The Tehran Stock Exchange (TSE), Iran’s only stock market, was the best performing market in dollars in 2019, yielding capital gains over 100 % on a year over year (YoY) basis. The TSE’s rally comes as an enormous surprise to most, given the turbulent year Iran experienced in 2019 due to increasing tensions with the United States, the disbandment of the nuclear deal, and sanctions imposed upon the country. Anyhow, its stock market seems to be flourishing and full of opportunities for incredibly risk-tolerant investors. The flourishing of the Iranian stock exchange does not mean the TSE is a safe bet considering its immense geopolitical, currency, and fiscal risks.
Geopolitical risk
One significant source of geopolitical risk for Iran is its conflict with the United States. Even though the recent crisis that led to the killing of General Quassem Soleimani seems to have deescalated, Iran’s foreign affairs do not look bright. In 2018, the country suffered severe sanctions from President Donald Trump, which made the country’s economy stagger. The American president restricted all foreign firms from dealing with Iran in an attempt to hinder the Iranian economy. Both the United States and European Union have also restricted almost all other sectors of the Iranian economy.
The present restrictions on the Iranian economy forbid citizens of the United States to operate in the TSE. Europeans who decide to invest in the TSE incur plenty of legal expenses. The burden of working on the TSE can be understood by the fact that the Bloomberg terminal, the world’s largest financial terminal, does not give access to the TSE’s index.
Currency risk
Iran has a high currency risk because of the many sanctions it is facing. Sanctions hinder the country’s access to international currency not only due to trade but also by rendering its monetary policy ineffective. The country has to ensure its ability to pay by trading directly with other countries and not by using the international currency.
Its incapacity to use foreign currency would constitute a colossal burden if it were not for its large share of essential commodities like petroleum. Constituting the world's 4th largest reserves of oil enables Iran to trade with relative ease and lightens the onus of foreign sanctions regarding currency risk.
Fiscal risk
The ample fiscal risk associated with the Iranian economy arises from its recent decrease in GDP and a significant part of the economy revolving around petroleum. The country saw its GDP rise near US$ 600 billion in 2012 and then descend back to US$ 385 billion only three years later. Such a collapse in GDP alone is enough to provoke a fiscal calamity since government revenue is directly proportional to GDP. However, ever since its lowest point in 2015, Iran's GDP was able to retrieve its growth for the following two years, followed by a slight decrease of 1.5% in 2018 after being imposed new foreign sanctions by the United States. Forecasts expect the slump to increase in the following years.
Iran’s services sector represents nearly 51 % of GDP, while petroleum still constitutes almost 20% of the country’s wealth. Having such a large portion of cash associated with oil leaves the country extremely susceptible to changes in the commodity’s price and other factors beyond Iran’s control.
Yet, a sea of opportunities
Despite all the risks associated with the Iranian market, its recent performance has been astonishing. In 2019 the TSE rallied from 161,000 to 375,000 index points representing a nominal increase of 132%. Even in 2020, after the killing of Soleimani and the various other geopolitical instabilities that plagued the country, the TSE has seen a near 10% increase.
Tehran’s stock exchange rally can be attributed to the sanctions imposed upon the country by foreign nations. Sanctions imposed on a country act as an unintended protectionist policy, which expels existing import firms and generates a barrier of entry to new international competitors. With the expulsion of import firms and the incapacity of foreign competitors in assuming the gap, national producers gain market share. Domestic producers increased market share enables them to access monopoly gains evidenced in the Iranian market through its heightened dividend payouts. Like economic profit, monopoly gains are a phenomenon prevalent in uncompetitive markets, which allow firms to have above-normal profits in a suboptimal equilibrium.
The ability to set higher prices established by colluding enterprises leads to an inefficient allocation of assets and inflation. In this specific scenario, there is a close relationship between inflation and an inefficient allocation of assets because the rise in prices that will lead to inflation is due to the firms’ capacity to set prices and incurrence on monopoly gains.
In the Iranian case, where they have little control over its protectionist policy (sanctions), society will continue suffering from rising inflation. Nevertheless, private enterprises accessing monopoly gains are having an atrocious increase in profit because production costs are relatively unchanged while prices increase. In the end, Iranian society is bearing the burden of the increased prices while the stock exchange rallies. It must be noted here that there is inflation all around the Iranian economy. Still, because of the Oligopolic firm’s capacity to set prices, they can increase prices at higher than inflation rates snowballing their profits.
Even with all its problems, Iran’s stock exchange looks like a great opportunity for massive returns if you have the means of accessing it. Anyhow, investors willing to take on its risks should be cautious and wary of the disruptive fashions of the market failures enabling TSE’s unforeseen rally.
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