Automotive brief: Iran
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Iran: Flexibility in contract negotiations to arise out of uneven enforcement of local content regulations
Iran’s automotive sector was the subject of early interest from foreign companies following the implementation in January 2016 of the Joint Comprehensive Plan of Action (JCPOA), which eased sanctions on the country in exchange for restrictions on its nuclear enrichment programme. Leading international manufacturers have since announced agreements with Iranian companies to produce commercial and passenger vehicles in Iran.
The automotive industry is a strategically important sector in Iran in which there is a high level of state involvement. President Hassan Rowhani’s government regards the entry of foreign automotive companies as an opportunity to make the industry more competitive. This in turn should enable Iran to become less reliant on imported vehicles and parts, and reduce the financial burden that the sector places on the government’s budget.
The International Organisation of Motor Vehicle Manufacturers (OICA) indicates that Iran’s automotive sector had the largest growth rate internationally in 2016.
OICA said that Iranian automakers in 2016 produced 1,074,000 cars and 90,710 commercial vehicles, recording an 18.6% annual growth. Iran is now 14th among the 39 countries that OICA says play an active role in the international automotive industry.
Iran aims to manufacture 3m vehicles annually by 2025, 1m of which will be for export. It also plans to export $6bn of auto parts each year. To achieve these objectives, the authorities have set local content requirements. They have stipulated that contracts with foreign carmakers should ensure that vehicles are manufactured with at least 40% of domestic parts, and that this figure should be gradually increased to 80% over the coming years. Iran also aims to become an export hub and therefore requires 30% of jointly manufactured automobiles to be exported. It has made changes to its tax system in an attempt to encourage exports: companies exporting at least 30% of what they produce are exempt from up to 50% of taxes.
Local content requirements in the automotive sector will be inconsistently enforced over the coming two years. Although Iran is likely to continue to require foreign companies to produce vehicles and parts domestically, and to have a significant amount of output in the sector, Control Risks’ sources in the industry have indicated that the government’s targets are unrealistic. Foreign partners in joint ventures will need to help Iranian parts manufacturers if the partnerships are to meet the 40% local content requirements. As such, foreign companies that are considering manufacturing in the country will have some scope to negotiate their local content targets. Our experience of advising companies in the country shows that the government has shown some flexibility in this regard during the early stages of production, and it is likely to continue to do so.
Although the 30% export quota will remain a legal requirement, it too is unlikely to be fully enforced. Such export requirements have been part of joint-production contracts in the past. However, they were not met as production levels were insufficient and the models manufactured did not meet the standards required by foreign buyers. Iranian manufacturers and parts providers are unlikely to be able to meet these standards over the coming years for the number of vehicles that the government is seeking to export.
A cornerstone of the ‘resistance economy’
Local content and export regulations in the automotive sector are unlikely to undergo any significant changes following May’s presidential elections. Supreme Leader Ali Khamenei will continue to champion the ‘resistance economy’, which aims to strengthen domestic economic capacity and reduce Iran’s dependence on oil and imports. The automotive sector will be among the cornerstones of such a strategy, and it is therefore unlikely that any government will formally relax these requirements. Nevertheless, we expect Rowhani to be re-elected and to find case-by-case workarounds that allow foreign companies to contribute to the development of Iran’s manufacturing sector, thereby deflecting criticism from his political opponents. If a more hard-line president takes power, there will be a further shift towards the ‘resistance economy’ that could result in even higher local content requirements and a greater shift towards protectionism.
Any foreign company that achieves concessions from the authorities will face criticism from hard-line politicians and their supporters in the Iranian media.
Any foreign company that achieves concessions from the authorities for its local content and export requirements will face criticism from hard-line politicians and their supporters in the Iranian media. Outlets controlled by hard-line factions will continue to portray the concessions as evidence that Rowhani’s government is neither willing nor able to make the ‘resistance economy’ a reality. Some representatives of Iran's Auto Parts Makers Guild have maintained that the concessions illustrate foreign companies’ unwillingness to use local parts manufacturers. Such criticisms will increase significantly should the government fail to keep its promise to limit the concessions in the initial phases of individual joint ventures. The ministry said that this period would comprise the first six months of production in Iran.
Regulatory change ahead?
There are unlikely to be any changes in Iran’s regulatory framework before the presidential elections. Significant changes in investment restriction and regulatory risks are unlikely unless Rowhani loses to a hard-line conservative candidate, which we do not currently believe is likely. The current minister of industry, mines and trade, Mohammad Reza Nematzadeh, is likely to be replaced after the election. Nematzadeh has faced criticism from across the Iranian political establishment. He is also elderly and was seen as close to the late former president Akbar Hashemi Rafsanjani (1989-97). It is also likely that other key officials in the automotive sector will change roles and that decision-making will slow down while people settle into their new roles. If Nematzadeh is replaced following Rowhani’s re-election, it will be unlikely to lead to any significant changes in the regulation of the automotive sector.
Nevertheless, in the longer term, the sector will be affected over the coming two years by regulatory unpredictability and political interference. These factors will be a consequence of the factional nature of Iranian domestic politics and the government’s efforts to balance business and political interests in Iran with the country’s need for foreign investment. Local content requirements will be inconsistently enforced and subject to negotiations between foreign companies and their Iranian joint venture partners.