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IRAN


 

REPUBLICAN REFERENCE

Area (sq.km)
1.648 million

Population
66,128,965

Capital
Teheran

Currency
Iranian rials

President
Mohammad Khatami-Ardakani

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Background:
Known as Persia until 1935, Iran became an Islamic republic in 1979 after the ruling shah was forced into exile. Conservative clerical forces subsequently crushed the westernising liberal element. During 1980-88, Iran fought a bloody, indecisive war with Iraq over disputed territory, which caused large-scale damage to its economy. The key current issue is how rapidly the country should open up to the modernising influences of the outside world, with a conservative faction in control of some key institutions, such as the Council of Guardians, and a reformist faction centred on elected President Khatami. 

US and Iran 
Despite the apparent improvement in the relations between the US and Iran, which had followed the 11 September terrorist attacks, by January 2002 the tension between the two countries had reached new peaks. President Bush accused Iran of being part of an "axis of evil" together with Iraq and North Korea and asked Iran to stop meddling in the internal affairs of Afghanistan and developing weapons of mass destruction. While the Iranian leadership has good reason to be worried about the intensification of American hostility, the Bush administration is clearly not planning any direct action yet. By July, however, with his call for "reform from below", President Bush appeared increasingly interested in fomenting a revolt against the Islamist regime. There are clear signs that the ruling elite feels seriously threatened and fears a tightening of the embargo. It is estimated that since the beginning of the year several billion US$ have returned to the country, as the government repatriates its gold reserves previously held by European central banks. By mid-May even the reformist President Khatami felt that he had to take a strong stance and warned the US administration against "threatening, insulting and humiliating" Iran. As a reaction to growing American pressure, Teheran strengthened its efforts to improve its relations with its Islamic neighbours, such as the Central Asian countries, Azerbaijan and even Saudi Arabia.
The reformist government of Iran is keen on improving relations with the US. Not only it stated that it was ready to accept a new, tougher resolution on Iraq, but also took the unprecedented step of declaring that a two-states solution is acceptable for Palestine, so long as the Palestinians accept it. There remains, however, strong opposition from the conservatives, who dominate a number of key institutions, first and foremost the Council of Guardians, and count among their members the Supreme spiritual leader, Ayatollah Khamenei. Calls for the formation of a united national front against "American aggression" appeared to be delivering some results until April, with a lull in the repression of dissidents and the liberal press. 
However, the conservatives are not uniformly hostile to improving Iran's relations with the US, as some of them argue that such an improvement would make it easier to maintain the status quo internally. Supporting a US war against Iraq could be a suitable way to buy American acquiescence for the lack of internal reforms. Still, many in Iran fear that in the event of a war its economy would suffer severely, not least because of a likely massive influx of refugees. The possibility of Kurdish nationalism being strengthened by a war in Iraq is also seen with apprehension in Teheran. On the whole, the Bush administration did not openly respond to hints coming from conservatives that a deal might be possible, but the press suggested that it might actually be considering to enlist some help from Iran. For sure, as the international attention turned to Iraq, from October Iran was spared the war of words that had afflicted it during the previous months. 

Iran and the rest of the world
The main tool in the hand of the US administration for exerting pressure on Iran is increasing its isolation from the rest of the world, in particular Iran's neighbours and trading partners. The largest economies appear the least likely to bow to the pressure. The European Union in particular looks inclined to actually expand its ties to Iran. After some initial anxiety, the EU announced in July its readiness to develop closer commercial ties with Teheran, although conditionally on Iranian willingness to discuss such issues as nuclear proliferation, terrorism and human rights. There have been delays in the negotiation of deals with Russia and Japan in the oil, nuclear and defence industries, but in the end both countries appear intent on continuing their flourishing trade with Iran. The main danger to Iran is that Russia could soon be lured towards a more pro-American stance in exchange for economic concessions, which might include forgiving Russia's Soviet era debt in exchange for the termination of nuclear cooperation with Iran. The fact that Russia and Iran have increasingly diverging ideas about how to deal with the resources of the Caspian Sea might have contributed to push Russia away from Iran. President Putin, however, appears to be trying to strike a delicate balance between continuing Russia's lucrative trade with Iran, while at the same time doing his best to appease American fears of Iranian interest in weapons of mass destruction. 

Economic prospects 
Apart from the international tensions, the economic and political situation of Iran remains uncertain. The development of oil extraction in Iran has been negatively affected by project delays and by some flaws in the buy-back deals negotiated with the international investors and it is by no means certain that Iran will succeed in increasing its production to the levels planned. A failure would have very negative consequences for the economic stability of the country, due to the rapid growth of internal consumption of oil, which is expected by some analysts to match the volume of exports during the current year. Petrol is sold within Iran at heavily subsidised prices, with a litre costing to the Iranian motorist just $0.063, which encourages high consumption levels and waste. Moreover, while Iran is being relatively successful in attracting investment towards the development of oil extraction, it has not succeeded yet in doing the same for the construction of pipelines to East Asia, a market for which the country is potentially very well placed. 

