Background:

During the 1960's through the early 1970's, Iran was regarded as one of the most open Middle Eastern countries with respect to foreign investment. Investment was sought via a bevy of tax incentives, import protections and guaranteed remitability of profits and investment capital. During this period foreign investors were allowed to hold majority stakes in their ventures and even when minority stakes were held, ownership influence was often boosted by management contracts that provided foreign partners decision making powers.

This state of affairs continued until 1975, with the issuance of legislation that not only declared that all major industrial companies sell 49% of their shares to their workers, farmers or the general public, but that also foreign ownership of Iranian industry be limited, with a maximum 35% equity stake in high technology industries, 25% in general manufacturing and 10% in traditional industrial sectors such as textiles.

The reasoning forwarded by the government of the time for such draconian regulations were initially shrouded in a veil of nationalistic fervor with the stated objective of spreading the fruits of industrial growth as broadly as possible amongst the general populace. In reality, it gradually emerged that the former Shah was using the legislation to prevent major economic and business wealth from accumulating in too few hands, thus creating new centers of power that could threaten his regime. According to one publication from the period, " the Shah doesn't want any Iranian Howard Hughes growing up in the shadows, and no matter how it hurts foreign investors, that's more important than a few bruised profit and loss statements". Not surprisingly, interest in Iran dampened considerably following the implementation of the share participation scheme and the imposition of ceilings on foreign equity. Concurrently, the scheme as a whole turned out to also be a massive failure and ended up neglecting the very segment of society it was designed to protect. For example, it was initially reckoned that one million industrial workers and two point seven million agricultural workers would benefit from the scheme. To further facilitate these share purchases, a special government backed financial institute was founded and 320 different companies were drafted into the scheme by which their shares would be first offered to their workers and then to the general public. In reality of the 320 companies designated for the scheme, only 151 had been able to actually meet the necessary criteria, and of those only 20% of the required 49% of the shares of these companies had actually been distributed. Of the one million industrial workers designated to benefit from the plan, only 72, 235 had actually received any form of shares, whereas of the 2.7 million agricultural workers, only 125,745 were in actual receipt of any form of shareholding.

The greatest damage of this scheme was on business confidence, both on the domestic as well as the industrial front. In Iran, the scheme set off capital flight as local businessmen and industrialists fearing greater governmental intervention began to transfer profit and liquid cash abroad. It is ironic to note that the flight of capital was in one sense aided by the share divestiture scheme, which served to turn industrial assets into cash in a country with a limited capital market Foreign companies reacted even more unfavorably, with several high profile companies such as BF.Goodrich deciding to

completely pull out of their Iranian ventures. During this period, the implementation of politically oriented and arbitrary restrictions on investment were further exacerbated by serious bottlenecks in infrastructure and availability of skilled manpower. These can be exemplified by:

Roads: During this period, Iran's road network was too small and poorly maintained. Of the more than 60,000 km of roads in existence at the time, only 16,000 had been paved by 1976.

Ports: By 1975, nominal port capacity stood at a nominal capacity of 7 million tons, yet ports were working at three times their capacity leading to log jams of hundreds of ships at a time with an average of three million tons of cargo waiting for periods up to 200 days in the Persian Gulf for berths. Concurrently, inland transport could not keep pace with the volume of goods being processed at Iran's ports, and shortfalls in trucks, drivers and the like further exacerbated existing problems.

Skilled Labor: The period of the 1970's signified critical shortages of skilled manpower and management personnel, with major shortfalls in semi-skilled and skilled labor with even greater shortages in mid-level technical and managerial personnel. The Labor Minister of the period, in the aftermath of the release of report stating that skilled and semi-skilled labor needs were to be in excess of 800,000 whereas only 200,000 would be available, publicly went on record urging industrialists and other employers to cope with these shortages by hiring more foreign workers as the means to deal with this shortfall.

Power: One of the major shortcomings of the government during this period was its failure to plan for the expansion of power generation capacity in accordance with rapidly rising demand. As such, continuos power shortages and recurring black outs had a devastating impact on industrial production. Concurrently, rapid rises in consumption by private households, came primarily at the expense of industrial users. In 1976/1977, industry's share of power fell from 51% to 48%, while households consumed 23%, 3% more than the previous year.

In sum, by 1976/1977, a foreign investor faced a number of dis-incentives including the aforementioned share participation law, ceilings on foreign equity, labor shortages and arbitrary government policies. Despite this environment, many point to the fact that by this year, the total accrued value of foreign investment stood at $5.2 billion with the total number of companies with foreign capital participation standing at 170. Under closer scrutiny however, it is seen that only 40% of this figure was foreign direct investment, the rest were in loans. Further scrutiny of available figures (see chart) from this period show that despite such a high overall figure, on average during the period of 1972-1974 private capital inflows stood at less than $20 million per year and for the period of 1975 -1976 this figure increased to no more than $60 million per year, with the total sum of foreign investment during the five year period of 1972 - 1977 standing at no more than $291.3 million dollars. This figure is all the more significant when compared to the overall volume of industrial investment taking place in Iran over the same time frame (over $11 billion), with over $3.6 billion taking place in 1976 alone.

