Iran’s cooperation with Central Asian countries: The impact of sanctions relief

by Dmitriy Belyanin

Introduction

Since the 1979 Revolution, the Islamic Republic of Iran has been facing sanctions, initially from only the United States, later from the European Union and the United Nations.  In July 2015, however, the West agreed to remove the sanctions.  In return, Iran would guarantee that its uranium enrichment program would remain peaceful. 

Lifting the sanctions increases oil supply and causes oil prices to plummet.  The exact impact of the sanctions relief must be weighed against other factors, such as excessive oil from Saudi Arabia, lifting the ban on oil exports from the United States, the growing use of alternative energy sources, the smuggling of oil by ISIL, and the economic slowdown in China.  The sanctions relief opens Iran to foreign investment and enables Iranian companies to invest abroad, which can lead to economic growth.  But adverse foreign exchange fluctuations, caused by low and plummeting oil prices, can get in the way.

Iran is developing strong ties with Central Asia and implementing many joint projects.  The Islamic Republic's geopolitical stance may compel Central Asian countries to choose whether to ally with Iran, or with Saudi Arabia and Turkey.  This is a dilemma.  After all, Saudi Arabia is vital to all Muslims, particularly Sunni Muslims; and Central Asian natives, except for Tajik, belong to the Turkic group.  The importance of Russian-Iranian relations and the conflict between Russia and Turkey add to the dilemma.  As a neutral player, China may try to keep this predicament from erupting into a full-scale conflict.  The presence of all three powers on the new Silk Road may mitigate confrontation.

Structure of Iran's Economy

Iran has the second largest economy in the Middle East and North Africa, after Saudi Arabia, and the second largest population, after Egypt. Crude oil accounted for 80% of Iran's exports in 2010, according to Economy Watch.  Iran has the second highest reserves of natural gas and the fourth largest reserves of crude oil in the world.  Primary partners for exports include China, Japan, India, South Korea and Turkey; and, for imports, the United Arab Emirates, China, Germany, South Korea, Russia and India. 

The state largely controls the economy.  It owns large enterprises in manufacturing and commerce, and it restricts business.  Iran ranks only 118^th on the Ease of Doing Business Index.  Enforcing contracts and dealing with construction permits are its main strengths; resolving insolvency, protecting minority investors, and trading across borders are its weaknesses.  Corporate transparency is low, with no disclosures of compensation of managers, poor protection of buyers that are limited companies, and no mandates to disclose board directors.  There are no legislative mechanisms for enforcing the liability of directors.  

Contract enforcement is also weak. There is no court devoted to commercial cases, no fast-track procedure for small claims, no procedures for filing cases electronically.  Export costs, including time costs, are higher than in North Africa and the Middle East, not to mention the OECD. 

Table 1 lists the components of the Ease of Doing Business Index for Iran, the Central Asian countries, and for other key players in the region.  Turkey and Saudi Arabia were included as geopolitical opponents of Russia and Iran. 

Economy	Ease of Doing Business Rank	Start a business	Deal wt. building permits	Get electricity	Register property	Get credit	Protect minority investors	Pay taxes	Trade across borders	Enforce contracts	Resolve insolvency
Kazakhstan	41	21	92	71	19	70	25	18	122	9	47
Russia	51	41	119	29	8	42	66	47	170	5	51
Turkey	55	94	98	36	52	79	20	61	62	36	124
Kyrgyzstan	67	35	20	160	6	28	36	138	83	137	126
Saudi Arabia	82	130	17	24	31	79	99	3	150	86	189
China	84	136	176	92	43	79	134	132	96	7	55
Iran	118	87	69	88	91	97	150	123	167	62	140
Tajikistan	132	57	152	177	102	109	29	172	132	54	147

Table 1: Components of the 2016 Ease of Doing Business Index for the Central Asian Countries (where available) and key players in the region

Source: World Bank Group

Starting a business in Iran is easy: It requires 15 days, in contrast to the regional average of 18.8 days for the Middle East and North Africa, and to 8.3 days for the OECD (Organization for Economic Co-operation and Development). Startups require eight procedures in Iran but an average of 8.2 in the region and 4.7 in the OECD.  The average cost is 2.7% of income per capita in Iran, lower than in the region (25.8%) and in the OECD (3.2%), according to the World Bank Group. 

