Election Aftershock in Corporate Iran

Stanley Reed and Babak Pirouz, BusinessWeek:

The President-elect is anti-capitalist and anti-West, so investment may suffer

The Iranian business community is still reeling. Most executives favored the pro-business Hashemi Rafsanjani in the Islamic Republic's June 24 presidential contest and expected him to win. Instead, the candidate of the hardliners, Tehran Mayor Mahmoud Ahmadinejad, triumphed by a landslide. Now the business community is trying to figure out what the conservative victory means for them. "I have stopped shaving, taking showers, and wearing ties," jokes one depressed executive, referring to the scruffy neo-revolutionary style. READ MORE

Ahmadinejad's win, with 62% of the vote, could well be a watershed for Iranian politics. It signals the end of the reform era that began when Rafsanjani first won the presidency in 1988. Rafsanjani's two terms, followed by outgoing President Mohammed Khatami's two, marked a gradual opening to the West and a relaxing of the Islamic Republic's social strictures. On the eve of this election, the business elite hoped that the Islamic regime, with its interference in peoples' lives and its xenophobia, was fading into the background. Rafsanjani was their man: a thoroughly flexible mullah who even hinted at reestablishing relations with the U.S. His election might have triggered an investment boom.

Instead of Rafsanjani, a new generation of hard-line Islamists, many with military backgrounds, has come to the fore. Ahmadinejad, a 49-year-old former revolutionary guard suspicious of outsiders, capitalists, and technocrats, typifies this breed of leader. Not a mullah, he is nonetheless close to the Supreme Leader, Ayatollah Ali Khamenei.

He struck a popular chord by criticizing the ruling elite as corrupt. Ahmadinejad's winning margin reflects disgust among Iranians with the elite's tendency to self-enrichment. Iranians saw him as the best hope to stamp out corruption and redistribute the country's oil wealth.

Many ordinary Iranians also approve of Ahmadinejad's nationalist streak. But his election increases the risk of confrontation with the U.S. and Europe on everything from Iran's nuclear program to political developments in neighboring Iraq. While he won't be directly in charge of Iran's nuclear efforts, which come under Khamenei's umbrella, Ahmadinejad's ascendancy is likely to bolster the hardliners who want Iran to take a tougher stance on nukes. That's bad news for the Europeans, who are trying to come up with a deal by the end of July to entice Iran to give up its nuclear fuel cycle permanently. The rhetoric from both Tehran and Washington may intensify, pushing oil prices even higher.

Ahmadinejad's Islamic socialist economic approach could also deal a blow to a country that badly needs private investment and foreign technology. Economic growth, which has hovered around 7% annually in the past two years, dipped below 5% recently as companies worried about the election and tension with the U.S. In his first press conference, on June 26, Ahmadinejad tried to calm the jittery business community. "The country is in need of progress, and for this reason we will support the stock market," he told reporters. But he had campaigned on a populist platform, blaming the emergence of private banks and Iran's very modest privatization program for increasing the income gap between rich and poor.

BLOATED DEFICIT

Now, economists worry that the new President will adopt irresponsible policies, offering big government handouts while discouraging investment. Giveaways are already at worrisome levels: Some $20 billion a year is spent to subsidize fuel and power. The budget deficit hit 7.8% of gross domestic product for the fiscal year ending in March, 2005. "[Ahmadinejad] doesn't have a program," says Hadi Zonooz, an assistant economics professor at Allameh Tabataba'i University in Tehran. "He is just pretending to protect the poor people."

Certainly, executives are concerned that the investment climate could deteriorate. Entrepreneurs such as Tehran-based Shahriar Besharat have discovered that they can make serious money in Iran's fast-growing market of nearly 70 million consumers. Three years ago he established one of Iran's first bottled-water operations with French partner Groupe Castel. Revenues have reached about $30 million, and sales could grow even faster than the current 40% to 50% per annum if Besharat could find managers to staff a new plant.

Now he plans to wait and see what kinds of policies emerge from the new government before expanding further. So do other industrialists and their foreign partners, who were laying the groundwork before the election for major investments totaling hundreds of million dollars. But big new projects won't go forward until companies know whether Ahmadinejad's skepticism of Western-style capitalism holds -- or whether he realizes the country sorely needs capital and knowhow to create enough economic growth to bring down 15% to 20% unemployment. "Everyone familiar with Iran knows we have a huge amount of potential," says Masoud Nili, head of the economics department at Sharif University of Technology in Tehran. "It all depends on how sensible our policies are."

Some investors are betting pragmatism will prevail. Marcus Gerhardt, a London financier, is raising $50 million to $100 million for his new private equity Turquoise Fund to pour into Iranian companies. He has lined up Iranian industrialists and financial specialists to help him identify targets, and found interest among investors in the Gulf. Gerhardt plans to move ahead despite the election result. "The pressure is now on the conservatives to deliver" better economic performance and jobs, he says.

But that may be wishful thinking. At the least, Tehran's new political lineup means uncertainty. The conservatives seem determined to settle scores at the Oil Ministry, which they have long considered corrupt. Rafsanjani allies, including Oil Minister Bijan Zanganeh, are likely to go, analysts say. In the short term, oil and gas production, which accounts for about 25% of gross domestic product, will likely stay at current levels. But over the longer term, projects could be delayed, hitting output.

Just how much Ahmadinejad plans to rock the boat will become clearer as he prepares to assume power on Aug. 4. Although he served as Tehran's mayor for two years and before that as governor-general of the city of Ardabil, his track record is undistinguished. The son of a blacksmith, Ahmadinejad portrays himself as a simple man. However, he holds bachelor's and master's degrees in civil engineering and a PhD. in traffic management -- though he has failed to tame the traffic in Iran's capital. In Tehran, Ahmadinejad is mainly known for his public relations skills -- he frequently held meetings with local citizens. His broader experience is limited.

Still, as long as oil prices hold up, Iran's new President will likely have the wherewithal to buy social peace with ever-larger subsidies. If oil earnings collapse and he fails to encourage investment, Ahmadinejad may wind up just as unpopular as the rival he defeated.

By Stanley Reed and Babak Pirouz in Tehran