THE PRESENT: Following the overthrow of the Shah with the victory of the Islamic Revolution and the subsequent invasion of Iran by Iraq, the resultant economic crises necessitated a re-orientation in economic policy geared towards war exigencies. As a result, much of the data on Iran's post - revolutionary economic affairs during the 1980's points to many undeniable economic shortfalls and setbacks and as such, foreign investment became almost non-existent. However, with the cessation of hostilities with Iraq in 1988 and the re-orientation of economic policy towards the reduction of government control, prevalence of market forces and the implementation of de-regulatory economic liberalization and privatization policies, post-war Iran is now a different story. As covered in Chapter 2, by 1991, economic growth began to take off and after a peak of 11.7% in 1990-1, maintained a steady average of 7.4% for the period of 1990-4 , and by 1995 - 6 real GDP averaged 7.5%. These figures were buoyed by major policies implemented via the two Five Year Development Plans which led to the implementation and development of comprehensive macro-economic policies combined with a massive infrastructure development program.

In terms of macro-economic policy, Iran has made marked shifts away from oil over dependence and public sector driven growth to private sector initiatives , has undertook diversification of her economic structure so as to minimize exposure to external factors with the creation of an industrial base that is self sustaining and independent from the oil sector, increased the added value of natural resources via downstream processing and her industries are striving to fulfill domestic demand while concurrently increasing exports by successfully capitalizing on Iran's relative advantage in certain industries.

As a detailed analysis of each of the above steps is covered in the preceding Chapters it suffices to say that the results of these policies have begun to make their mark.

In terms of diversification of industrial structure, figures for the year 1972 show that the export of capital goods stood at 0.8%, raw materials at 50% and consumer goods at 40%. By 1995, these figures show 2.6% for capital goods, 27.1% for raw materials and 71.2% for consumer goods. In some sectors, export growth has been in double digit figures including vehicles and spare parts, non-metal minerals and processed foodstuffs.

Concurrently, steps taken to increase added value by way of downstream processing have been primarily focused on Iran's massive hydrocarbon resources, as evidenced by a fourteen fold surge in output in Iran's petrochemical industries (from 0.8 million tons in 1989 to approximately 11 million tons today).

None of the above steps and success would have been possible without the development of a comprehensive infrastructural framework combined with Iran's unique geo-economic position in the region. It is within this context that in light of the growing role of Iran in the region as a catalyst for regional trade links combined with the rapid development her non-oil sectors, Iranian policy planners have fully understood the need to complement physical product with the availability of superior infrastructural and transit facilities. Thus, in addition to the implementation of major steps for the enhancement and access to regional markets, a comprehensive infrastructural framework has been developed as well, including a developed capital market covered earlier in Chapter 2 and major rail, road and air links, Free and Special Trade Zones, Ports and Infostructure explored earlier in Chapter 3. These steps are further complemented by :

Skilled Labor: The development and utilization of human resources has emerged as one of the most important aspects of Iran's development strategy. As such, a trained, educated and skilled workforce is a must if Iran is to attain her developmental goals. As covered earlier in Chapter 1 massive successes have been achieved in the areas of literacy, vocational training and higher education, with the resultant effect that the major shortages in skilled and semi-skilled labor that were once plaguing Iran in the 1970's have now been replaced by a vast trained and educated pool of talent.

Power: The days of blackouts and brown outs are now history as Iran has emerged as a major electricity exporter as evidenced by an increase in power generation from 14,500 megawatts to 24,500 megawatts in the 1989-1996 period alone with a concurrent increase from 48,725 million kilowatts/hour to 87,000 million kilowatts per
 
 

hour. These steps are expected to be further bolstered by the opening of the power sector to foreign investment (see sidebox). Iran's utility rates (gas, electricity, water etc.) are among the lowest in the region providing a comparative advantage for utility intensive industries. Surplus electricity is now being exported to peripheral countries such as Armenia and Pakistan.

In sum, a look at the past reflects the fact that despite attracting the attention of many international companies before and after the oil windfall of the 1970's, the implementation of arbitrary politically oriented policies, (i.e. the share participation scheme), major lags in infrastructure and skilled and semi-skilled labor and the like served to discourage foreign investment in Iran as evidenced by the figures covered earlier.

