Will Foreign Investment Return to Iran’s Automotive Sector?

Iran produced just 770,000 automobiles in 2019, down from 1,418,550 just two years prior. The re-imposition of U.S. secondary sanctions interrupted new investment in Iran’s automotive sector, particularly by European automakers such as Renault, Peugeot, and Volkswagen.

The median age in Iran is just 32. Limited public transport options and cheap petrol make car ownership attractive and even necessary—under normal circumstances, the Iranians would purchase up to 2 million cars each year, with a total sales value of up to $20 billion. 

The rising cost of manufacturing inputs and a shortfall in production has contributed to a sharp increase in the price of automobiles, particularly in the secondary market. While Iranian policymakers consider the automotive industry as a “strategic sector,” with state-owned firms Iran Khodro and SAIPA among the country’s largest employers, the hit to output over past two years has made clear the limits of the government’s ability to grow the automotive sector without foreign partnerships. 

Over the last year, companies linked to Iran’s defense ministry have stepped in to support production at the Iran Khodro and SAIPA in an attempt to localize the production of more parts and shield automakers from the rising cost of imports. At a signing ceremony in December of 2019, SAIPA CEO Seyyed Javad Soleimani told reporters, “With Defense Ministry’s help, domestic substitutes for 35 key auto parts are to be produced in Iran to curb the industry’s reliance on the global supply chain.” 

The cooperation between automakers and defense contractors is best understood as a stop-gap solution for the automotive industry. In the short-term the goal is to raise output. In the medium-term, the automotive sector will still require the transformative investment that only foreign automakers can provide.

Foreign automakers have long understood the potential of Iran’s large domestic market and the combination of low labor costs and local parts production. Iran’s industrial workforce is skilled and experience, particularly relative to their compensation. The monthly minimum wage is IRR 18.34 million for the current Iranian calendar year—now equivalent to less than USD 100 per month at current exchange rates. Between 2009 and 2011, two out of every 100 cars and commercial vehicles produced worldwide was manufactured in Iran.

These dynamics led numerous European, Korean, and, more recently, Chinese car and truck manufactures to establish license manufacturing agreements and even full joint ventures with Iranian automakers. Iranian auto parts makers developed the supply chain to provide the local parts content on which Iranian policymakers insisted. The manufacturing of the Renault Tondar, known as the Dacia Logan in most markets, saw Iranian spare parts manufacture obtain “Grade A” certifications from Renault. Following the new investments committed after the implementation of sanctions relief in 2016, there were growing expectations that Iran would become an exporter of European-branded automobiles to regional markets. 

Notably, the new post-JCPOA investment was intended to facilitate the partial privatization of the state-owned manufacturers. Through the Industrial Development and Renovation Organization (IDRO), the Iranian state was set to become a minority shareholder in the new Renault joint venture. A similar deal was struck between Daimler and Iran Khodro Diesel for the manufacturing of Mercedes-Benz trucks in Iran. 

Allowing foreign firms to be the majority shareholders of their joint ventures was an important shift in industrial policy for the “strategic” automotive sector. Such policy was also intended to address the long-running issue of inefficiency and poor productivity among the state-owned automakers. There were also a number of deals between foreign automakers and private sector firms in Iran, such as the agreement between Volkswagen and Mammut, which has produced Scania trucks in Iran since 2008. Scania’s persistence in the Iranian market has earned it a commanding market share of over 60 percent.

Clearly, prior to the re-imposition of sanctions, Iran was set to deepen its dependence on foreign investment to drive growth in the automotive sector. In the case that sanctions are once again lifted, that drive for foreign investment would no doubt resume. Iran’s automotive market will remain attractive, but foreign automakers will want to be sure that any new round of sanctions relief will be durable.

Photo: IRNA

Iran's Automakers Need a Rescue, But Face a Reckoning

Iran’s giant automakers, Iran Khodro and Saipa, are in a tug of war with the Rouhani administration over demands to lift price controls. The state-owned firms are seeking to increase prices by 40 percent.

Executives in Iran’s automotive industry, which counts among the country’s largest employers and includes both state-owned and private sector enterprises, argue that rising inflation and the increased cost of parts and raw materials justify increasing automobile prices, which have long been subject to controls. Rising inflation in Iran has been spurred by the depreciation of the rial, first triggered by the reimposition of secondary sanctions by the administration of U.S. President Donald Trump.

