Sunday’s New York Times story that the US and Iran have agreed in principle to direct bilateral negotiations over Iran’s nuclear program provides opportunity for a more honest conversation on Iran than the presidential candidates have had so far. Well, at least this is my hope.

I know the NYT [...]]]> via Lobe Log

Sunday’s New York Times story that the US and Iran have agreed in principle to direct bilateral negotiations over Iran’s nuclear program provides opportunity for a more honest conversation on Iran than the presidential candidates have had so far. Well, at least this is my hope.

I know the NYT report has already been rejected by the US and Iran. But the rejections on both sides have a similar quality. Despite the Iranian refusal to meet with the US in the talks that began in Istanbul last April, neither has rejected the possibility of bilateral talks as an outgrowth of the P5+1 process. And both have said that talks within the P5+1 frame will begin in late November (time and place to be determined). In any case, the P5+1 frame has increasingly become a venue dominated by US demands.

But the value of the NYT revelation or leak is not in the reporting of an agreement on a potential meeting but in the impact it may have on the nature of the conversation about Iran’s nuclear program. The reality is that the presidential race has so far managed to avoid the real Iran question. Certainly there has been grandstanding and threats. There was the frenzy over the need to set red line or deadline for Iran which was thankfully calmed — at least temporarily — by Prime Minister’s Benjamin Netanyahu’s inane performance at the UN.

The campaign has also been full of sounds bites regarding the seeming contrast between “having Israel’s back” and “not allowing daylight between Israel and the United States”. But there has been no conversation regarding the rapidly approaching decision time regarding Iran. No conversation regarding whether the United States, after years of offering what it knew would be refused, is willing to offer something that Iran can accept.

Everyone knows what the elements of the offer are: limits on levels of enrichment combined with a more robust inspection regime in exchange for calibrated reduction of some of the sanctions. There are many details to be worked out in difficult negotiations, but these details cannot even begin to be addressed without public acceptance of some enrichment in Iran or the acknowledgment of Iran’s proverbial “inalienable right.”

Why do I say that there is a rapidly approaching decision time for which direction to go in? Well, sanctions have worked to create economic havoc in Iran. No doubt both President Mahmoud Ahmadinejad and Leader Ali Khamenei are primarily responsible for the deteriorating conditions. But their responsibility lies not in their incompetence in managing the economy per se but in their miscalculation. Khamenei, in particular, suspected negotiations would not go anywhere (at least, this is what he keeps saying) but he failed to prepare the country for his publicized “resistance economy.”

A resistance economy cannot be created overnight; certainly not when the economic helm of the country is in the combined hands of a populist president who underestimated the force of sanctions and a cantankerous Parliament caught between the demands of higher ups and pressures from lobbies and constituencies.

Not that Khamenei does not want a deal. He does and the encounters of the past four years have exhibited his openness to talks whenever there was hope in or detection of a degree of flexibility in the US position. But these encounters have also shown that he perceives himself as standing at the helm of a highly contentious political terrain that demands addressing certain bottom lines for Iran.

With the draconian economic measures imposed on Iran in the past year, the same political terrain makes quite impossible the acceptance of a deal that does not bring about some immediate, palpable, even if small, relaxation of the sanctions regime.

Some would say that this is precisely why this is no time for flexibility on the part of the United States. It will be throwing a lifeline to Khamenei and “them,” whoever they are. Now that sanctions are working, going for the throat is the right thing to do, they say. In response to this argument, which is also prevalent among some in the Iranian Diaspora who yell hard, accusing any country negotiating with Iran of being a traitor to the cause of the Iranian people, I would say that they are not adequately aware of the social and ideological forces than can be mobilized inside Iran to maintain a defiant, albeit limping, country.

Unless Khamenei and company are given a way out of the mess they have taken Iran into (with some help from the US and company), chances are that we are heading into a war in the same way we headed to war in Iraq. A recent Foreign Affairs article by Ralf Ekeus, the former executive chairman of the UN special Commission on Iraq, and Malfrid-Braut hegghammer, is a good primer on how this could happen.

The reality is that the current sanctions regime does not constitute a stable situation. First, the instability (and instability is different from regime change as we are sadly learning in Syria) it might beget is a constant force for policy re-evaluation on all sides (other members of the P5+1 included). Second, maintaining sanctions require vigilance while egging on the sanctioned regime to become more risk-taking in trying to get around them. This is a formula for war and it will happen if a real effort at compromise is not made. Inflexibility will beget inflexibility.

An additional benefit from directing the conversation away from whether to attack Iran and how to sanction it further is the positive impact on the nuclear debate inside Iran. There is no doubt in my mind that the conversation that has focused on attacking or sanctioning Iran until it kneels or submits has had the effect of making the hardliners defiantly louder and silencing those pushing for the resolution of the “Amrika issue.”

The loudness of the defiant folks rests on a simple argument again articulated last week in no uncertain terms by Khamenei himself: America’s problem with Iran is not the nuclear issue and talks for the US are not intended to resolve the nuclear standoff; they are a means to extract surrender from Iran.

If Khamenei is not correct, then a clearer public articulation of the extent of compromises the United States may be contemplating in order to resolve the nuclear standoff can encourage a conversation inside Iran as well. My bet is that it will also empower those pushing for Iran to show a bit more flexibility in its bottom line.