In the Iran of today however, as can be clearly seen to any visitor as well as from available statistics, Iran's economic and infrastructural development has been well under way , laying the foundation for a bright industrial future. With the largest market in the Middle East , a strategic geo-economic position presenting access to a market of over 330 million, abundant natural resources, raw materials, industries, educated and disciplined workforce, and a well developed financial infrastructure, combined with cross country and regional rail linkages, highways, modern office blocks and a state of the art telecommunications network buoyed by intelligent networks, fiber optic links and satellites has led many to identify these characteristics as the prime market in the area and as a growing magnet for foreign investment. The attraction of in excess of $750 million in foreign investment in the last three years, while seemingly small in comparison to existing potential, has already far exceeded the figures achieved during the oil boom years. It is of note that these figures exclude the recent investments in Iran's oil sector as exemplified by the investments undertaken by the likes of France's TOTAL, Malaysia's Petronas and Russia's GAZPROM in the $ 600 million Sirri oil project and the $ 2 billion South Pars Gas project.

INSTITUTIONAL FRAMEWORK:

In order to sustain and maintain such advances by Iran, a predictable and equitable institutional framework is required. Such a framework must include basic steps such as comprehensive laws and regulations geared towards economic development as well as investor security. On the domestic front, Iran's Islamic legal and economic system is geared specifically towards the key aspects of economic development - private property, profit incentives and eternal reward for hard work, all

within the framework of the ethical norms set forth in the Holy Quran. Concurrently however, a precise and all encompassing set of foreign investment regulations specifically geared towards investor security are also in place which are covered below.

As provided in the actual text of Iran's Law for the Attraction and Protection of Foreign Investment (hereinafter the "Law"), foreign natural or legal persons importing capital, either in the form of cash or in the form of factories, machinery, parts with the aim of utilizing these proceeds for the purpose of development and productive activities in industry, mining, agriculture and transportation shall benefit from the facilities available under the Law. The Law is also applicable to credit and financial facilities extended to Iranian entities engaged in the aforementioned activities.

Investments approved under the Law are guaranteed by means such as: the transferability of net profits in the currency of the original investment; repatriation of the original capital and the accrued profits derived therefrom and proceeds of the sale of capital or shares and the remaining portion of capital in the event of liquidation, Government guarantee of fair compensation in the event of expropriation pursuant to Law calculated at the exchange rate of the Central Bank on the day of the actual transfer. Additionally, all rights, exemptions and facilities accorded to domestic investors are also available to foreign investors.

The responsibility for attracting and supervising foreign investment lies with the Organization for Investment & Economic and Technical Assistance of Iran (OIETAI) located within the Ministry of Economic Affairs & Finance. For a prospective foreign investor to have his investment registered and approved in Iran, the following steps are necessary:

Step1. Find a Suitable Partner:

This can be done either by the identification and direct contact with prospective partners in the Iranian private and public sectors, correspondence with relevant Ministries under whose jurisdiction the desired project may fall, or other entities such as the Iran Chamber of Commerce, Industries and Mines, Commercial offices of Iranian embassies abroad, OIETAI etc.

Step 2. Obtain the 'Establishment License':

The second step in the initiation of the foreign investment process requires the submission of an application by the foreign and domestic partner to the concerned Ministry for sanction of the project. This application is to be supported by:
a. A specially prescribed questionnaire for setting up the project.
b. A copy of the project feasibility study.
Following a review of the project by the concerned Ministry, should the Ministry approve the project, an 'Establishment License' will then be issued.

Step 3. Submission of Documentation to OIETAI:

Once Step 2 is completed, an investor is permitted to start the practical steps of the project, i.e. starting construction, etc. However, so as to be eligible for direct participation and legal protection, simultaneously along with step 2 or afterwards, the foreign investor may apply to OIETAI for direct participation in the realization of the sanctioned project. This application should be supported with:

a) Properly filled "Application for the Import of Capital";
b) A copy of the feasibility study of the project;
c) Copy of the draft joint venture agreement and the articles of association of the joint company;
d) Power of attorney authorizing person(s) for the signature of the application and other contractual texts and notarized by Iranian consulate in the country of the investor;
e) Copies of other draft agreements, if any, in case the foreign investor is the supplier of know-how, processes etc;
f) Copies of the articles of association and financial report of the foreign investor including balance sheet and profit and loss statement covering the preceding years;
g) Any other supportive information deemed helpful.

Step 4. Review of Application

Upon submission of the documentation in Step 3 above, the application is reviewed by the Supervisory Board for the Attraction and Protection of Foreign Investments ( hereinafter The Board). The members of the Supervisory Board include:
-Deputy Minister of Economic Affairs and Finance who also serves as the President of OIETAI;

- Deputy Minister of Foreign Affairs;

- Deputy Minister of Industries;

- Deputy Minister of Mines and Metals;

- Head of the Plan and Budget Organization;

- Deputy Governor of the Central Bank;

- President of Iran's Chamber of Commerce;

Should it be determined that the application meets the country's overall interests, the Board will recommend its positive decision to the Minister of Economic Affairs and Finance for final approval and the issuance of a decree. The issuance of the decree permits the foreign investor to commence operations through the import of the required capital into the country. Once officially registered, the imported capital becomes fully protected by the Law. Furthermore, upon issuance of the decree, the local and foreign investors may implement their joint venture agreement and commence joint venture operations.