THROUGHOUT THE MIDDLE EAST there is a desire to modernise banking systems in order to create an infrastructure to support a financial industry. From fledgeling stock exchanges to overhauling 10-year old computing systems, modernisation is moving at a rapid pace. Iran is no exception, and is currently

Iranian modernisation and automation of the banking system are regarded as an essential underpinning to the first five year plan, due to expire in March 1994. They will also be a part of the drive toward economic liberalisation and mar-ket-based reform, including a reduction in state control, freeing of prices and a new spirit of enterprise.

The five year plan has endorsed (though not yet implemented) a liberalisation of bank deposits and lending rates whilst also aspiring to create new markets for government debt. With the aim of creating a stronger banking sector, the majlis has authorised private credit institutions to compete with the state-owned commercial banks, which are able to offer current accounts, savings accounts and other financial services.

The banking sector comprises Bank Markazi (the central bank), six commercial banks and four specialised banks in the fields of agriculture, industry, housing and export promotion. The recently approved non-bank credit institutions are able to engage in a range of banking operations except the opening of current accounts, the taking of demand deposits or issuance of cheques, the core products of modern banking services.

Banking reform is high on the list of government priorities, including the authorisation of new products such as mutual funds and unit trusts, and the licensing of securities firms. Ultimately the state banks may be privatised, but there is no widespread agreement on this point and the current law forbids such a change. Another key point is the willingness to have a more independent Bank Markazi, giving the central bank a broader berth to formulate monetary policy.

On an operational level, the Bank Markazi has initiated a plan of reforms to modernise Iranian banks and operating systems, with the aim of positioning them for integration within the international banking network. Additionally, the central bank has been acting as a gateway for Iranian banks to procure the services of bank and software consultancies. Access to Western capital and knowledge is viewed as essential if Iran is to implement the new reforms.

It all started about four years ago when the Iranian government placed an advertisement in the London-based bankers' house journal Euromoney, in which organisations were invited to tender. They were not disappointed by the response, except the eager consultants were not aware just what they were letting themselves in for.

Consultants have met a challenge in dealing with financial academics in Iran who effectively have the power to veto any decision taken or solution offered. The difficulty lies in the conflict between hard-nosed, commercial software salesmen and the domestic and not overtly commercial professors. On the other hand, the money is good and the consultants are fast learning how to cope with their ideological counterparts.

As a result, the large banks have been able to increase their levels of automation. Bank Sedarat has fully automated one-sixth of its 3,000 branches, and is currently seeking to create automated teller machine (ATM) links with Bank Tejarat and Bank Sepah. Credit and debit cards are being more aggressively marketed, with Bank Melli being the first to offer Visa services and Mastercard. One problem is reaching new demand in rural areas, the solution to which would certainly be advanced by electronic banking services.

The international automated links are being provided via Society for Worldwide Interbank Financial Telecommunications (Swift), a financial electronic messenging network, which has recently made inroads to Iran, providing the banks with messenger services to their global correspondent banks. Such a network is essential if a bank is to operate for clients beyond domestic borders.

What will take longer is development of the stock exchange, which holds no restrictions for foreign investors, but has little attraction for them either at this stage. Some of the Iranian banks have set up joint-stock investment companies, but foreign investors are wary of the lack of reliable information on listed firms. However, investors from the UAE and India, as well as expatriate Iranians, are active on the Tehran stock exchange, and the majlis is considering legislation to attract others. Privatisation has not been as rapid as was first hoped, but the government has launched 100 companies onto the stock exchange, and sold 200 more through public auction.

Since 1991 the World Bank has approved loans to Iran amounting to $847m in spite of US opposition. American distaste or even the size of the loans is less significant than the implicit seal of approval granted to Iran as a creditworthy soverign borrower in the eyes of the international lending community. Their collective wisdom is not infallible, as the mountain of debt which developing countries were allowed to build up in the 1970s and 1980s demonstrates. However, this approval may encourage investors into Iran in the never-ending search for broader investment margins and new liquid markets.

