Trade, Not Investment, is Iran's Sanctions Relief Must-Have

05 Dec 2021

Trade, Not Investment, is Iran's Sanctions Relief Must-Have

By Esfandyar Batmanghelidj

Bourse & Bazaar Foundation

December 5, 2021


Last week, the seventh round of the negotiations over the fate of the JCPOA saw Iran table an initial proposal on sanctions relief. The proposal led to complaints from Western officials that the Iranian negotiators were being unreasonable. Iranian officials responded by insisting their proposals were “pragmatic.” The initial exchange suggested to some that disagreements over sanctions relief issue are going to prove the intractable because what Iran wants—significant investment—is impossible for the P5+1 to guarantee. Gérard Araud, former French ambassador to the United States and an astute observer of the nuclear talks, tweeted that “Even if the JCPOA was restored, no Western company would dare invest a cent in Iran.”

Araud is rightly concerned. Western companies will be reluctant to invest in Iran due to fears that a Republican president could reimpose sanctions in 2025, putting their investments in jeopardy. In the months following the implementation of the JCPOA in January 2016, a flurry of big-ticket investment deals were announced. These deals became the symbols of the economic benefits of sanctions relief and of Iran’s moves towards normalised economic relations, namely with Europe and China. The deals included planned investments in Iran’s oil fields by Total and CNPC, the joint ventures planned by PSA Group and Volkswagen in Iran’s automotive sector, and Novo Nordisk’s decision to build a manufacturing plant in Iran, among others. But following President Trump’s decision to withdraw from the nuclear deal, essentially all European and Chinese efforts to invest in Iran unravelled (the Novo Nordisk project, with its humanitarian dimension, proved a rare exception).

For the P5+1, a significant technical interventions will be necessary to create conditions conducive to foreign direct investment. But, the economic value of the nuclear deal does not actually hinge on increased foreign direct investment, which was primarily sought by Iran as a commitment mechanism for technology transfer.

But for most Iranian manufacturers, the ambition is not to produce high-technology products. Rather, the ambition is to use high-technology equipment to more efficiently produce the wide range of basic goods that can be sold in the domestic and regional markets. Iran will receive most of the benefits on offer from sanctions relief when Iranian manufacturing firms can purchase new equipment from foreign suppliers that can be used to increase the quality and quantity of output. Such purchases represent a critical example of domestic investment deferred due to sanctions related pressures.

The industrial equipment on which Iranian factories depend is overwhelmingly imported from just two sources: the European Union and China. This trade can be tracked by looking at the relevant chapters of the so-called Harmonized System used by customs agencies categorise goods. Chapter 84 covers equipment such as boilers, pumps, turbines, furnaces, freezers, ovens, pulleys, cranes, forklifts, and other machinery that would be seen on a factory floor. Chapter 85 covers electrical equipment such as motors fuses, switches, lasers, heaters, magnets, batteries with various industrial applications. Looking at European and Chinese exports to Iran across these two categories offers a measure of whether Iranian factories are proving able to maintain or upgrade the equipment on their assembly lines. What’s clear is that sanctions significantly reduced European and Chinese exports of these goods to Iran, with significant consequences for Iranian productivity. Between the first quarter of 2018, prior to Trump’s withdrawal from JCPOA, and the last quarter of the year, by which point US secondary sanctions had been reimposed in full, Iran’s industrial output fell by 20 percent.

Part of the drop in production can be attributed to reduced demand. But many manufacturing firms also struggled to maintain output given difficulties not only in importing raw materials and intermediate goods, but also the parts and equipment necessary to keep assembly lines running at high capacity. Moreover, it wasn’t the wind down of foreign investment that was responsible for the drop in production—few investment projects had broken ground. Rather, it was disruption in the availability of European and Chinese industrial goods that saw Iran’s manufacturing sector regress.

In 2016, the first year of sanctions relief, European industrial exports to Iran averaged EUR 250 million per month. Over the first 8 months of 2021, the monthly average has been just EUR 80 million. That means, on an annualised basis, Iran is importing about EUR 2 billion less industrial goods from Europe than prior to the reimposition of US secondary sanctions.

The trends are similar when looking at Chinese exports to Iran. In 2016, average monthly exports to Iran totalled about USD 453 million. Over the first 10 months of 2021, the monthly average has been just USD 241 million. On an annualised basis, that is a difference of about USD 2.5 billion.

Looking at the European and Chinese data together suggests that sanctions relief could be worth around USD 4.8 billion in additional annual industrial exports to Iran from its two largest suppliers, if trade returns to pre-sanctions levels. A significant portion of the goods imported in these two categories are purchased as part of fixed capital investments by Iranian manufacturing companies, meaning that Iranian firms can be expected to invest billions of dollars in their own production capacity if sanctions are lifted and European and Chinese exports rebound.

Such a rebound is probable. For European and Chinese companies, the decision to enter the Iranian market as a supplier is far less risky than the decision to enter as an investor. Even with concerns that JCPOA implementation may falter again in 2025, the data from 2016-2017 makes clear that trade in industrial goods can rebound quickly, even in an environment where banking challenges and legal ambiguities persist. Many European and Chinese companies will be able to make lucrative sales to Iranian customers within the 2-3 year window in which sanctions relief is basically assured, especially those suppliers who are currently selling to Iran while US secondary sanctions remain in place.

Importantly, the fact that trade in industrial goods can rebound in a short period of time does not mean that the benefits will be short-lived. Equipment like pumps and furnaces have lifespans up to 20 years. Many Iranian factories are hampered with old equipment. Sanctions relief would enable these firms to finally upgrade old equipment, much of which was installed in the early 2000s during which Iranian industry underwent a critical development phase characterised by the installation of European manufacturing equipment. Should more Iranian companies be able to avail themselves of the opportunity to invest in new industrial equipment following the restoration of the JCPOA, Iran industrial output would benefit from higher productivity and greater resilience for a decade or longer, a fact that makes sanctions relief, even if cut short by political events, fundamentally attractive.

Economically speaking, trade, not investment, is the key for robust Iranian growth in the years immediately following restoration of the JCPOA. Attracting foreign direct investment would of course maximise Iran’s developmental outcomes, and has a crucial role to pay should Iran aim to return to its pre-sanctions growth trajectory, but such investment is not essential for Iran’s short-term economic recovery. The primary goal for the P5+1 should be to ensure that trade rebounds as quickly and robustly as possible. Here, the provision of trade finance is important and technical work will need to be done to ensure that global export credit agencies can serve companies that wish to sell equipment to Iran. Still, finding solutions to extend billions in trade finance will prove far easier than facilitating billions in foreign direct investment in the short term.

Politically, facilitating foreign direct investment would usefully demonstrate that the P5+1 is making good on economic commitments set forth in the JCPOA. On one hand, the Raisi administration would surely welcome more intensive efforts on the part of Western governments to ensure foreign investments can materialise, particular in sectors where such investment is really necessary like the energy sector. On the other hand, the fact that trade, and not investment, is the real economic must-have will suit the Raisi administration just fine. President Raisi is unlikely to make Western foreign investment a major target of JCPOA implementation given the emphasis on economic self-reliance that colours his administration’s economic planning and the reluctance to undertake deeper structural reforms on which many foreign investors will insist. But by focusing on trade, Raisi will have a compelling story to tell—sanctions relief will enable Iran to buy the industrial goods that will undergird the country’s economic resilience for the next two decades.