Over the weekend, the International Atomic Energy Agency (IAEA) verified that Iran had taken all steps required for the implementation of the Iran Deal. The deal is straightforward: Iran reduces its nuclear activity to an agreed level while the US and allies remove nuclear sanctions. The implementation is estimated to boost Iran's economy, which is the second biggest in the region after Saudi Arabia with gross domestic product (GDP) of US$406.3 billion (S$579.9 billion) in 2014 according to a World Bank estimate.
The world's oil market is estimated to be influenced. The IAEA estimates that Iran could provide an additional daily supply of 300,000 barrels while Iran is confident it could provide 500,000 barrels. Naturally, Iran is among the Organisation of the Petroleum Exporting Countries (OPEC) members opposing oil production cuts despite the all-time low oil price. Holding the fourth largest reserve in the world, Iran in 2015 approved a new contract model for exploration to increase production capacity and attracted US$30 billion in new investment. The contract was presented last November during an energy conference in Teheran attended by industry officials from around the world.As for gas commodities, Iran owns the second biggest natural gas reserve in the world while it supplies only 1 per cent to the market.
Considering the combination of Iran's upper-middle income level - 60 per cent of the 78.5 million-population being below 30 years old in 2014 - and an internet penetration rate of 77 per cent in Teheran and 53 per cent nationwide, Iran is very attractive to tech firms. Netflix is planning to expand its services there. HP and Apple have been reviewing plans to appoint official distributors. At present a lot of Apple products enter Iran as contraband through black markets.
How the sanctions limit Iran's international trade have much to do with cross-border payment systems, which in general involves an intermediary country with a major currency. Without sanctions, a money transfer from Indonesia to Iran would most likely go through the US: The sender's bank in Indonesia would forward the funds to a bank in the US, which would subsequently forward it to a recipient's bank in Iran. This process is done through SWIFT, a network that enables banks worldwide to conduct financial transactions securely. This indirect route is due to most banks (including the sender's bank) not maintaining liquidity for non-major currencies (known as 'exotic currencies' in industry parlance), including Iranian rial (IRR). Consequently the funds must be converted from rupiah to US dollars and then to rial.The US sanctions cut this route by prohibiting banks under US jurisdiction from processing Iran-related US dollar payments, while EU sanctions alienate Iran from the SWIFT network. Some banks have been found illegally processing Iran-related US dollar transactions. The US government imposed penalties on these banks, including HSBC (US$1.9 billion) and BNP Paribas (US$8.9 billion).
Faced with the US dollar channel cut off, Iran turned to another superpower. China, the main consumer of Iran's crude oil, is allowed to pay with renminbi. This is in line with China's efforts to expand renminbi use globally. The China-Iran relationship dates back to the 1980s, when China assisted Iran in uranium exploration and enrichment. In the 1990s China assisted in establishing the Esfahan Nuclear Research Center. Chinese engineers also built various pieces of public infrastructure. More than 20,000 Chinese reside in Iran and many speak Farsi.
The sanctions reduced the number of countries to which Iran could sell oil from 21 down to six: China, India, Japan, South Korea, Taiwan and Turkey, all paying with non-US dollar currency. Although interested, businesses have been very quiet with their plans. Banks prefer to wait until clarity appears. A lot of risks are at play after all. The biggest potential risk is Iran's failure to stay committed to the deal, in which case the sanctions would be re-enacted. In fact, the US has imposed new sanctions on Iran's ballistic missile test-firing.
Another risk is geopolitical instability, particularly the Iran-Saudi rivalry. Sanction removal would increase Iran's economic and political influence, further challenging Saudi Arabia's status quo in the region. Iranian-Saudi relations hit rock bottom following the execution of a leading Shiite cleric in early January. Protesters ransacked the Saudi embassy in Tehran afterwards and Saudi Arabia subsequently cut diplomatic ties. Both are also involved at different levels in the ongoing conflicts in Syria and Yemen, turning them into proxy battlefields. Many, including The Jakarta Post, are wary of the worst-case scenario of full-scale war.
The region's instability has created interesting developments and unlikely allies. The year 2015 saw signs of Israel-Saudi Arabia's blossoming relationship, united by the same concern that Iran could not be trusted with the deal. Unfortunately, the region's geopolitical conflicts are often packaged, translated and exported overseas as religious/sectarian conflicts, making them relatable to external parties without any geopolitical interests whatsoever. In Indonesia, this is observable through the interesting shift of religious narrative within the Muslim community. A few years ago the common narrative was Islam versus Islam's enemies (Israel, the US or Zionists), while the common one now is Shia versus Sunni (Iran against Saudi Arabia).After all, religious issues resonate better with a majority of the public compared to geopolitical issues. Consequently, we have witnessed how "Zionist-supporting product" stigma can hurt businesses. In Bahrain at the height of the Arab Spring, sectarian divide led to boycotts of Shia or Sunni businesses. In 2014, some Iranian businessmen called for a boycott on Malaysian goods, triggered by Malaysia's largest political party the UMNO's anti-Shia campaign. The Shiite cleric execution led to Iran banning imports from Saudi Arabia, while the latter halted trade links with Iran. In Saudi Arabia, a consumer activist group scolded Ikea for selling a Persian carpet with a "made in Iran" label. This sort of risk to reputation, although subtle, could be disruptive for businesses.
In mitigating risks, firms, particularly those in capital-intensive industries and manufacturers with long product-cycle times, need to engage in scenario development based on worst-case scenarios (e.g. the reenactment of sanctions or Iran being involved in full-scale war) and develop strategies around them. Ultimately, to minimise loss when everything goes south, firms entering the Iranian market need an exit strategy, which depends on the entry approach. Historically, scholars view foreign direct investment as the optimal approach compared to exporting for entering foreign markets, as it allows better local market knowledge acquisition. However, exporting provides firms with greater flexibility for exit strategies as no equity investment is made.
