Iran and Foreign Investment: Restatement of a case

Iran Chamber of Commerce, Industries and Mines
Quarterly Magazine,
Winter, 1994,Vol. 2, No. 3-4, PP. 5-10

According to historical data, the Iranian government turned to rather heavy borrowing from Western financial sources almost at a time when the phenomenon had just appeared on the scene. In most cases, we regret to say, these we used for extravagant consumption purposes. The loans usually were received against granting of "concessions" which ranged from customs farming to never-to-be built national railway lines, and from exploring oil fields to setting up a bank. Many of these carried clear monopoly right which made the term "concession" carry an unpleasant connotation for most Iranians who criticized the policy as measures which pawned the country for a pittance.

Besides financial borrowing, at least from the first decades of the twentieth century a number of enterprising- real or self-titled- businessmen arrived from abroad in search of local partners specifically for projects in the manufacturing sector. One result was establishment of a number of workshops and small factories to make matches, glass, sugar bits and the like. However, almost none of these took off the ground. Factors such as undeveloped infrastructures, lack of work discipline and, unfortunately, the absence of business scruples of some of those entrepreneurs were responsible.

Disappointing though the fates of these ventures proved to be, they gave the country a pool of experience about positive and negative sides of foreign economic participation and the need to approach it in a systematic way. Consequently, in 1921 the first company Law of the country was enacted by the Majlis in which direct references were made to foreign investment. Article 3 of the Act made it compulsory for any foreign national who wished to enter into business activity in Iran to undergo the formalities of registering a company. [This Article was amended in 1955 when entry of foreign investment was made subject to a new set of requirements]. It is interesting to note that among the first companies - Iranian or otherwise- to register under the Act were a number of foreign companies, at least one of which has survived to this day.

Modernizing Investment Rules: The decade 1920s was notable for the changes to the political face of the region, and consequently, this country. In that decade commenced the process of industrialization of the economy which, notwithstanding its social and political side-effects, necessitated a greater deal of interaction with the rest of the world. Though direct foreign investment in the usual form was rare, the country resorted to importation of machinery, know-how and skills for use in industrial projects.

Nonetheless, the phenomenon of direct foreign investment was still in its early youth until the conclusion of the Second World War. With all its heinous implications, the War seems to have set free economic energies which had been suppressed by antiquated institutional straitjackets. Among these was the great technological progress which, on the one hand, raised the wealth of industrial nations. And on the other hand, turned the non-industrial parts of the world into essential components of an increasingly internationalized economic system.

The War, also, tolled the bells for old colonial powers. No only global center of economic and political gravity shifted away from colonial metropolitan state, there also emerged a large number of independent countries whose leaders were keen to make up for lost decades and centuries of economic underdevelopment by acquiring the basic means to industrialize.

The economic map of the world in the decade following the War was interesting, and for the first time, consistent with modern technological imperatives, Industrial countries had to turn to export of technologies which were no longer suited to their local factor endowment. And developing ones created the market to import them. Consequently, technology embodied in capital became a commodity with its own international market and made for a great leap forward in the process of direct foreign investment in its different forms.

Iran was no exception and the idea of industrial development, beginning with import substitution industrialization, was uppermost in the minds of planners. This called for a fresh look at the subject of industrial development and the place of foreign contribution to it. Thus was born the Attraction and Protection of Foreign Investment Act of 1955.

Even now, the 1955 Act, despite getting on in age, deserves serious attention. For one thing, even though an heir is expected, it continues to regulate foreign participation in the Iranian economy. For one thin, even though an heir is expected, it continues to regulate foreign participation in the Iranian economy. For another, the way it was prepared, approved and amended has a great deal to tell us about interdependence among various components of the overall investment environment.

The Act offered a satisfactory definition of direct foreign investment by including finance, machinery, know how, and the like which could "develop ... productive capacity in industrial, agricultural and transport industries" of Iran.

Services were notable for their absence. Apparently, makers of the Bill had the overall objectives of the development plan of the time in the back of their minds and were looking at foreign projects which would supplement, rather than supplant, the indigenous enterprise. They were, also, aware of the problems of the economy in terms of exchange, technology, enterprise and infrastructure bottlenecks.

According to the Law, the foreign investor had to be a private individual or corporate person. Apparently, with the trouble over nationalization of the oil sector in 1951-53 period still fresh in everyone's mind, the fear was that the national government might again face a challenge in its jurisdiction over sectors of the economy. Any foreign state participation had to be of a specific duration and be terminated when this expired.

