Decentralizing the banking system | Impressive performer with ambitious plans
AT FIRST GLANCE, the Iranian economy looks to be on a roll. The IMF declared in June 2004 that growth should remain strong at 6.5% in the Iranian fiscal year to 21 March 2005. This comes after growth of 6.8% in the previous fiscal year, slightly down on 2002-03 growth of 7.4%. The Tehran Stock Exchange (TSE) is continuing to perform strongly, after recording 116% growth in 2003, and oil prices are at historical highs.
Yet beyond the short term the picture appears less rosy. The IMF has stressed that reform must be accelerated if Iran's medium- to long-term economic health is to be ensured. Financial sector liberalization is at the heart of the issue, and crucial to the country's future is the Fourth Five Year Development Plan (FYDP).
Its fate now hangs in the balance. James McCormack, senior director of sovereigns at Fitch Ratings, believes that "the real debate over where Iran is going over the next five years is taking place right now".
The FYDPs have set the economic agenda in Iran since 1990. The plans are drawn up by government technocrats but must then be approved by the Majlis, Iran's parliament (pictured); the 12-member parliamentary watchdog the Council of Guardians; and supreme leader Ayatollah Ali Khamenei.
Although the Fourth FYDP was approved by the outgoing reformist-dominated Majlis in May 2004, control over the legislature has now been handed over to conservatives, following their landslide February election victory. The changed political landscape, largely the result of mass disqualifications of reformist election candidates, is having an impact on economic reform, and the Council of Guardians has sent elements of the FYDP back to the new parliament for reconsideration.
Mohammed Mahdavian, director of economic affairs at the Central Bank of Iran (CBI) says that "the new parliament is not in favour of hasty liberalization".
Comments by Majlis deputies and leading officials have raised fears that banking sector privatization and liberalization measures could be watered down, or removed from, the next FYPD. Khamenei recently said Iran should not follow the World Bank and IMF models as it overhauls its economic structures, and Majlis deputies have railed against foreign dominance and a loss of national sovereignty.
At the heart of the reform programme are plans to privatize state-owned companies in a variety of sectors. Some progress has already been made, particularly by the government's Industrial Development and Renovation Organization, which controls a sizeable chunk of domestic industry. According to Davood Haghighi, Idro's vice-chairman of economics and finance: "Idro has privatized 101 companies since 1990 with the value of $1.6 billion, at the present rate of exchange. For the current Iranian year we will offer 75 more companies to be privatized, valued at around $1 billion."
Controversy surrounds bank privatization
Yet looking ahead, Haghighi acknowledges that future plans are not yet clear: "The privatization of all state-owned holding companies, such as Idro, is now being debated and will, if decided, shorten the process of privatization of subsidiary companies." While he believes that privatization will continue in the Forth FYDP, he highlights the fact that Article 44 of the constitution – which defines the sectors that the state should control – is currently undergoing reinterpretation by the relevant bodies. One such body is the Expediency Council, headed by powerful former president Ali Akbar Hashemi Rafsanjani, whose roles include formulation of strategic economic policy.
Haghighi stresses that the rights of foreign investors to participate in privatization are enshrined in law. He says: "Article 7 of the Implementation Regulations of the Foreign Investment Promotion and Protection Act [FIPPA] has set the ground for participation of foreign investors in the ownership of the existing firms without referring to any restrictions regarding IPOs of state-owned companies."
Although this may be the case for Idro's industrial subsidiaries, the issue of foreign participation in the banking sector, and even the concept of banking privatization itself, remains extremely controversial.
After the 1979 Islamic revolution, Iran's banking system was nationalized and privately owned banks were banned. Thirty-seven pre-revolution financial institutions were merged to create six public commercial banks: Bank Refah, Bank Melli, Bank Saderat, Bank Tejerat, Bank Mellat and Bank Sepah. The banking system was obliged to conform to Islamic banking principles, and the usury-free banking law was passed in 1983.
The effect of more than two decades of ostensibly Islamic banking regulations has been a decline in the banking sector's asset growth. Government controls on the expansion of credit have limited banks' ability to lend, and high inflation has led to negative real rates of return on capital. Fitch's McCormack says the credit assessment skills of domestic banks are underdeveloped, and their services and decisions continue to be guided by the state.
The end result is that the majority of commercial banks' loan portfolios consist of low-return loans to state-run firms and quasi-state charitable organizations known as bonyads. Some change has come, however, with the licensing of privately owned banks. In 2000 the Majlis overturned the ban on private financial institutions and has now issued licences for four private banks: Bank Parsian, Bank Saman, Bank Karafarin, and Bank Eqtesad-e-Novin. Two of the banks have already been listed on the TSE, and the exchange's secretary-general, Hossein Abdoh Tabrizi, says a third will be listed very soon.
Although they are tiny compared with the state owned banks, the private banks are growing quickly. Their market share is just 2.5% at present, but is forecast to grow to 5% by the end of the current Iranian fiscal year. This strong performance has heightened foreign banks' interest in opening branches in Iran.
Foreign banks are limited to running representative offices in mainland Iran, of which there are now around 40. They also have the option of opening branches in Iran's free trade zones. In July 2004, Standard Chartered became the first foreign bank to be given a licence to establish an offshore branch. It plans to begin operations on the island of Kish by the end of the year, and will focus on corporate banking and trade finance. Its mainland representative office, which opened in 1993, focuses on corporate and trade finance, syndications, and cash management.