The escalating sanctions regime that has been imposed on Iran by the United States and European Union has placed all parties involved in a rather strange position. On the US side, the palpable glee over the dropping value of the Iranian currency and the success sanctions have had in causing misery [...]]]> via Lobe Log

The escalating sanctions regime that has been imposed on Iran by the United States and European Union has placed all parties involved in a rather strange position. On the US side, the palpable glee over the dropping value of the Iranian currency and the success sanctions have had in causing misery has been hard to hide. It is also politically astute for domestic electoral purposes to take credit for the success of sanctions. That is why State Department spokeswoman Victoria Nuland simply couldn’t resist giving quite a bit of credit to the sanctions regime in the immediate aftermath of the currency devaluation in Iran:

Our understanding is that the Iranian currency has dropped to a historic low today against the dollar in informal currency trading, this despite some frantic efforts by the Iranian government last week to try to prop it up, rearrange the way it dealt with these issues…..From our perspective, this speaks to the unrelenting and increasingly successful international pressure that we are all bringing to bear on the Iranian economy. It is under incredible strain. Iran is increasingly cut off from the global financial system.

Yet it is not particularly seemly or civilized to take too much credit for causing misery in front of a global audience. That’s why Obama Administration officials twist and turn to explain that while sanctions are the mark of the administration’s great success, it is the Iranian government that is responsible for the deteriorating state of Iran’s economy. In the words of White House spokesman Jay Carney:

Iran’s leaders have made conscious choices about how they manage their economy, how they prioritize their budget and how they respond to the concerns of their people.  The regime has chosen to spend money to pursue nuclear activities in violation of its international obligations, to support Bashar al-Assad’s brutal regime, to enable terrorist acts around the world, and to undertake destabilizing activities around the region.

The chosen examples of mismanagement is telling. Somehow we are expected to believe that the Iranian economy is in significantly worse shape than it was, let’s say, two years ago because of military and nuclear-related spending which I doubt constitutes even 1 percent of the country’s gross domestic product. (The latest figure that the Stockholm Institute for Peace Research has for Iran’s total military spending as a percentage of Gross National Product is 2 percent for 2008 while the CIA fact book puts the 2006 percentage at 2.5 percent. That’s a significantly lower percentage than neighboring countries like Turkey, Saudi Arabia and of course the United States, which, given its vast military presence in the region, is effectively Iran’s neighbor).

But US government officials are not the only ones caught in a delicate situation regarding the impact of sanctions, trying as they are to balance their jovial sense of success for the imposed policy of collective punishment and their avowed care for the “freedom loving people” of Iran. The EU foreign ministers’ statement on the latest sanctions slaps more broad punishment against the whole country while attempting to protect its writers from a guilty conscious. They want the world to remember that the innocuously worded “restrictive measures” are not aimed at the Iranian people but only “at affecting Iran’s nuclear program and revenues of the Iranian regime used to fund the program.”

The conversation regarding the impact of sanctions is as surreal and even more politicized inside Iran. President Mahmoud Ahmadinejad, after years of describing sanctions as worthless pieces of torn paper but also a source of native talents’ great advancement, has suddenly found vested interest in identifying sanctions as the source of all the country’s economic woes.

It is not his fault and if you don’t believe him he is now more than willing to hand in his resignation letter, he tells a somewhat stunned audience of Iranian politicos, in a press conference last week. Just like that, with a shrug and annoying smirk, presumably assured that none of his political opponents has the energy to get too riled up about the wreckage he has made of the Iranian political and economic landscape.

Still, his conservative opponents do try to score a point by arguing otherwise. Iran’s presidential election is coming up in June 2013 and no one can afford to be associated with the policies of the past few years. These conservative opponents do not deny the impact of sanctions but see the source of the problem in Ahmadinejad’s populist and expansionary economic policies in the face of a tightening sanctions regime that he refused to take seriously and is now unable to address adequately because of the incompetence of his economic team. Their own complicity in the creation of this wreckage is of course a topic to be ignored.

Standing on top of this cantankerous conversation is Leader Ali Khamenei whose attempt to walk a tightrope in a series of speeches to various audiences in the North Khorasan Province last week was truly a spectacle. On one hand, he has been careful not to blame the sanctions too much. He is, after all, Iran’s “decider” and the person in charge of the “general direction of the country.” All along his talking point has been that Iran’s defying stance against external bullying is actually good for the country’s blossoming talent. Iran’s “resistant economy” is his brainchild.

In North Khorasan, Khamenei again reiterated his view that the sanctions regime is not about Iran’s nuclear program and is about Iran giving in to the dictates of US hegemony. The US “does not want Iran to come back to the negotiating table; it wants Iran to surrender to Western bullying during negotiation,” he said. Rightly or wrongly, it is this rather dark view of US intentions that prevents Khamenei from blaming sanctions. Iran’s defiant posture relies on the denial of the severe impact of the sanctions regime.

But Khamenei cannot go too far in blaming government policies and general incompetence for Iran’s current economic woes either. His continued support for the Ahmadinejad government is the only thing left between the latter and a testy and worried conservative political class ready to impeach the president for incompetence along with, as I mentioned above, the hope of ridding itself of the charge of complicity in bringing about Iran’s current economic problems.