Economics and demographics of a latent crisis 
If the debate about the chances of success of Iran's plan to expand its oil production is still undecided, there is no doubt that the Islamic Republic cannot afford a failure. Although the birth rate has now been brought down to manageable levels, the baby boom generation is beginning to join the workforce, causing a terrible headache to the government. With 5.5 million high school certificate holders expected to join the job market in the next four years, the government needs to create more than 1,300,000 new jobs every year to prevent an increase in the unemployment rate and keep the population happy, but in 2000/2001 it succeeded in creating just 400,000. To generate the required amount of jobs, Iran's economy should growth at the yearly rate of 12%. Economic growth reached 4.5% in 2000/2001, short of the 6% target but still not a bad achievement when judged by the standards of Iran's performance over the last decade. In 2001/2002, which according to the Iranian calendar ended on 21 March, low oil prices and a cut in production will ensure that growth will be lower, probably around 3.5%. It appears obvious that it will be difficult to achieve significantly higher growth rates without attracting massive foreign investment, but there is a strong opposition among conservatives against foreigners playing a much larger role in Iran's economy. Moreover, during the early months of 2002 the negotiations with potential investors in Iran's oil and gas industry took a negative turn, although there were signs of improvement towards the end of the summer. A wave of financial scandals has hit executives of some Iranian oil companies involved in partnerships with foreign investors and Iranian officials are now delaying the negotiations, fearful of attracting the attention of a judiciary which is closely aligned with the conservative faction. International investors, on the other hand, are increasingly sceptical of the Iranian market under the present conditions and are demanding more favourable contracts. During May there were indeed some signs of a growing willingness to offer more appealing conditions to foreign investors, as the chairman of the parliamentary energy committee, Hossein Aferideh, proposed to lengthen the buy-back contracts which represent Iran's approach to reaching agreements with international investors. At present, buy-back contracts last five to seven years, which is considered too short by many players in the oil industry. Iran will need to invest $30 billion over the next 8-9 years to maintain its share of world oil exports. The ageing Iranian fields have lost production capacity at the rate of 250,000 barrels per day, 6.4% of annual production. At least $1 billion are needed every year to maintain production at the current levels. This year, the situation is compounded by an extensive program of well maintenance and by a series of strikes in the industry, which is resulting in a 8-9% decline in exports of crude Iranian oil. In the strategy of the Khatami government, gas is supposed to make up for the shortcomings of the oil industry. Since Iran has huge reserves of gas, which at present are largely under-exploited, it would make good sense to move the focus of the investments in that direction. It is significant, however, that one of Iran's newest gas clients, Turkey, successfully bargained for lower prices after being offered a substantial discount by Russia. Russia's increasingly aggressive marketing practices might cause more problems to Iran in the future, as it continues its efforts to penetrate the European market.

Foreign investments and internal politics 
Investment in the oil industry is less controversial, because it tends to be easier to isolate from the mainstream of society and because the rewards are so obvious. But that will likely not be enough to inject enough dynamism in the Iranian economy. The opportunity to attract funds towards other sectors certainly exists. An important sign was the successful launch in July of the new euro bonds, the first denominated in a foreign currency since the Islamic revolution. There are now plans for new issues of euro bonds and even a proposal to receive oil payments in euros. Foreign businesses express a strong interest in the Iranian internal market, which at present is underdeveloped, due to restrictions to imports, which are not allowed to exceed $15 billion, and to the inability of the domestic industries to meet demand. In the car industry, for example, it is estimated that annual sales of 300,000 cover only half of potential demand. It is expected that in the foreseeable future most investments in the non-oil sector will come from Arab countries, but already some European companies are beginning to invest small sums. Even the World Bank is planning to invest in Iran, despite the likelihood of us opposition.
The attempts to reform the Iranian economy and political system have been slowed by the opposition of the conservative faction. The Council of Guardians has been blocking the introduction of several laws, including the new foreign investment law, approved by the parliament. There are however some signs that doubts are emerging within the conservative camp, with some taking a more moderate stance. On the other hand, there are divisions within the ranks of the reformists too, as they include both groups favourable to the liberalisation of the economy and others, such as the Islamic left, who are cold towards it. Even the 2002-2003 Iranian budget, approved during the spring, reflects the political constraints under which Khatami and his government have to operate. Spending has gone up massively on the previous year, with tax cuts and massive pay rises to civil servants, whose real income is increasing by 17% in real terms. The government expects to pay for a large part of such increases in expenditures through the privatisation program, which however has been stagnating for a while and might well continue to do so in the near future. Most observers therefore believe that Teheran will soon be running a massive deficit. 
Some reformists are also showing signs of growing impatience with the pace of the reforms and Khatami is beginning to be accused of failing to deliver the democratic reforms he had promised. A number of draft laws, which are crucial to the re-launching of Iran's economy, remain blocked, due to the opposition of the conservatives. Such laws include a project to end the unaccountability of the foundations, which control a large part of the Iranian economy, a large-scale privatisation program, a new labour code and several others. The renewed pressure of the units of the "moral" police on an increasingly impatient youth, together with the ongoing repression against the reformist press, only contributes to the radicalisation of a part of the opposition. There is a concrete danger that at some point in the future the political climate might deteriorate to the point where the economic and social framework is seriously disrupted. Faced with a conservative opposition that showed little sign of wearing down, President Khatami finally decided for an all-out assault on the main conservative stronghold, the council of guardians. During September the reformist government presented a draft law, which would greatly reduce the powers of the council, especially as far as its ability to disqualify election candidates is concerned. The government also appears to be about to present other constitutional and administrative reforms, including greater powers for the president. President Khatami has already warned that he might resign if his projects are not approved, leaving the country in a state of chaos.
The outcome of the conflict between conservatives and reformists remains uncertain. while the possibility of a conservative coup d'état has long been in the air, Khatami's move appears to weaken what many saw as the only alternative to a head-on clash between left and right, that is a new coalition between moderate conservative and moderate reformers. The latter would include the reformist right of the executives of reconstruction party and the moderate left of the militant clerics society, which are both part of the current government coalition. By contrast, the more radical reformers of the Islamic Iran participation front and of the Mujahidin of the Islamic revolution would be left in opposition, once weakened in partially rigged new elections. 

