The devaluation of Iran’s currency has led to a number of conspiracy theories, one of which focuses on the premise that the government has intentionally devalued the rial in order to improve its own finances. The thesis argues that the government’s financial position has improved significantly as the main source of its revenues is in hard currency while its liabilities are mainly in rials. Nonetheless, the devaluation of the rial has had various negative impacts on the Iranian economy and the question is thus whether the government would actually benefit from an intentional devaluation.
The latest Central Bank of Iran (CBI) report on the government’s financial position covering the first four months in the current Iranian year (March 21-July 22) indicates that the government has been running a budget deficit. In fact, revenues from taxes and privatization stood at 421.1 trillion rials (roughly $10 billion), i.e., only 57% of the planned revenues in those categories. Some of the loss in revenue was compensated through the higher-than-expected proceeds from the petroleum sector that amounted to 420 trillion rials, i.e., 15% higher than budgeted. Nonetheless, the government was running an operational budget deficit of 312.5 trillion rials ($7.43 billion).
It is this type of budget deficit that has led to an increase in the government’s debts to the CBI — a phenomenon that contributes to the growth of money supply. In fact, as of June, the government owed 1,620 trillion rials ($38.5 billion) to the CBI. Add to this the figure of approximately 1,000 trillion rials ($23.8 billion) of debts to commercial banks and various subcontractors in the fields of power generation, road and rail construction, infrastructure, etc.
Key players in the Iranian economy were well-aware of the challenges facing the country. In fact, back in March, in a meeting between the representatives of the private sector and the government, the business community had stated its concern about three issues: the sustainability of the exchange rate, the state of the government’s debt to its subcontractors and the negative outlook for capital formation.
Now, the question is whether the rial collapsed because of the government’s unfavorable financial position or whether the administration allowed the rial to be devalued in order to improve its finances.
The fact is that the main problem facing the Iranian economy has been high money supply. From the current 16,000 trillion rials money supply, some 2,500 trillion rials is in printed notes and 13,000 trillion rials in deposit accounts. High interest rates have led to a growth of money supply that has put the national currency under pressure.
There is no doubt that the government and the CBI’s inability to contain the growth of money supply is partly related to structural deficiencies. At the same time, while a higher exchange rate could be a tempting tool to improve government finances and absorb a segment of the liquidity, it has a number of downsides in a country like Iran, especially the inflationary impact that in turn will lead to a growth in liquidity. In addition, acknowledging the negative impact of government debts to economic players, at the beginning of the current Iranian year — well before the emergence of the rial collapse — the vice president in charge of the Management and Planning Organization, Mohammad-Bagher Nobakht, stated that the government will settle these debts by March 2019.
Economists agree that shifting the financial flows away from the speculative markets and toward productive economic activity is an efficient approach to containing liquidity growth. However, one of the obstacles to a healthy development of the manufacturing and services sectors in Iran has been massive government debts. Hence, the one positive development in recent months has been the fact that in July, the government actually put in place a mechanism to settle all its debts to Iranian businesses. The government has devised tools such as issuance of rial-based government bonds as well as the exchange of debts versus receivables — a phenomenon that is prevalent among companies that both buy and sell commodities from and to the government, for instance power plants that receive their natural gas from the government and then sell their electricity to the state. A successful implementation of this decision could empower many of the subcontractors and private sector entities to resume their activities without the financial burden of outstanding government payments.
The question still remains whether the Rouhani administration created the recent exchange rate crisis, especially considering that the collapse of the rial coincided with the concerns about the impact of reimposed US secondary sanctions on Iran. The fact is that in most cases, the government is not allowed to sell its hard currency at the open market rate making it difficult to benefit directly from the high rate on the open market. Indeed, by law most of the government’s hard currency revenues are either used for basic imports at the much lower official rate or are injected into the National Development Fund. However, there are different schemes that allow the government to cash out some of its hard currency reserves at a higher rate. For instance, it can offer to settle some of its debts to Iranian banks and subcontractors in hard currency at a mutually agreeable rate. That rate will almost certainly be closer to the open market rate as opposed to the governmental one. This will capitalize the banks and empower subcontractors without boosting liquidity. Furthermore, at specific occasions, the government could extend special rates to various target groups.
There are also suggestions to barter the government’s debt to the banking sector against the debt of the banks to the CBI. This would mean that the government would convert a major segment of its debts to commercial banks into a debt to the CBI that can be settled through the sale of the government’s hard currency holdings within the CBI. The Central Bank can then use the excess holdings to inject hard currency into the currency market to manage the open market rate. Again, this move will help reduce the financial stress on Iranian banks and prepare them for needed banking reforms including potential mergers of banks without boosting money supply.
All in all, while it is not clear how much of the recent crisis was intended, it remains valid that the latest developments could function as a needed shock therapy to adjust a number of inherent problems in the Iranian economy. No doubt that in the short term there will be many losers, especially the Iranian society, but in the medium to long term, a positive impact could emerge, if the government uses this opportunity. In other words, the devaluation of the rial has the potential to help key Iranian economic players — including the government and the CBI — to gain a new and sustainable balance in their finances, while allowing Iranian businesses to plan their future activities in a more stable financial environment. No doubt that the existing and emerging US sanctions will have a disruptive impact, but the shock therapy may have been intended to make the economy more resilient to the external pressures that are on the horizon.
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