The Act mean to combine two apparently contradictory objectives into one. The first was to counter Iranians' historical suspicion of unregulated foreign participation in the economy. The second, to allay the fear of potential investors that nationalization of foreign assets might have been habit forming after the oil nationalization episode in which foreign control over the sector was ended by the state.

Companion Order: It is important to note that the Attraction and Protection of Foreign Investment Act of 1955 was not addressing what is named "joint investment" in the technical sense of the word and as one type of foreign investment. Rather, the Law, which is still valid, dealt with the subject in its more general form.

Equipped with the outlines of the Law, in October 1956 the Majlis formed a special committee to draw up the Executive Order containing the mode of implementation of the Law. The order offered foreign companies set up under the auspices of the Act the same business facilities open to Iranian corporate bodies. It emphasized the private nature of foreign investment once more. On repatriation, the Order made no restrictions apart from the usual proviso that profits earned had to pay before leaving the country.

Other sections of the Law and its companion Order deal with various contingencies which might arise in the process of investing in Iran and repatriation the profit. At the same time, they reflected the general state of the economy in that particular point in time.

After the oil nationalization crisis was resolved in 1953, the economy received a temporary respite through the belated inflow of quantities of foreign aid and loans. But despite improvements in macro-economic indicators, it was clear that structure of the economy and social system has remained relatively unchanged. This was, perhaps instinctively, sensed by both Iranian experts and potential foreign investors. a comparison between available figures for foreign investment in two periods before and after the passage of the Act seem to vindicate this . Foreign investment inflow for the period 1949-56 was around US $70m. while the corresponding figure for 1956-63 was only slightly higher at US $80m. Correcting for the state of the economy during the 1950-53 oil nationalization period when inflow of capital was negligible, and for the changes in the real value of the dollar, the conclusion is that the Act had little practical effect in the absence of more solid economic developments.

Subsequent Changes: The legal status of foreign investment was again mentioned in 1960 when the Majlis legislated the Banking and Money Act. The change was, however, only about the administrative arrangements. The 1955-56 package had created an investment investigating Council composed of several ministers and high ranking officials chaired by the Minister of Finance. The new Act transferred the chairmanship to the Government or of the newly established Central Bank.

Though of little economic importance, the change had to do with different economic circumstances. In 1960, the country was facing a severe recession which tightened exchange and savings bottlenecks. As a result, attentions were focused on the cash in flow part of foreign investment which, on the whole, is an unhealthy attitude to adopt.

The recession came to an abrupt end through certain changes in Iran's foreign standing, consequently, in 1961, the Council went to a more appropriate organization and was placed under the Ministry of Economy with the Minister, or his chief deputy, as chairman.

Both the 1955-6 and 1960-61 developments had their roots in the general state of the economy. With differing intensities, both periods witnessed the emergence of an indigenous entrepreneurial class which was still too weak to undertake major industrial projects. The private sector was entrusted with the task of catering for the light consumers industrial sector, while the state took upon itself larger, heavy industrial projects. In the middle, foreign investors were expected to inject into the economy the needed exchange and more importantly, enterprise and known-how required for a smoother, more balanced course of industrial development. In this the planners seem to have been quite successful- at least in terms of the quantity of investment received. Compared to 1950 - 63, foreign investment inflow increased several folds to the phenomenal figure of over $2.5bn.

Enter Joint Venture: Both the 1955 Act, its 1956 Order and other pieces of rules and regulations tended to treat foreign investment in its most original form; a non- national committing his funds and enterprise to a specific project. Whit the passage of time, earlier misgivings about local risk to foreign capital had subsided and Iran seemed as good as any, and better than many, places in taking good care of foreign businesses. But radical changes lay ahead.

From the middle of 1960s, the idea that foreign investment might open a window to admit neocolonial infiltration had become endemic in Third World public opinion. Though by no stretch of imagination, the Iranian government of the time could be seen overtly worried about such concepts, still most people preferred less foreign investment to more, if this could be helped. The problem was that it could not, since much of what the developing countries required had no vehicle other than foreign investment. In these conditions, the 1970s arrived.

