Seb Country Analysis 2007 Iran

Islamic Republic of Iran SEB MERCHANT BANKING – COUNTRY RISK ANALYSIS

October 18, 2007

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Country Risk Analysis Excessive use of oil revenues threatens financial stability should the oil price fall.   Growth accelerated only slightly to 4,9% in the first nine months of 2006/07 (Iranian  year ending March 2007) despite persistent weakness in the oil sector where the  main operator, state‐owned oil company, INOC, struggled to meet production  targets.  However, unexpected high oil revenues as a result of hard international oil  prices allowed the government to boost domestic demand through considerable  budgetary overspending.  That helped compensate flagging private sector  investment demand hit by mounting uncertainty from the government’s hard‐line  foreign policy adventures.  But the inevitable result of expansive fiscal policies with  a non‐oil deficit exceeding 20% of GDP combined with looser monetary policies as  the government forced the central bank to cut  interest rates by 2 percentage points, was the  Inflation rem ains rise of inflation to the 15‐20% range, a situation  endem ic that soon could destabilize Iran’s finances and  20% complicate economic management.   15%   10% Unemployment could rise sharply.  5% Unemployment eased slightly in 2006 to 11%  but the government continues to face the  0% 2002 2004 2006 challenge of creating jobs for 750,000 new  labour market entrants every year to prevent  growing social discontent to get out of control.  Reflecting the long war with Iraq in  the 1980s, Iran’s demographics are such that the employment situation will cause the  government increased headache over the next decade.  The global oil price has so far  come to its rescue.  As oil still represents some 80% of exports, despite declining  export volumes, high prices have kept Iran’s external current account in a healthy  surplus around $15 bill. a year.  That will help the central bank build reserves to an  estimated $41 bill by the end of 2007 ‐‐ including the government’s Oil Stabilisation  Fund, equivalent to nine months of merchandise imports.   But high oil prices could become a two‐edged sword.  The economy benefits from  high oil prices which keep rising in part thanks to the risk premium created by Iran’s  standoff with the outside world over the country’s uranium enrichment program ‐‐ a  smokescreen for clandestine nuclear weapons research according to claims of the US  and other western nations. That standoff, however, is now causing growing  problems for the non‐oil economy, which has begun to feel the sting of the UN 

SEB Merchant Banking Country Risk Analysis October 18, 2007

sanctions regime since first introduced in late 2006 and subsequently tightened twice  including the freezing of foreign assets of Sepah, one of the five Iranian state owned  banks.      Even tighter UN‐sanctions could follow in November.  During last summer,  Iran  reached an agreement with the International Atomic Energy Agency (IAEA) on a  new inspection program.  That gave the “soft” members of the UN Security Council  (UNSC), mainly China and Russia, an excuse to postpone the next sanctions  discussion scheduled for September.  The likelihood is now for the UNSC not to  meet on this matter before end November pending the inspection report from IAEA  and also possible results of renewed EU‐Iran negotiations.  Further sanctions will  then depend on all UNSC members regarding the progress under these two  initiatives insufficient. At the moment that may seem unlikely.      Alternatively, EU could join the unilateral US sanction effort. Should the UNSC in  November once again defer the sanction discussion, the likelihood is growing for EU  to join the US in a tighter unilateral sanctions regime against Iran outside the UN.  A  number of new names of companies, banks and individuals could then be added to  the existing UN‐blacklist.  The US could also revive earlier plans to retaliate against  non‐US companies that engage in transactions with Iran.  The mere threat of such  actions are said to make many western companies now think twice before entering  into deals with Iran.  All this, however, could be pre‐empted by a military action,  most likely led by US forces. The US has recently increased its military presence in  the Gulf with a third aircraft carrier and some analysts see a last window of  opportunity for Mr. Bush, the US President, to make good his promise to “solve” the  Iran problem before the end of his term.   JJGJJ= ^ë=äçåÖ=~ë=éêÉëÉåí=éçéìäáëí=éçäáÅáÉë=ÅçåíáåìÉI=fê~å=ëÉÉãë=éçáëÉÇ=Ñçê=ÉîÉê=ÇÉÉéÉê= ÉÅçåçãáÅ=éêçÄäÉãë=ïÜáÅÜ=ã~ó=êÉîÉ~ä=íÜÉãëÉäîÉë=~ë=ëççå=~ë=éêÉëÉåí=ëìéÉê=ÜáÖÜ=çáä= éêáÅÉë=êÉíêÉ~íK===få=íÜÉ=ãÉ~åíáãÉ=íÜÉ=äáâÉäáÜççÇ=áë=ÖêçïáåÖ=Ñçê=~å=ÉåÜ~åÅÉÇ=ë~åÅíáçåë= êÉÖáãÉ=áå=íÜÉ=åÉ~ê=ÑìíìêÉ=íÜ~í=äáâÉäó=ïçìäÇ=ÄÉ=ÄáåÇáåÖ=~í=äÉ~ëí=Ñçê=br=Åçãé~åáÉëK==få= ~=ïçêëí=Å~ëÉ=ëÅÉå~êáç=fê~å=ÅçìäÇ=ëíáää=Ñ~ÅÉ=ï~ê=ÄÉÑçêÉ=íçç=äçåÖK=qÜÉ=áåÉîáí~ÄäÉ= ÅçåÅäìëáçå=áë=íÜÉêÉÑçêÉ=íÜ~í=fê~åÛë=ÅêÉÇáíïçêíÜáåÉëë=ÅçåíáåìÉë=íç=ÇÉíÉêáçê~íÉ= Öê~Çì~ääó=Ñêçã=~å=~äêÉ~Çó=äçï=äÉîÉäK== =

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How to read the chart? Moving out from the center reduces risk.

