Fitch Ratings-London-06 February 2006: Fitch Ratings (UK) Limited has today revised the Outlook on the Islamic Republic of Iran's foreign currency and local currency Issuer Default Ratings to Negative from Stable. Both ratings and the Country Ceiling are affirmed at 'BB-' (BB minus). The Short-term rating is affirmed at 'B'.
"The Negative Outlook balances the improvement in many of Iran's external indicators, due to current high oil prices, against a deterioration in political risk manifest both in weaker macroeconomic policy settings and the escalation of the dispute over Iran's nuclear programme, which heightens the risk of damaging sanctions being imposed," says Richard Fox, Head of Middle East and Africa sovereign ratings at Fitch (UK). A further deterioration in Iran's relations with the international community would likely prompt a downgrade of Iran's sovereign ratings, as it would materially increase the risk of international financial sanctions being imposed.
Iran is the largest net external creditor rated below investment grade, just ahead of newly rated Nigeria, also 'BB-' (BB minus). Political risk already weighs heavily on the rating. However, with the IAEA having decided last week to "report" Iran to the UN Security Council, the risk of sanctions being imposed has increased. Space for a negotiated settlement still exists, but room for compromise appears to have diminished. Future rating action will be driven primarily by political developments as they affect both economic policy and especially international relations and the prospect of sanctions.
The macroeconomic policy stance has also taken a turn for the worse over the past year. A large proportion of windfall oil revenues is being spent, with the Oil Stabilisation Fund (OSF) not fulfilling its role as an effective countercyclical device. Current spending rose 37% in the first half of Iranian year 2005/6 and was almost a quarter over budget. Particularly damaging was the Majlis' decision to freeze already low petroleum prices and some utility prices, increasing the cost of subsidies, which already account for a quarter of all spending. This goes against the thrust of the latest Five Year Development Plan (FYDP), which envisages a gradual phasing out of subsidies. The 2006/7 budget has still to be finalised, but Fitch expects fiscal policy to remain expansionary. The underlying oil price assumption, which sets the baseline for spending, is set to rise by over 40%. Fitch is concerned that if oil prices weaken even modestly, current rapid spending growth could quickly erode the budget and current account surpluses. For the time being, however, high oil prices have increased the cushion available to Iran in such an eventuality. Fitch estimates that Iran's international reserves and the balance of the OSF combined will increase at least USD10 billion this year.
Rapid spending of oil revenues also threatens to increase inflation, with the tools available to the monetary authorities to counter this fairly limited. The Majlis last year removed the authority of the central bank to issue participation paper for sterilisation purposes; this now rests with the cabinet. Interest rates are also inflexible and there is political pressure to reduce them. Although the latest FYDP targets single-digit inflation, the combination of fiscal indiscipline and a lack of coordination of fiscal and monetary policy threaten to undermine this target.
The FYDP envisages further structural reform, for example privatisation, but little progress is evident yet. The appetite of foreign investors will meanwhile have been diminished by the negative signal sent by the Majlis last year when it decided to reduce the stake of a foreign investor in Iran's second mobile license to 49% from 70%. The business climate is also increasingly being affected by the escalation of Iran's dispute with the international community over its nuclear programme.
Contact: Richard Fox, London, Tel: +44 (0)20 7417 4357; Paul Rawkins, +44 (0)20 7417 4239.
Media Relations: Jon Laycock, London, Tel: +44 20 7417 4327.
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