Even so, Iranian industries suffer from economic arthritis.  State-owned banks dominate finance. Private farms are numerous and small.  The rigid labor market creates few jobs. 

Iran's economy is much more diversified than many other oil-dependent economies in the region.  In spite of low oil prices, Iran’s economy can grow by as much 5-8% per year, reports The Economist.  Predictions of the International Monetary Fund for economic growth are more conservative (Table 2).  Due to sanctions, Iran has experienced double-digit inflation, though the IMF expects this to change in 2017.

Subject	Units	2013	2014	2015	2016F	2017F
Gross domestic product, constant prices	Percent change	-1.912	4.343	0.827	4.360	3.990
Inflation, average consumer prices	Percent change	34.727	15.549	15.092	11.500	8.250
Volume of imports of goods and services	Percent change	-7.782	11.448	2.053	16.212	12.101
Volume of exports of goods and services	Percent change	-2.424	15.666	16.082	22.316	5.595
Unemployment rate	Percent of total labor force	10.439	10.600	11.668	12.268	12.347

  Source: IMF World Economic Outlook Database, October 2015

 Table 2: Key macroeconomic parameters of Iran (2013-2017)

Timeline of sanctions on Iran

Relations between Iran and the West worsened after the Islamic Revolution of 1979.  The Shah, backed by the U.S., was forced to flee.  On November 4, fundamentalist students seized the US embassy and held the staff hostage for 444 days.  US President Jimmy Carter responded by cutting diplomatic ties, seizing Iranian assets, and prohibiting most trade.  But Iran did not release the hostages until the inaugural day of Carter’s rival and successor, Ronald Reagan, in January 1981. 

In 1984, Reagan classified Iran as a state supporting terrorism.  Nevertheless, in 1986, his administration violated the embargo on the sale of weapons to Iran.  It secretly and illegally earmarked sales revenues to support anti-communist guerrillas in Nicaragua. 

In 2002, US President George W. Bush accused Tehran of operating a nuclear arms program.  He denounced Iran as a member of the Axis of Evil, along with North Korea and Iraq.  An opposition group in exile noted that two undisclosed nuclear facilities in Iran were under construction.  In 2006, the West opened talks with Iran on its nuclear program, but they stalled in 2009.  In 2012, the US Congress empowered President Barack Obama to impose sanctions on banks, including central banks of US allies, if they refused to cut sharply imports of Iranian oil.  Iran’s economy began reeling, and the government agreed to talks.  In 2013, Iran elected the moderate Hassan Rouhani as president.  He promised to improve foreign relations. 

In November 2013, Iran and six major powers (the United States, China, Britain, France, Germany and Russia) reached an interim agreement called the Joint Plan of Action.  Iran agreed to curb its nuclear projects in exchange for lifting some sanctions.  Last July, the plan was signed. Iran would decrease centrifuges and disable a key section of its Arak nuclear reactor; in return, the US, UN and European Union would cancel many sanctions.  In January 2016, the International Atomic Energy Agency confirmed that Iran had complied with the plan, and all sanctions were lifted, reports Reuters.

This thawed over $30 billion of Iranian assets immediately, out of the $100 billion that were frozen, according to Iran's official reports.  The sanctions relief would help overcome double-digit inflation and unemployment.  Ending the European oil embargo made 38 million barrels available for export. 

Amir Hossein Zamaninia, deputy oil minister, said Iran had planned to increase oil exports by 500,000 barrels per day, reports Aljazeera. Since oil-exporting nations now plan reductions, in practice Iran may export less.  World crude oil prices fell in July 2015 by 11.2%, compared to the decrease of 1.9% in the prior month, suggesting that speculators expected the price to drop due to sanctions relief.

Iran’s Cooperation with Central Asia

Iran plans a passel of joint projects in Central Asia.  It is willing to invest up to $100 million in agricultural projects in Kyrgyzstan, which wastes 30% of its farm products due to its lack of fertilizer factories, logistics facilities and refrigerators.  Kyrgyzstan is willing to export green beans and other environmentally clean foods, expecting investments in return, reports Alina Kozhekova from 24.kg.