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Summary for 2002

US and Iran 
Despite the apparent improvement in the relations between the US and Iran, which had followed the 11 September terrorist attacks, by January 2002 the tension between the two countries had reached new peaks. President Bush accused Iran of being part of an "axis of evil" together with Iraq and North Korea and asked Iran to stop meddling in the internal affairs of Afghanistan and developing weapons of mass destruction. While the Iranian leadership had good reason to be worried about the intensification of American hostility, the Bush administration was clearly not planning any direct action yet. By July, however, with his call for "reform from below", President Bush appeared increasingly interested in fomenting a revolt against the Islamist regime. There are clear signs that the ruling elite felt seriously threatened and feared at least a tightening of the embargo. It seems that at least part of the several billion US$ that returned to the country during 2002 was made up of the gold reserves of the government, previously held by European central banks. By mid-May even the reformist President Khatami felt that he had to take a strong stance and warned the US administration against "threatening, insulting and humiliating" Iran. As a reaction to growing American pressure, Teheran strengthened its efforts to improve its relations with its Muslim neighbours, such as the Central Asian countries, Azerbaijan and even Saudi Arabia.
The reformist government of Iran remained in reality keen on improving relations with the US. During 2002 it gave out plenty of signals pointing in this direction. Among them, not only it stated that it was ready to accept a new, tougher resolution on Iraq and collaborated to enforce a stricter embargo, but also took the unprecedented step of declaring that a two-states solution is acceptable for Palestine, so long as the Palestinians accept it. Even the conservatives, who dominate a number of key institutions, first and foremost the Council of Guardians, and count among their members the Supreme Spiritual Leader, Ayatollah Khamenei, were not uniformly hostile to improving Iran's relations with the US, at least not at all times. Some of them argued that such an improvement would make it easier to maintain the status quo internally. Supporting a US war against Iraq could be a suitable way to buy American acquiescence for the lack of internal reforms. The majority of the conservatives, in any case, maintained at least on the surface a strong opposition to reconciliation with the US. 
Even if the reformists were willing to acquiesce to US war plans in neighbouring Iraq, they feared that in the event of a war its economy would suffer severely, not least because of a likely massive influx of refugees. The possibility of Kurdish nationalism being strengthened by a war in Iraq was also seen with apprehension in Teheran. On the whole, the Bush administration did not openly respond to hints coming from conservatives that a deal might be possible, but the press suggested that it might actually be considering to enlist some help from Iran. For sure, as the international attention turned to Iraq, from October Iran was spared the war of words that had afflicted it during the previous months. In any case, as the end of 2002 approached, the Bush administration maintained that it would welcome an internal overthrow of the Iranian regime.

