This article was written by Banu Asik Elizondo, senior portfolio manager on the Emerging Market Debt team, focuses on both sovereign analysis and portfolio management.
After two years of continuous negotiations, the P5+1 — the United Nations Security Council’s five permanent members (China, France, Russia, the UK and the US) plus Germany — agreed to a nuclear deal with Iran on July 14. Pending several phases of implementation, the agreement means Iran may no longer be excluded from world financial markets. After analyzing the implications for emerging markets of Iran’s reintegration into the world economy, Invesco’s Emerging Markets Debt team believes the effects will be mixed for regional countries and their fixed income risk premiums.
The good
Due to sanctions, Iran’s trade ties with its close neighbors have been below potential. As sanctions are phased out and the Iranian economy goes from treading water to growing, there is tremendous opportunity for the United Arab Emirates (UAE), Iraq and Turkey to benefit from increased trade ties. For example, Turkish and Iraqi cement companies could have major opportunities as Iran rebuilds its infrastructure. Service-oriented companies, from banking to telecommunications, in the UAE and Turkey stand to benefit from entering and expanding in the underpenetrated Iranian market.
Conversely, demand for gas in the UAE and Turkey has increased dramatically, and Iran’s rich gas reserves could be a cost-efficient way to address this import need. Additional oil supply from Iran, once available, may also put further downward pressure on oil prices. A sustained period of lower oil prices would benefit oil importers like Turkey, Tunisia, Egypt, Morocco and Lebanon.
The bad
In addition to its rich oil and gas natural resources, Iran also benefits from favorable demographics with high-quality human capital. In terms of key social indicators, Iran ranks higher than its emerging market peers, with a literacy rate greater than 80% and high levels of secondary and tertiary school enrollment.1 As a result, once necessary structural reforms are implemented, Iran could present an economic threat to neighboring countries, such as Turkey, whose manufacturing economies offer little in terms of value added because of their heavy dependence on importing raw materials.
Further, if Iran — with about 18% of the world’s natural gas reserve base 2 — is able to ramp up capacity quickly with significant exploration and production work, we believe Iranian natural gas supply could meet a good portion of the demand in the region, potentially rendering the regional oligopoly of Russia and Qatar less relevant.
Finally, we believe that as Iranian oil supply potentially pushes down oil prices, Iraq and all Gulf Cooperation Council countries — including Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE — will suffer because oil represents anywhere from 60% to 80% of government revenues for these countries.1 As fiscal revenues fall and current account surpluses erode with oil prices, we would argue that these credits will no longer be able to trade with the tight spreads they have enjoyed for some time now.
The ugly
The ugly picture isn’t driven as much by natural resources or trade as it is by geopolitical currents. Given the ongoing conflicts in Syria and Yemen, Iran’s foreign policy stance will be critical going forward. Any coordination with Saudi Arabia, the other regional power, to ensure peace in the region would be positive. Likewise, any adverse conversations and unwillingness to cooperate might push the region toward further violence, in my view. While our base case scenario assumes cooperation between the two regional powers, a lack of cooperation would likely cause the overall risk premium in the region to increase significantly.
1 Source: CEIC data, July 16, 2015
2 Source: BP Statistical Review of World Energy, 2015
Read more about emerging markets by Banu Elizondo.
Important information
A risk premium is the amount of return an asset generates above cash.
An oligopoly is a situation in which a particular market is controlled by a small group of firms.
Spread represents the difference between two values.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.