Rouhani's U-Turn to Save Economy

As the United States officially began enforcing sanctions on Iran’s economy on August 6, and after four months of increased volatility in the currency exchange market, the Iranian government finally made the decision to change the course by unveiling a new set of financial policies. 

When Iran’s national currency the rial (IRR) began to fall sharply five months ago, President Rouhani’s administration responded by tightening its control of the markets, banning any currency exchange outside the banking system and setting an official exchange rate at half of the market rate. The outcome was what any economist could have predicted, and what many warned against. The rial declined even further, and people, fearful of losing their assets, rushed to convert their savings into any currency other than the rial. Afghan workers began to leave as their real wages were cut by half and Iranians braced themselves for an increase in inflation. 

It took the government four months to realize the destructive nature of its naïve policies. Now the time has arrived for a change in course, without disturbing too many stakeholders. 

Iran’s new currency exchange policies, unveiled by Abdolnasser Hemmati, the new governor of Central Bank of Iran (CBI), create a secondary market for currency exchange, reopen currency exchange offices across the country, promise to allocate hard currency at the official rate to imports of essential commodities and necessities, and eliminate any hard currency at the official rate for the purpose of foreign travel. The package is not a complete reversal of the previous approach, but it goes far enough to assure the markets of an increase in the supply of hard currency. 

The currency exchange market has reacted favorably, with the rial gaining against the US dollar (USD) by roughly 15 percent. The exchange rate has dropped from a peak of 120,000 IRR per USD to 92,500 IRR per USD. The secondary market registered an exchange at 89,500 IRR per USD, and experts expect the exchange rate to drop further, to 80,000 IRR per USD. This rate will be twice what it was more than five months ago, but still a third less when compared to the end of July. The rial has lost its value and the new policies have lessened the shock. But they have not reversed the free fall. 

If anything, the new policy does nothing to change the essential assumption that the government should control the currency exchange market. The policy mandates Iran’s Ministry of Industries, Mining and Trade with the task of identifying essential goods and commodities. Those who import any item on this list can receive US dollars at 42,000 IRR per USD or 44,000 IRR per USD from the Central Bank of Iran. This rate is still less than half the market-based exchange rate. Any businessman can make a profit margin as large as 60 percent by simply selling the allocated hard currency in the open market. The administration’s rationale is to keep the price of essential commodities and medical supplies low. But in reality, President Rouhani just empowered public employees to make decisions regarding who can benefit favorably from hard currency reserves. 

Greater Risks of Corruption?

Policy makers want to demonstrate that they can control the economy and have the ability to lower prices. In reality, consumers care about the end price they pay, not how much the government is charging the major importers. The government has now just created a more complicated bureaucratic process — and more opportunities for corruption. There will be long lines for commodities at the official price and long waits to receive hard currencies. And administrators can alter fortunes by accepting a product as essential or by rejecting it as not. It is hard to imagine how the new approach will be able keep the end prices consistent. The average Iranian has weathered a volatile business environment for 40 years now, and he or she knows that not everything is decided by the official exchange rate for US dollars versus the Iranian rial. 

On the positive side, the new policy increases the supply of hard currency by permitting major exporters to sell their revenues according to a market-based rate. This rate will be determined in the secondary market. Businesses, licenced by the government, can bid to buy and exporters are able to sell. This is a major departure from the previous policy, where exporters could have accepted only the official rate of 42,000 IRR per USD for their holdings. That policy discouraged exporters from even entering the market and prompted a new wave of financial abuse. Many executives would have sold their companies’ hard currency at the official rate, taking major cuts and sharing the price gap with the buyers. The newly-introduced policy promises that exporters will be the main beneficiaries of their own revenues by giving them permission to use a market rate instead of a rigid official rate. Some executives might be unhappy, since they will have lost a great opportunity to bolster their own bank accounts, but markets and consumers have given this change a warm welcome. 

The shift in the policy does not mean all exporters will transfer their currency holdings to Iran. Iran is not a member of the intergovernmental Financial Action Task Force on Money Laundering, its banks are under considerable pressure and no international financial institutions are currently active in Iran. Iranian exporters realize that they can bypass sanctions if they keep their money outside Iran and its banks. So, while they are encouraged to engage in currency exchange in Iran, they are cautious to keep portions of their holdings outside of Iran in the banks unhindered by the sanctions. 

The government has also reopened currency exchange offices. This is another change of direction. Four months ago, these offices were banned from conducting any interaction outside Iranian banks and the official system. Several shut down their business and left or began operating on the black market. This already has increased the volume of currency exchange in Iran. Policy makers might have realized that shutting down this nationwide network would push the rial down even further. There was nowhere for people to buy or to sell currency. That meant as the rial declined, no one would have had the opportunity to sell their holdings. Now the government recognizes the role the network of currency exchange offices plays in the economy. They can sell currencies to travelers heading abroad and to people trying to build their personal savings, and the currency rates varies with respect to the size of transactions. The government would prefer for these offices to remain limited to travelers and personal investors. It does not want to inject the market with hard currency earned from oil sales, and yet it is difficult to see how this market can remain balanced without access to currency reserves. 

Overall, President Rouhani’s administration has admitted its initial response was wrong and mismanaged. It has not addressed the abuses of the last four months, but it promises to prevent abuse in future. It is encouraging the supply of gold and hard currency by eliminating customs on gold imports and permitting travelers to bring in as much as currency as they want into Iran. The move has been welcome and the markets are partially recovering, although many individual investors have begun to sell their stashes, fearing further drops. Although the situation is looking somewhat brighter, the economy has already paid dearly for President Rouhani’s mistake, and the opportunities for rent-seeking and profiteering that does not benefit the wider economy remain a risk. The new policies cannot reverse what has happened in the past, but they do signal an acceptance of the present.