CI Ratings affirms Iran's sovereign ratings at 'B', with a stable outlook
Capital Intelligence Ratings (CI Ratings) has affirmed Iran’s Long-Term Foreign and Local Currency Sovereign Ratings at ‘BB-’ and its Short-Term Foreign and Local Currency Sovereign Ratings at ‘B’. At the same time, the Outlook for Iran’s ratings has been affirmed at ‘Stable’.
The ratings reflect the relatively favourable short to medium-term economic and fiscal outlook following the lifting of international economic and financial sanctions relating to the country’s nuclear programme. As a result, Iran has begun to gradually repatriate previously frozen external financial assets and export more hydrocarbons to a wider range of markets, thereby improving the country’s medium-term economic growth prospects and increasing the central government’s oil revenues. However, the ratings remain constrained by the uncertainty surrounding the tense relationship between Iran and the current US administration with regards to the lifted sanctions, as well as by the slow pace of fundamental reforms and high political and geopolitical uncertainties.
The Iranian economy is expected to continue its recovery in FYE 2018, underpinned by the growth of the hydrocarbon sector, a small rebound in other key sectors that receive financial support from the government (such as the petrochemical and construction sectors), and a pickup in domestic demand.
Real output is estimated to increase by 3.8 per cent in the fiscal year that ends in March 2018, up from an estimated 3.5 per cent in FYE 2017. The outlook remains broadly favourable in the short to medium term with real GDP expected to grow by an average of 4 per cent in FYE 2019-20. In March 2017 the Iranian parliament approved the sixth national development plan, which sets out the economic targets to be achieved over the next 5 years. The plan focuses on attracting investment and introducing full legal, banking, and economic reforms to reduce fundamental weaknesses. In CI Ratings’ view, the plan could boost the medium-term outlook if reforms are implemented as planned and targets met.
Despite the recent volatility in the exchange rate associated with the uncertainty surrounding the US’ commitment to the nuclear deal, the gap between the official exchange rate and the market rate has fallen further to around 17 per cent as of April 2017, compared to a record high of 114 per cent two years ago. Inflation has also declined, standing at 10.5 per cent in FYE 2017, compared to a record high of 34.7 per cent in FYE 2013, and is expected to stabilise at around 9 per cent in FYE 2019-20.
Notwithstanding the positive macroeconomic developments, political and geopolitical uncertainties continue to hamper a speedier recovery. The uncertainty surrounding the latest US stance with regards to the nuclear agreement, as well as the Islamic Republic’s foreign policy towards neighbouring Syria and Iraq, could spur a new bout of tension, increasing the ambiguity regarding the sustainability of the nuclear agreement.
However, CI’s view is that a possible US withdrawal from the nuclear agreement is not likely to affect the continuity of the nuclear agreement with European counterparts. Moreover, the impact on the Iranian economy is expected to be contained and limited mostly to capital inflows given the fact that Iran manages its foreign transactions in Euro and it relies on Asian markets for its trade. Additionally, geopolitical risk factors remain elevated in view of the ongoing conflicts in Syria, Iraq, and Yemen, in addition to the tense relationship with some key GCC member states, especially Saudi Arabia.
On the fiscal front, the public finances are expected to remain satisfactory. The structure of the budget is expected to continue improving due to policy reforms and efforts to broaden the tax base. The primary central government budget position is expected to return to surplus in FYE 2019, conditional on the implementation of planned fiscal consolidation measures and premised upon an increase in OPEC oil prices to an average of $60 per barrel.
Iran’s public debt remains low and official foreign assets remain sizeable, estimated by the International Monetary Fund (IMF) to be equivalent to around 25 months of imports of goods and services and around 14 times as high as external debt payments falling due in FYE 2018 (although there is still some ambiguity regarding the liquidity and usability of these assets).
The banking system remains undercapitalized and poses substantial contingent liabilities to the sovereign. Asset quality, capital adequacy, liquidity, and profitability have been adversely affected by the sanctions and rigid government credit policies. Outstanding government payments (arrears) are a challenge for corporates and banks.
Iran’s sovereign ratings remain constrained by the heavy reliance on oil and by fundamental weaknesses in the economy, which have been aggravated by the long period of economic sanctions. It will take time and ongoing commitment to implement important structural reforms. The ratings are also constrained by continued government expenditure rigidity, as well as the weak financial system, institutional shortcomings (including limited disclosure of data), and complex internal politics.
The outlook for the ratings is ‘Stable’. This indicates that Iran’s sovereign ratings are likely to remain unchanged within the next 12 months provided that key metrics evolve as envisioned in CI’s baseline scenario and no other credit quality concerns arise.