Central Bank's Efforts to Overcome Currency Market Turmoil

To address the turmoil in Tehran's currency market, which pushed the price of the US dollar to nearly five thousand tomans, the Central Bank of the Islamic Republic unveiled a new policy on Wednesday, August 25, organized around three main pillars. The three pillars and one goal are summarized in the Central Bank's announcement as follows: 1) Issuance of rial deposit certificates: The banking network is allowed to issue rial deposit certificates starting from Saturday, February 28, for a duration of two weeks. The holder of this certificate will receive a twenty-year interest rate if they keep it for one year, and if they sell it before one year, their interest rate will drop to forty percent. 2) Issuance of currency-based rial deposit certificates: The banking network is allowed to issue currency-based rial deposit certificates with one-year (four percent interest rate) and two-year (four and a half percent interest rate) maturities. In other words, depositors can deposit an equivalent rial amount of a certain currency with the bank and, upon settlement at the end of the one or two-year period, in addition to receiving four or four and a half percent interest, they will receive the equivalent rial amount of that currency based on the current price (the average exchange rate of the desired currency in the week prior to the issuance of the certificate). In other words, depositors are assured that their deposits will be protected from currency fluctuations. 3) Pre-sale of Bahar Azadi gold coins: The Central Bank will initiate a six-month pre-sale of Bahar Azadi coins at a price of one million four hundred thousand tomans and a one-year pre-sale at a price of one million three hundred thousand tomans. Since the current price of the coin is around one million six hundred thousand tomans and will likely increase over the next year, the Central Bank hopes that some depositors will transfer part of their assets from the currency market to this commodity market in hopes of profiting from the pre-purchase of coins. In fact, all three pillars of the Central Bank's new policy pursue a common goal: to offer diverse options to depositors in order to withdraw liquidity from the currency market and quell its turmoil. To understand this common goal, we must go back a few months, when the government and the Central Bank, based on a wrong decision and despite warnings from many experts, caused a significant amount of liquidity to be withdrawn from banks and directed toward the currency market. This initiative is one of the reasons for the severe turmoil gripping this market. It is emphasized that this turmoil has other causes, which will be mentioned later. On the 31st of Mordad last year, the Central Bank issued a directive asking banks and credit institutions to reduce the ceiling for the interest rate on one-year bank deposits, which was previously around twenty percent, to a maximum of fifteen percent. The reasoning was that since inflation had decreased, the interest rate paid to depositors should also decrease. This reasoning seems apparently acceptable. A twenty percent interest rate pours windfall profits into the pockets of some privileged owners and prevents capital from moving toward production. Moreover, when banks pay twenty percent interest to depositors, they are forced to charge twenty-five to thirty percent interest from borrowers, and what activity can bear such a heavy cost and still be profitable? On the other hand, again based on the same reasoning, the government of Hassan Rouhani has reduced the inflation rate from around forty percent to ten percent, and there is no longer any reason for a twenty percent interest rate to be paid to depositors. However, such reasoning, contrary to its appearance, has multiple weaknesses. A high interest rate in Iran is a sign of economic illness and not a cause of it. In other words, to reduce the interest rate, the underlying factors must be addressed. Instead of creating a structural basis for a sustainable reduction in inflation and, consequently, a decrease in bank interest rates, the Central Bank resorts to directives and orders to solve the problem. The inflation rate in Iran has indeed decreased compared to four or five years ago, but inflation expectations remain high, at least because a large portion of depositors do not believe in the stability of the exchange rate and know that the spring will be released sooner or later, and inflation will rise alongside currency jumps. Given factors such as the risk of the national currency's collapse, the possibility of renewed inflationary tensions, and the unstable and unreliable banking system, depositors naturally demand a high 'price' for depositing their assets. Beyond the few thousand billion tomans depositors, there are millions of small depositors who bring their few tens of millions of tomans into the chaotic monetary market and are constantly anxious about losing them. In this situation, with the mandated reduction in bank interest rates, a significant portion of savings will exit the money market and flow into other markets, with currency being the most important among them in the current conditions of Iran. Concurrently with the Central Bank's directive to reduce bank interest rates, many expert circles in Tehran warned about the negative consequences of such an initiative. Central Bank officials did not heed these warnings and did not learn from the experiences of countries that found themselves in somewhat similar situations to Iran. For example, in late 2014, when the Russian ruble was under severe pressure due to falling oil prices and the pressures of foreign economic sanctions, the Central Bank of that country raised its base interest rate from six percent to seventeen percent to attract people's assets back to banks and prevent speculation in the currency market. This action worked, and the ruble strengthened. In contrast, the Central Bank of the Islamic Republic, relying solely on the reduction of inflation (the unsustainability of which is evident to everyone), reduced the interest rate, and this action, as mentioned, is one of the factors that has created the current situation in the currency market. Will the 'anti-turmoil' package reach its destination? To compensate for the error resulting from the directive of the 31st of Mordad last year, the Central Bank has presented an 'anti-turmoil' currency package aimed at reducing liquidity pressure on the currency market. A very important point in this package is the return to a twenty percent interest rate to bring depositors back to banks. The issuance of currency-based rial deposit certificates and the pre-sale of gold coins also offer new options to cash asset holders to dissuade them from moving toward the currency market. However, the Central Bank of the Islamic Republic, relying solely on the reduction of inflation (the unsustainability of which is evident to everyone), reduced the interest rate, and this action, as mentioned, is one of the factors that has created the current situation in the currency market. Can this three-pillar package reduce the turmoil in the currency market? The day after the announcement of the proposed pillars, the dollar rate in the Tehran free currency market decreased by about one hundred tomans, but it was not observed that the proposed package had a significant psychological impact. However, hasty conclusions should be avoided, and it is necessary to wait and see how market players and holders of both small and large liquidity will react. The reality is that the Central Bank's influence on the Iranian currency market is not very extensive. One of the methods of influence that this institution frequently uses is injecting 'intervention' currency into the market to prevent its surge by increasing supply. The use of this method naturally depends on the volume of the Central Bank's foreign assets and the outlook for assets that are expected to overflow into its treasury. In the current conditions, the Central Bank is naturally forced to tread carefully in using this method. Another method for the Central Bank to influence the currency market is the aforementioned three-pillar policy package. Meanwhile, several variables affecting the Iranian currency market are beyond the Central Bank's reach. Global oil market fluctuations naturally impact Iran's currency market, simply because oil dollars are the main source of the country's foreign receipts, and if the price of 'black gold' falls, Iran's national currency will also decline accordingly. Geopolitical variables also significantly impact Iran's currency market. Market players are watching the fate of the 'JCPOA' and will perceive the potential exit of the United States from this agreement as a warning sign for further destabilization of the rial. Regional tensions, including the risk of Iran becoming more deeply involved in Middle Eastern conflicts, also affect the country's currency market. It goes without saying that managing such variables is beyond the Central Bank's control.