Iran and the rest of the world
The main tool in the hand of the US administration for exerting pressure on Iran is increasing its isolation from the rest of the world, in particular Iran's neighbours and trading partners. During 2002, it appeared clear that the largest economies were the least likely to bow to the pressure. The European Union in particular decided to actually expand its ties to Iran. After some initial anxiety, the EU announced in July its readiness to develop closer commercial ties with Teheran, although conditionally on Iranian willingness to discuss such issues as nuclear proliferation, terrorism and human rights. There have been delays in the negotiation of deals with Russia and Japan in the oil, nuclear and defence industries, but in the end both countries looked intent on continuing their flourishing trade with Iran. The main danger to Iran could have been that Russia could soon be lured towards a more pro-American stance in exchange for economic concessions, which might include forgiving Russia's Soviet era debt in exchange for the termination of nuclear cooperation with Iran. The fact that Russia and Iran developed diverging ideas about how to deal with the resources of the Caspian Sea might have contributed to push Russia away from Iran. President Putin, however, opted instead to strike a delicate balance between continuing Russia's lucrative trade with Iran, while at the same time doing his best to appease American fears of Iranian interest in weapons of mass destruction. 

Economic prospects 
Apart from the international tensions, the economic and political situation of Iran remained highly uncertain throughout 2002. The development of oil extraction in Iran was negatively affected by project delays and by some flaws in the buy-back deals negotiated with the international investors and it increasingly looked doubtful whether Iran could succeed in increasing its production to the levels planned. A failure would have very negative consequences for the economic stability of the country, due to the rapid growth of internal consumption of oil, which was expected by some analysts to match the volume of exports as early as in 2002 itself. Petrol is sold within Iran at heavily subsidised prices, with a litre costing to the Iranian motorist just $0.063, which encourages therefore high consumption levels and waste, only makes the matter more urgent. 

Economics and demographics of a latent crisis 
If the debate about the chances of success of Iran's plan to expand its oil production was still undecided at the end of 2002, there has never been any doubt that the Islamic Republic cannot afford a failure. Although the birth rate has been brought down to manageable levels in recent years, the baby boom generation is beginning to join the workforce, causing a terrible headache to the government. With 5.5 million high school certificate holders expected to join the job market in 2002-2005, the government needs to create more than 1,300,000 new jobs every year to prevent an increase in the unemployment rate and keep the population happy, but in 2000/2001 it succeeded in creating just 400,000. To generate the required amount of jobs, Iran's economy should grow at the yearly rate of 12%. Economic growth reached 4.5% in 2000/2001, short of the 6% target but still not a bad achievement when judged by the standards of Iran's performance over the last decade. In 2001/2002, which according to the Iranian calendar ended on 21 March, low oil prices and a cut in production ensured that growth was lower, around 3.5%. In 2002-2003 very favourable circumstances, including most of all an increase in oil prices, contributed decisively to strengthen economic growth, now expected to reach 6.4%. Many Iranian businessmen, faced with poor performances in the American and European markets, moved their assets back to Iran, which on the other hand has reduced taxes and has approved a more friendly foreign investment law. It is estimated that private funds account for a large part of at least US$7 billion which have gone back to Iran in 2002, underpinning among other things a very good performance of the Teheran stock exchange, which became one of the world's best performing, up by 30%. However, even such as performance will not be enough to cure Iran's economic ills. Moreover, during the early months of 2002 the negotiations with potential investors in Iran's oil and gas industry took a negative turn, although there were signs of improvement towards the end of the summer. In 2002 a wave of financial scandals hit executives of some Iranian oil companies involved in partnerships with foreign investors and Iranian officials showed a marked tendency to delay negotiations, fearful of attracting the attention of a judiciary which is closely aligned with the conservative faction. International investors, on the other hand, became increasingly wary of investing in the Iranian market, in particular as they began to feel that it might be possible to extract better conditions. Only state-owned companies, such as Norwegian Statoil, continued to sign contracts with the Iranian government. Starting from May there were indeed some signs of a growing willingness to offer more appealing conditions to foreign investors, as the chairman of the parliamentary energy committee, Hossein Aferideh, proposed to lengthen the buy-back contracts which represent Iran's approach to reaching agreements with international investors. At present, buy-back contracts last five to seven years, which is considered too short by many players in the oil industry. 
In 2002, the situation of the oil industry was compounded by an extensive program of well maintenance and by a series of strikes in the industry, which resulted in an estimated 8-9% decline in exports of crude Iranian oil. It is significant, however, that one of Iran's newest gas clients, Turkey, successfully bargained for lower prices after being offered a substantial discount by Russia. Russia's increasingly aggressive marketing practices might cause more problems to Iran in the future, as it continues its efforts to penetrate the European market.