A railroad, linking Kyrgyzstan, Tajikistan, Afghanistan and Iran, is to be built.  Iran may also help build a hydroelectric power plant in Kyrgyzstan.  And direct air flights between Kyrgyzstan and Iran may soon become reality, reports Tengri News.

Constructing a railroad through instable Afghanistan is risky. While visiting Turkmenistan, Islam Karimov, President of Uzbekistan, proposed constructing a new transportation and transit route, linking Uzbekistan, Turkmenistan, Iran and Oman. Uzbekistan and Turkmenistan would get around the constraint of being landlocked, reports TurkmenBusiness. 

There are 120 joint enterprises, including 20 with 100% Iranian capital, in Uzbekistan.  Cotton, ferrous and non-ferrous metals, minerals and chemicals are among the main exports of Uzbekistan to Iran.  Its main imports from Iran are construction materials, household chemicals, food products and tea.

But relations between the two countries are complicated, due to Uzbekistan’s extensive military cooperation with the US.  The Americans had a military base in Karshi-Khanabad, until Karimov kicked them out in 2005.  In 2014, relations thawed when the two countries agreed on supplying weapons and creating a regional bureau of NATO.  But Uzbekistan’s relations with Tajikistan, which has strong ties with Iran, remain tense.

As of 2014, Iran was the third largest trading partner of Turkmenistan (after China and Russia).  In 2014, the trade turnover between Iran and Turkmenistan was $4 billion, which the two countries planned to boost to $60 billion.  From Turkmenistan, Iran imports natural gas, electricity, agricultural products and textiles.  Turkmenistan imports construction materials, equipment, cars, buses, agricultural products, and petrochemicals, reports Elnur Mekhdiyev of the Gorchakov Foundation.

Tajikistan has the closest ties with Iran in Central Asia, since the two nation-forming ethnic groups have the same origin. Iran was the first country to establish a diplomatic mission in Tajikistan. Iran had assisted Tajikistan in sustaining peace after the Tajik civil war, and it provided humanitarian aid.  According to Iranian media, trade turnover between the two countries between March 2011 and March 2012 amounted to $500 million. Tajikistan exports raw aluminum and cotton, while importing construction materials, chemicals, machines and food. 

Large projects in Tajikistan include: The Sangruda-2 hydroelectric power plant, in which Iran had invested $220 million; the Anzob tunnel, linking Dushanbe, Tajikistan's capital, and Khujand, the second largest city (Iranians invested $30 million there); and a recent pact with Afghanistan to transport potable water through this country from Tajikistan to Iran.  Recently, it was decided that Iranian oil would move in the reverse direction.  Tajikistan plans to attract Iranian investments to establish the first oil refinery in the country.  In 2010, Tajikistan and Iran also signed an agreement on military cooperation, reports Anton Yevstratov from Iran.ru. 

In March 2008, Tajikistan, Afghanistan and Iran agreed to create the Economic Council of the Persian-Language Union.   A TV channel of Persian-speaking countries, headquartered in Dushanbe, may be created.  The Union is still in its infancy.  There are various joint projects in culture, electricity transmission, railroad construction, water supply and energy, but not on trade regimes.   According to Manouchehr Mottaki, Iran’s former foreign minister, it is sufficient for the three countries to belong to the Economic Cooperation Organization, which was founded by Iran, Turkey, and Pakistan in 1985 and now includes Afghanistan, Azerbaijan, and the five Central Asian states.  The group promotes economic cooperation and the gradual removal of trade barriers so no other structure is needed.  Nevertheless, the visit of Akhmad Vahidi, Iran’s former defense minister, to Dushanbe, suggests the possibility of a military union of the three countries. Tajikistan is surrounded by Turkic-language states, particularly Uzbekistan, with which it has uneasy relations because Uzbekistan depends on its neighbor for water.  So Tajikistan is particularly interested in a military union.  Despite frosty relations, Russia supported Uzbekistan in the conflict with Tajikistan over water in 2010.