The rules for investors are favourable, with foreign investment being legally permitted under the Law for the Attraction and Protection of Foreign Capital, instituted as far back as 1955 during the Shah's regime. Under this persisting legislation, foreign investors enjoy full protection, are allowed to repatriate net profits and enjoy the same treatment as domestic individuals and entities. For international institutional investors these are essential prerequisites for placing funds in a foreign market.

However, the rescheduling of letters of credit and protracted negotiations with German banks has put a big questionmark over the country's debt, in addition to reservations regarding Iran's disinclination to accept sovereign debt on behalf of its commercial banks. If the economy does not function properly, the new banking infrastructure will simply become a technological white elephant rather than the framework of a strong financial market place.

One barrier to reform (and to the attraction of foreign investors) may be interest-free banking, which came into force in 1983 with the Law for Usury-Free Banking. Some of the consultancy firms have seen this, however, as yet another opportunity and have speedily created Islamic banking software packages. Foreign bankers have viewed Islamic banking practice as a positive element, giving them a marketing tool to chase the business of devout Muslims in Iran and elsewhere.

While the Bank Markazi may continue to fall in line with government policy, it has been a catalyst for change by relaxing its hold on the banks and giving them a freer rein to develop banking business and improve the range of services. The central bank would like to see the commercial banks compete more directly than before, and would like to see more foreign banks operate more freely. However, its room for manoeuvre is heavily restricted by the Islamic Republic's constitution.

What is at stake is not just domestic business and foreign investment, but the opportunity for Iranian banks to gain business in the newly-independent Muslim states of Central Asia. Bank Melli has already positioned itself to do so by opening a branch office capitalised at $5m at Baku in Azerbaijan.

The Bank Markazi has organised an informal agreement to limit this expansion by allocating one bank per territory, with Bank Melli having Azerbaijan, Tejerat in Tajikistan and Saderat in Turkmenistan. Thus, the financial reform in Iran has both inward and outward connotations, the effects of which will be felt beyond its own borders.

Dire straits

NOT WITHOUT REASON, Iranian politicians are getting very worried about the dismal prospects for oil prices in the year ahead. The government is trying to be as cheerful as it can by projecting an average price of $14 a barrel over the next year. That is glum enough news because it indicates that oil revenues will scarcely reach $12bn this year. More despondently, however, some members of the majlis think that Iran will be lucky to sell its oil at more than $12 a barrel in 1994, implying export earnings of under $10bn. By comparison, total government expenditure for the financial year beginning this month is estimated by press reports at almost $20bn.

The budget is being debated as vociferously as usual by the majlis. There is plenty of room for argument since oil export levels are as hard to predict as prices. Government calculations appear to be based on 2.3m b/d being exported in 1994. More pessimistic (and probably realistic) projections aim no higher than than 2.1m b/d. Both contrast sharply with an estimated 2.6m b/d sold abroad last year.

Longer-term projections are even more impossible to assess. Gholamreza Aqazadeh, the oil minister, claims that under the new five-year plan (which also begins this month) oil revenues will reach $64bn. Earlier reports had suggested expected income to exceed $77bn over the plan period.

One certainty, however, is that the domestic sector will have to bear the brunt of depressed export earnings. Aqazadeh has admitted that subsidies on fuel prices for the home market will be reduced drastically. The government proposes that the price of petrol, for example, is scheduled to rise by 140% over the course of the next year.

The government will also have to curb imports in the coming year to between $10bn and $12bn, which is almost half the planned level in 1993. The effect of such measures is already being felt as the public-sector cuts back on its workforce and is reduced to working at around half its capacity.

Nor is there any quick way out through foreign borrowing. Overseas debt now exceeds $20bn, and Iran is in arrears on repayments by at least $6bn.

Grindingly slow economic reform may transform the economic picture over the next few years (see above). The paramount question is whether the public, deeply wounded by revolutionary economic policies and the sacrifices incurred by the war with Iraq, will be prepared to tighten belts further.