In the mind of the influential conservative MP, Ahmad Tavakoli, “Ahamdinejad’s period is over and the continuation of his presidency is not positive” but a “consensus” regarding this issue has not yet developed. When asked whether this is due to the fact that some people — read Khamenei –  would like to keep the country calm in the 9 months that are left in Ahmadinejad’s presidency, Tavakoli answers in the affirmative and emphatically rejects rumors that Khamenei’s circumspection is because “Ahmadinejad and his team has threatened the Leadership.” He says that it can be accepted that at this time “tranquility is a value and losing it is considered a loss of value but the conclusion will not always be this.” In fact, Tavakoli goes on to make clear that he disagrees with Khamenei’s decision to tolerate Ahmadinejad until the end of his term for the sake of political tranquility.

There are others who seem to agree. Last week, over 100 MPs once again signed on to a question from the president regarding the currency situation. If Khamenei doesn’t put a stop to this process – and he probably will – Ahmadinejad will be hauled to the Parliament for a second time this year. Given the rule changes put in place after his last showing, if the Parliament is not satisfied with his answer, a vote will have to be taken regarding whether to lodge a complaint against him in the Judiciary.

The likelihood of this happening is low but I guess it is important to note that even if the Iranian economy is imploding and on the verge of collapse as some western officials claim, the politics of bickering continues to rule supreme even in Iran and is bound to get worse with the nearing of the election season despite Khamanei’s repeated calls for calm and not treating competitors as enemies.

Virginia Tech economist Djavad Salehi-Isfahani’s recent explanation of the rial situation in Iran generated a lot of attention, and much in the way of non-expert criticism, likely because it sways considerably from the prevailing narrative on Iran’s economy: it’s about to collapse. But Salehi-Isfahani is sticking to his guns. [...]]]> via Lobe Log

Virginia Tech economist Djavad Salehi-Isfahani’s recent explanation of the rial situation in Iran generated a lot of attention, and much in the way of non-expert criticism, likely because it sways considerably from the prevailing narrative on Iran’s economy: it’s about to collapse. But Salehi-Isfahani is sticking to his guns. He elaborates on his reasoning and the effect of sanctions on his personal website:

Admittedly, the situation in Tehran is both confusing and shrouded in secrecy– for understandable reasons –and I do not claim to fully understand what is going on between oil exports, frozen and unfrozen Central Bank of Iran (CBI) accounts abroad, and rupees and yuans.  But some reporters I talked to in the last few days did not know that Iran had a multiple exchange rate system, or that currency crises in oil exporting countries are different from those in which private sector earns the bulk of the foreign exchange.  So, it seemed there was reason to say something.

With its diminished oil revenues the government can still shield large sections of the economy from the adverse impact of large devaluations in the the parallel market.  The import classification system put into place last December was precisely for that.  I do not know how much of the CBI forex goes to basic goods, how much to the Exchange Center, and how much, if any, to the parallel market.  My guess is that, for obvious reasons, this market is not near the top of the list CBI priorities for cash infusion.  I am not sure if any central bank faced with the same difficulties would use its foreign currency to calm a currency market gripped by fears stemming from tightening sanctions, even war.  Any politician who decides otherwise would have to answer to voters (or people in the streets) when the country runs out of foreign exchange for essential  imports.

In my view, given the sanctions and the emergency conditions that the country faces, the rise in the value of the rial in the parallel market is not at all surprising   It should be no more a source of shock or surprise to see high ticket prices outside sports or entertainment events, especially when the quality of the event is uncertain beforehand.  There are people who believe that scalpers should not be allowed to buy and sell concert tickets, and there are those who believe that such trades at the curb even at very high prices have their place.  I happen to belong to the latter group.  However, I fear that with the hoopla over the “rial’s collapse,” the government may run out of patience with the free market and send it underground.  That would be unfortunate.

Some readers of my Lobelog post thought that it painted an overly optimistic picture of the situation.  I had said that the currency crisis did not amount to economic collapse.  It is also true that, as a matter of habit, I did not discuss conspiracy theories (which I rarely believe), such as those that would blame the government for creating this mess on purpose in order to make more rials, or those that blame a few ringleaders for corrupting the system.  (But, as they say, just because you are paranoid it does not mean that they are not out to get you!)

Sanctions are not a game. They are designed to inflict pain on the people of the country they are imposed on, and as we have seen they are doing just that in Iran, and not all social strata feel the pain at the same rate.  Iran’s government is in a position to decide who gets hurt more and who get off with less pain.  For example, it has decided that keeping chicken production going is more important than paying the tuition of thousands of students abroad.  That is a choice that many would disagree with, but to say that it makes sense from the point of view of Iran’s government is not to minimize the gravity of the situation or the level of pain on those who lose more than others.  If the economy has not collapsed, economic growth has and with it the hopes of young people for finding a job and setting up new families.

