Iran — Renewed geopolitical tensions frustrate economic potential

The new year saw market sentiment boosted by tentative signs that manufacturing activity was bottoming out, favourable developments on US-China trade negotiations, and diminished fears of a no-deal Brexit. But the new year also brought new geopolitical risks. A US airstrike that killed a top Iranian general raised fears of another war in the Middle East (Chart), which could disrupt global oil supply and weaken already tentative business investment. While oil prices surged following Qasem Soleimani’s assassination, calm quickly returned, consistent with past geopolitical events in the region. Oil prices have also recently fallen on concerns of reduced demand due to the COVID-19 outbreak. But the potential for a major escalation poses material downside risks to global growth. US sanctions have virtually wiped out Iran’s ability to export oil—causing deep economic recession for a second consecutive year and raising annual inflation to 50%. Economic hardship has fuelled violent unrest and prompted a severe security crackdown. An increasingly hardliner-dominated political landscape will further heighten tensions in an already unstable region.

While Australian exports to Iran are limited, indirect exposure arises through oil prices and risk sentiment. Australia is a net oil importer, along with the majority of our major trading partners. Higher oil prices would increase the import bill for all economies in our region, bar Malaysia. Important markets like Indonesia, Malaysia, Thailand and Vietnam have oil subsidy policies which would see public budgets take a hit to keep fuel prices affordable. Meanwhile, materialisation of geopolitical risks could trigger rapid reallocation of capital toward safe assets, raising rollover risks for vulnerable corporate and sovereign borrowers. At the very least, US sanctions, the reimposition of Financial Action Task Force countermeasures on Iran, and a challenging market will frustrate Iran’s considerable economic potential. With a population of 85 million, considerable oil and gas resources, a relatively diversified economy, and a well-educated labour force, Iran’s exclusion from the global economy is a missed opportunity for Australian exports.