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Iran: Foreign Investors Willing But Wary

Recent visits by EU leaders to Iran have emphasized both sides' desire to expand trade ties. But many Europeans say Tehran needs to carry out reforms before business can substantially increase. In the first part of a three-part series on foreign investment in Iran, RFE/RL correspondent Charles Recknagel looks at the challenges would-be investors face.

Prague, 23 March 2000 (RFE/RL) -- When the foreign ministers of Italy and Germany went to Iran this month, they left no doubt they want to see more of their countrymen do business there.

Italy's Foreign Minister Lamberto Dini used the occasion to call on his country's banks to do more to support Italian enterprises seeking to take advantage of opportunities opening up in countries like Iran. Germany's chief diplomat, Joschka Fischer, called for rebuilding what he termed Germany and Iran's historic relationship -- by which he meant trade. In recent history, Germany was Iran's biggest European trading partner, until diplomatic spats during much of this decade allowed Italy to overtake it.

Iran, for its part, made it clear that it sees investment by European Union members as a way to help it expand its economy as it fights high unemployment. But if EU leaders are eager for their countries to participate in Iran's potentially lucrative oil and gas sectors -- and are equally interested in its mining, steel and other industries -- the European companies which must actually do the investing are often more cautious.

The caution is visible when Iran tenders contracts for foreign companies to invest in oil fields on condition they build, operate, then transfer wells back to Iran. The result is, years go by with very few contracts signed. It is equally visible when private and state credit agencies consider whether to advance loans to businesses seeking to invest in Iran or even to the Iranian government itself.

The reasons for such caution are mostly due to the fact that the Islamic Republic -- even as it increasingly courts foreign investment -- remains a market with many rules which seem written to keep investors out.

Analysts say that the biggest obstacles to investment are Iran's restrictions on foreign ownership of property, its punishing tax rates and multiple foreign exchange rates. Simon Williams is an expert on Iran's economy at the Economist Intelligence Unit in London. He says that many European companies are interested in Iran's oil fields but are put off by Tehran's refusal to allow them an ownership stake in the operations.

"When we are looking at the kind of investments [foreign companies] are engaged in -- certainly the oil and gas sectors -- we are not looking at traditional foreign direct investment, we are not looking at them buying a 25 percent stake in an Iranian firm. What we are looking at them doing, is providing the finance and expertise for a particular project which they will then gain a return on when they come into operation. We are looking at 'build-operate-transfer' set-ups, we are not looking at actual ownership of Iranian assets."

Under the Islamic Republic's constitution, foreign companies are not allowed to buy property in Iran, including property rights to oil wells.

Analysts say another disincentive to investors is Iran's tax code, which many consider vague and even punitive. Raquel Ajona , a regional expert at Deutsche Bank's research department in Frankfurt, says that Iran's tax code applies several layers of taxes on foreign companies' earnings.

"The tax policy system in Iran is very complicated. We could say in principle that 10 percent of the total taxable income is deducted from any corporation, this is a priori, then there is a tax of 12 to 54 percent in addition to this on the taxable income. If the income is earned by the assignment of free royalties, then those rights are taxed between 20 and 90 percent. So, the tax money can be very high and [the system] is very complicated to understand."

In an effort to attract some investors despite the high tax rates, the government has established a limited number of free trade zones in which foreign companies can operate with tax breaks.

Foreign companies considering working in Iran are also discouraged by its multiple exchange rates. Iran has long had three exchange rates varying from official to illegal. Currently, these comprise an official rate of some 17.50 rials to the dollar, an export rate of 3,000 rials to the dollar, and a floating black market rate.

Tehran has used the multi-tiered exchange rates to conserve foreign exchange and to subsidize imports. Maintaining an official rate of 17.50 to the dollar, when the open-market rate is about 10,000 to the dollar, allows the public sector and other favored industries to import goods at a much lower cost.

Investors have considered this multi-tiered system as a substantial hidden cost to doing business in Iran.

"What it means for foreign investors -- someone operating in the country -- is that if they want to get foreign exchange, if they are not allowed to get the official or export rate, then they have to buy it on the black market. But, at the same time, the official rate is applied when they want to repatriate some income. So it means that in principle you are imposing a cost on the foreign investor."

In recent months, the Iranian government has moved to try to create a fourth, floating, market-based exchange rate by making some of its foreign currency holdings available for trading on the Tehran Stock Exchange, or TSE. The goal is to create a readily exchangeable free-floating currency to help Iranian businesses -- principally non-oil exporters -- which do not have access to the government-fixed official and export rates. It would also help foreign investors.

But Williams cautions that the Tehran Stock Exchange mechanism remains fragile because Iran's ability to float the rial on the exchange rate is tied to the high oil prices it now enjoys. Williams:

"Iran has the larger portion of its foreign exchange earnings coming from the oil and gas sector. Should those earnings begin to slump, then I would expect the government again to be looking to conserve foreign exchange wherever it could to meet its essential import requirements and to meet its fairly burdensome debt repayment schedule as well. While oil earnings are high, while debt repayments can be met fairly easily, the TSE rate will continue."

The analysts say that Iran's ability to attract greater foreign investment will depend largely on its ability to address companies' concerns over property ownership and taxation, as well as on its ability to maintain a readily exchangeable free-floating currency.

But none of that is likely to come easily. Iran is now moving from a period of rapid political change -- which has pitted reformists against conservatives over social issues such as freedom of speech -- to an equally tough battle over whether to restructure its domestic economy and how much to open it to outsiders. And that may mean that any real boom in foreign investment will have to await the outcome of Iran's own domestic debates, no matter how many EU leaders visit Iran in the months ahead.

(The second part of this three-part series looks at how international creditors view Iran.)