Religious differences have blocked cultural cooperation between the three countries.  Before the US invasion in 2001, Afghanistan was ruled by the Sunni fundamentalist Taliban.  Iran is a Shiite state prone to local conflicts.   The president of Afghanistan, Ashraf Ghani, is pro-western but wants peace talks with the Taliban.  The government of Tajikistan is secular, and most of the population is Sunni. The government forcibly resists islamization of the Tajikistanis, though this is supported by the government of Iran, reports Mesamed, of the Institute of the Middle East.  

Over 400 citizens of Tajikistan study in Iran, at the request of Dushanbe.  Iranian medical schools have a good reputation.  Due to a similar culture and language, Tajiks can study in Iran more easily than in the US or Europe. 

 Tajikistan had opposed sanctions on Iran, arguing that it had a right to pursue a "peaceful nuclear program."  In summer 2010, Iran supported Tajikistan in a conflict with Uzbekistan by limiting the transit of Uzbek cargo until delays of Tajik cargo were mitigated, reports Eradzh Bagban, on Maxala.org.

In December 2014, a railroad linking Kazakhstan, Turkmenistan and Iran was launched.  To run the road at capacity, estimated at 10 million tons, the three countries must adjust their regulations, unifying tariffs.  The most important problem is that the three economies have similar structures; this limits cargo volume because the countries have little reason to trade.  Cargo volume will increase if Russia joins the project, but it would rather supply Tajikistan (which depends heavily on Russia) than Iran.  Transit matters less for Russia than for Kazakhstan, which has low population density and relies on transit to pay for infrastructure. 

The railroad created 812 jobs and raised Kazakhstani trade towards the Persian Gulf by 38% in 2014, said President Nursultan Nazarbayev.  The railroad cost Turkmenistan $371 million, Kazakhstan $430 million, and Iran $106 million.  It runs for 146 kilometers in Kazakhstan, 470 in Turkmenistan, and 70 in Iran, report Yuliya Ten and Askar Muminov of Kursiv.kz.

Shortly after sanctions ended, a Kazakh-Iranian forum was organized, with 200 Kazakh companies and 700 Iranian companies taking part.  The first contract supplied Kazakhstani meat to Iran for $30 million. Kazakhstan would also export locomotives, construction materials, and metals.  The two countries have also talked about abolishing visas. 

The removal of sanctions will give Kazakhstan a powerful rival.  According to World Bank experts, an increase in Iran's exports of one million barrels per day will cut oil prices by 13%, or $3 per barrel, reports Tulegen Askarov from Delovoi Kazakhstan, a weekly business newspaper.  But Iran will find it hard to regain its market share, since modernizing equipment would cost $200 million, reports Yelena Kotchemasova from RBC channel. 

Iran's relations with other major players

Iran and Russia have cooperated mostly in the military sphere, signing a pact in January 2015.  Russia joined the sanctions against Iran in 2010 but subsequently lost $13 billion, reports Vesti.ru.  Last summer, Moscow and Tehran agreed to support the troops of President Bashar al-Assad.  In October Iran had 2,000 troops there, but they stopped cooperating in December.

Like Russia’s, Iran's leaders believe in using the Kurdistan Worker's Party, which Ankara regards as terrorist, to fight ISILTehran has been accused of failing to prevent Turkish attacks across its borders, reports Dorian Jones, of Voanews.com.

Relations with Saudi Arabia suffered from the Saudi execution of the Shiite preacher Nimra an-Nimra.  Shiites stormed the Saudi embassy in Tehran, and Saudi Arabia cut off diplomatic ties.  They have taken opposing sides in the conflicts in Yemen and Syria.

Saudi investment in Central Asia pales when compared to China’s ($27 billion), the EU’s ($21 billion), and Russia’s.  But Saudi support of religious organizations is estimated at $5 billion and is strongest in Kyrgyzstan.  Qatar, another foe of Iran, is targeting Tajikistan to weaken Tehran’s influence there, according to Akbar Asanov, of CA-Portal.

Since launching embargoes against Turkey and the European Union, Russia has tried to cooperate more with Iran by increasing agricultural imports from it.  Over 2015, Iran is estimated to have increased farm imports into Russia sixfold, reports Lifenews.ru.  But Turkey had exported incomparably more than this.      

