Investment Path Clearing

Attracting investors to the Iranian capital markets has long been a challenge, as international investors have been scared off by sanctions and the reputational risk of doing business in Iran.

This is true even for domestic counterparts who have found it more profitable to keep their money in banks than in the more volatile stock market, writes Euromoney.

Yet the outlook is changing for both groups. Could Tehran Stock Exchange be on the cusp of a breakthrough?

The appeal for many investors in TSE and Iran Fara Bourse over-the-counter market is largely tied to the difference between bank deposit rates and the returns they can expect from investments in listed companies.

That gap has been narrowing, most recently in June when the Central Bank of Iran cut the one-year deposit rate from 18% to 15%, still an astronomical level for most markets. However, interest rates in money markets are still higher.

“Interbank borrowing rates are still at 20% and banks still offer 20% interest on large deposits (over $14 million),” said an Iranian investment banker that did not wish to be identified. This is while dividend yields are at 12%, according to Turquoise Partners, a Tehran-based investment firm.

  Shifting Landscape

For foreign investors, the big change was the Joint Comprehensive Plan of Action in January to lift most sanctions, in return for Tehran scaling back its nuclear energy program. Invariably, those coming to Iran find the puzzle that is more complex than they might like, but the pieces are gradually falling into place.

“The United States further eased financial sanctions on Iran through regulatory measures that could significantly bolster Tehran’s ability to access global financial markets and attract foreign investment,” the Wall Street Journal reported on Saturday.

But one sticking point has been the relatively high cost of bank transfers, but this is also set to change. Until recently, bank transfers had to be based on the official exchange rate, which in early August was running at 30,900 rials to the dollar, around 14% more expensive than the market rate of 35,344 rials.

However, in late July, the central bank said it would allow banks to offer the market rate on foreign exchange transactions, which should mean that more investment will flow into the country through the banks.

“This is very significant, as it should allow large FDI to come into Iran more easily,” says Kiyan Zandiyeh, portfolio manager for London-based Sturgeon Capital, which operates an equity fund investing in listed Iranian companies.

In the medium term, the central bank has vowed to close the gap between the two rates and end the system of parallel exchange rates, either later in 2016, or at least by the end of the current Iranian year, which falls in March 2017.

Instead of using banks, other investors have preferred to transfer money into Iran via exchange houses–credit institutions regulated by the central bank that can facilitate cross-border money transfers.

  Certainty of Growth

There is certainly the potential for the Iranian economy to grow quickly, but its short-term fortunes rely on domestic and international political issues, which are hard to predict. For one thing, the outcome of Iran’s presidential elections in May 2017 will set the template for the country’s relations with the outside world for years to come.

The IMF suggests GDP will expand by 3.7% to 4.5% between now and 2021. Others are more bullish, predicting growth rates between 6% and 8%.

There are a few reasons why some companies should grow quickly in the coming years, even if the economy as a whole does not match the highest hopes.

For one thing, many Iranian businesses have been operating below capacity during the sanctions years and, with the shackles now removed, they should be able to expand their output even without much investment. For companies that were more productive, expansion plans that had been put on hold can start to move forward.

Turquoise predicts that listed companies will post earnings growth of around 10% on average over the year to March 2017.

The biggest boost of all could come from Iran’s inclusion in international indices, such as those run by MSCI.

Zandiyeh believes that, based on the size of TSE, it “should conservatively occupy between 25% and 30% of the MSCI Frontier Index. Looking at the money which tracks the index, up to $7 billion to $10 billion would have to enter the market. That could happen in the next year or two.”

  Outdated Rules and Infrastructure

Beyond the problems of scarce banking links and parallel exchange rates, there are further concerns for investors, as a consequence of the relatively immature nature of the market and because it has been separated from the international mainstream for so many years.

Local regulations stipulate that stocks cannot be held by a global custodian, but instead must be held by the Central Securities Depository of Iran. This month the market regulator issued new directions, allowing local banks to act as custodians for large investors. The SEO claims this will alleviate concerns.

Furthermore, there are no credit ratings agencies working in Iran, nor a culture of analyst reports and coverage.

Financial reports and other data are often only available in Persian, and global accounting norms, such as international financial accounting standards, are only starting to be introduced. All this makes it harder to evaluate companies for investment. Instead, investors will have to rely on the forward guidance that companies issue and their own research into a company’s performance and prospects.

  A Wager for the Future

Some of these concerns are being addressed and there have been signs that the market is moving to become more professional, with a wider range of tools on offer to investors.

Macroeconomic trends in Iran ought to drive more investors toward the market too, helping improve liquidity levels, which are another concern, particularly for many of the smaller stocks.

Bonds on the other hand are underwritten by the banks in Iran, carry high fixed interest rates for multiple years and can always be redeemed for at least their par value. That means investors can lock in high double-digit returns for several years.

Clemente Cappello, chief investment officer of Sturgeon Capital, says, “Nearly $10 trillion in global bonds trade at negative yields, whereas in Iran the yields are 18% to 20%. GDP is rising and the population is young—60% are under the age of 30—while it is aging in the west. It makes for an interesting situation for investment.”

The question is how quickly will international investors be willing, able or brave enough to take advantage of those trends?