The US and EU are touting Iran’s currency woes as proof that sanctions are working, though it’s not clear to what end. The Wall Street Journal reports that the Western powers “are working on new coordinated measures intended to accelerate the recent plunge of Iran’s currency and drain its foreign-exchange reserves”:

The first [...]]]> via Lobe Log

The US and EU are touting Iran’s currency woes as proof that sanctions are working, though it’s not clear to what end. The Wall Street Journal reports that the Western powers “are working on new coordinated measures intended to accelerate the recent plunge of Iran’s currency and drain its foreign-exchange reserves”:

The first salvos in this stepped-up sanctions campaign are expected at a meeting of EU foreign ministers on Oct. 15, including a ban on Iranian natural-gas exports and tighter restrictions on transactions with Tehran’s central bank, European officials said.

The U.S. and EU are also considering imposing a de facto trade embargo early next year by moving to block all export and import transactions through Iran’s banking system ….

To that end, U.S. lawmakers are drafting legislation that would require the White House to block all international dealings with Iran’s central bank, while also seeking to enforce a ban on all outside insuring of Iranian companies.

David Cohen, who coordinates the US’s Iran sanctions policy from within the Treasury, outlined the US’s stance in a speech before a British think tank. Reuters reports:

[David] Cohen, undersecretary for terrorism and financial intelligence, added in remarks on a visit to Britain’s Chatham House think-tank that Iran had the ability to “relieve the pressure its people are feeling” by resolving concerns over its nuclear work.

“What in particular has sparked the most recent precipitous decline in the rial, I’m not in a position to say on a granular basis,” he said, adding however that over the past year it had fallen substantially.

The Washington Post also reported that EU officials are “even more blunt” over the intentions behind the sanctions:

One senior European official said the goal of the tightened sanctions was to “bring the Iranian economy to its knees,” and to “make it in a way that really hurts the regime more than the population. That is very difficult.”

But US officials are also attempting to downplay the negative effects of the sanctions by blaming the regime. State Department spokeswoman Victoria Nuland said yesterday that “[t]he Iranian state has horribly mismanaged all aspects of their internal situation.” Cohen told the Chatham House audience that the unrest in Iran “is undoubtedly in significant part due to the Iranian government’s own mismanagement of its economy and it is in part due to the effect of sanctions. The Iranian leadership has within its capacity the ability to relieve the pressure its people are feeling.” Secretary of State Hillary Clinton offered the following qualifier:

“They have made their own government decisions– having nothing to do with the sanctions– that have had an impact on the economic conditions inside of the country,”" Mrs. Clinton said. “Of course, the sanctions have had an impact as well, but those could be remedied in short order if the Iranian government were willing to work with. . .the international community in a sincere manner.”

via the United States Institute of Peace

What are the primary reasons that the Iranian rial has lost half of its value against the U.S. dollar in just one year? Iran’s currency was valued at about 10,000 rials to the dollar in the summer of 2011. It plummeted to more than [...]]]> By Kevan Harris

via the United States Institute of Peace

What are the primary reasons that the Iranian rial has lost half of its value against the U.S. dollar in just one year? Iran’s currency was valued at about 10,000 rials to the dollar in the summer of 2011. It plummeted to more than 20,000 to the dollar in the summer of 2012.

Inflation in Iran’s economy has not been this bad since the end of the Iran-Iraq War or the economic crisis of the early 1990s, which also caused high inflation. The rial’s value began to slide rapidly at the beginning of 2012 after the United States announced new sanctions above and beyond the latest U.N. sanctions. The slide was due partly to the psychology of sanctions.

By Jahangir Amuzegar

*Dr. Amuzegar is a distinguished economist and former member of the IMF Executive Board.

During the last 12 months, and particularly since January 2012, the erratic and unhinged behavior of the Iranian currency, the rial, has been added to the Islamic Republic’s other thorny and protracted [...]]]> via Middle East Economic Survey

By Jahangir Amuzegar

*Dr. Amuzegar is a distinguished economist and former member of the IMF Executive Board.

During the last 12 months, and particularly since January 2012, the erratic and unhinged behavior of the Iranian currency, the rial, has been added to the Islamic Republic’s other thorny and protracted economic woes. After nearly a decade of relative stability in both the official and free market, the rial experienced a precipitous plunge in late December 2011, and subsequently lost nearly half of its value within a short time. With far-reaching effects not only on external trade, but also on domestic prices, interest rates, savings, investments and capital flows, the rial’s value has become the Mahmoud Ahmadinejad administration’s biggest daily economic headache.

While the explanations, reasons, and guesses so far offered for the upheaval have ranged from the probable (eg deteriorating business climate and political uncertainties) to the bizarre (eg sabotage by government “enemies”, manipulation by local currency dealers, and the administration’s own stratagem to make up for budget deficits), the real reasons are more numerous and far more complicated. This review attempts to seek the underlying causes of the recent events in a number of deeper-rooted and interrelated phenomena not so far sufficiently scrutinized.

The Unfolding Drama

The fall of the rial’s value has a long history. On the eve of the 1979 revolution, Iran’s domestic exchange rate for the US dollar was IR70.6. The revolution’s subsequent economic disasters – the bureaucracy’s massive upheaval, wholesale nationalization of banks, industries, and commercial enterprises, the exodus of nearly all experienced industrial managers, and massive capital flights exerted relentless daily pressure on the rial. The ruinous 1980-88 Iran/Iraq war and the drastic fall in Iran’s annual oil exports, accompanied by lower oil prices in the mid 1980s, imposed further heavy burdens on the Iranian currency. A series of misguided economic policies followed by Mir Hossein Mousavi’s left-center government during the 1980s, designed to control prices and wages, resulted in the rise of a multiple exchange rate system. So, by the end of the war, the Islamic Republic had 12 different official exchange rates for the US dollar. Subsequent attempts by the postwar government of President Hashemi Rafsanjani designed to cope with rent-seeking activities, spreading corruption, and economic injustices gradually reduced the exchange number to four. Under President Mohammad Khatami’s “reformist” government, the last four exchange rates were finally unified in 2002.