The opening years of the decade were full of surprise, or shock, depending on which side one was looking from. For the first time in modern history, the world was pushed into a different setting without a war or a revolution. For the first time, the instigators were not the mighty and the big, but a group of developing countries who got together to look after their common interest. With an unprecedented degree of political self restraint and maturity, members of the Organization of Petroleum Exporting Countries voice their dissatisfaction at the shares in the proceeds from the sale of their resources.

For Iran, the most important one was the fact that the problem of exchange shortage - a feature of almost all developing countries-seemed to have been given an easy solution . In a few calculated steps, and within a few years, export revenues of the country rose from a few hundred million to several billion dollars.

It is easy today to complain that in many cases, OPEC governments of the time failed to put the newly gained wealth to the most constructive developmental use. But to them, just as easy riches from colonial possessions had prepared the grounds for industrialization of advanced countries, petrodollars were the gift of history of perform the same miracle themselves. While their Western critics rejected the whole spectacle as something against the "natural law of pricing" and insisted than oil prices were to be set at the production cost, the producers were sure that they were getting just about their rightful share in the sale of resources which were being depleted with every mile a car drove anywhere in the world.

Naturally, the fields of foreign trade and investment were affected more than any, and almost immediately after the price rise came about. In exports sector, the domestic market expanded tremendously almost overnight. In 1973, the government adopted the much criticized measure to revise all expenditure items of its current development plan upwards. This affected investment plans of both the government and the private sector.

Unfortunately, it seems that in the excitement of doing everything rapidly, one important point slipped planner's minds. That it was sue to the careless use of economic terminology that people never made clear the distinction between capital as a means of access to productive capacity itself. To the Iranian authorities, the petrodollar was the magic wand which, once wielded by the politician, would grant him his development wishes. In fact nothing could be further from truth.

Injection of exchange into the economy increased the level of domestic consumption which could be met through imports. It also removed any exchange barriers to productive investment since machines could be selected and bought right from the pages of the manufacturers' catalogues. But the mere physical presence of machinery did not ensure the existence of productive capacity. Very soon, various bottlenecks cropped up especially in such sensitive areas as semi-skilled manpower and infrastructures. But they were to come later. At the time, the idea of forcing the economy grow at figures which looked more mathematical than economic, was contagious among many government planners and officials. And to that end, all means at hand had to be used.

Among changes to various rules and regulations, the role of foreign investment in the expected growth was decided by the Economic and Financial Act of 1974. The Act re-christened the foreign investment Council and made it the Organization for Investment and Economic and Technological Assistance of Iran, abbreviated to OIETAL which was still quite a mouthful. The new body was now placed under the newly formed Ministry of Economic and Financial Affairs and was given more discretion than its predecessor.

The most important aspect of the new piece of legislation and the relevant rules and regulations which subsequently appeared was the formal introduction of the concept of joint ventures. The former act had allowed foreign investment without specifying its relation with potential indigenous investors. The initiative, then, came from the foreign investor. Now, the country was not in need of foreign cash and the national market was growing fast enough to make the mounts of any trader water. At the same time, the experience of previous two decades had resulted in the emergence of a relatively enterprising investor class in the country. In dividing the perks, they were to have the first pick with the hope that in time, they might do what all responsible capitalists are supposed to do: invest and expand the modern sectors of the economy.

On the whole, the 1974 laws and regulations reflected the new state of the economy and its needs as perceived by the government. The first was to attract that kind of technology which the indigenous entrepreneur was not able to provide and manage. And secondly, to save the lion's share of the market for the local, rather than foreign businesses.

Both requirements were supposed to be met by the Act. we may add, without openly offending the rest of the world. Thus, the most important section dealt with the question of ownership. Now, foreign investment shares were limited to 49% of the total unless, of course, special concessions were granted on merit. Again , commerce was not included among acceptable proposals, unless directly connected with a "production' project . Repatriation of the accrued profit was assured, and the government was responsible for protection of the enterprise against normal legal risks-such as confiscation.

Post-1979 Restatement of Intention: In February 1979, the Monarchy was replaced by revolutionary government. In April the formal title of the county was changed to the Islamic Republic: and a few months later, its Constitution was written and approved.

A revolution, as the term suggests, aims at as comprehensive a social change as stated by its principles. The Islamic revolution was no exception. Among the changes were those directly or indirectly affecting the future of the economy. In a formal way, these began by the same Constitutional Law which devoted a section to economic matters. Among them, Article 81 dealt with the subject of foreign participation. The Article proscribed granting of any "concessions" to non-nationals to enter various sectors of the domestic economy.

