Al-monitor — Most economists and monetary policymakers in Iran have been supportive of getting rid of the country’s dual foreign exchange rate system by as soon as March 20, 2017, when the current Iranian fiscal year comes to an end. However, there appears to be a gulf between what the Central Bank of Iran (CBI) wants to do and what it is actually able to do. Indeed, the repercussions of a single rate system offers insight into why the CBI has so far resisted calls on it to unify the official and open market rates.
As I noted in Al-Monitor last year, the government must address a series of challenges before a final decision is made on the issue. These issues include the fragile nature of economic growth, the low level of nonoil exports and the vulnerable state of domestic manufacturers.
Although President Hassan Rouhani’s administration claims that it has addressed most of these challenges, experts say there is still much that must be done in the coming months. This is particularly the case when it comes to small businesses. Indeed, the government must have a well-prepared program to help minimize the “possible losses” of small business once the exchange rate unification plan is implemented, Tehran-based business analyst Mohammad Reza Bahraman said in an interview with the Young Journalists Club on Aug. 15. “The government has to take care of manufacturers whose products are only used in the domestic market,” he noted, as a weakened rial could increase production costs since these firms must import raw material at higher prices.
Yet, Minister of Economic Affairs and Finance Ali Tayebnia and CBI Governor Valiollah Seif have both announced that the time is getting ripe to make a radical change in the country’s currency regime. Citing Tayebnia, Mehr News Agency reported Aug. 10 that only a few steps need to be taken before the economy gets fully ready for the key decision. A few days later, Seif addressed an audience in Nepal of central bank chiefs of South East Asian countries, New Zealand and Australia, announcing that the Joint Comprehensive Plan of Action has already paved the ground for the implementation of the rial rate unification plan, which he said would “boost our exports and growth of the gross domestic product.”
Although these remarks may be appealing to foreign investors, there are still doubts about how prepared the Rouhani administration really is when it comes to making such a change in the country’s currency regime. The CBI recently allowed commercial banks to buy and sell foreign currency at open market rates — a move signaling that the central bank will loosen its grip on the rial. Since 2011, Iranian banks have only recognized the official currency rates set by the CBI, while only exchange houses have been free to trade foreign currencies using rial rates set in the open market. Of note, foreign currency at present costs almost 15% more on the open market.
Since taking office in August 2013, the Rouhani administration has tried to improve economic conditions. It has managed to curb inflation to single digits, significantly cut interest rates and pushed the economy out of a deep two-year recession. However, some economists still argue that the government is not yet sufficiently prepared to move ahead with the planned elimination of the dual exchange rate regime by the end of March 2017.
The Iranian economy has for a long time been highly reliant on foreign currency brought in via petroleum exports and, therefore, it is vulnerable to price shocks on the oil market. The current weak state of the oil market is, in effect, depriving the Iranian government of the hard currency necessary to bring down the open market rate in the event of an exchange rate unification, Sajad Barkhordari, an economist in Tehran, argued in a May article published in leading economic newspaper Donya-e Eqtesad.
The sanctions have added to the problem, leaving the CBI with a lack of certainty about the availability of foreign currency resources in the second half of the current Iranian year. Meanwhile, it is not yet clear how the government would move to protect domestic manufacturing after the exchange rate unification. Under the current dual exchange rate regime, the government can provide domestic manufacturers with subsidized foreign currency — a policy that has helped these companies import raw material and intermediate goods at lower prices. It is not clear how the government expects the manufacturing sector to recover in the absence of subsidized hard currency. Meanwhile, the government should also be concerned about the potential return of high inflation. Indeed, the Rouhani administration has expended much effort to reach single-digit inflation — a unique achievement that has not occurred in the past 25 years. Any weakening of the rial could lead to a hike in commodity prices, making the Iranian economy unstable once again.
Thus, the Rouhani administration may have to put off the exchange rate unification at least until after May 2017, when the next presidential elections are due to be held. Indeed, Rouhani may be well-advised to avoid any potential negative social and political consequences that could jeopardize his bid for a second term.
The Rouhani administration’s position has become shakier in recent months over its handling of the economy. Political rivals argue that the nuclear deal has failed to meet public expectations since the economic recovery continues to be fragile while the manufacturing sector is still in recession. Meanwhile, big multinational banks refuse to interact with Iranian banks, and multinational companies are still waiting on the doorstep for developments that could tangibly cut their business risks in Iran. Thus, any new decision over the currency rate could make the foreign exchange market volatile, leading to the depreciation of the rial and a hike in prices of consumer goods. This could further antagonize millions of citizens from the lower and middle classes only a few months before the country’s next presidential elections. Indeed, if the economic situation gets worse, the president’s popularity could easily be undermined by hard-liners awaiting a fresh pretext to escalate attacks on the moderate administration.