During 1978-2002 the rial lost its foreign exchange value steadily year after year. While the official dollar rate – announced by the Central Bank of Iran (CBI) under its so-called “managed float” system – started weakening from $1=IR70 in 1978 to $1=IR1,750 in 2001, the free market rate rose from $1=IR100 to $1=IR7,920 during the same 23 years. As the free market rate had reached $1=IR8,000 by 2002, the new unified rate was set at $1=IR7,950 and was periodically raised by small increments.

In the meantime, the free market rate’s difference with the official rate was virtually eliminated until September 2010 when a relatively modest difference of about IR1,300 began between the two rates, and repeated attempts to eliminate the daily difference were not successful. On 7 June 2011, the rial unexpectedly crashed on the open market and traded near $1=IR11,800. The CBI, moving to eliminate the difference and unify the two rates, raised the ongoing official rate from $1=IR10,590 to $1=IR11,740 – a 10.5% devaluation. In a matter of days, due to the CBI’s massive market interventions, a new stability was established. In order to minimize future rate differences, the CBI opened a “secondary” exchange window designed to deal with dollar demands for services (eg travel) at a third rate between official and free.

In early November 2011, while the foreign political climate became cloudier, the dollar rate in the secondary and free markets registered IR12,800, and IR13,300 respectively while the official dollar rate was fixed at IR10,850. By 30 November, while the official rate was $1=IR10,900 the free market rate climbed to $1=IR13,300. In the third week of December 2011, the free market rate climbed to $1=IR14,300 and by 30 December it reached $1=IR15,480. On 2 January the US currency sold at IR18,000 and climbed to $1=IR22,100 by 24 January. A series of panicked reactions by the CBI (eg frequently adjusting the official rate up and down) were of no avail, and market volatility intensified. Failing to calm the situation through monetary interventions and a sizeable injection of dollars in the market, the government resorted to a coercive policy. The Majlis passed legislation forbidding street venders (ie unlicensed money changers) from selling foreign currencies, ordering licensed dealers to sell dollars at no more than the specified rate, and blocking websites that reported hourly dollar prices. The Judiciary chief threatened execution of currency manipulators.

On 18 January 2012, failing to stop the currency’s continued decline, the central bank lowered the official rate by 8.5% to $1=IR12,260, and promised to offer unlimited dollars for current transactions. Then the Council on Money and Credit on 25 January 2012 changed its long-held policy of fixing deposit interest rates, allowing both government and private banks to set their own competitive rates. While the official rate was kept unchanged, the rial continued to slip and slide in the free market as the CBI was not prepared to meet all daily dollar demands. Powerless to maintain parity between official and free market rates, the CBI finally sanctified the coexistence of the “dual markets” on 14 March 2012, and let private money changers handle dollar demands for “non-essential” imports. The free market rate in late March 2012 fell to $1=IR19,000, or about 55% of its 2002-11 value. Five months after the previous high in January, the dollar rate was ranging between IR17,000 and IR19,000, surpassing $1=IR20,000 for a brief period. It has hovered around $1=IR19,000 since, with no particular direction and responsive mainly to current political events.

Leading Causes

The official explanations of the rial’s turbulence are few, far between and occasionally even bizarre. Despite reams of theoretical proofs, and decades of practical evidence to the contrary, President Ahmadinejad has linked the currency upheaval to a conspiracy between private exchange dealers, opposition politicians and the hostile press. The Central Bank governor has called it the reflection of a mob mentality, and the product of a “defective exchange market” where “hoarders, smugglers and soulless speculators” are trying to create “a false demand” for dollars as a “venue for investment”.

An objective and realistic look at the recent events, however, seems to show that the real factors behind the precipitous fall in the rial’s exchange value should be traced to: (1) a mistaken belief in the high value of the national currency as an economic desideratum; (2) a series of wrongheaded economic policies pursued by the Ahmadinejad administration to deal with both inflation and unemployment; (3) the perseverant pursuit of a national nuclear power policy, inviting the West’s wrath and resulting in a series of hardening economic sanctions; and (4) significant loss of  public confidence in the government’s ability to support the official exchange rate in the face of external pressures.

The ‘Strong Currency’ Myth

The strength of the national currency and the high exchange value of the rial has always been more of a political, rather than a monetary or market phenomenon, in Iran. A strong rial, in the eyes of both the man in the street and the seasoned politicians, has always been a clear sign of economic vigor, and a symbol of political power and prestige. The intensity of faith in this myth has also been related to the believers’ economic literacy. Keeping the dollar/rial rate deliberately (and artificially) low, while one of the clearest economic policy mistakes of the past decade, is still widely demanded and revered. A current Persian website – Asr-e Iran – nostalgically laments that while the Iranian national currency unit – the Shahi – was equal to one shilling or one-twentieth of the English pound in the 16^th century, the value of today’s rial is officially equal to 1/19,500 of the British currency and its free market rate as little as1/30,000.

