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Iran nuclear deal: why investors should beware

A picture taken on August 20, 2010 showsA picture taken on August 20, 2010 shows
One of the oil world's oldest powers is set for a long-term comeback.Photograph by Vahid Reza Alaei — AFP/Getty Images

Since U.S. President Barack Obama struck a tentative deal with world leaders last week to curb Iran’s nuclear ambitions in exchange for lifting economic sanctions, the business community has been getting excited about commercial possibilities in the energy-rich nation. Though the deal is not yet final and Congress could very well reject it altogether, Iran could become the biggest country to rejoin the global economy since the fall of Communism in Eastern Europe in the early 1990s.

On the surface, the optimism makes sense: removing sanctions against Iran could increase its GDP growth by two percentage points to 5%, according to economist Mehrdad Emadi of London’s Betamatrix consultancy. Thereafter, Iran’s economy is predicted to grow 7% to 8%, generating business opportunities in the region. Iran’s export of an extra one million barrels of oil per day could eventually reduce oil prices further, helping industries and consumers worldwide. Most importantly, the deal could pave the way for an Iranian Spring that would open the economy to free market trade.

But the euphoria may be outpacing reality, and investors should beware.

First, the idea of preventing Iran from developing nuclear weapons through an ongoing regime of international inspections is great in theory, but the plan will be extremely difficult to execute.

Expecting a proudly sovereign nation like Iran that has been immensely secretive about its nuclear program to radically change its policies and give inspectors full access is naïve and potentially an invitation to subterfuge. As recently as October of 2014, the nation was criticized by the International Atomic Energy Agency for stonewalling UN weapons inspectors even after a year of negotiations. Nor is this the first time that Iran has reneged on its promises; the fact is that the Iranian government, despite President Hassan Rouhani’s moderate rhetoric, is not a very credible counter-party.

That doesn’t mean there is no hope for a successful deal, but the possibility of failure is high and anyone who wants to do business there should factor that in. Under the new agreement struck in Lausanne, Switzerland, if Iran fails to keep its end of the bargain, sanctions will automatically snap back into place, sending any economic progress quickly down the drain.

Second, it’s important to remember that religious hardliners hold considerable sway in the Persian nation, and have been vocal about their reluctance to agree to a nuclear deal with the West. Even though a final plan will probably win the tacit approval of Iran’s supreme leader, Ayatollah Ali Khamenei, such approval will be far from an eager endorsement but more likely motivated by the immediate need to ease the pressure on Iran’s economy. That’s a tenuous motivation that can change in the long run.

The danger here is that once Iran’s economy begins to improve and the pressure on the government eases, the hardliners might seek to regain lost ground and reverse some of the reforms that would make the new agreement work. While it’s hard to predict how powerful the religious hawks will be in the future, given that a nuclear threat remains the most powerful tool for Tehran to exert clout on the international stage, it’s hard to believe that hardliners would give up their advantage so easily in the long term.

In addition, even if an Iranian Spring does happen, the results may not be as rosy as investors hope. Any major upheaval could lead to chaos and political instability the way it did in Egypt, Libya, and Yemen in the aftermath of the Arab Spring, and take a long time to resolve.

The other possibility, as Quartz points out, is that the hardliners could take over an economically stronger Iran under the guise of a democratic government and turn the place into another Saudi Arabia, with even greater resources and power to threaten the West. This could lead to some short-term profits for businesses and investors, but damage their long-term interests if Iran has greater control over the wider Middle East and its oil reserves.

Given Iran’s totalitarian past, it’s unlikely that lifting sanctions would create a real free market, but rather a pseudo (state-controlled) free market where strict restrictions could frustrate foreigner investors faced with sudden changes in government policies, such as commercial or banking restrictions and anti-capitalist laws.

In this environment, service providers like financial advisors or consultants, who can work with Iranian clients remotely or through a small local office, might still do well. But manufacturers, retailers, and anyone who needs to invest heavily in local infrastructure, such as factories or stores, or investors who commit their capital to Iranian companies, are taking a big risk.

A nuclear deal may be welcome news for geopolitics and a step forward in international diplomacy, but it may not usher in the incredible new emerging market opportunity that some are assuming it will.

Sanjay Sanghoee is a business commentator. He has worked at investment banks Lazard Freres and Dresdner Kleinwort Wasserstein, as well as at hedge fund Ramius Capital.

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