560 63.4224 73.1215 24.0655 48.50 49.5670 64.0831 73.8832 24.3162 49.00 50.0780 64.7437 74.6449 24.5669 49.50 50.5890 65.4044 75.4065 24.8175 50.00 51.1000 66.0650 76.1682 25.0682 50.50 51.6110 66.7257 76.9299 25.3189 51.00 52.1220 67.3863 77.6916 25.5696 51.50 52.6330 68.0470 78.4533 25.8203 52.00 53.1440 68.7076 79.2150 26.0710 52.50 53.6550 69.3683 79.9766 26.3216 53.00 54.1660 70.0289 80.7383 26.5723 Sources: IMF; The World Bank; Wall Street Journal Sources: Bloomberg

Appendix 2: Determining Country Hurdle Rates Hurdle rates are an analysis used to assess the additional risk of international investment Iran s Exports Country hurdle rates measure the relative risk of a country the associated risk of investing in a country. An investor that is looking at making an international investment can add the country hurdle rate to their domestic weighted average cost of capital (the required return on investment projects) to determine what the required return would be on an international investment. Because Iran is has not been given a credit rating it is impossible to determine an exact hurdle rate. Comparable were found using their last credit rating (B- or Caa3). The average of three comparable countries was taken to arrive at a proxy hurdle rate of Iran Hurdle Rates = Credit Defualt Swap Volatility of Local Equity Markets Volatility of Local Bonds Markets Inputs Greece Ukraine Venezuela Iranian Proxy South Africa Lebanon Nigeria Bond Default Spread (CDS) 11.18% 6.00% 35.88% 17.69% 1.11% 3.42% 3.29% SD (Equity)/SD (Debt)* 2.30 2.30 2.30 2.30 2.30 2.30 2.30 Hurdle Rate 25.67% 13.77% 82.36% 40.60% 2.54% 7.84% 7.55% *Emerging market ETF's used as approximate Sources: IMF; The World Bank; Wall Street Journal Sources: ishares