Due to the pervasive influence of this myth, there were neither any effective business demands, nor any urgent political will, to adjust the exchange rate to its proper level after the 2002 rate unification – although all leading economic indicators warranted such realignment. There were faint voices of advice by private economists, and desperate pleas by disadvantaged exporters for the rate adjustment. The first group was contemptuously ignored by the authorities, and the second was partly silenced through the so-called “export prizes” and subsidies.

Neglecting Realities

Handicapped by the nostalgic feeling about the high national currency value, and obsessed by certain “out-of-the-box” economic convictions, President Ahmadinejad began his tenure in 2005 by following a populist and welfare-oriented economic policy, promising to “put the oil money on everyone’s table.” His economic agenda included: (a) an expansionist fiscal policy aimed at “eradicating poverty;” (b) a distinctly overvalued rial to reduce imports’ cost; (c) a mandatory low interest rates policy to minimize capital costs of business; and (d) the use of bank loans, bond issues, and sale of state enterprise to finance budget deficits – instead of tax hikes or more efficient tax collection.

The expansionist binge began with: (i) extensive and poorly supervised loans to the so-called “quick-return projects” in order to increase employment; (ii) an immense nationwide housing project (Maskan-e-Mehr) to increase home ownership; (iii) hundreds of half-baked local development projects to satisfy the crowds who greeted the president in his countrywide tours; and (iv) a “subsidies reform program” involving monthly cash payments to nearly the entire population to make up for higher energy and bread prices. As a result, the national budget rose from IR1,590 trillion in 2005 to IR5,100 trillion in 2011 – or more than three times in seven years. With annual budget deficits running at more than 4% of GDP each year, total liquidity rose from IR921 trillion in 2005 to IR3,720 trillion in 2011, or nearly fourfold.

Protracted budget deficits and liquidity expansion during 2005-11 caused the average officialcost of living index to rise by nearly 17% a year – with the most conservative privateestimate showing 22%. During the same period, Iran’s main trading partners had price increases of 2-4% a year. By a simple calculation, the difference between Iran’s cumulated inflation during the seven-year period compared with those of its trade partners would have warranted some 90% devaluation of the Iranian rial. In actuality, the exchange rate only rose from $1=IR9,025 in 2005 to $1=IR10,445 before the December crash, or a total correction of less than 16%. Thus, the government not only ignored the facts; it also violated the clear mandates of both the Fourth and Fifth Economic Development Plans, requiring annual adjustments of the rial’s exchange rate in line with the differences between domestic and foreign inflation rates. Curiously enough, in December 2010, while announcing his subsidies reform program, President Ahmadinejad asked the head of the CBI to come up with a new and “realistic” exchange rate in view of Iran’s “ample foreign exchange reserves” – an order which  some of his aides at the time interpreted to mean revaluing the rial towards $1=IR5,000!

The same incongruous treatment greeted the government’s regulations of bank interest rates. During the first six years of the Ahmadinejad administration, the authorized interest rate on short term savings deposits frequently trailed the annual inflation rate, eroding the net value of the depositors’ wealth. The maximum interest rate (called “profit share” to comply with Islamic principles) payable by commercial banks on short term (less than five years) deposits during 2005-10 averaged 13% per annum, while the corresponding inflation rate registered 17-22%. In the highly inflationary year 2008, the negative spread reached 10%. As a result, there was a steady decline in the growth of savings deposits during the entire period. Despite these warning signs, however, and even ignoring the mandates of the Fifth Economic Development Plan (2010-15), requiring periodic adjustments of the deposit rates in line with the inflation rate, the Council on Money and Credit, chaired by the president, refused to budge. Even when faced with continued turmoil in the exchange market in early January 2012, the Council (in the absence of the president) allowed interest rates paid on savings deposits to be left at the individual bank’s discretion (in order to divert liquidity from gold and dollars markets). The decision was vetoed once the president returned from a foreign trip. It was only after strong public pressures that on 25 January 2012 the president finally approved the rate adjustments.

President Ahmadinejad’s third gamble with the teetering economy was to fight a virulent and cumulative inflation with the wrong weapon. Instead of controlling consumer prices through conventional means, eg balancing the budget, raising interest rates, reducing bank borrowings, controlling liquidity, or raising factor efficiency, he chose the easy way. Blessed by the best six years of oil export receipts from Iran’s 106-year-old oil industry, he opened the imports’ floodgate. Iran’s revenues during the first six years of the Ahmadinejad administration reached $560bn, compared to only $433bn by all the eight previous governments since the 1979 revolution. In the same six years, imports amounted to $330bn – three times those of the Khatami and Rafsanjani administrations. Yet, during the same six-year period, the government debt to the banking system rose from IR113 trillion to IR403 trillion – or four times. The pernicious policy of trying to fight domestic inflation through cheap imports required the rial to be kept highly overvalued.