Analysis and predictions

Since Russia and Iran have strong interests in Tajikistan and oppose the West, their tacit alliance is likely to be strong, despite vying for the oil export market.  Both countries want to contain extremism by stabilizing Central Asia, particularly the historically unstable Tajikistan and Kyrgyzstan.  Also, due to the migrant crisis in Europe and the recession, Russia also discourages migrant workers from these two countries.  A constitutional amendment has transformed Kyrgyzstan into a parliamentary republic, stilling fears about a president’s sudden departure.  But this is not yet the case for the repressive regime in Dushanbe.

Iran will seek good relations with Russia in hopes of averting future sanctions.  It is likely to be accepted into the Shanghai Cooperation Organization, a regional talkfest.  China, which imports oil and has long enjoyed ties with Iran, may lend to Central Asia to prevent color revolutions.

At the same time, since it competes with many countries in the region, Iran will keep oil and natural gas prices low.  Iran is unlikely to restrict petroleum supply for long, since it must compensate for income lost during sanctions. 

Iran will probably relax repressive laws, in order to attract investors and tourists and to avoid more sanctions.  The elections in Iran last month supported reformers and moderates, particularly in Tehran.  They won majorities in the 290-member Parliament and the 88-member Assembly of Experts.  The latter elects the Supreme Leader of Iran, the most powerful person in the country. The Supreme Leader now is Ayatollah Ali Khamenei, 76 and in poor health, reports The New York Times.

Moderates got 52 seats, winning a 59% majority in the Assembly of Experts.  Reformers won about 85 seats in the Parliament, while moderate conservatives won about 73 seats.  If they form a coalition, this would yield a 54% majority.  Opponents of Iran’s nuclear deal won only 68 seats, which is 23% of the Parliament.  This is a drastic change from the outgoing Parliament, where hardliners accounted for 65% of the seats, reports RT.  The victory of moderates slow islamization in Tajikistan.

Iran ranks low on the Ease of Doing Business Index and the Index of Economic Freedom.  Politics come before business, and poor enforcement of contracts plagues small firms. 

Iran, Tajikistan and Afghanistan belong to the Union of Persian-Language Countries, which promotes joint projects in culture, energy and railroad construction and may someday extend to military cooperation.  This benefits those countries but can be risky for Iran:  Having underdeveloped economies, Tajikistan and Afghanistan may borrow from Iran and ask for discounts when it’s time to pay up.  Also, regional peacekeeping would be expensive for Iran, and it would be opposed by other world players.  This weakness may prevent the union from becoming a regional power like NATO, the EU, the Collective Security Treaty Organization or the Eurasian Economic Union.  To join the Eurasian union, Tajikistan may have to negotiate with Iran, and its position is weak.    

In Uzbekistan, Karimov’s successor may try to negotiate better conditions with Russia and Iran.  The Kremlin is already trying to strengthen ties with Uzbekistan through Gazprom, purchasing more Uzbek natural gas and ceasing to purchase Turkmen gas, reported Gazeta.ru.  Nevertheless, neither Uzbekistan nor Turkmenistan is likely to join key Eurasian organizations, since this would undermine their traditionally closed economies and their authoritarianism. 

Turkmenistan is likely to vie with Russia in selling natural gas to Europe.  In the long run, gas usage is likely to increase, prolonging the regime in Ashgabat.  Russia must tolerate Turkmenistan's policy, since a color revolution there can spread extremism and since the Kremlin can do little about the autarky anyway. Turkmenistan will remain outside the Commonwealth of Independent States.

Kazakhstan, Turkmenistan and Iran have similar economies, and they must diversify if they want to encourage trade.  Incentives for this are weak in Turkmenistan, since its regime is practically unchallenged and since welfare benefits (given the blockage of information from abroad) create the illusion of prosperity.  In spite of low oil prices, the Government of Iran, too, will be tempted to keep its economic structure, due to resurgence of economic growth and lower inflation. Diversification is most likely in Kazakhstan, where the currency underwent a record depreciation, which will eventually encourage exports, if the country has enough to export.  Nevertheless, the government may be tempted to subsidize projects that will go bankrupt, making the road to building a diversified economy slow and costly, which typifies diversification problems for countries undergoing recession, particularly transition economies.