Foreign investments and internal politics 
Investment in the oil industry is less controversial, because it tends to be easier to isolate from the mainstream of society and because the rewards are so obvious. But that will likely not be enough to inject enough dynamism in the Iranian economy. The opportunity to attract funds towards other sectors certainly exists. An important sign was the successful launch in July of the new euro bonds, the first denominated in a foreign currency since the Islamic revolution. Soon the government was planning new issues of euro bonds, while the Iranian parliament was asked to examine a proposal to receive oil payments in euros.
The attempts to reform the Iranian economy and political system were slowed by the opposition of the conservative faction. The Council of Guardians blocked the introduction of several laws, including the new foreign investment law, despite its approval by the parliament, forcing its amendment. Other such laws were still blocked by the Council of Guardians at the end of 2002, including a project to end the unaccountability of the foundations, which control a large part of the Iranian economy, a large-scale privatisation program, a new labour code and several others. There are however some signs that during 2002 a split began to emerge within the conservative camp, with some taking a more moderate stance. On the other hand, there were divisions within the ranks of the reformists too. At the beginning of 2002, the main item of contention among the reformists was the liberalisation of the economy, with some groups favourable to the liberalisation of the economy and others, such as the Islamic left, who were cold towards it. by the end of the year, however, the picture had been redrawn and the main fault line was now running between moderates, willing to accept Khatami's slow pace, and more radical reformers, who were clamouring for a final confrontation with the conservatives and were beginning to voice criticism of Khatami himself. The renewed pressure of the units of the "moral" police on an increasingly impatient youth, together with the ongoing repression against the reformist press, only contributes to the radicalisation of a part of the opposition. The death sentence against a reformist intellectual, Hashem Aghajari, guilty of having attacked the power of the conservative clerics during a lecture, unleashed in November a new wave of student unrest across the country, the largest after that of 1999. The resurgent student movement took most observers by surprise, as many had diagnosed its demise. 
Even the 2002-2003 Iranian budget, approved during the spring, reflected the political constraints under which Khatami and his government had to operate. Spending went up massively on the previous year, with tax cuts and massive pay rises to civil servants, whose real income would increase by 17% in real terms. The government expected to pay for a large part of such increases in expenditures through the privatisation program, which however had been stagnating for a while and might well continue to do so in the near future. Most observers therefore believe that Teheran will soon be running a massive deficit. 
Fearful of losing his own base of support, during September President Khatami finally decided for an all-out assault on the main conservative stronghold, the Council of Guardians. During September the reformist government presented a draft law, which would greatly reduce the powers of the Council, especially as far as its ability to disqualify election candidates is concerned. The government also presented other constitutional and administrative reforms, including greater powers for the president. President Khatami warned that he might resign if his projects were not approved, leaving the country in a state of chaos.

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Forecast 2003

Developments in and around Iran in 2003 will inevitably depend on the fate of neighbouring Iraq. Even when a war is over, an Iraq occupied by the Americans will inevitably affect Iranian internal politics. The more radical reformers and the extra-parliamentary opposition are likely to become emboldened, while it is much more difficult to predict how the conservatives might react. The trend which emerged during 2002, of a split between moderate and hard-line conservatives, might well strengthen in 2003, but in order to have much impact it would need to be supported by a similar split within the ranks of the reformists. Then, the two moderate factions might ally and form a centrist government, which would try to reform the economy and certain institutions, without challenging however the clerical nature of the Iranian state. Towards the end of 2002, Supreme Leader Khamenei's intervention against the judiciary, which had passed the death sentence against Hashem Aghajari, appeared a sign that Khamenei himself could have taken the leadership of the moderate conservatives. Other moderate conservatives, such as Hassan Khomeini, the Ayatollah's grandson, and Ahmad Takoli, who had challenged Khatami in the 2001 elections, also condemned the death sentence, while the judiciary, a stronghold of hardliners, resisted their criticism. However, among the reformers there seem to be little appetite for a compromise, mainly because their support base opposes it. In 2003 some moderate reformists will continue to argue in favour of a compromise, for example by dropping the proposal that the President should acquire the power to prevent the execution of a sentence delivered by the judiciary. However, the large majority of reformers will oppose such deals, because their constituencies are in risk of switching over to the anti-system opposition. 
For 2003, therefore, political developments within Iran might take three different turns. The conservatives might refuse to concede any ground and, if faced with an increasingly militant opposition in the streets, stage a coup d'état. Some prominent conservative leaders, such as Khamenei himself and former president Rafsanjani, threatened openly the recourse to force already during the course of 2002.
It is also possible that the conservatives might succeed in attracting moderate reformers such as Khatami towards a compromise which stills increases his powers, although without weakening the capability of the conservatives to resist the reforms as much as most reformists desire. Khatami, a moderate himself, might find difficult to refuse such an offer. From the conservative point of view, the loss of power would be offset by a likely split in the reformist coalition and by the possibility of blaming future failures of the reforms on the newly enfranchised Khatami. The most likely outcome, however, is a new government headed by moderate conservatives and right-wing reformers, maybe strengthened through recourse to rigged elections.
Whether the reforms accelerate or not, political and social tensions are not going to die down in 2003. faster reforms will in any case mean more hardship for some sectors of the population. The latest estimate of the inflation rate in 2002/2003 was 15.3%, up four percentage points on the previous year due at least in part to the abolition of privileged currency exchange rates for some Iranian institutions, which was one of the reforms of the Khatami government. 
A compromise between moderates on both sides, however, would at least be likely to unblock the development of the oil industry. Iran will need to invest $30 billion over the next 8-9 years to maintain its share of world oil exports. The ageing Iranian fields have lost production capacity at the rate of 250,000 barrels per day, 6.4% of annual production. At least $1 billion are needed every year to maintain production at the current levels. To maintain the level of exports in the face of rising internal consumption and to increase them to satisfy the needs of a growing population, much more than that amount will be needed. 
In the strategy of the Khatami government, gas is supposed to make up for the shortcomings of the oil industry. Since Iran has huge reserves of gas, which at present are largely under-exploited, it would make good sense to move the focus of the investments in that direction. After the blow of the re-negotiation of the deal with Turkey, which could have cost Iran as much as 20% in discounts on the previously agreed price, Iran will be looking east, having identified China and most of all India as potential major markets of the future. 
Despite the improved economic performance of 2002/2003, it appears obvious that it will be difficult to achieve significantly higher growth rates without attracting massive foreign investment. The forecast of the Economist intelligence Unit for 2003/2004 is 5.3%, lower than in the current year, although still comparatively good. Even in this regard, a successful compromise among moderates could play an important role in reducing the opposition among conservatives against foreigners playing a much larger role in Iran's economy. Foreign businesses express a strong interest in the Iranian internal market, which at present is underdeveloped, due to restrictions to imports, which the government tries to maintain at around $15 billion, and to the inability of the domestic industries to meet demand. After achieving the first modest successes in attracting foreign investments in 2002, 2003 might well see an upsurge in such investments, for example in the car industry, whose annual sales of 300,000 are estimated to cover only half of potential demand. It is expected that in the foreseeable future most investments in the non-oil sector will come from Arab countries, but already some European companies are beginning to invest small sums. 

