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In the face of international sanctions, the Iranian government has prioritised its domestic auto industry. The government has invested in new capacity and the country's automotive production is reaching record levels. In early March, Reuters reported Iran Khodro as saying that it was setting a new record for output and that it expected to produce 680,000 vehicles for the 2009-2010 Iranian year ended March 21. The automaker, the largest in the Middle East, is bullish on the future and reportedly is aiming to boost production to 730,000 units in the 2010-2011 Iranian year. We are not surprised by this optimistic forecast. It is in line with our view of an uptick in overall vehicle production in Iran in 2010. BMI believes output growth will be driven by government investment in the sector. This is evidenced by the establishment in May of a new car plant that Iran claims is the largest in the Middle East. The US$350mn plant in Kashan, launched by state-run automaker Saipa, will have an annual output capacity of 150,000 units. Saipa was Iran's biggest automaker in the 2009-2010 year, according to official data cited by local press. Saipa accounted for 54% of total vehicle output in 2009. The launch of the plant in Kashan is part of the government's broader goal of minimising the threat of sanctions on local manufacturing. Saipa, increasing local production. Sanctions are an ongoing threat for Iran's auto sector, as evidenced by German automaker Daimler's decision in April to sell its 30% stake in Iranian Diesel Engine Manufacturing. Daimler also announced plans to stop exporting commercial vehicles to Iran. With the government standing behind it, the Iranian automotive industry has a fair amount of protection from external threats such as sanctions. But it cannot be completely sheltered from the global downturn in auto demand. With only moderate auto sales growth estimated for the domestic market, the sector will have to look to export demand to drive production growth. But this strategy has its risks, as the world economy remains on a fragile road to recovery. We foresee total vehicle production rising 5% to 789,066 units this year.