Iran struggles to avert currency crisis

Published in GSN, 16 April 2018

The rial’s rapid decline in recent weeks is a matter of increasing concern to President Hassan Rouhani’s government, businesses and Iranian consumers. The rial’s open market rate (one of two exchange rates for the currency) has gone from around $1=IR37,700 in mid-2017 to rise above IR50,000 against the dollar on 6 March. Since then the decline has accelerated, reaching over IR60,000 in early April.

There have been two rates for the rial for many years: the official rate set by Central Bank of Iran (CBI), which is used for official transactions, and an open market rate set by currency traders. There has been significant disparity between the two for some time, with the average official and market rates being $1=IR29,645 and IR34,359 respectively in fiscal year 2015/16, rising to $1=IR31,457 and IR36,328 respectively in FY2016/17, according to the International Monetary Fund.

The presence of two divergent rates has complicated trade and investment and led to market distortions. In its recent Article IV report on the Iranian economy, published on 29 March, the IMF said the official rate overvalued the rial by 13%-16% in FY2016/17, while the market rate was broadly in line with fundamentals at the end of the period. It said the gap was “eroding reserves, creating distortions and undermining competitiveness” – essentially acting as a lucrative state subsidy to companies and individuals able to access the official rate.

The CBI has been increasing the official rate this year to take account of the moves in the open market. Even so, the rapidly-declining exchange rate has made the two-tier system even more unwieldy. The government’s patience came to an end on 9 April, when it held what was described in Iranian media as an “emergency meeting”, chaired by Rouhani; it agreed a single rate of $1=IR42,000 and said anyone dealing at other rates would be breaking the law and deemed to be a smuggler. “No one has the right to buy or sell currency with any other rate,” first vice president Eshaq Jahangiri said after the meeting.

Jahangiri tried to assure the public there would be no currency shortages. “With this exchange rate, the required currency for all sectors will be supplied by the Central Bank of Iran, bureaux de change, and banks under the control of the CBI,” he said. “Businesspeople and people mustn’t have any concerns for purchasing their required currency with this exchange rate”.

Despite the threats of criminal prosecutions, the black market in currency trading is set to be reinvigorated. There is a risk currency shortages at the official rate could emerge over time, notwithstanding the government’s efforts to calm nerves.

The authorities’ track record in managing these risks is not all that promising. The government has tried a number of other tacks in recent months, which have failed to arrest the rial’s slide. In February, currency exchange shops were closed down, almost 100 traders detained and their bank accounts frozen; the government also ordered customs officials to refuse to process any imports priced in dollars. At that point, the rial was trading at around $1=IR45,000. Local currency interest rates have been increased this year, but none of these actions have succeeded in halting the rial’s slide.

The rial’s falling value has taken some observers by surprise. “In theory, the currency shouldn’t be weakening as much as it is,” said one investor involved in Iran. What is driving the decline is a matter of speculation, but the tough rhetoric coming from the White House appears to be playing a part, heightening fears of a renewed burst of sanctions. CBI governor Valiollah Seif has also sought to point a finger at Tehran’s opponents in the neighbourhood, blaming the currency’s fall on a “lack of confidence in the future” on 10 April. He also warned that Saudi Arabia and the UAE were trying to disrupt the market. “There are signs of neighbouring countries’ plots,” he said, without offering any further details.

The rial’s fall also threatens to undermine one of the Rouhani administration’s main economic achievements: the fall in inflation. “If the currency weakness persists, it will show up in inflation. It creates more uncertainty,” said one analyst.

It could also lead to a slowdown in inward investment, which in any case is running lower than many had hoped after the nuclear deal came into effect in January 2016. A falling exchange rate may make Iranian investments better value, but it adds to the already plentiful uncertainty involved in engaging with the economy. Even before the most recent slides, currency risk was seen as a key factor for investors. “Over the last few years, we have carried out a great deal of work analysing the rial and we consider currency risk as a key component in all investment decisions,” wrote Tehran-based Turquoise Partners’ chief investment officer Shervin Shahriari, in a report published in March. On the flipside, any Iranian company earning dollars from exports will report higher profits in local currency terms.

One clear lesson from the episode is the central role the dollar continues to play in Iranian economic life, despite years of attempts by Washington to cut Iran off from the US currency. CBI hassaid it plans to stop using the dollar in its reports; it will instead switch to denominating data and transactions in euros. “An approval [to change the reporting currency] will be adopted by the government soon,” Seif told reporters. But he made similar statements in January 2017, which have not been followed through. When the government struggles to make relatively simple changes which are fully within its control, such as which currency to use in its reports, there must be doubts about its ability to enforce its will on the forex markets.