Iranian exporters to suffer impact of frozen exchange rate

To:

Al-Monitor Pro Members

From:

Dr. Bijan Khajehpour

Managing Partner, Eurasian Nexus Partners, Vienna, Austria

Date:

Jan. 9, 2023

Bottom Line:

As long as the underlying political factors are not addressed, Iran’s national currency will lose value and put additional pressure on the Iranian economy and society. The latest decision by the Central Bank of Iran (CBI) to freeze the exchange rate for one year, won’t provide the economy with the level of certainty and predictability that is required for meaningful economic development.

Background Facts:
  • Over the past few weeks, the value of the Iranian rial has crashed on the so-called free market. However, on the more significant parallel Nima market the parity has been relatively stable.
  • Iran has had a multi-tiered exchange rate system for the past few decades. The current status is a continuation of what emerged in the aftermath of the US withdrawal from the nuclear deal, also known as the Joint Comprehensive Plan of Action (JCPOA), in May 2018.
  • At that juncture, authorities attempted to unify the previously two-tiered rate and introduced a unified parity of 42,000 rials to the greenback. However, after a few months, the business community was faced with a three-tiered system: a) Subsidized exchange rate of 42,000 rials – a rate only used for the import of essential goods such as food and medicine; b) The Nima rate, a hard currency exchange platform for importers and exporters managed by the CBI; and c) The free market operated by official and unofficial foreign exchange bureaus that supply hard currency to segments of business and society that were not covered by the first two markets.
  • Between 2018 and April 2022, when the subsidized rate was discontinued, the existence of a massive differential between the subsidized rate and the free market parity had become a major platform for corrupt dealings in the economy. Though the discontinuation of the lower rate limited the scope for corruption, it simultaneously increased the inflationary pressures on the economy.
  • Since April 2022, the two-tiered system is back; the Nima rate — which according to officials provides 95% of the economy’s needs — and the Free Market rate. On Jan. 8, the two rates stood at 285,000 rials and 407,600 rials to the US dollar, respectively.
  • There are a number of factors contributing to the currency devaluation, including the government’s high budget deficit that is expected to be as high as 4,000 trillion rials (more than $14 billion at the current Nima parity), high inflation, continuation of external sanctions, among others.
  • Psychological and social factors are also significant. Since the beginning of the social protests in Iran in mid-September, Iran’s national currency has lost 27% of its value due to socio-political uncertainties and a growing push for migration.
  • Furthermore, the government’s failure to present two important economic bills, including the draft five-year plan and the state budget for the year starting on March 21, 2023, has also agitated the business community increasing concerns about overall macroeconomic development.
  • Though the new CBI governor, Mohammad Reza Farzin, has committed to freeze the Nima rate at 285,000 rials for at least one year, there are far too many uncertainties to anticipate a positive outlook.
Alternative Scenarios:

Scenario 1: The rial will stabilize based on CBI interventions.

The complexities of the Iranian economy make it difficult to present educated predictions. However, the announced policy of the new CBI governor to maintain the Nima rate at 285,000 rials for the next 12 months could calm the market and reduce the pressures on the free market. For this to happen, a certain degree of stability has to return to the economy, which will only be possible if Iran and the other signatories of the JCPOA agree to restore the agreement. The consequent lifting of sanctions will allow the Iranian government to access its vast hard currency holdings on international bank accounts and also reduce its budget deficit by increasing revenues from petroleum exports. However, the likelihood of this scenario is very low as long as the divide between the Islamic Republic and Western governments becomes deeper due to Iran’s brutal clampdown on domestic protests and its support for Russia in the Ukraine war.

Scenario 2: The rial will crash further and reach unimaginable devaluation.

In 2021, a task force in the country’s Budget and Planning Organization had produced a table projecting macroeconomic indicators until 2027 in two scenarios: a) Sanctions are lifted; and b) Sanctions remain in place. In the pessimistic scenario, the experts had predicted an exchange rate of 350,000 rials for early 2023 and 460,000 for early 2024. Some are arguing that those predictions are emerging and that the rial would be devalued further in the next few years. However, no economic development happens in a vacuum and there are components, such as the growing trade and economic cooperation between Iran and Russia, that could not be seen in the original projections. As such, a total collapse of the rial is unlikely, unless internal and external tensions escalate further.

Conclusion - Most Likely Scenario:

The most likely scenario is that the figure of 285,000 rials will become the lower exchange rate that the government offers to importers of goods and services. Exporters will push for a higher parity to remain competitive in export markets. Considering the fact that the country has experienced high inflation over the last few years, many businesses will lose their export markets at the current rate. The end result will be a new three-tiered regime that comprises the CBI rate for importers, a new rate for exporters, potentially hovering just below 400,000 rials and the free market parity at around 450,000 rials. Inflationary pressure will push all these rates up, but the CBI will try to maintain the lower rate, while it will reduce the list of goods that will be allocated the fixed parity. The main losers of the emerging system will be the Iranian society and business community who will endure the inflationary impact as well as the new platform for corruption that the differential between the various rates will result in.

Contributor Background:

Bijan Khajehpour is the managing partner at Eurasian Nexus Partners - eunepa.com - a Vienna-based international consulting firm. He also sits on the board of the Europe Middle East Research Group. He is considered an expert on geopolitics of energy and the Iranian economy and energy sector.

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