Being a competitor of Turkey in tourism and textiles, dependent on remittances from Russia, and having been ruled until 2010 by the pro-American President Kurmanbek Bakiyev, who failed to implement political reforms, Kyrgyzstan will remain loyal to the Russia-Iran alliance. Economic problems of Saudi Arabia and Qatar will inhibit their influence on Kyrgyzstan.

All countries in Central Asia will find it hard to maintain a multi-vector policy, but Kazakhstan will be in an especially difficult position, because of ties with the US and especially with Turkey -- the first countries to recognize Kazakhstan's independence.  By 2012, total Turkish investment in Kazakhstan since independence approached $2 billion, reports Kazinform.  At the recent World Economic Forum in Davos, prime ministers Karim Masimov and Akhmet Davutoglu agreed to increase trade, said Masimov’s official Web site.

Turkey’s conflict with Kurds and its involvement in Syria can decimate its economy and investment potential. To benefit, it can diversify exports by supplying goods to Iran’s mega-market and by taking advantage of scale economies.  Rial depreciation would be an obstacle.

Sanctions relief may slow this depreciation or even lead to appreciation over the next few years.   Central Asian countries should take advantage of this now, since the rial may weaken later.  If IMF forecasts are correct, Iran’s unemployment may rise slightly by 2017 due to increased foreign competition.  Assuming that European debt, migrant crises, and low oil prices continue, measures to create jobs despite inflation may appeal to policymakers. 

Sanctions relief has not strengthened the rial, but it is depreciating more slowly than the ruble or tenge.  This may put Kazakh exporters at a disadvantage.  However, Iranian oil firms may find equipment imports expensive. 

In sum, economic growth in Iran will expand its influence in Central Asia. 

Conclusion

Since the Islamic Revolution of 1979, Iran's relations with the West, and with the US in particular, have been uneasy.  Iran was accused of supporting terrorism and, starting from 2002, of building nuclear weapons.  It was placed under sanctions that crippled its economy.  Talks accomplished little until 2013, when the new president, the reformer Hassan Rouhani, set out to improve foreign relations.  Last July, world powers agreed to lift sanctions in 2016 once Iran was dismantling nuclear reactors suspected of producing nuclear weapons. 

Iran has the second largest economy in the Middle East and Northern Africa (after Saudi Arabia) and the second largest population (after Egypt). But the state largely controls the economy, which ranks lower than other nations in terms of business independence.  The state prevails in manufacturing and finance, and most farms are small.  Corporations are not transparent.

Iran has undertaken many joint projects in Central Asia.  Tajikistan, having a similar language, has the closest ties with Iran.  Along with Afghanistan, they belong to the Alliance of Persian-speaking Countries.  Due to its ambiguous, largely pro-American geopolitical position and its tense relations with Tajikistan, Uzbekistan’s ties to Iran are weak, though this may change after Karimov leaves office.   Turkmenistan's isolation from the rest of the CIS and its ties with Turkey impede relations with Iran.  Due to its economic structure, Kyrgyzstan is likely to remain loyal to the Russia-Iran alliance.  The issue is more complicated for Kazakhstan, which has a large trade turnover with Turkey, the first country to have recognized its independence.

Iran’s large population can enable its trading partners to exploit scale economies.  Their firms will have to face various restrictions from Iranian authorities, which will affect joint projects.  Iran's trading partners will have to face volatile exchange rates due to oil price changes and, hence, the volume of Iran's exports.  Railroads joining Central Asian countries with China will utilize their full capacity only if the economies of these countries are properly diversified.  In diversifying their economies, governments may be tempted to subsidize enterprises that may ultimately go bankrupt.  Diversification is not an end in itself. 

Dmitriy Belyanin has a Master’s degree of Business Administration in finance and a Bachelor of Arts degree in economics from KIMEP University.  Since 2007, he has been writing on issues in economics and finance ranging from stock markets to environmental economics. He is the associate editor of this blog.

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