Iran Analysis: Why the Currency Fell....And What That Means for Iranians (Namazi)

Siamak Namazi writes a guest analysis for EA:

News of currency fluctuations in Iran is making headlines these days, often with US sanctions being given credit for instigating the fall of the value of the Rial.  While sanctions have certainly played a role in this matter, it is unclear whether these outweigh longer-term internal issues. And if there is a fixation on sanctions, few will consider the impact of the devaluation and what it means for Iran’s economic and political development.

Two opening arguments: (a) government mismanagement has had a much bigger role to play than sanctions here; and (b) that irrespective of the culprit, the current situation is to the detriment of the Iranian private sector and in favour of governmental and quasi-governmental businesses.

Let’s start with the proposition that devaluation in and of itself is not a bad thing. For years now Iran has experienced double digit inflation with very little change in the exchange rate. Coupled with high rates of interest in the banks, an investor was far better off keeping funds in Rials than in hard currency deposits.  In fact, Iranian producers have consistently complained that they cannot compete with cheap imports and were pressing for an adjustment of the rate between the US dollar and the Rial.  So, why are they now upset?

Of course there is a huge difference between planned and unplanned devaluation.  Unpredictability is the worst enemy of business. When the value of the currency changes dramatically and unexpectedly, the producers lose large sums having to fulfill contracts that were calculated based on very different costs of production.  In Iran, that effect is exacerbated because industry is heavily reliant on import of raw and semi-finished products as well as all sorts of machinery.  

Even this shock could be managed if it were uniform to all Iranian business. However, the private sector is at a major disadvantage to entities with governmental affiliations.

Unfortunately, Iran has returned to the days of multiple exchange rate systems, essentially wiping away one of the tangible achievements of the previous administration, which had unified these rates.  Today, Iranians face three different rates of exchange: an official rate (around 11000 IRR to the USD); a rate for travelers with a limit of $2000 per trip and other restrictions; and a free market, or, more accurately, black market, rate (which has vacillated between 14000 and 18000 IRR/USD in the past week).

The outcome is that those persons and entities that can gain access to the official rate enjoy a major advantage over their competitors.  Clearly, state-owned and quasi-governmental entities are much more likely to benefit from this highly preferential rate than the private sector is.

Remember the powerful Bonyads (foundations)?  Well, the exchange rate differential was precisely one of the key tools that afforded them an unfair competitive advantage versus the private sector and allowed them to grow into a powerful force in the Iranian economy. If the current state of affairs continues, we can be sure that Iran’s private sector will cede ground to 
state-owned entities.

It is also important to think through the causes of the sudden drop in the Rial’s value.  If sanctions played an important role, the main culprit was Government mismanagement.

The key to understanding this phenomenon is appreciating the role of high liquidity in the Iranian economy.  In short, there is a lot of cash laying around, and when Iranians target a certain investment vehicle, prices surge.

The term "investment vehicle" is quite broad. For example: In the 1990s, personal automobiles became the target of choice and  one could easily make a handsome profit by buying and selling used cars.
During the early 2000s, villas in the Iranian Caspian region became the favoured investment and prices surged with dizzying speed.  More recently, we have seen the phenomenon play out in the Tehran Stock Exchange.

Managing inflation, therefore, is highly reliant on policies aimed at absorbing the cash in the hands of Iranians.  For a long time, this goal was largely achieved by offering high interests on government-backed bonds for various projects (cashable at any time without penalty) and through 
high interests offered in savings accounts.  If an Iranian citizen had spare cash, he/she was most likely to seek a bond to park their money until they found a home to buy or a business in which to invest.

The real beginning of the fall of the Rial was the government’s decision --- against the advice of the Central Bank --- to lower interest yields. At a time of high inflation, the government encouraged 
Iranians to pull their money out of their savings accounts and look for other “investment vehicles”.  No wonder that bond issues which used to sell out in hours were met with lack of investor interest. 

A worse time could hardly have been found for this decision. Liquidity was already on the rise ---
and inflation with it --- due to the cash handouts coming from the new subsidy cuts programme.  A lot of cash was available and looking for an  alternative when the currency crisis started with the announcement (later withdrawn) that Iran planned to restrict imports from the UAE.  We are not 
just talking about wealthy businessmen, or the so-called “Northern Tehran” crowd. Even lower-income groups jump on the bandwagon, trying to make a quick profit using their modest savings or salaries to buy and sell dollars and gold coins when prices begin to spiral.

So yes, sanctions have played a part in this story, but for the Rial to plummet this much and this quickly, talented mismanagement had to be in the leading role.

There are still a number of ways for Iran to combat the pounding of its currency value without altering its international relations --- namely, by dramatically curbing demand for hard currency --- though it is unwise to bet on the team that created this mess finding a durable fix. Recall that Iranian imports have surged and that the current government has essentially used the oil wealth of the country to import cheap goods as a far-from-creative tool for curbing inflation, to the detriment of the Iranian industrial and agricultural sectors.

The scale of this policy? In the Iranian year 1381 (2002/3) imports totaled just over $22 billion.  In 1388 (2009/10) this figure stood at $66.6 billion, despite all the sanctions.  For a country experiencing a forex crisis --- whatever the cause --- does Iran really need to be wasting its resources to bring in goods such as foreign chocolates, energy drinks, and fancy fruits? 

Interest rates on savings accounts and bonds can be hiked again, though it is not as easy to absorb people’s money in banks as it is to lose it.  Instead, the likely forecast is a continued downward vacillation of the Rial, to the detriment of the private sector and the expansion of the government 
hand in the economy.