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Absence of event risk

Iran

Information

Average EM

Graph: The pentagon shows Iran's risk profile Graph: The pentagon shows Turkey's risk worse heavily skewed toward liquidity and (to a lesser) than average in all respects including to its extent macro balance, while it scores weakly on traditional competitor, Brazil, reflecting weaker resilience and very low on information and event risk liquidity, macro balance and absence of event risk. (absence of). =

important your attention is drawn to the statement on the back cover of this report which affects your rights.

SEB Merchant Banking Country Risk Analysis October 18, 2007

= = = = mêçÄ~Äáäáíó=çÑ=ÇÉÑ~ìäí=E~ååì~äáòÉÇF= X=Scenario

Iran complies with UN

Enhanced sanctions

War

Probability of X

0,2

X

Default probability given X

0,1

=

Total default probability of X

Default probability not knowing the state of X

0,02

0,60

0,25

0,15

0,2

0,9

0,18

0,02+ 0,15+ 0,18 =0,35

= = = = = In view of recent events we have trimmed our scenario probabilities slightly, and also raised the default = probability in case “Iran complies” to 10%, reflecting the risk that continued populist policies and = social/political discontent in the population could cause economic/political collapse. That raises total = default probability to 35%. We emphasize that these probabilities are “guestimates”, provided here for illustrative =purposes. = = =

important your attention is drawn to the statement on the back cover of this report which affects your rights.

SEB Merchant Banking Country Risk Analysis October 18, 2007

Key data: 2002 2003 2004 2005 GDP (bill.US$) 116 135 163 190 GDP/capita (US$) 1728 1991 2377 2734 GDP (real change) 7,5% 7,1% 5,1% 4,4% Investments/GDP 33,9% 35,1% 35,7% 36,2% Budget balance/GDP -4,0% -4,0% -3,5% -3,6% Govt net debt/GDP 21,4% 20,5% 26,3% 22,4% CPI inflation (%) 14,3% 16,5% 14,8% 13,4% Money demand (%) 24,9% 24,5% 23,0% 22,8% Stock prices (%change) 33,8% 33,6% 72,0% 66,0% Interest rates 7,0% 11,7% 11,7% 11,8% Exch. Rate ($) 6907 8194 8614 8964 Trade/GDP (%) 43% 47% 50% 53% Oil price (Brent) $25 $29 $38 $54 Billions US $ Export of goods 28,2 34,0 43,9 60,0 Imports of goods 22,0 29,6 38,2 41,0 Other: -2,6 -3,6 -4,2 -5,0 3,6 0,8 1,4 14,0 Current account Curr.Acc. Bal/GDP 3,1% 0,6% 0,9% 7,4% FDI (net) 0,0 0,0 0,4 0,3 Loan repayments -0,1 -0,1 -0,2 -0,2 Net other capital flows -3,0 3,1 5,3 -8,2 0,5 3,8 7,0 5,9 Balance of payments Reserves (bill $) 9,2 13,0 20,0 25,9 Total debt 10,3 14,3 21,2 27,1 o/w short term debt 2,1 4,8 10,3 10,7 Source: OEF (Oxford Economic Forecasting) and SEB estimates. Rating history Fitch (eoy) Moody's (eoy) S&P (eoy) Type of government: Next elections Other: Latest PC deal Latest IMF arrangements

Not rated

B+ B+ Rating withdrawn

2006 218 3099 4,9% 37,4% -4,5% 19,1% 11,9% 28,5% -6,8% 11,8% 9171 56% $65

2007 261 3661 4,6% 37,9% -5,0% 16,6% 16,0% 25,1%

2008 290 4016 4,5% 38,1% -4,9% 19,1% 14,5% 17,2%

2009 313 4277 4,8% 38,1% -4,6% 21,0% 12,8% 15,8%

11,8% 9300 49% $67

11,8% 9800 46% $68

11,8% 10500 44% $61

73,1 49,2 -5,4 18,4 8,5% 0,1 -0,2 -8,2 10,1 36,0 24,7 9,0

72,6 53,9 -5,6 13,1 5,0% 0,1 -0,2 -7,9 5,1 41,1 27,1 9,9

77,0 56,4 -5,7 14,9 5,1% 0,1 -0,2 -16,9 -2,1 39,0 28,3 10,4

77,6 58,9 -5,8 12,8 4,1% 0,1 -0,2 -12,4 0,3 39,3 29,6 10,8

BB-

B+

Not rated Islamic Republic with partially free elections. 2008 - legislative, 2009 - presidential None None

$ mill.

Iran's loans from and deposits with BIS banks 40000 30000 20000 10000 0

Deposits Loans 1999

2001

2003

2005

2007Q1

Iran's net position with BIS banks was in surplus up to 2004, when it turned negative (loans exceeding deposits). Over the last year, it has once again turned positie as many BIS banks have restricted lending to Iran, while Iran's deposits with BIS banks have continued to rise, reflecting the growth in its foreign reserves. Some observers had predicted that Iran would rather place its foreign reserves with banks outside the BIS area to avoid sanctions and freezing of its assets. That does not seem to have been the case to any major extent, probably reflecting the absence of any viable alternatives for "safely" placing large amounts of money out of reach for the US and EU.

= = important your attention is drawn to the statement on the back cover of this report which affects your rights.

=

SEB Merchant Banking Country Risk Analysis October 18, 2007

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important your attention is drawn to the statement on the back cover of this report which affects your rights.