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Update 013 - (01/01/03)

Towards a coup d'état?
If during November it had appeared that a compromise, if not an outright victory of the reformists, had been possible in the ongoing confrontation in Teheran, during December different signals came from Iran. Increasingly, sources close to the conservative faction began spreading the "gossip" that the conservative establishment had finally decided to reject the reforms proposed by President Khatami. There were also signs that the security forces were stepping up indoctrination and "ideological training" of the rank and file, possibly preparing for taking part in a violent repression. While some conservatives still claimed to believe in the possibility of establishing a coalition government, the chances of President Khatami actually agreeing to such a development seem limited to the instance of Iran being seriously threatened from abroad. The forthcoming war between the US and Iraq could provide such a background, but some conservative circles are increasingly promoting former President Rafsanjani as the right man to lead a coalition of moderates, aimed at addressing the economic difficulties of the country, without touching the institutional framework. 
Interestingly, even many reformists during December came to share the opinion that the hardliners were taking complete control of the conservative faction and Mohammed-Reza Khatami, the President's brother and leader of the Islamic Iran Participation Front (a leading reformist party), even said that openly at the party's congress.

Manoeuvring for a deal
After having hinted in the past that some cooperation with the US on Iraq was possible, December was rather characterised by a reassertion of Iran's unwillingness to work with the US. For example, Foreign Minister Kamal Kharazi denied that any plan to allow the United States to use Iran's airspace was being considered, while a government spokesman stated that Iran will not allow the Iraqi opposition to mount attacks from Iranian territory. Similarly, President Khatami too attacked the policies of the Bush Administration in December. While reformists were busy trying to demonstrate their loyalty to the Islamic Republic and avoid charges of dealing with the enemy, conservatives were busy positioning themselves as possible partners of the Americans. Significantly, Rafsanjani stated that if the US were to renounce their "bullying", a dialog between the two countries could be opened. Such statements could be seen as an attempt to reassure the world that in the event of a ejection from power of the reformist coalition, the foreign policy of Iran would not necessarily become more radical. 
In any case, the Bush Administration kept the pressure on Iran during December. The State Department, for example, accused Iran of building underground nuclear plants, implying that these would only make sense within the context of a military nuclear program. At the same time, top US officials warned the EU that its efforts to engage Iran would only benefit the hardliners. On the other hand, not everybody in the Bush Administration maintained a hawkish line towards Iran. Secretary of State Powell, in fact, stated his support for the EU approach to trade talks with Iran, which have been linked to the issue of human and political rights.
Unsure about what the future holds for it, Iran continued to strive for better relations with countries of the region. At the beginning of December an advisor to President Khatami stated that Iran and Egypt should restore diplomatic relations, although the reply of the Egyptian Foreign Minister was quite cold. During December Iran also showed some more willingness to tackle the issue of the Caspian Sea resources. Talks with the Turkomans and the Russians appeared to be making some progress towards building a bridge between their different positions. 

