Last week the President Vladimir Putin paid a visit to Iran for the first time in eight years, where he took part in the Gas Exporting Countries Forum. Although the ‘Gas OPEC’ summit is clearly resource-oriented, the arrival of the Russian President may in fact mark the start of building a close ‘non-resource’ partnership with the country that is more and more often referred to as the new regional leader of the Middle East. Symbolically, they agreed that Moscow will provide a $5 billion ‘export’ credit to Iran. According to Vladimir Putin, this money will be spent on ‘industrial cooperation’. Experts believe that if the export financing issue is addressed promptly, Iran, which has remained internationally isolated for the last several decades, may become a 'universal' trading partner with Moscow, purchasing a wide range of goods and services from Russian producers.

Suspended Modernization

"Iran finds itself in the state of a disrupted “second industrial modernization," says Professor Dmitry Yevstafiev from the Higher School of Economics. "This modernization was interrupted by the crisis of the Shah’s regime and the war with Iraq. After the sanctions are lifted, the country has a good chance of completing its modernization. And Russia has a good opportunity to become the leading provider for it. As modernization is to encompass practically all spheres of the country’s economy, the scale of investment will be colossal. And this will stimulate our own manufacturing industry."

Iran’s modernization of the 1970s, the so-called 'White Revolution', became possible largely due to a surge in oil prices. This enabled the country to develop several industries: automobile building, petrochemistry, radio technology, metallurgy, machine building. After the Islamic Revolution of 1979 and the consequent economic orientation entirely to the Islamic world, the development practically ground to a halt. The international isolation, including oil export restriction, hindered the attempts of the Iranian government to create a competitive economy. In July this year, Iran and the six world powers agreed that the sanctions would be lifted in exchange for closer international monitoring of the Iranian nuclear programme.

The unpublicized strategy of turning Iran into a regional leader, which the country’s government is currently implementing, is nothing short of a renewed attempt to quickly modernize the country. This presupposes a whole set of measures in the political, economic and military spheres. In the next 15 or 20 years, Iran may spend up to $500 billion on modernization purposes. Ruslan Pukhov, Director of the Centre for the Analysis of Strategies and Technologies, believes that Iran is driven to reforms by objective issues, which need to be addressed promptly. "Iran is a rather problematic state," he says. "It has a very complicated ethnic balance. Besides, not everyone shares the values of the Islamic Revolution. In this respect, the situation is a like that in the USSR before Gorbachov came to power. One set of morals for home, another for work, yet another for the street. There is significant tension inside society. Another enormous ‘weight’ is that a large part of state property is ineffective."

The new strategy of the Iranian government to launch large-scale economic transformations opens ample new opportunities for the Russian export, especially now that Russia and Iran are entering into a new political alliance. At present, the trade turnover between the two countries is extremely low: about $1.7 billion according to the Russian customs statistics (80% of which is the Russian export). Only 0.2% of the total Russian export goes to Iran (though it must be admitted that many more contracts go through Cyprus, Switzerland, Singapore or Hong Kong). The structure of this export is not very versatile. “All we export is rolled steel (steel parts at very low prices), timber, cereals. But in May Iran introduced a wheat import duty of $50 per ton, so even here the prospects are unclear,” says Alexander Sharov, Head of RusIranExpo, a company developing trade connections between the two countries.

Last year, the trade turnover rose insignificantly compared with 2013: from $1.6 to $1.682 billion. However, Russia’s export grew somewhat: from $1.168 to $1.327 billion. According to the customs statistics, there was a rise in the export of ferrous metals (about 1/3 of the whole export volume), cereals (another 1/3), wood pulp and other fibrous pulp materials, while the export of timber and paper products dropped. On the other hand, there was a dramatic increase in the export volume of some groups of commodities: for instance, from January to August, the export of animal and vegetable fats and oils grew by 55.7% reaching in terms of value $34.5 million, while the export of oil-bearing seeds and vegetables went up by 43.8% ($10.5 million). The volume of Russia’s export of plastic materials and products increased by 34.4% ($4.5 million), that of inorganic chemical products by 222.9% ($10.2 million), fertilizers by 2384.2% ($1.4 million), and aircraft by 811.9% ($4.3 million).

The extremely low trade turnover with Iran is largely explained by the sanctions that the country was exposed to until recently, and the absence of insurance on export goods. However, Iran is a promising market, which is evident even through purely qualitative indices. The country’s population is half that of Russia (around 78 million people). Iran has the second largest economy in the Middle East after Saudi Arabia. The per capita GDP to the current exchange rate is around $2500, which is approximately equal to that of Ukraine, but unlike that country, Iran is quite a solvent partner. It has about 10% of the world’s known reserves of oil and 15% of gas reserves (the fourth and second largest reserves respectively). Even though oil prices have sunk over the past year and a half, this is still a liquid commodity that can be sold in the global market. At present, Iran is exporting 1.4 million barrels of oil a day, but after the ‘nuclear deal’, it has a good chance of getting back to the 2011 level: 2.6 million barrels. In other words, even at the current price level, this comes to over $40 billion a year. "With its geographical position, Iran is the natural leader in the region, and it is essential for us in our ‘drive South’. We should not head towards the East, as it is almost totally occupied, we should be looking to the South," says Dmitry Yevstafiev.

