Iran’s plan to get rid of the subsidized exchange rate

Al-Monitor – There are signs that Iran will officially get rid of its official subsidized exchange rate — at 42,000 rial to one US dollar — by the end of the current Iranian year on March 20, 2022. If implemented correctly, the move could actually help the Iranian economy find a new balance, but the question is whether political and socioeconomic realities will allow the government to implement a sound approach to exchange rate policy. 

Iran currently uses three different exchange rates: the official subsidized rate, the market rate, and a rate controlled by the central bank available to importers and exporters of essential goods. The latter is known as the NIMA rate.

In February 2021, while Iran’s parliament was debating the government’s budget bill, lawmakers proposed the elimination of the low exchange rate and the introduction of a new rate at 175,000 rials to the dollar, hoping that the new approach would unify the three existing rates. However, the government of then-President Hassan Rouhani rejected the proposal and lobbied strongly to continue using the subsidized rate, arguing that its discontinuation would lead to major inflationary impulses in the economy.

While opposing the parliamentary initiative, the Rouhani administration gradually shortened the list of import items that would be eligible to receive the subsidized rate. In fact, between May 2018 when the rate was introduced and September 2021, the list has gone from 25 essential commodities to only seven: wheat, corn, barley, oilseeds, edible oil, soybeans and pharmaceutical products including selected medical devices. In the last Iranian year, the government allocated a total of $9.6 billion to the importation of these items. Other essential commodities such as rice, meat, poultry, tea, sugar, paper and raw materials for key industries that used to be on the mentioned list are now being imported using the so-called NIMA rate that currently stands at about 270,000 rials to the US dollar. Consequently, one can already see the inflationary impact of removing many key food items from the list. This fact also explains why in the past year inflation in rural areas has been higher than in urban areas — the share of food products is higher in the household expenses of a rural family compared to an urban family.

In other words, the low exchange rate only has a positive impact on the cost of selected items, especially bread, which is an important staple in Iran. Now that the low rate is applied to a shorter list of commodities, the expected inflationary shock to the Iranian economy will be more limited than it could have been in the past few years. 

In the meantime, a new government is in place and two of the key ministers — Minister of Finance and Economic Affairs Ehsan Khandoozi and Minister of Industry, Mining and Trade Reza Fatemi Amin — have already commented in favor of the policy shift. In August, Khandoozi had opined that the existence of the low exchange rate would be an obstacle to economic and industrial development. Fatemi Amin has expressed the view that the government’s task will be to make sure that the benefits of subsidies reach the lower-income classes and not flow into the pockets of large enterprises.

There are many proponents and opponents to this plan. The opponents are concerned about the inflationary impact, especially eroding the purchasing power of the lower-income classes that have mainly relied on subsidized goods in their households. Proponents on the other side, including powerful ministers, are focused on the imbalances created by the existence of a multitiered foreign exchange system.

In a complex economy like Iran’s, there are also other aspects to consider. For example, a lot of analysis has emerged on the impact of the plan on investments at the Tehran Stock Exchange (TSE). Considering the fact that a large number of Iranians have shares on the TSE, a sudden shift of share prices could lead to panic transactions that would also be harmful to the economy. While a number of companies, especially the pharmaceutical sector, will be hit by the planned shift, depending on how the government compensates the lower-income classes, there will be a new balance in the economy once the negative psychological impacts are over.

What to expect next?

The authorities will keep the timing of the implementation as well as its operational details as confidential as possible in order to limit the hoarding of goods. In terms of the financial approach, indications are that the government will issue debit cards for all citizens who are in the lower seven income deciles of society and will then extend monthly allocations to citizens. According to Hadi Ghavami, deputy minister of finance and economic affairs, the government’s plan is to transfer the monetized value of the subsidies to the lower-income classes so that they can compensate for the plan’s inflationary impact. He has predicted that a monthly amount of 4.3 million rials (equal to $16 at the NIMA rate) would be paid to every Iranian belonging to the mentioned deciles. Evidently, the amount will be significant for lower-income families but only marginal for the middle-income groups.

Identifying the ideal timing of such a scheme will depend on the government’s assessment of the political, legal, financial, cultural and operational aspects. Considering the low level of trust in the population toward the authorities, one can imagine that there will be a low level of cooperation among social groups. The most desirable scenario for the government would be to implement this change parallel to the possible lifting of sanctions, if all parties agree on a return to the 2015 nuclear deal, i.e., utilizing the potential momentum of sanctions lifting to enforce an unpopular policy change. Failing that, the sequencing will become crucial. If the government increases the targeted cash handouts before officially removing the lower exchange rate, the population as a whole would be more at ease with the plan.

In any case, the emerging shift will have the potential of causing social unrest, especially if the real inflationary impact is higher than expected. Therefore, containing the potential devaluation of the rial on the free market rate will be of utmost importance. This, in turn, would only be viable if enough hard currency is injected into the parallel currency market — a phenomenon that will also depend on the lifting of sanctions.

Final word

Many experts believe that the continuation of the subsidized exchange rate will only benefit corrupt networks that have taken advantage of their access to the cheaper rate. As such, despite all its challenges, the government will have to eliminate the rate and replace the system with a viable approach in order to fulfill its own promise to push back against corruption. This may be too difficult as it will require huge political capital in the current political system.

At the same time, the core problem in Iran is the prevalence of a culture of corruption and any system that is not implemented and supervised properly will be abused by some segments of the power structure. Even systems such as direct cash handouts or fuel rations have been abused in the past. Therefore, a half-baked and/or poorly implemented policy shift will only make matters worse by imposing further costs on the Iranian economy, which is in dire need of some degree of stability.