Sanctions As Catalyst

The Islamic Republic’s nuclear development program has been the third factor in the exchange rate drama. Widespread suspicion in the West regarding the ultimate objective of Iran’s uranium enrichment activities initially led the United Nations Security Council to issue four consecutive sanctions resolutions. And the move was subsequently followed by the US, the European Union and others. Thus, the original “targeted” and “smart” penalties gradually morphed into the current “crippling” restrictions. They currently consist of stiff and extensive restrictions on travel, trade, banking, finance, shipping, insurance, investment, and transfers of nuclear technology involving hundreds of individuals, businesses, and agencies associated with the Tehran government. Their sole objective has been to dissuade Iran from pursuing its nuclear program – a program which Tehran claims to be for purely civilian energy research and production, but the “sanctioneers” suspect it to involve certain military objectives and possibly even nuclear weapons ambitions.

Although the current sanctions have not targeted the exchange rate in any direct way, their indirect impact on the rate’s movement has been notable. While the rial’s equilibrium exchange rate was due for a substantial correction and for a long time, the plunge would not have occurred without a catalyst. The currency could still have remained out of equilibrium for a while thanks to rising oil export earnings. The trigger for the precipitous plunge was supplied by the news of forthcoming new crippling American and European sanctions in early December 2011 – particularly the oil embargo. The exchange market was visibly rattled. And, on 31 December, when US President Barack Obama signed into law the new (and unprecedented) sanctions involving Iran’s central bank, the exchange dam burst, and the downward movement began.

In the same vein, while negative interest rates on bank deposits were not unique to the Ahmadinejad administration, and never a lever for a game change, two specific factors related to sanctions heralded a dynamic change. The first was a shift in the investment climate, shaken by the threatening sanctions. Prior to 2010, when there was relative political calm, the real estate market was flourishing, and rising liquidity would flow into land, apartment building, and the Tehran Stock Exchange. With the news of ominous times ahead, the funds started to invade the gold and foreign exchange markets as far safer and better havens. The second factor was a bewildering and untimely decision by the Council on Money and Credit, aimed at compensating the effects of sanctions, to lower short term interest rates from 16% in 2008 and 13% in 2009, down to11% in 2010 and 10% in 2011, at the very time that consumer prices had begun to rise from 12% towards 22%!

Loss Of Market Confidence

The fourth factor in the rial’s declining value has been the loss of people’s confidence in the CBI’s ability to cope with the crisis. The bank officials’ frequent empty promises, inadequate determination to follow declared policies, insufficient action to deal with the crisis, and inadequate supply of dollars to stem the growing speculative demand have all been major sources of popular disappointment. To wit, when the free market rate for the dollar dropped by more than 10% in less of a day in late December 2011, the CBI governor responded with a firm promise to bring it back even below the official rate. Yet nothing happened. On 5 January 2011, the bank ordered private exchange dealers to charge no more than IR14,000 for the dollar. The order was totally ignored. And the rate by the street vendors jumped to $1=IR16,250. The governor said he had firm plans to stabilize the market, but it was not in the public interest to reveal them. On 25 January 2012, the governor said the four demerged exchange rates (reference, official free, travelers, and open market) would be unified in 48 hours, and there would be no limitation in the dollar supply for various current transactions. It proved to be an empty gesture. And there was mistake after mistake. For example, one of the reasons for the people’s rush to buy dollars in the first days of the new year was their lack of confidence in the CBI’s claim of ample gold and dollar reserves. Yet, instead of reducing this skepticism by showing resolve to meet all dollar demands, the central bank on 6 January 2012 cut the travelers’ ongoing $2,000 allowance down to $1,000 – thus reinforcing the people’s conviction that the bank was running out of dollars. As a result, the public was convinced that due to hardening sanctions, Iran’s oil exports would be drastically reduced, and higher oil prices caused by global tensions would not be enough to compensate for total receipts, thus, sooner or later, forcing the CBI to ration foreign exchange sale.

The Ideal Exchange Rate

The hottest current economic issue in Iran is the proper exchange value of the rial in terms of the US dollar. In the absence of an objective determinant of the equilibrium exchange rate, suggestions about the right number abound. Private analysts, on the basis of rapid inflation and sluggish exchange rate adjustments in the last few years, argue for a rial devaluation towards the current free market rate of about $1=IR19,000. Government officials, aware of the devaluation’s effect on import costs and further domestic inflation, favor the opposite course and hope to bring the free market rate down towards the official rate. Traders are also divided on the basis of strict self-interests. Exporters and domestic producers of tradable goods are demanding a lower rial rate in order to become more competitive abroad. Importers, on the other hand, argue that since the bulk of Iran’s imports consist of raw materials and semi processed goods, a strong rial is in the national interest as it keeps down producers’ costs. Anti-devaluation groups also argue that since Iran is dependent on imports for 30% of its food consumption, any upward adjustment of the exchange rate would add to the already high domestic consumer living costs. They similarly allude to the low price elasticity of both Iran’s exports and imports as a significant disincentive for devaluation.

Private market analysts also argue for substantial devaluation, pointing to the fact that due to cheap dollars, Iran’s imports have increased from $18bn in 2001 to more than $64bn in 2010 (not including payments of $19bn for services, and an estimated $20bn in smuggling). The latest imports roster, mostly from China, comprises items that have never been on Iran’s import list. As a result, not only have traditional exporters been unable to compete in foreign markets due to the overvalued national currency, domestic producers have also lost their competitive power, gone bankrupt, or become packagers and handlers of foreign articles. Domestic industry has become increasingly hallowed.