Even given the situation with the oil prices, the Iranian economy completed the year 2014 in the black. It had grown by 3% in contrast with a 1.9% decline of 2013. The inflation went down from a peak of 45% in 2012 to 15.6% last summer. The country’s economic strategy is based largely on two key documents: a 20-year strategy of market oriented reforms and a 5-year development plan for 2016-2021. According to the five-year plan, Iran’s development is to repose on three pillars, two of which are economic: the creation of a ‘self-sufficient’ economy and the development of science and technology. The country plans to maintain an economic growth rate of at least 8% until 2021. Economic transition implies the overhaul of the loss-making state companies, changes in the financial and banking sector, and more efficient allocation of the profits of the oil industry.Financing is Crucial

Experts believe that with Iran, Russia must act as quickly as possible. "There is a problem with the institutionalization of our economic relations," says Dmitry Yevstafiev. "During the sanction period, it was impossible to do it properly, as it would create additional and unnecessary risks in terms of the ‘general profitability of relations’. Now this is a matter of principle. This issue is relevant both strategically (a new format of bilateral cooperation) and operationally. The latter is especially significant: Iran and Russia must acquire conceptually new platforms for implementing new projects, complete with good infrastructure and trade opportunities."

So far, Moscow has been responding to the new status quo in Iran rather promptly, offering cooperation in the sphere where our business feels sufficiently confident. According to Vladimir Putin, last week’s export credit agreement includes "35 priority projects in the sphere of energy, construction, sea terminals, electrification, railways, etc.” Alexander Sharov agrees that with Iran, there can be ‘a broad scope of work’. "In terms of new projects, deliveries of some new equipment from Russia, this could be first and foremost in the sphere of energy, and oil and gas machinery. We could also build new chemical plants, oil refinery capacity. Transport infrastructure, transport machine building," he says.

So far, the Russian business has already staked several key areas. The first one is, naturally, energy. Beside fuel, it is electric power generation. The consumption of electric power in Iran increases annually by about 8%, following the population growth. Therefore, the prospects in this area look really promising. Many will remember the epic construction of the first atomic power generating unit in Bushehr, which Russia started back in the difficult 1990s. The unit worth $1 billion was brought into operation 19 years after the signing of the contract. Today, the country has a far greater financial and technical capability to develop Iran’s atomic energy. A year ago, Rosatom signed an agreement, according to which the two countries are to cooperate in the construction of eight power generating units in Iran, for which Russia is to supply pressurized water reactors on a turnkey basis (four power generating units at the Bushehr plant and four at another plant). In mid-November, another agreement was signed between Technopromexport and the Iranian Ministry of Economy to construct two heat and power stations with a total capacity of over 2,000 MWt, worth over $3 billion.

Another promising field is transportation projects. The largest one is the Russian Railway’s plan to adapt Iranian railways to electric traction. The total volume of prospective contracts of the Russian Railways to construct and electrify railways in Iran encompasses 5,600 km of railways and has been estimated at about $6 billion. In October 2012, the Russian Railways completed its first project in Iran, under which it electrified the 46 km long line between Tebriz and Azarshahr with 5 stations. At present, Iran has initialed a part of the ‘bigger’ contract worth $860 million. In total, according to the Minister of Energy, Russia and Iran are discussing "a large range of transport projects worth a total of $25 billion."

The producers of rolled steel pin their hopes on Iranian modernization, too. To increase the consumption of gas, the Iranian government plans to build 4,500 km of pipelines in the next 5 years, which will require about 3 million tons of large-diameter pipes. The Chelyabinsk Pipe-rolling Plant, which used to sell up to 30,000 tons of its products to Iran before the imposition of the sanctions, has already announced its plan to get back to the Iranian market in the nearest future. In early October, an Iranian delegation including the Iranian Ambassador to the Russian Federation visited the pipe-rolling production site in Chelyabinsk.

As for machine building products, Iran is interested in buying Russian cars (for example, produced at the Ulyanovsk Car Factory), railway cars, aircraft and helicopters. Last summer, at the Zhukovsky airshow, several contracts were signed to supply aerospace equipment to Iran worth $21 billion. Uralvagonzavod (a railway car producer) intends to start promoting its products to the Iranian market soon. Experts estimate that over the coming decade, Iran will need 30,000 new freight and passenger railway cars.

Now that the international sanctions against Iran are becoming a thing of the past, the key problem for the development of the bilateral trade is the financial issue. "Iran at present does not have sufficient financial resources to significantly increase its import from Russia, as it still has to operate under clearing schemes, supplying oil in exchange for reciprocal deliveries of goods. Tehran has no spare dollars or rubles to buy Russian products", the Russian trade representative in Iran Andrey Lugansky told Rossiyskaya Gazeta in an interview in November. The trade representative rests hopes on the creation of a Russian-Iranian Bank, which could resolve such complications by attracting third countries, like China, with which both Iran and Russia have buoyant commercial relations.

According to Radjab Safarov, head of the Centre for Studies of Modern Iran, the annual trade turnover could grow up to $10 billion a year. There are all the prerequisites for that: the opening market, the logistic link across the Caspian Sea, the political will. Alexander Sharov agrees that this figure is realistic, although Iran’s import tax on equipment is from 17 to 70%. But, he points out, there is one condition: "The chief problem for the Russian export to Iran is the absence of financing. There are a great number of companies from Europe and the region that can enter and are entering the Iranian market with their own funds. That means, our business in the Iranian market can work only if export financing is provided. Over the past three years, not a single insurance policy has been issued on export deliveries to Iran. Companies had to find the means on their own. For example, the Elektrostal Heavy Machine Plant used this way to deliver two pipe rolling mills to Iran."

Dmitry Yevstafiev of the Higher School of Economics warns: the development of the above mentioned ‘industrial cooperation’ can be also hampered by the differently directed tactical interests of Moscow and Tehran in the oil market. Russia is interested in a higher price of fossil fuels, while Iran wants by any means possible to regain its market share lost during the sanctions period. "The chief issue on the agenda is oil. This reflects the objective reality of our relations. However, the domination of oil and obsession with it can thwart the progress of long-term cooperation in non-fuel areas. And it is such areas that must become the core. The important thing is not to waste ourselves on trifles and not to put short-term goals above our long-term interests."