The final say on any price increase lies with the Market Regulation Authority of Iran’s industry ministry. A meeting of the authority on May 4 led to a disappointing outcome for the automakers, as the authority’s board gave preliminary approval to a price increase of just 5 percent.

Despite the outcome, market regulators appear increasingly sympathetic to the demands of automakers and further deliberations are planned. The deputy minister who chaired the meeting, Hossein Modarres Khiabani, acknowledged the challenges facing Iran’s automotive sector, stating “For 15 months, the price controls have remained unchanged while many of the production costs have jumped during the period in question.” While carmakers have been unable to increase their prices, the price of automobiles on the secondary market has surged as inflation picked-up. The growing margin between the two prices has given license to many car dealers to engage in enormous profiteering.

However, regulators are reluctant to allow automakers to increase prices without demonstrating some new economic value. The 5 percent price increase preliminarily approved earlier this month is conditioned on a  “70 percent improvement in efficiency,” although no detail was provided as to how improved efficiency is to be assessed.

For decades, the poor-quality of locally produced automobiles has been at the core of growing discontent among Iranian consumers with state-owned carmakers. Iran Khodro and Saipa are accused of exploiting an uncompetitive market, operating as a duopoly and disregarding customer satisfaction in order to produce cars with fewer features and worse build quality. Even Iran’s Supreme Leader appeared to acknowledge the lagging quality of domestic cars in a recent tweet.

Despite the role that the price controls have played in deepening losses, Iran Khodro and Saipa have also been repeatedly bailed out by administrations unwilling to swallow the political consequences of mass layoffs. Iranian carmakers, particular those that are state owned, benefit from unfettered access to financing and cheap foreign currency, despite a track record of contributing to the non-performing loan crisis at many Iranian banks and a reputation for corruption among senior management. By one estimate, Iran Khodro and Saipa have received over USD 4.7 billion in foreign currency at the subsidized government rate. With the Rouhani administration now facing an unprecedented fiscal crisis spurred by sanctions, low oil prices, and the COVID-19 crisis, observers of the automotive sector are wondering whether the state remains able to support the embattled auto industry.

Any prolonged shutdown at Iran Khodro or Sapia would hammer Iran’s many parts manufacturers, which constitute the backbone of the auto industry. These companies have already been squeezed as sanctions have made sourcing the foreign currency needed to pay for imported raw materials far more difficult. Parts manufacturers are also owed huge sums by the likes of Iran Khodro and Saipa, who use their dominance in the domestic market to bully suppliers.

But the increasingly dysfunctional supply chain is catching up to the automakers. A recent report from Donya-e-Eqtesad estimates that up to 50,000 cars remain unfinished, parked in storage yards, due to a lack of parts. Falling productivity in the automotive sector, which accounts for 4 percent of Iran’s gross domestic product, could have a significant impact on the wider economy. The negative outlook for the sector stands in stark contrast to the optimism that followed the implementation of the nuclear deal. In 2017, buoyed by the resumption of industrial cooperation and investment by European automakers such as France’s PSA Group, automobile production hit a record high of over 1.4 million vehicles.

The swift decline in output spurred by the reimposition of U.S. secondary sanctions the following year has only been accelerated by the global pandemic. In the period from March 21 to April 20, corresponding to the first month of the Iranian calendar year, Iran Khodro manufactured just 23,246 vehicles, registering a stunning 43 percent decline in production year-on-year. The automaker has discontinued production of seven models, which relied on imported complete knock-down kits, including the Peugeot 2008 SUV and the Suzuki Vitaras. Production at Saipa fell even further, registering a 56 percent decline year-on-year, with just over 9,000 cars produced in the same period. Part of this slowdown is attributable to measures being taken to reduce the risk of transmission of COVID-19 among assembly line workers. Nonetheless, the collapse in production and the controversies around price controls contributed to the ouster of industry minister Reza Rahmani earlier this week. Khiabani has been appointed as caretaker.