Determining the right rate of exchange for the Iranian currency, however, is difficult due to the country’s heavily oil-based economy, and the unpredictable effects of sanctions. Iran’s oil industry – responsible for more than 85% of the country’s annual foreign exchange earnings – is state-owned. The government is the sole arbiter of daily oil extraction, and the sole dispenser of oil export receipts (ie injection into the economy). The government’s decision to sell more or less oil thus influences the exchange rate automatically. The small “free market” plays only a marginal role. In such a case, where the main provider of the foreign exchange is the treasury, and the major users of the foreign money are state enterprises, whatever rate the central bank might set would be arbitrary and not necessarily the “equilibrium” rate. The rate that is determined in the “free market” by private importers, travelers, students, smugglers, and capital movers is marginal. The free market’s difference with the official rate at any given time is only indicative of the fact that the official rate is “out of range” and that the government is not willing (or able) to meet the entire “discretionary” demand.

Searching For The Right Exchange Number

Already five months into the Persian New Year, there is still no clearly declared exchange rate policy by the CBI, and the dollar rate is drifting up and down with no clear direction. On 27 July 2012 the deputy director of Iran’s Export Promotion Organization announced a “consensus agreement” among the CBI and other government agencies to divide the entire imports list into 10 main categories, with the first five (comprising a list of specific consumer staples and industrial necessities) eligible to receive dollars at the official rate, and the other five (discretionary and luxury items) supplied with the dollars earned from non-oil exports and other free market sources. The secondary market is closed, and foreign exchange at the official rate will now be sold only for travel to religious destinations.

A successful and orderly administration of such a complex exchange regime is highly difficult in normal times. It would be extremely complicated and hazardous in the present domestic economic conditions. Under the strain of biting sanctions, Iran’s economy is experiencing an unprecedented anemic economic growth, disturbing double-digit inflation, worsening youth unemployment, falling oil output, reduced oil exports, and lower oil prices. GDP growth this year is estimated to be no more than 1%. Unemployment among 18-25 year-olds is officially 29.1%, with many analysts estimating much higher rates. Press reports point to a large portion of the production sector operating at half-capacity, with a wave of bankruptcies and business closures. The latest CBI data show wholesale prices up by 33.4% and the consumer price index by 22.4%, with certain food items (eg chicken, red meat, and milk) up by a staggering 30-80%. OPEC and other sources report Iran’s daily oil production (the economy’s life blood) at 2.9mn b/d, down from 3.9mn b/d last year. Oil exports (the country’s main foreign exchange source) are reportedly at 1.2mn b/d, compared to 2.3mn b/d prior to the oil embargo. Oil export earnings (the annual budget’s major source of income) are reduced considerably due largely to the European oil embargo, and partly to lower oil prices (from the record $126/B in March to $96/B in June). According to reliable estimates, the Islamic Republic needs a $117/B price to finance its current fiscal budget, while market prices have lately been running at $105-111/B.

The sanctions’ role in these setbacks is coming to light as days go by. After years of defiantly denying the stiffening results of universal restriction, and in fact welcoming them as a spur to national self-sufficiency, a chorus of influential voices is now openly showing concern. Supreme Leader Ali Khamenei himself still remains defiant, and claims that Iran is currently “100 times stronger” than before, and that “Westerners” themselves have “vaccinated” the country against sanctions through their 30 years of censure – arguing that an oil-less, and knowledge-based economy could well resist any sanctions. But a growing group of top civilian and military leaders, Majlis lawmakers, and even high-ranking clergy show clear signs of unease and openly bemoan current economic hardships.  President Ahmadinejad has recently acknowledged serious financial impact of what he called the “toughest” measures ever imposed on the Iranian economy. The Minister of Industry and Trade has called them “devastating.” The Majlis speaker has acknowledged the sanctions’ share in the current plight.

The Insoluble Dilemma

The central bank’s latest de facto acceptance of a multi-tiered official exchange regime has now reopened the old Pandora’s Box of economic rents, appropriation of cheaper dollars to insiders, and widespread corruption – reminiscent of the 1980s as a major source of ill-gotten wealth for the Islamic Republic’s current financial moguls. There are already press reports regarding industrial producers complaining about lack of access to the official rate, the necessity of bribing bank officials to receive cheaper dollars, and the growth of under-the-table deals. The current IR7,000 difference between official and free market rates, if continued, would promise to generate billions of new “rent” to materialize in the next few months to be grabbed by insiders.

However, despite strong verbal objections to the current multiple exchange system by certain influential groups in and out of the government, and strong popular demands for the return to currency unification, the dilemma continues insoluble. An early return by the CBI to a single rate around the current official rate would seem out of the question without prior easing of the crushing sanctions, eg the oil embargo and central bank operations. On the other hand, a more logical realignment towards the free market rate would also be nearly impossible at this juncture without first taming the intolerable high domestic inflation.

What seems certain is that in the next few months and beyond, the Islamic Republic is going to face its toughest and most troublesome economic challenge since the end of Iran/Iraq war, with unprecedented major headwinds. The fate of the rial also will, by more than any other factor, be directly tied to the course of Tehran’s relations with the 5+1 group, and the resolution of the nuclear issue.