Good days for Iran's finances
Despite the uncertainty surrounding the future of the government and of the region, the prospect of having access to the Iranian internal market still causes excitement among multinationals. Car manufacturing, for example, attracted much attention in December. It is expected that the Iranian government will try to establish one or more joint venture for the local production of cars. Peugeot and Fiat appear to be those most interested and their representatives visited Teheran in December. Reflecting the positive mood about Iran on the international markets, the country's new Eurobonds were assigned a positive B+ rating by Fitch Ratings, on the strength of the high oil prices and of Iran's good external position. Consolidating the positive image of Iran in this regard, in December even the World Bank announced its first investment in Iran since the 1970s. Although this is only a small sum and the initiative will be probably vetoed by the US, its symbolic importance cannot be mistaken. Even internally the financial side of the Iranian economy looks quite rosy. The stock exchange in Teheran is becoming quite popular and already 3 million Iranians invest in it. 
Even if successful, however, attracting foreign investment or mobilising internal savings will only ease the latent economic crisis in the medium and long term. In the short term, all seem to indicate that the government will continue to increase spending in the hope of appeasing an increasingly restless population. The 2003/2004 draft budget was presented to the parliament in December, showing a 21% increase in spending on the previous year. While promising to public employees salary increases to match inflation, the draft budget counts on privatisations to reduce spending and getting some extra revenue. The government plans to spend extra money on the creation of jobs, in part drawing resources from the country's foreign reserves. Reflecting the compromise character of the budget, military expenditures are also going to increase. In part, however, the rising expenditures reflect the effects of one of the reforms that the Khatami government managed to carry out so far, namely the abolition of the double exchange rate. Previously, a number of state companies and foundations were granted the use of favourable exchange rates for their imports as a form of funding their activities, but with the abolition of the double system the government will have to replace them with direct funding. Observers estimate that the fiscal surplus of 2001/2002 will turn to a 2.1% budget deficit this year and might still double in 2003/2004. It should be considered, however, that Iran's government debt is comparatively low, at just 19% of GDP.

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BONDS

Iran plans second eurobond before '03

Iran is to issue an unknown amount of Eurobonds before 2003 following its successful US$625 million Eurobond issue earlier this year an Iran newspaper reported quoting a senior central bank official as saying.
The bond would be Iran's second foray into the European financial market following an issue in July, = its first since the 1979 Islamic revolution, which analysts said was oversubscribed.
"The foreign currency section of the Central Bank is taking into account a second issue by the year's end," the state-owned newspaper cited Central Bank Governor, Mohsen Nourbakhsh, as saying.
Nourbakhsh said the central bank was consulting foreign banks before they decided which one to mandate for the new issue. Lead managers for Iran's first issue were BNP Paribas and Commerzbank.
"We will use our past experience, but a final decision will come about only after consultations," he said.
The bonds are part of Iran's current budget that has authorised the government to seek up to US$2bn from external markets in the year to March 2003 to finance its many incomplete infrastructure projects.
Nourbakhsh did not comment on the size of the new issue but his deputy for foreign currency affairs told Reuters last month it would range between US$300 -$400m.

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FINANCIAL NEWS

Iran's economic growth to top 6.4 per cent for year to March

Iran expects its economy to grow by more than 6.4 per cent in the current Iranian year ending in March 2003, up from 4.8 per cent last year, Reuters has reported quoting an Asia newspaper.
It quoted a report by the State Planning and Management Organisation as forecasting a growth rate of 13 per cent in construction, 11.8 per cent for industries and mines, 6.1 per cent for agriculture, five percent in services and 1.2 per cent in oil and gas.
The organisation said inflation would increase to 15.3 per cent for the year to March, compared to 11.3 per cent last year.
The paper said the inflation increase was due to a change from a two-tier exchange to a single rate and growth in liquidity over the past two years. The organisation predicted a 31 per cent rise in liquidity for this year compared to 28.8 per cent last year.
One factor behind the growth of liquidity is that the Central Bank managed to raise its foreign exchange reserves and assets, the paper said.

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FOREIGN ECONOMIC RELATIONS

Iran to hold first exclusive trade fair in Kabul 

The Islamic Republic of Iran will hold its first exclusive trade fair in Afghanistan called 'Kabul 2003', officials in charge of export department for foodstuff Mohammad Bisotoni said on 9th November. 
In a exclusive interview with IRNA, he said the agreement to the effect was signed between the Iranian private sector and the Afghan commerce ministry following a year of market survey and negotiations. 
The first exclusive trade fair 'Kabul 2003' is slated for January 30th for a ten-day period in which foodstuff and industrial products will be put on display, he said. 
The second exclusive trade fair dubbed as 'Norouz-e Kabul' is to be held on March 1st for a ten-day period in which foodstuff as well as industrial products will be put on public display, he said. 
The fairs will prepare grounds for about 1,000 Iranian companies to present their products and services in four phases at the fairs, he pointed out. 
UN representatives in Afghanistan, active non-governmental organizations (NGO's) as well as foreign embassies in Afghanistan have cooperated in organizing such events, he said. 