At the time the Constitution was prepared, the country was passing the aftermath of the revolution and the process of fundamental change was still in progress. Thus, the opinion of the "Mother of all Laws" about the issue of foreign participation did not receive the full attention of the public. The experts, however, seemed to be satisfied.

To understand the state of the mind of the writers of the Law, we have to go no further than review the history of foreign investment in Iran. In particular, meaning of the term concession, referring to near monopoly rights given to foreign subjects at the turn of the century, and their dire consequences, was vivid enough. A repeat performance was not allowed. But what about other forms of participation?

Fortunately, the proceedings of the constituent assembly are available and many of those who either served as members or watched them at work are with us. To cut a long story shore, economic historians and analysts assure us that the intention of the authors of the constitution, understandably circumspect, was not to prohibit international economic cooperation. The ban on "granting of concession" not only was confined to "monopolistic rights", it in fact had foreign monopoly control over basic economic sectors in mind.

Be it as it may, the actual directives of the Law have to be derived from its contents and the way authorized institutions have interpreted them. And the most reliable sources in this case are the rulings by the Custodian Council in charge of safeguarding the Constitution.

Soon after the approval of the Law, an occasion arose to put Article 81 to a practical test. That was in 1981 when the head of the government appealed to the Custodian Council for ruling over joint venture participation with foreign investors. The Iranian side was as state entity. In his reply, the Secretary of the Council assured the government that the project could go ahead and did not "require legislation by the Majlis". Then, in 1985, the premier, probably after being questioned about the subject and having investigated the legal grounds, issued a circular to government departments in which the same sentiment was expressed. In the same year, the Direct Taxation Act, passed by the Majlis and endorsed by the Custodian Council, contained a specific reference to taxes levied on incomes of foreign corporate bodies.

Of course, these legal statements were not of much interests during the decade following the revolution of 1979. The revolution was followed by an external war which drained the economic, political and diplomatic resources of the country for eight long years. Yet, although the general conditions of the country were hardly conducive to appearance of foreign investment, foreign economic participation continued in a low key. The most popular and feasible context at the time was the buy-back method. Though criticized for its trade diversion results, the policy proved one point at least. That it was not the intention of the Islamic government to ban foreign investment.

More earnest pursuit of this, and other economic objectives, was left to the conclusion of hostilities in 1988 and the declaration of the political will to attend to the economy with the publication of the text of the Plan Bill the following year. The Bill, and the resultant Act, contained specific references to the subject of foreign capital. Dealing with state investment programs, the Act allowed foreign participation of up to $ 10bn. in five years.

At the same time, it was made clear that the government was keen to promote economic growth by reconstruction and restructuring of the economy. The main proposal was revival of the private sector, dormant for a decade as an important agent of development. Naturally, foreign participation, up to then mainly confined to the public sector, was now opened to all interested businessmen in and outside the country. In support of this notion, high ranking officials made it clear that the IRI was interested in appropriate types of foreign investment and would offer legal facilities for their promotion.

The legal facilities, as it turned out, were contained in the investment Act of 1955 and its subsequent amendments. The text was prepared and published an early as 1989 to indicated the readiness of Iran to partake of international capital transfer.

Future Steps: Although the provisions of the existing laws and regulations are by no means restrictive, in order to clarify the situation and counter misgivings about the legal and institutional approach of the IRI to the subject, there have been reports of a new piece of legislation being prepared. The text of the proposed bill has not been made public, but its main points have been hinted upon by informed sources.

Perhaps the most significant contribution it makes to the investment environment of the country is the reiteration that the 49-51% share division is not final, and is open to negotiation. In other parts, it removes worries about the effect of uncontrolled exchange rate fluctuations by assuring the investor that his profits, and principle, are transferable at the officially set rate of conversion. Also, the question of protection of foreign assets in specifically turned to.

Hopefully, the new law will soon appear on the statue books and remove existing ambiguities. Equipped with clear legal guidelines, and with appropriate institutional backing, the country can take an active part in the field of international investment. That is an essential prerequisite of economic development today. After all, the main goal of bringing about a more integrated world economic system is to arrive at optimum allocation of global resources. That is what the whole science of economics, from the time of classical pessimists to the present-day business consultants has been about.

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