The Rouhani administration finds itself at a crossroads and the auto industry faces a reckoning. While regulators have been unwilling to increase the price of automobiles for fear of angering a public already facing diminishing purchasing power, the government cannot simply continue to rescue automakers that have failed to operate efficiently and transparently, selling their products into a profoundly dysfunctional market.

Photo: IRNA

Iran Automakers Face Rocky Road as Output Falls While Demand Rises

Iran’s automakers have pre-sold more than 1 million vehicles, most of which are earmarked for delivery to customers in the current Iranian year that started in March. But with vehicle production declining at a steep rate, fulfilling these orders will be no easy task.

Following the reimposition of US secondary sanctions in November of last year, the Iranian economy has begun to contract. Inflation is driving up the price of goods, including automobiles. 

For instance, the cheapest vehicle in the Iranian market, SAIPA’s Pride sedan, is now sold at IRR 450 million, just over USD 10,000. The same model was offered for just IRR 200 million one year ago. Despite the sharp increase in prices, demand for cars has also increased.

With the rial losing around 70 percent of its value over the past few months, many have rushed to convert their cash into safe-haven assets—including foreign currency, gold coins, real estate and even cars. Iranian consumers see cars as a safe investment and it is not uncommon for used cars to actually appreciate in value during periods of high-inflation.

Pre-orders for entry-level models like the Pride have also increased as consumers typically interested in more expensive models, such as locally produced Peugeots, are priced out of the luxury bracket.

Mounting Pre-Orders

With US sanctions taking a toll on the country’s auto industries, Iran’s automakers face an uphill battle to deliver the pre-ordered cars on time.

In order to service mounting debts, state automakers Iran Khodro and SAIPA sought permission from authorities to launch extended sales periods in which they racked-up 1 million preorders, with cash being injected into company balance sheets.

But just as the orders are becoming due, sanctions are restricting the import of critical parts and raw materials needed for the automakers to produce sufficient vehicles. Production output has declined significantly.

During the 11 months to February 20th, Iranian automotive companies produced 873,243 cars and commercial vehicles, indicating a 38 percent year-on-year decline in output. Output at Iran Khodro fell to 386,523 vehicles compared to 653,593 at the same period last year, reflecting a 41 percent decline. Meanwhile, total vehicle output at SAIPA has fallen to 381,085 from 605,348 at the same point last year—down 37 percent.

Foreign exchange rates have hit all-time highs and production costs have soared, forcing car companies to increase prices. With production plummeting, prices in the automotive market have been further distorted by dealers and middlemen who have sought to raise prices in the secondary market.

Persistent Hopes

Iranian automakers must therefore strike a balance between supply constraints and robust demand. Pre-sale deposits are an important source of cash flow for car companies, but delays in delivery can cause negative publicity and also add to financial pressure. In a quirk of #Iran’s automotive market, pre-sale terms entitle customers to get back their deposit with accrued interest in the event they decide not to take delivery of the vehicle—in effect customer deposits are a kind of loan made to the automaker.

Given these pressures, Iran’s automakers must aim to sustain output despite headwinds. Firms have actually targeted increased output in the coming year. Leading automakers plan to produce at least 1.2 million vehicles in the 2019-2020 fiscal year, leveraging their experience in the previous sanctions period to boost local capacities and establish new supplier relationships.

Iranian car companies have tried to forge new ties with international automakers like Russian car company AvtoVAZ. SAIPA is in talks with AvtoVAZ to import auto parts and completely knocked down (CKD) kits from Russia to restore production to normal levels.

Iranian automakers have also sought to expand operations outside of Iran to help earn much needed cash. Earlier last week, a joint venture between Iran Khodro and Azermash OJSC started pre-sales of a jointly-produced Peugeot 206 in Azerbaijan.

The joint venture was inaugurated during a state visit to Baku by President Hassan Rouhani last March. In addition to the Peugeot 206, two sedan models designed by Iran Khodro, the Dena and Dena+, will be produced at the Khazar Car Factory, located in the Neftchala Industrial District in southeast Azerbaijan.

With an initial annual production capacity of 10,000 vehicles, the Khazar Car Factory will increase output to 15,000 vehicles. The joint venture partners hope to produce 6,000 vehicles this year.

Photo: IRNA