The Inevitable Rise of the Dollar in Iran's Currency Market

In recent days, with the advance of the US dollar in Tehran's currency market reaching the threshold of three thousand seven hundred tomans per unit, the heated debate about the exchange rate of Iran's national currency against the greenback has resumed. The questions raised in this old debate are often repetitive: What factors have fueled the rise in the dollar's price? How will the Central Bank respond to this event? Is this increase temporary or is it expected to continue? However, beyond these repetitive questions, a new question has been persistently heard in Tehran's currency market since the signing of the Joint Comprehensive Plan of Action (JCPOA) last July: How is it that after reaching a nuclear agreement between Iran and the P5+1 group, contrary to expectations, the price of currency in the country has not only not decreased but continues to rise? Temporary Factors In answering these questions, currency market analysts often point to a series of temporary factors: 1) Iran's national currency and its exchange rate against other currencies are closely linked to the country's foreign exchange revenues from oil. The sixty percent drop in oil prices over the past year and a half and the outlook for continued recession in the global oil market have severely reduced Iran's foreign exchange revenues. The price of the oil basket of OPEC member countries, which previously fluctuated around one hundred and ten dollars per barrel, has now fallen below forty dollars. Given this sixty percent drop (and the reduction of Iran's oil exports due to sanctions), the country's oil revenues, according to President Hassan Rouhani, have plummeted from one hundred and ten billion dollars in the year 1390 (2011-2012) to twenty-five billion dollars in the current solar year, and next year will not be in a better situation. How can a country whose most important source of foreign exchange revenue has dropped to about one-fifth in such a short time prevent the erosion of its national currency's value? 2) The second factor for the weakness of the rial, which stems from the first factor, is the very high budget deficit that Rouhani's government is facing this year. It is likely that in the first seven months of this year, about fifty percent of budget revenues have not been realized, and next year's budget, the draft of which is to be presented to Parliament in the coming days, will face the same problem. There is no doubt that the government will have to compensate for part of this deficit by increasing the exchange rate. 3) The permanent rise in the dollar's price internationally, especially the disruption of relations between the dollar and the euro in favor of the greenback, cannot fail to affect the dollar's price in Tehran's free currency market. It is highly likely that in the next two or three months, and perhaps sooner, the dollar and euro will equalize in the international currency market. In this case, how can this change not be reflected in Tehran's currency market? 4) Recently, the exchange rate of the dollar, also known as the official dollar, has risen above three thousand tomans. Currency market players have interpreted this increase as a sign of the government's willingness to raise the exchange rate in the free market. 5) Whispers of interest rate cuts over the past two or three months have encouraged some depositors to gradually exit the money market and turn to the currency market. This trend has naturally increased the demand for dollars and consequently its price. 6) The travel of many pilgrims during the Arbaeen and the last days of Safar has impacted the demand for currency and its price increase. 7) The severe recession in gold and the outlook for its continuation have led some players in the yellow metal market to try their luck in the currency market. This shift has also contributed to the rise in currency prices. The Most Important Factor in Currency Surge All these factors have undoubtedly influenced the rising movement of the dollar in Tehran's currency market. However, beyond these factors, some of which, especially oil prices and budget deficits, are of great importance, the main reason for the surge in exchange rates in Iran should not be forgotten: the high inflation rate in Iran. Over the past fifteen years, from 1380 to today, the average official inflation rate in Iran has been about seventeen percent, and if we were to consider the difference between this index and the inflation rates of the US and the eurozone and apply this difference to the exchange rate in Iran, the real price of each dollar in the country would likely fluctuate around 5500 tomans. In fact, if we consider the two countries, the most important factor influencing the exchange rates of their currencies against each other is the difference in their inflation rates. A country with a higher inflation rate will see its currency weaken against the second country. We reiterate that in the relationship between the currencies of two countries, the inflation rate is the main factor, but it is certainly not the only factor. Iran's current inflation rate, based on official statistics, fluctuates around 14 percent. While it is a cause for happiness that the country's inflation rate has decreased from about 40 percent to the current level over the past two years and a few months, this happiness will not last long when comparing Iran with the world. Of the 189 countries in the world that publish official inflation statistics, about half have inflation rates equal to or less than two percent. Among these, the inflation rate in twenty-three advanced economies is two-tenths of a percent. Iran, alongside Venezuela, Syria, Belarus, and a few other countries, is among the fourteen countries with double-digit inflation rates. Over the past fifteen years, from 1380 to today, the average official inflation rate in Iran has been about seventeen percent, and if we were to consider the difference between this index and the inflation rates of the US and the eurozone and apply this difference to the exchange rate in Iran, the real price of each dollar in the country would likely fluctuate around 5500 tomans. Surprisingly, the Islamic Republic of Iran's government has, as much as possible, refrained from a logical and gradual adjustment of the exchange rate based on the differences between inflation rates in Iran and advanced countries. The lever used to prevent this adjustment is oil dollars. In fact, over all these years, the Islamic Republic government - relying on oil exports, which has a very large portion of the country's foreign exchange resources - has artificially kept the exchange rate low by injecting oil dollars into the market. Of course, in some cases, due to various factors including the drop in oil prices or sanctions, the government's control has slipped away, and the currency spring, which had been artificially compressed, has been released, causing the dollar to surge. This event occurred in the years 1374, 1381, and 1391. By ignoring the difference in inflation rates between Iran and abroad and preventing a logical adjustment of the exchange rate, Iran's non-oil exports become expensive, and conversely, foreign goods are imported at a cheaper price. In fact, with a completely incorrect currency policy, Iran is one of the few countries in the world that punishes its non-oil exporters by artificially keeping the exchange rate low (as it does not allow the dollar price to rise in line with high inflation so that the competitiveness of exporters' goods is preserved) and, at the same time, subsidizes foreign goods (as these goods are imported at a lower price due to the high artificial exchange rate in Iran, ruining domestic producers). It is worth comparing Iran's currency policy with China's, which has created much more favorable conditions for seizing global markets by keeping the price of its national currency (the yuan) low. Eurozone member countries are also currently very happy that the value of the euro has fallen against the dollar, as they can export more goods to the US. Misconception In Iran, there is a misconception that a decrease in the dollar rate is beneficial for the country's economy. Of course, nothing is better than a country being able to strengthen its currency based on improved productivity, a strong production apparatus, controlled inflation, and robust foreign trade. But a severely ill economy, which according to one of Rouhani's ministers needs to declare a state of emergency, with double-digit inflation, a multitude of bankrupt businesses, and a budget facing astronomical deficits, how can it hope to strengthen its currency? The author of this note is confident that as long as the inflation rate in Iran does not decrease to the global average level, the increase in the dollar rate in Iran's currency market is inevitable. Of course, it is still possible that in the coming months, under pressure from populist tendencies, the Central Bank may be forced to continue to prevent the real adjustment of the exchange rate and even lower its price. It seems that currently, members of Rouhani's economic team have differing opinions on how to manage the exchange rate. Apparently, the Central Bank is willing to pave the way for a gradual increase in the exchange rate, while Ali Tayyebnia, the Minister of Economic Affairs and Finance, and Mohammad Baqer Nobakht, the head of the Management and Planning Organization, promise a decrease in the exchange rate. However, experience shows that it is possible to prevent the increase in the exchange rate for a relatively long time despite high inflation. But the currency spring will eventually be released, and this sudden increase in the exchange rate will create chaos. Is a logical and gradual increase in the exchange rate at a limited level better than the aftershock caused by its sudden rise? The best way to prevent the collapse of the national currency's value is to control inflation. In this case, the rial will not need a guardian and will be able to defend itself.