Iran plans to unify its dual currency exchange rates with the dollar as a measure to streamline its ailing economy and boost economic growth before the end of Persian calendar year, ending 20th 2017, according to governor of Central Bank of Iran, Valiolah Seif. The move is a major step towards floating the rial after about one decade of state control over the currency market.
Currently, Iran has both an official exchange rate to the dollar and another rate that is used in unregulated markets. The rial trades at above 35,000 per dollar on the street on average, compared to the official rate of less than 31,000 cited on the central bank’s website.
According to Bloomberg, the rial lost about 80 percent of its value in the year to late 2012 as a result of sanctions by international community related to alleged nuclear program by Islamic Republic. However, since President Hassan Rouhani took office in August 2013, the Central Bank has tightened credit and stabilized the currency.
source: Tabnak News Agency
Indeed, the policy makers in Iran has long been entertaining the notion of ending the multi-tier currency rate system, harming the economy. Thanks to Rouhani’s efforts, this is considerably facilitated by the implementation of Joint Comprehensive Plan of Action (JCPOA) signed between Iran and p5+l and consequent ease of sanctions on Iran.
But eradicating dual currency rate now is a tricky line of action posing its own threats to the success of the scheme should the necessary conditions and prerequisites are not prepared. Unluckily, there is a precedence to its possible failure as inappropriate foreign exchange rate policies adopted back in 1993 completely failed.
A recent survey conducted by Tehran Chamber of Commerce dubbed as “solidifying the economy by targeting the correct foreign exchange rate” works out the dynamics of an appropriate FX rate system for the economy of Iran.
The study puts forward three reasons why the fluctuations in the currency rate cannot be taken for granted, as this can impact the whole economy, whether intended or not. They are listed as follows:
- Firstly, the FX rate is a macro-economic variant in any economy and thus, its volatility is a mirror of actual realties of any typical one, since its merits and demerits are readily perceived.
- Secondly, FX rate is a factor pertaining one country’s currency rate to that of other countries’.
- Thirdly, it is a variant revealed real time to economic experts and observers. It is not possible to conceal its changes or postpone posting its probable performance to market watchers.
According to the same research findings, no country has utilized multi-tier currency system for a long time. This is essentially due to unfavorable impacts of not-optimal allocation of scarce resources. As continuation of such policies can lead to formation of inefficient patterns in production and consumption, escalation of speculative money-changing activities and rent-seeking, further unwanted engagement in bureaucracy and weakening of the private sector in favor of the public one in the long term.
This study, also, concentrates on two similar experiences in unification of foreign currencies in the previous decades in Iran.
The first one, as mentioned earlier, was performed in 1993 which turned out to be failure due to some vital fundamentals not being catered to.
In fact, contractionary monetary policies and inflation reduction, fiscal discipline, accounts balance surplus, low foreign debts, currency reserves accumulation, managed currency floating system, inter banking market creation, cutting subsidies on importing elements and finally preparing necessary legal grounds were defined as the basic factors behind the success of the scheme later in president Khatami’s period, according to the same research.
The research investigates the change in the currency rate in the 1370’s, 1380’s and early 1390’s in the Iranian calendar—roughly equaling 1990’s, 2000’s and early 2010’s , respectively.
According to the finds of this study, the currency rate in the 1380’s, while the currency rate unification was underway, went up by just 3%. This was, oddly, 92% in 2012 and averagely increased by 53% annually in 2012 and 2013, while Mr. Ahmadinejad was president. The FX shock at the time combined with the sanctions on the banking transactions exerted the most dramatic effect ever recorded on the production outcome across the economy.
This research stresses that if the government once in office before Rouhani’s had acted upon the mandates of the Fifth Development Plan of the country—the Sixth one just started at the current year (2016-2021)–and every year fixed the foreign currency rate in proportion to the difference between domestic and foreign inflation rate, the economic shock of the time could have been less severe than the one the country had to undergo.
This is to say that the actual currency rate changes in the 1380’s (1990’s) thought to be destructive bullets ruthlessly shot one after the other at Iran’s economic ammunition. This was mainly attributed to limited revenues from foreign commercial transactions in the wake of sanctions on Iran, hardship of transferring funds from overseas accounts and lower share of non-oil exports revenues compared to oil.
What is noteworthy to pay attention to with the current plan to unify double currency rate system is the likely repercussions of such policy. As this should not jeopardize the economic competitiveness of Iranian enterprises in international arena and instead boost their capacity to combat with their foreign peers.
This is not a big deal as the study shows that the currency appreciation may not be as counter-effective as thought. It has been revealed that the down effect is less than 5% on the overall added value of an industry, for instance, such as motor vehicles. Thus, it is not much of a worry as it might have been anticipated.
Furthermore, provided that implemented properly, this policy has its own advantages in the long run. Since it will enhance the quality of the items made in Iran and, in turn, gradually bolster the demand for domestic products abroad. In the same vein, the country can benefit a lot from this opportunity and profit from exporting goods and services it has competitive advantage of.
Finally, this study endeavors to figure out the impact of upward adjustment to exchange rate. This happens in two stages. In the first phase, the price of importing goods hikes. Next, the imported items prices at the wholesale and retail outlets, alike, go up.
Based on the outcomes of the same research, it has been evidenced that the immediate effect of currency overvaluation on domestic inflation in Iran is deemed to be around 12% in the short term and 31% in the long term. Also, the consumer prices have recorded to be inflated more than the producer prices.
Regarding the study results, a 10% rise in the currency rate in next Iranian year 1396 (May20, 2017- May 19, 2018) will spike the inflation rate by just 2.6%. This is not to be worried about as its reversing consequences will not stay long, since it would take about two years for the possible inflation to lose its pressing steam on the economy, based on the outcomes of the study.
On top of that, inflation is on a down trajectory as the central bank of Iran proved to succeed in its mission to rein in inflation by recording a single-digit inflation rate at below 10% currently. This would have its respective positive impact on currency exchange rate unification aftermaths and cool down its tendency to climb up inflation dramatically.
Considering what was said in this article, there is one thing which is left out of the survey and that is the rate the central bank intends to fix rial per dollar. This will, without doubt, widely influence the earnings margins of firms present in the stock exchanges of Iran, as more than 50% of them are commodity based companies in spaces such as petrochemicals, materials, oil refineries, pharmaceuticals and automotive.
As a result, we have to wait and see how the currency unification policy will roll out, as it is one of the key drivers of FDI (Foreign Direct Investment) and FPI (Foreign Portfolio Investment) injection to the country, alongside foreign currency futures market, to keep safe the potential investors’ money from currency movements and possible devaluations in an investment universe like Iran.
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