EU-Iran Cooperation for sake of peace and security 

Iranian Foreign Minister Kamal Kharrazi has stressed that EU-Iranian cooperation is not for the sake of economy and trade only, but equally for promoting peace and security, IRNA News Agency has reported.
''Cooperation between Iran and the EU will not be only in the interest of economy for both sides, but also for promotion of peace and security,'' Kharrazi told a press conference in Brussels at the end of his 2-day visit.
He said the EU and Iran are to start comprehensive negotiations that would include trade and economic cooperation as well as the political dialogue in December.
''Both sides have the political will to continue these talks. This would be in the interest of both sides, Iran and the EU.'' Kharrazi noted that he had ''very good'' discussions in the last two days in Brussels with EU officials including Romano Prodi, Javier Solana.
He also met the speaker of the Belgian Parliament and the foreign ministers of Belgium and France, Louis Michel and Dominique de Villepin.
Kharrazi said he discussed with them relations between Iran and the EU, the situation in Iraq, Afghanistan and the Middle East.
''We were very satisfied with the talks over relations between EU and Iran.'' Kharrazi said he hoped war would now be avoided in the region after Iraq has accepted to grant unhindered access to UN weapons inspectors.
He said he was glad that the EU is now a partner in playing a role in the Middle East.
''Our expectation from the EU is to advise the Americans to be neutral in Palestinian affairs. Unfortunately, till now the Americans are on the side of Israel. They fully support Israel and this does not lead to any peaceful resolution of the Palestinian problem.'' Kharrazi left Brussels for Bonn on Wednesday and held talks with his German counterpart Joschka Fischer.
German Foreign Ministry Spokesman Walter Lindner told IRNA that both sides stressed the need to further boost bilateral ties in all areas.
"Both sides discussed the possibilities to continue the intensification of ties within the framework of an ongoing dialogue, notably through the exchange of parliamentary contacts," Lindner said.
Both ministers underlined that the dialogue of cultures should be a 'focal point' in strengthening bilateral ties, Lindner added.
Fischer invited Iranian Kharrazi to attend next month's one-day follow-up conference on peace and reconstruction in Afghanistan, scheduled to take place on December 2 at the Petersberg Castle near Bonn. "The (German) foreign minister extended the invitation to the Iranian foreign minister," Walter said.

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NUCLEAR ENERGY

Russia says Iran nuclear plant won't make weapons

Russia has given assurances to a top Western diplomat visiting Moscow that it had taken steps to ensure that Iran could not use a Russian-built nuclear power station to produce arms, Ron Popeski reported for Reuters News Agency .
The United States has urged Russia to reconsider its contract to help build the power plant, saying Iran, one of the states on President Bush's "axis of evil," could use the facility to make nuclear weapons.
But visiting Canadian Foreign Ministe,r Bill Graham, said he had received assurances from Russian Atomic Energy Minister, Alexander Rumyantsev, that Iran, Russia's neighbour across the Caspian Sea, was committed to the peaceful use of nuclear technology.
"(The Russians) have a vested interest in making sure this plant works in such a way that nuclear materials don't get diverted to improper purposes," Graham told reporters at the end of a two-day visit to Moscow.
He said Rumyantsev had pointed to 60 inspections of the site at Bushehr in the past two years with no evidence of illegal activity. Other assurances, he said, could come from proposals to ensure spent fuel was removed and reprocessed safely outside the country.
"I got very good assurances from the minister that the Russians are serious about monitoring and controlling and they'll make sure that Bushehr does not become a place for diversion of materials," he said.
But one regional expert, Celeste Wallander, of the Washington-based Centre for Strategic and International Studies, has said the main concern over Bushehr lay in Tehran acquiring know-how rather than materials for producing weapons.
"Although technically legal under the Nuclear Non-Proliferation Treaty ... Bushehr poses a proliferation risk by contributing to Iran's knowledge for developing an independent fuel cycle for producing weapons-grade fuel," Wallander wrote in a paper last month.
Graham said Russia could play an important role in avoiding conflict in Iran's neighbour Iraq, accused by the United States of developing weapons of mass destruction, following the approval of a tough new U.N. Security Council resolution on disarmament.
"Iraq has demonstrated a capacity to ... slide around problems. We have to make sure they understand there is no wriggle room. That is one place where Russian interlocutors are very valuable as they have the best contacts with Iraq at the most in-depth level, certainly more than anyone in the West," he said.

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