To Unify or not to Unify; That is the Question
By Mahdi Goodarzi & Mojde Rezaee
In every sitting with foreign investors interested in Iran’s market, whether they intended to do FDI or FPI, fluctuations in foreign exchange rate in the country had always been on top of their concerns. Unfortunately, it became even worse when they would realize that there were no instrument and/or mechanism to hedge such volatilities and they were (and still are) usually forced to accept them and resort to indirect methods to secure themselves to the extent possible (this is, for instance, true for investors interested in the stock market and purchasing shares of companies which export their products). Below, we have tried to discuss the importance of defining a path to take steps towards FX rate unification in Iran, in addition to explaining attempts done so far.
The topic of FX rate unification in Iran was first discussed in 2014. Officials in the country interpreted this matter dependent on achieving one-digit inflation rate and economic stability. Although the wild fluctuations of FX rate have been controlled over the past 4 years (President Rouhani’s first term, 2013-17), a strong unity and harmony is required at the national level to achieve such a goal. The following diagram demonstrates the dollar price trend over this period.
Under the current conditions, two major steps must be set and taken in advance to predict different consequences of implementing this policy; these are qualifying and quantifying the effects of FX rate unification as well as formulating separate packages to manage such effects.
Considering the dependence of different sectors on the FX rate, the government along with the Central Bank of Iran (CBI) must project the consequences of any changes on each sector and their subsidiaries. It appears that areas like automotive and food industries will go through the largest amount of change. In this regard, the investigation of the relation between different industries and the FX rate in the past years proves that final prices tend to rise after FX rate goes up, owing to their dependence on import.
The main requisite for implementing FX rate unification, nevertheless, is the existence of enough FX resources in the country, a pre-requisite of which is the normalization of Iranian banks’ relation with their foreign counterparts; although it has been slow, the current conditions pictures a brighter vision in this regard and many, including the Governor of the CBI, believes that such a process will speed up soon.
To do so, the CBI must guarantee its ability to meet the market need in order to avoid any turbulence and inflationary pressure in the financial sector. In fact, the CBI must be able to manage such a need for 2-3 years in order for market players to tangibly feel the stability in the economy in order for this policy to succeed.
The probable inflation rate increase arising from FX rate unification is one of the greatest challenges ahead. Currently, the gap between official and open market rates has reduced and the CBI is gradually preparing grounds for the unification; since the CBI is determined to curb and manage inflation rate in line with promoting economic growth, no severe inflationary effect is predicted.
Regarding the effect of FX rate unification on the export, it is assumed that such a matter can draw a more vivid picture of transactions for exporters, despite the harms it might exert on smaller firms, which must be avoided and lowered to the extent possible by the government.
Those producers and manufacturers whose businesses mostly depend on FX rate with products domestically consumed must also be provided with the required assurances after the FX rate unification is implemented. Furthermore, conditions must also be met for the presence of other sectors like mining and petrochemicals industries in global markets.
In case the FX rate approaches the open market rate after unification, a price jump is predicted, which is accepted as well. The problem, however, will be the ups and downs in prices. If the CBI fails in managing such fluctuations, it will lead to the return of high inflation rates. The government must in fact implement this policy in a way to remain in control of the FX rate after the probable rise following the unification, which again calls for having access to enough FX resources, mostly cash in dollar.
A few important conditions like reaching the one-digit inflation rate, the lowering of FX fluctuations as well as granting permission to banks, rather than exchange houses, to trade foreign exchanges have now been satisfied, although some other must also be met for successfully implementing such a policy, the most important of which are explained below:
Having access to foreign funds
At present, linking Iranian banks to foreign ones is not yet possible mainly due to
- constraints to use US dollar in FX trading;
- lack of credit rating among Iranian banks;
- low interest and doubt among large international banks to enter into business with Iran, which mostly come from the US government malicious attempts;
- limitations imposed by the US Treasury in granting permission to European banks and economic institutes;
- Iranian banks’ financial structure and reporting formats; and
- other limitations imposed due to the non-membership of Iran in international organizations like the WTO.
Having access to FX resources of the country
Unfortunately, the CBI does not have full access to all its FX resources due to certain political and legal impediments; some countries which host Iran’s FX resources or those that are in debt of Iran due to purchasing oil are not in desirable economic conditions, which make them unable to pay Iran or settle their debt, some due to limitations in using dollar and are planned to pay such amounts in installments over a 1-3 year period.
Concerns over the return of high inflation rate
The entrance of the inflation rate into the one-digit zone lies with no doubt among the most important accomplishments of the CBI during the past 3 years, which has been equal with the return of stability to Iran’s economy, putting this body strongly against any action which might threaten it. In this regard, it is noteworthy to remind that FX rate unification might at first lead to the decline in rial value, which itself will add to inflationary pressures, that if not properly managed, might end in the rise of inflation rate within a few months.
Economic recession and anti-recession policies
The decline in oil prices and export during the past year on one hand and the drop in economic growth in China and Europe on the other contributed to the decrease in oil export and the government revenue. The government, being heavily in debt of contractors, banks and pension funds, also caused economic institutes to become in debt of banks and therefore, the significant growth in banks’ claims. Furthermore, the economic recession arising from anti-inflationary policies and the government debt had dragged down investment by the private sector, negatively affecting the economic growth and unemployment rate. As the result, any increase in economic recession and those policies fighting it can play a considerable role in policy making for FX rate unification and sufficient care must be taken to avoid the deepening of the recession; otherwise, it will end in the failure of this process.
The stability of FX rate will build foreign investors’ trust in Iran’s government and its economic policies. Iran has been enjoying perfect investment opportunities, mostly realized (and seem to continue to realize) through the European Union, for which the recent $4.8 bn contract with the giant Total Company is a reliable example. In fact, from another perspective, this deal can be interpreted as the result of the Islamic Republic of Iran’s serious intention to attract foreign investment. Consequently, if decision makers reach a unanimous voice on the FX rate unification matter, the close cooperation between governmental organizations, including (but not limited to) the Ministry of Economy and Financial Affairs, The Budget and Plan Organization and the Central Bank of Iran will act as the number one pre-requisite for its success. In this regard, the help and guidance of the international institutes like the International Monetary Fund and the World Bank along with making the most out of the past experience gained by other countries will add to the chance of successfully applying this policy in our country.
DISCLAIMER: This report has been prepared and issued by Agah Brokerage Firm on the basis of publicly available information, internally developed data and other sources believed to be reliable. The information contained herein is not guaranteed, does not purport to be comprehensive and is strictly for information purposes only. Agah does not assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. Any expressions of opinions are subject to change without notice.
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